Mercantile Bank Corp (MBWM) 2009 Q1 法說會逐字稿

Welcome to the Mercantile Bank Corporation first quarter earnings conference call. (Operator Instructions) Before we begin today's call, I would like to remind everyone that this call may involve certain forward-looking statements such as projections of revenue, earnings in and capital structure as well as statements on the plans and objectives of the Company or its management. Statements on economic performance and statements regarding the underlying assumptions of the business, due to important factors described in the Company's latest Securities and Exchange Commission filings. The Company assumes no obligation to update any forward-looking statements made during this call. If anyone does not already have a copy of the press release issued by Mercantile Bank today, you can access it at the Company's Web site, www.mercbank.com.

On the conference today from Mercantile Bank Corporation we have Mike Price, Chairman, President and Chief Executive Officer, Bob Kaminski, Executive Vice President and Chief Operating Officer, and Chuck Christmas, Senior Vice President and Chief Financial Officer. We will begin the call with the managements prepared statements and then open the call to the questions. At this point I would like to turn the call over to Mr. Price.

Thank you, and good morning, everyone. And thank you for your interest in our Company. The economic crisis in our country affected our customers greatly during the first quarter of 2009 and we are unable to continue our return to profitability we saw during the last two quarters of 2008. The sharp and dramatic retail in automotive and retail sales combined with deep pessimism for the future to create intense pressure on our customers who participate in those areas of the economy. While this was unlike the stress on our portfolio of the early portion of 2008 which was largely focused on residential real estate development, it was very similar as to its (inaudible) effect on the risk profile of our commercial real estate and automotive related loans.

The bank has implemented and will continue to develop strong initiatives to strengthen credit administration and margin and to control expenses. While these initiatives have been successful in many regards asset quality continues to be challenged by the environment and will continue to be a drag on earnings until the market stabilizes. To maintain our well capitalized status we have significantly reduced our loan portfolio and cut the dividend on the common shares yet again.

This morning Chuck Christmas will give an overview of the quarter followed by asset quality comments by Bob Kaminski. We will then have the Q&A session before wrapping up. At this time I would like to turn it over to Chuck thanks.

Thanks Mike and good morning everybody. What I would like to do is give you an overview of Mercantile's financial condition and operating results for the first quarter of 2009, highlighting major financial condition and performance balances and ratios.

We recorded a net loss of $4.5 million or $0.53 per share during the first quarter of 2009, compared to a net loss of $3.7 million or $0.44 per share during the first quarter of 2008. The net loss in both first quarters is primarily the result of the significant provision expense, which reflects the impact of state, regional and national economic struggles on some of our borrowers cash flows and reduction of underlying collateral values. A vast majority of the provision expense during the first quarter of 2009 was related to commercial real estate loans and C&I loans compared to a year ago when residential real estate development loans were a significant contributing factor.

Net interest income during the first quarter of 2009 totaled $11.8 million, an increase of $0.4 million over the $11.4 million recorded during the first quarter of 2008. Average earnings assets equaled $2.16 billion during the first quarter of 2009, an increase of $140 million from the level of average earning assets during the first quarter of 2008. While historically the growth in earning assets has been led by growth in total loans, in this case, a temporary increase in short term investments during the first quarter of 2009 is a primary contributor for the increase in average earning assets. While average loans were up about $27 million, average federal funding sold and CD investments were up a combined $82 million.

During the first quarter of this year and in particular the last half of the quarter we experienced a significant influx of cash resulting from a reduction in total loans, about $79 million, and a growth in local retail and municipal certificates of deposit about $130 million. While we immediately started to reduce the level of wholesale funds, the inflow of cash, far out paced the outflows from wholesale funding maturities. Currently we continue to utilize our short term investment position to fund wholesale funding maturities and expect our balance sheet to be closer to more normalized levels, within the next couple of weeks. As of last night, our short term investment balances were already down almost $50 million from the levels at quarter end.

The increased level of short term investments combined with an increased level of nonperforming assets had a negative impact on our asset yield was which only partially offset by a continuing decline in our cost of funds resulting in a 12 basis point reduction in our net interest margin in the first quarter compared to the fourth quarter of last year. Coincidentally, the impact of the larger short term investment position approximated the decline in our net interest margin or put another way, a normalized balance sheet during the first quarter would have provided for a relatively flat net interest margin as a reduction in our cost of funds was about equal to the decline in our yield on loans.

As I just mentioned, we are nearing a more normalized balance sheet position which will benefit our asset yield. In addition, we fully expect our cost of funds to continue to decline as higher rate wholesale funds are replaced with new funds at much lower rates, once we burn off the excess short-term investments. For the second quarter we have about $340 million in wholesale funds maturing, at an average rate of about 3.5%. For the last six months of 2009, we have about $475 million in the wholesale funds maturing at an average rate of about 3.6%. To put things into perspective, the current one-year brokered CD rate is about 1.25%.

While we see the benefit to our yield on loans from the strategic and pricing initiatives we started back in 2008, the increased level of nonperforming assets has been significant. While a continuation of these initiatives combined with the continued reduction in our cost of funds and the benefits from right sizing our balance sheet will have a positive impact on our net interest margin, the impact of asset quality on our net interest margin is difficult to predict.

The provision expense during the first quarter of 2009 totaled $10.4 million, compared to $9.1 million expensed during the first quarter of 2008. Our loan loss reserve totaled almost $32 million at March 31 or 1.79% of total loans. Our reserve equaled 1.46% of total loans at the end of 2008. I will have specific and more detail commentary on asset quality later during the conference call.

Noninterest income totaled $2 million during the first quarter of 2009 an increase of $140,000 or about 7% from the level earned during the first quarter of 2008. We recorded increases in most fee income categories led by $129,000 increases in mortgage banking activity fee income and rent payments on foreclosed properties. Noninterest expense totaled $10.8 million during the first quarter of 2009 an increase of $0.4 million or about 4% from the $10.3 million expensed during the first quarter of 2008. Salary and benefit costs declined by $220,000 primarily reflecting a reduction in FTE's from 317 a year ago to 298 currently.

Occupancy, furniture and equipment costs declined by $125,000 primarily reflecting an aggregate reduction in depreciation, repairs, maintenance and janitorial costs. Growth and other overhead costs totaled $790,000 reflecting an increase in costs associated with the administration and resolution of problem assets, about $500,000 and increased FDIC insurance premium assessments about $345,000. Funding strategy has not changed as we continue to grow local deposits and bridge the funding gap of wholesale funds namely brokered CDs and FHLB advances.

Although our reliance on wholesale funds increased during 2008, we saw a notable decline during the first quarter of 2009, reflecting a very successful retail CD campaign and increased municipal CD deposits. Our wholesale funds to total funds as of March 31st was 65%, a significant reduction from the 70% at the beginning of the quarter.

With regard to capital, we remain in a well capitalized position with our banks total risk based capital ratio of 10.6%, about $12 million above the minimum well capitalized threshold. That's my prepared remarks, be happy to answer questions later on. I'll now turn it over to Bob.

Thank you, Chuck and good morning. My comments this morning will focus on the banks asset quality, I will start with a review of the asset quality headlines from the past several quarters. In the first quarter of 2008, there was a continued deterioration of residential real estate plus we identified some deterioration in the commercial real estate and C&I portfolios. In the second quarter of 2008 there was continued deterioration of commercial real estate loans previously identified as distressed including significant charges taken for degradation of real estate property values. In the third quarter previously some identified impairable charges were charged off. Additionally the bank identified some loan upgrades and payoffs that helped offset the reduced influx of new problem loans. In the fourth quarter, we saw continued stresses on real estate values including commercial real estate.

In the first quarter of 2009, we saw further deterioration of some C&I credits and some commercial real estate credits. Real estate and equipment values of credits going into liquidation continue to be challenged. New nonperforming loans consisted of a mixture of previously classified watch credits as well as some credits that experienced the rapid deterioration due to the economic conditions. These rapidly deteriorating loans were credits dominated in terms of dollar value by the automotive industry related businesses. Previously classified watch credits migrating to nonperforming status were primarily commercial real estate in nature.

The residential real estate performance in the portfolio appeared to have stabilized. Lending personnel are spending countless hours within their lending groups to appropriately monitor all credit relationships. Commercial real estate borrowers are being tested by their lenders to identify any weak links in the performance of the their tenant bases. The lenders maintain continuous contact with C&I, auto related borrowers to gain the latest updates on production backlogs and payment information from their customers, to ultimately assess current and projected cash flow.

Regarding the loan portfolio as Chuck mentioned, we settled in at $1.778 billion for the period ended March 31st representing a $78 million, almost $79 million reduction in the portfolio. Regarding composition of the portfolio, let me go through and give you some of the various components by dollar amounts. Land development and vacant lots at the end of March was $130 million. One to four family construction, $41 million, commercial construction $81 million, one to four family rental was $139 million, multi-family was $50 million. Commercial real estate owner-occupied credits represent $366 million. Commercial real estate non-owner occupied represented about $500 million. Commercial industrial loans represented $457 million, and other loans to individuals represented $14 million. These numbers reveal that the largest reductions came from C&I related loans followed by commercial real estate.

Portfolio reduction from line pay downs totaled nearly $40 million. The loan loss reserve at the end of March was $31.833 million or 1.79% of the loan portfolio. Regarding nonperforming assets I am going to go through and give you the same stratification based on type of loan. Land development residential lots for nonperforming was $12.7 million at the end of the quarter represented a $1.6 million decline from December. Commercial land development was $2.4 million which is virtually unchanged from December. One to four family construction was $13.5 million, a $2.5 million increase. Commercial construction was zero. One to four family loans was $4.7 million, small increase. Commercial owner occupied nonperforming loans was $8.8 million that was a $2.3 million increase. Commercial nonowner occupied real estate was $28.4 million, that was $14.3 million of an increase. And finally, commercial industrial loans was $13.2 million at the end of the quarter that represented an $8.1 million increase, total nonperforming assets was $83.7 million or $26.3 million had dollars increase over the end of December.

Some further stratification of the nonperforming asset change from the fourth quarter to the first quarter is as follows. At December 31st, we had $57.4 million in nonperforming assets. We had newly identified MPAs in the quarter of $35.6 million. Pay downs on MPA's including new MPA's was $1.9 million. We had $1.6, almost $1.7 million that was removed from the list. And we had charge offs gross charge offs of $5.7 million, again for total nonperforming of $83.7 million. Net increase of $26.3 million. Past due loans over 30 but less than 90 days were $10.1 million at March 31st compared to $2.6 million at December 31st. A majority of the increase relates to commercial real estate credits.

Regarding charge offs, first quarter net chargeoffs totaled $5.6 million. Of that amount, $770,000 was impairments reserved at the end of the fourth quarter, $970,000 was newly identifiable losses on those previously impaired loans, $3.9 million was for losses on previously identified watch credits not classified as impaired at December 31st. Specific stratification of the chargeoffs is as follows. Land and development loans we had $624,000. One to four family construction, $86,000. One to four family including rental was $1.4 million. Commercial owner occupied $75,000. Commercial nonowner occupied $786,000. Commercial and industrial $2.4 million almost $2.5 million. And other loans was $136,000. Again for net charge offs of $5.6 million for the quarter.

Break down of the provision is as follows. The provision expense was $10.4 million allocated as $700,000 for land development and vacant lot loans, one to four family construction was $700,000. Commercial construction was $30,000. One to four family including rental $1.4 million. Commercial owner occupied $720,000. Commercial nonowner occupied $2.6 million. And commercial and industrial $4.2 million, rounding out to a provision for the quarter of $10.4 million. Those are my prepared remarks on the analysis of the portfolio. I will now turn it over the to Mike.

Thank you, Bob. Thank you, Chuck. At this time we would like to open it up for questions.

Thank you, Mr. Price. (Operator Instructions). We will take our first question from Jon Arfstrom RBC Capital Markets.

Thanks good morning guys. Chuck you talked-- a phrase you used in your prepared comments--right sizing the balance sheet. Can you maybe expand on that a little bit and give us an idea of where you expect the size of the balance sheet to go?

Yes Jon. What I meant by right sizing the balance sheet is we had a pretty significant level of federal funds sold as well as some CD investments we made at a correspondent bank with some of those funds that came in as a result of the reduction of our loan portfolio and also some of the local deposit growth that we had. Going forward, what we would expect is that fed funds sold, maybe some CD investments, will probably be in the range of $30 million to $35 million on an average basis which is obviously significantly lower than we were on average in the first quarter, but also at the end of the first quarter as you saw in the our financial statement. That's what I mean by right sizing the balance sheet is bleeding off quite a bit of that current short term investment by and using those funds to let some of the brokered CDs and possibly some federal (inaudible) advances go without replacing as they mature.

How is the market in terms of loan demand? I think Mike you talked a little bit last quarter about more rational lending occurring in the market. It sounds like things maybe changed pretty severely the last few months.

Yes I will try to answer that, Jon, and certainly Bob or Chuck can amplify at the appropriate time. Back to your original question, what is the loan demand out there. It is pretty, it is pretty soft right now as you might imagine. Chuck's comments highlighted the fact that we saw significant reduction in loan balances out there. Part of that was intentional where we are deliberately trying to move some commercial real estate out of the bank and we have been fairly successful in doing that. But another good size portion of the loan reduction came from less balance, line balance from our commercial C&I customers and that's a direct result of there's not a lot of economic activity or certainly at reduced level.

New loan requests are fairly scarce these days and what we do see are things that we deliberately do not want which is commercial real estate because our portfolio has already gotten enough of that in there. As far as the real good news is on what we do see out there is that rational lending has made a, a very welcome return back into the marketplace. Pricing has gone where it needs to be and should be and structure is definitely been to a point where we think it should be, and that is good to see, and hopefully we will continue to see that going forward.

Okay. That's helpful. And then, in terms of the nonperforming balances, what is your attitude toward potentially selling some of these loans versus hanging on to them, working them out, and just secondarily how is the health of that market in terms of the gap between what buyers are willing to pay between the loans you might have versus, where you--

Yes your second part of the question answers the first there, and that is right now, there's very, very little market out there for people private parties buying banks, distressed assets. The main reason for that is everybody is still waiting to see how the Government program is going to work. So, that may change relatively soon here when the Government program gets up and ramped up and we will be curious to see how that works.

Prior to this last let's say three or four months when the Government was rolling out its ideas for the plan, the market was, was very soft. And even if you had the intention of, gee, let's sell some of these assets, you were far better off trying to work them out. And even though there were in some situations very distressed asset realization values, the secondary market for these type of assets really got flooded as you might imagine and the prices offered for stressed bank debt went away down.

But you really don't have aversion to selling some of these?

No. I think in certain situations if the price was right and the situation was right with the customer and the situation, we don't have a stated aversion to it. We would never say we wouldn't do it. And we continue quite honestly to look into that. And we follow what is going on in current trends out there as well as we are very interested to see how the Government program works out. In theory, it looks great, but we will see what happens in practice.

Thank you.

You bet.

We will take our next question from Terry McEvoy, Oppenheimer.

Good morning.

Morning, Terry.

I was wondering your auto related portfolio and what percentage of those loans were nonperforming at the end of the first quarter?

I think we spent a lot of time analyzing the degree of the automotive component of our portfolio. That's a hard question to answer because there are some credits who have a very small percentage of their work that involves auto and there are some that are quite concentrated. It is something that has been on our radar screen for practically a year now as we saw the downturn in the automotive industry becoming very acute. And I think a lot of the increase that I mentioned in nonperforming loans over the last quarter was directly related to some of those distresses coming to a head on some of our credits.

That being said, there are parts of the portfolio that is commercial, industrial in nature that has some auto components that are doing quite well, but there are some and that was obvious in our numbers we showed and numbers I outlined for the nonperforming loans and the chargeoffs for the quarter. So again trying to give you numbers as far as the size of the auto portfolio is pretty difficult but it is one that we have got on our radar screen and continue to watch very closely for any companies that may have some involvement in aspect of that industry.

And a question related to the $21 million under the CPP. Your evaluating the decision whether to essentially to take that capital. Could you just go through your thought process, where you are right now and some of the key factors in deciding whether that is going to happen?

In general terms, we certainly as we always say on these conference calls, continually evaluate our capital structure and capital planning techniques. And the CPP program and its preliminary approval is just one of the tools to add to the tool box. Without going into a long dissertation about TARP as everyone on this call or listening to this call later has thoroughly vetted TARP in their mind but we can all say at least our management board feels there's many reasons to consider it. There are certainly reasons to take pause before deciding to participate in it. And we will thoroughly discuss each one of those in analyzing the decision whether or not to participant.

And just one last question, any coincidence at all in your real proactiveness in getting rid of some of those brokered CDs and what I would describe as maybe a late TARP approval, April 13th, or are those two events not connected at all?

Well, the reduction in brokered CDs is something we had been trying to do for a long time. It is something that before this economic crisis hit, we had worked our wholesale funding down to less than 60% of the balance sheet. We were pretty happy with that. Then the economic crisis happened. Some things changed in the marketplace and it pushed our wholesale funding up to a level that-- even though we have always used it we're very comfortable with the strategy-- we wanted to get it down. TARP applications, I don't know of anybody that can give me a rational answer as to, the whys or where nots as to, you know, when you get information back on approvals. I do know that the treasury from everything we were told was extremely backed up with applications and we have watched and you have probably seen the same thing they go in waves, and apparently they finally got to ours. But as far as we know there was no direct connection to that. But quite honestly, I think you'll talk to every bank CEO that applied under TARP it was a very hard process to understand because once the application left, we really didn't get a lot of information.

Thank you, Mike.

You bet.

We will go next to Eileen Rooney, KBW.

Good morning, guys. Actually all of my questions have been asked already.

Okay. Thank you.

We will go next to Steve Covington, Stieven Capital

Hey, guys it's actually Joe Stieven Thank you, Steven.

Hi Joe.

Good morning. Chuck and Mike, isn't this your annual time for your normal exam? I guess that's question number one and question number two. If it was is there anything to do or can you talk about that and did that have anything do with the uptick in the NPAs?

We annually get reviewed by our regulators, and we are not at liberty to discuss those results but I can tell you we are in very good standing with the regulators, and we don't, we have never had any problems with the regulators. What you see as far as on a quarter-to-quarter basis, I can tell you is all driven by our internal analysis of what needs to be done. So I don't know that I could say that for every bank but I can tell you that as far as our bank goes.

But Mike don't you guys typically have your exam right around year end though?

Well, I can tell you we really don't discuss about when we have exams publicly. And I will just reiterate, Joe what I just told you. I can tell you 100% confidently that what you see as far as what's on nonperforming and what we do as far as chargeoffs or downgrades or upgrades are 100% of the reaction of management. If you listen closely you will probably get the answer to your question.

Okay. Thank you, Mike.

You bet.

(Operator Instructions). We will go next to Stephen Geyen, Stifel Nicolaus.

Good morning. The deposits were up. I am just wondering, the rates on the CDs that you paid in market, were those significantly different than the brokered CDs-- Chuck, I think you gave the 1.25%?

Yes that 1.25%, let's put things a little bit into perspective.We started the-- our retail CD campaign I believe towards, I know we set the rate at the end of January, and ran that campaign throughout most of February, and into the first couple of weeks of March. At that time, the 1.25% I mentioned on brokered CDs was actually above 2%. The CD campaign, rate we had was above brokered markets but as we have always talked about in general, the rates offered in our markets for CD products are usually at or above brokered markets anyways. There was certainly a little bit of a premium in regards to our retail CD campaign and it brought in a significant amount of money. The other part of that increase in local deposits, a good chunk was municipal deposits and those rates were right at market.

Okay. And could you quantify what part of the increase in reserves was general reserve versus specific reserve?

Our reserve is calculated as it has been since we opened the bank based on a specific formula, that, that bases the calculation on the greater the loan as well as specific impairments identified in loans that have become stressed and based on placed on nonaccrual. So we don't allocate blocks of loans, blocks of dollars to the reserve just to boost the reserve at all. It is all based upon a calculation that drives it to loan grade. With that said, we've had some downgrades on credits, we've had increased impairments and that drove the increase in the overall reserve to the 179 that we saw at the end of the quarter.

Okay. And I just want to clarify, the FDIC assessment in first quarter, is that a good rate including the possibility of the one-time assessment in 3Q?

No, the one time assessment will be a second quarter event.

Okay. And so the initial, the assessment in first quarter excluding the third quarter or excuse me the second quarter additional assessment you are talking about, is that a good run rate for third and fourth quarter.

Yes.

Okay. Thank you.

(Operator Instructions). Mr. Price it appears we have no other questions at this time. I will turn the conference back to you for any additional or closing remarks.

Thank you very much and thank you all for your interest again and your questions. If you have any further follow up questions feel free to give us a call directly. At the point we will end the call. Thank you very much.

Again, ladies and gentlemen, that does conclude today's conference call. We do thank you for your participation. You may disconnect.