Mercantile Bank Corp (MBWM) 2009 Q3 法說會逐字稿

Welcome to the Mercantile Bank Corporation's third-quarter earnings conference call. Today's call is being recorded. There will be a question-and-answer period at the end of the presentation. (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, 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 Company's business.

The Company's actual results could differ materially from any forward-looking statements made today 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 today, you can access it at the Company's website, www.mercbank.com.

On the conference today from Mercantile Bank Corp. we have Mike Price, Chairman, President, and Chief Executive Officer; and Chuck Christmas, Senior Vice President and Chief Financial Officer. We will begin the call with management's prepared remarks and then open up the call up to questions.

At this point I would like to turn the call over to Mr. Price.

Thank you, Dana. Good morning, everyone, and welcome. The third quarter again was dominated by the severe economic conditions that persist. Because of our conservative recognition of potential problem loans, we again felt it prudent to aggressively enhance our loan loss provision creating a net loss for the quarter.

The large loan loss provision was the dominant story. However, Mercantile made important progress in many areas during the quarter. Net interest margin grew again and continues to trend upward, the branch consolidation project completed during the second quarter has lower our monthly overhead cost, and significant reductions were again made to our level of commercial real estate loans and broker deposits.

Most importantly, during this very difficult economic crisis we have taken the necessary actions to strengthen our capital ratios. While these improvements were not robust enough to counteract the increased loan loss expense, they should help us continue to improve results in the upcoming quarter.

As we have greatly expanded the amount of data in our press release, our comments this morning will be briefer than normal leaving more time for Q&A at the end of the call. Our Chief Operating Officer Bob Kaminski, who normally participates in these calls, has the flu today so you have Chuck Christmas and I to ask the questions. And at this time we will turn it over to Chuck.

Thanks, Mike. Good morning, everybody. As I typically do, I would like to give an overview of our financial condition and operating results for the third quarter of this year as well as the first nine months of this year highlighting the major financial condition and performance balances and ratios.

As you saw in the release, we did record a net loss of $5.6 million during the third quarter of this year compared to net income of $1.1 million in the third quarter of 2008. And for the first nine months of this year we recorded a net loss of $16.5 million compared to a net loss of $5.3 million in the first nine months of 2008.

As Mike indicated, our earnings performance continues to reflect the negative impact from significant provisions to the loan loss reserve which primarily reflects the impact of state, local, and national economic struggles on the condition of our loan and lease portfolio. Although in 2009 we have recorded increases in net interest income and reductions in controllable overhead costs, the significant provision expense has resulted in a loss position.

Net interest income during the third quarter of 2009 totaled $13.6 million. That is an increase of $1.8 million over the level learned in the third quarter of 2008. And for the first nine months of 2009 our net interest income totals $37.8 million; that is an increase of $4.1 million over the level earned during the first nine months of 2008.

Our net interest margin during the third quarter of 2009 equaled 2.85%, up from the 2.50% margin during the second quarter of 2009 and the 2.28% margin during the first quarter of 2009. The net interest margin during the third quarter of 2008 was 2.30%.

Our yield on assets has remained virtually unchanged throughout 2009 as our strategic pricing initiatives within our commercial lending function have mitigated the negative impact of increased non-performing assets. Meanwhile, our cost of funds has declined by about 60 basis points as we have been able to replace higher-costing matured brokered CDs and FHLB advances at significantly lower rates. We do expect our cost of funds to continue to decline throughout the remainder of 2009 and into 2010 as well.

We have about $300 million of wholesale funds maturing during the fourth quarter at an average rate of 2.85% and an additional $175 million at an average rate of 2.75% coming due in the first quarter of next year and another $100 million maturing at an average rate of 2.40% in the second quarter. To put this into perspective, current rates generally range from 0.75% to 2.50% depending on product and term, and during the just completed third quarter the average rate on the new wholesale funds we obtained averaged 1.15%.

The improvement in our net interest margin has more than offset the negative impact to our net interest income resulting from a reduction in total loans and higher level of non-performing assets and an increase in short-term investments. The increase in short-term investments reflects our decision to increase on balance sheet liquidity in light of market conditions.

We believe that continued reduction of our cost of funds combined with the benefit of our strategic and pricing lending initiatives on our yield on assets should provide for further notable improvements in our net interest margin and net interest income during the next few quarters, despite the difficulty of predicting the impact of asset quality.

The provision expense during the third quarter of 2009 totaled $11.8 million while during the first nine months totaled $33.7 million, both significant increases from the levels of 2008. Our loan loss reserve totaled $33.4 million or 2.07% of total loans at the end of the third quarter compared to $27.1 million or 1.46% of loans at the beginning of the year.

Non-interest expense totaled $12.5 million during the third quarter of 2009, an increase of $2 million over the level expensed a year ago, and non-interest expense totaled $35.7 million during the first nine months of this year, an increase of $4 million over the level expensed during the same time period last year. Excluding the charges associated with our branch consolidation and the FDIC special assessment, primarily during the second quarter, non-interest expense was $1.8 million higher during the first nine months of 2009 when compared to the same time period last year.

Branch consolidation costs totaled $1.3 million during the first nine months of this year with all but $158,000 expensed during the second quarter. However, we are already starting to see the positive impact that decision and other related decisions have made. During the third quarter of 2009 salaries, benefits, occupancy, and furniture and equipment costs totaled $6.1 million, a decrease of $0.9 million from the amount expensed during the third quarter of last year.

We have also recorded a higher cost associated with the administration and resolution of problem assets, namely legal expenses, property tax payments, and write-downs on foreclosed properties, during this year than in comparison to last year. These costs totaled $2.9 million during the third quarter and $5.0 million during the first nine months of this year compared to $0.8 million and $2.3 million in the year-ago time periods.

Our funding strategy has not changed significantly as we continued to grow local deposits and bridge any funding gap with wholesale funds, namely brokered CDs and Federal Home Loan Bank advances. We have seen a significant decline during the first nine months of 2009 in wholesale funding, primarily reflecting an increase of $193 million in local deposits and sweep accounts, which along with a $243 million reduction in total loans and leases has allowed us to reduce wholesale funds by about $380 million during the first nine months of this year.

Our average wholesale funds to total funds are approximately 58% currently compared to 71% at the beginning of the year. We remain in a well-capitalized position per bank regulatory definitions with our bank's total risk-based capital ratio at the end of the third quarter of 11.7%. In dollar terms that is about $32 million above the 10.0% minimum well-capitalized threshold.

Our capital ratios currently exclude $10.2 million in deferred tax assets as well as $10.4 million of our loan-loss reserve per the regulatory capital calculation requirements, which equates to about 100 basis points off of our capital ratios.

That is my prepared remarks. Now I will turn it back over to Mike for his.

Thank you, Chuck. At this time we would like to answer any questions that you may have.

(Operator Instructions) Terry McEvoy, Oppenheimer.

Good morning. Local deposits, I am guessing most of your banks within Western Michigan have had strong retail deposit growth as have you guys. Do you feel like you are getting more than your peers in that market or is it simply everyone is benefiting from just the trends we are seeing on deposits?

Terry, this is Chuck. I certainly can't comment on what other banks are doing specifically, but I would agree with your overall generalization that the banking industry is seeing some increases in local deposits. We are doing a lot of different initiatives and different programs here. Primarily as a commercial bank historically we didn't do a lot of advertising, especially on the retail side.

But one of the things that we have done starting almost at the beginning of this year is we really stepped up the advertising, not only our products, but also just who Mercantile is and getting our name out there much more in the marketplace. Mercantile has always had relatively aggressive rates. We are never the top, but they have been relatively aggressive on the retail side especially. But now with the concerted effort to get our name out there, I think we are just getting more bang for our buck there.

But we are doing some things. We are making concerted efforts to get more of the deposits out of our commercial lending function, whether it be the business accounts themselves or the business owners and executives and other employees. In some cases we are requiring escrow deposits on commercial real estate loans.

We got some really exciting innovations in our deposits, especially with the consumer. With some of the advances in technology that we have introduced that has helped expand our local deposits as well. So we have kind of turned over every rock that we can and we have had great success in doing that.

And then you mentioned your workout strategy or workout plans in the press release and you talk about writing down loans to the market value for the collateral. Could you talk about what types of marks or write-downs you are taking on the kind of original appraised value and where you are writing that down to?

Yes, Terry. This is Mike; I will try to answer that. It varies. It's hard to generalize, but in general I can tell you that to the original appraisal we are seeing some of the real distressed situations be 60% of original appraisal write-downs. Some of them aren't that bad, but I would say at this point any time we are getting ORE or NPAs that appear we are seeing probably at least down 80% of original appraisal.

What we are seeing and what we did this last quarter is we are well off original appraisals. In other words, original appraisals now on most of these deals are three, four, five or even older as far as age goes, but we are constantly looking at the validations of our write-downs. In other words, we had a large one this quarter, for example, where we had a -- we are very comfortable with the values.

When we got this thing back, this particular project back, a year ago everything indicated that the values were ex and nothing had moved though in a while -- six, seven months up in this particular project. And another landowner in the project sold a couple of lots at auction and at a very significantly reduced price from what we have them at. At that point we feel that the only way to do it is to write it down to what they were sold at at auction.

So we are at sometimes second or third generation of write-downs, unfortunately. We are seeing fewer of those things, but they still pop up from time to time.

And then just one last question. You are, yes, above the regulatory minimum requirements for your capital levels, but one might say your capital cushion is maybe a little bit light where it should be given maybe the stress in your portfolio and some of the earnings losses that you have recorded.

How do you feel looking out over the next 12 months in terms of that capital cushion and do you have some specific strategies in place to potentially increase that cushion?

Terry, this is Chuck. I will attack that first.

One of the things you see, especially in the third quarter, although unfortunately we did have the net loss, you see our capital ratios actually went up which primarily reflects the reduction in the loan portfolio. I think notwithstanding the earnings performance as we go forward obviously, which is going to be driven by the provision expense, is that we do expect our loan portfolio to continue to reduce. Probably not at the pace that it has in the first nine months, but we do see some reduction.

The normal amortization of just the principal payments, monthly principal payments on term and real estate debt has probably an $8 million or $9 million per month reduction so we will see that. And there is always others that will be leaving the bank for one reason or another. So we don't want to put too many forward-looking comments out there, but the trend that you saw in the third quarter, just looking at that quarter alone, is a trend that we do expect can happen as we go forward.

As far as how much capital we are supposed to have, as far as we know the 10% is still the minimum. But like you, we do hear from other banks or of other banks out there that -- banks that are struggling with asset quality the regulators would expect a little bit higher than the 10%. But on an overall basis, we are accountable with where we are at and we like the direction that it's going and the direction we think it's going to go just kind of through normal operations.

I just can't reinforce that enough, Terry. I mean, we don't like the fact obviously that we took a $5 million loss for the quarter, but during the same quarter we employed enough strategies and did what we had to do to get that total risk-based capital ratio up 20% basis points. So I don't want to keep testing that theory, but we are going to do what we got to do to keep those capital ratios as strong as we possibly can.

Appreciate it. Thank you.

Jason Royer, Raymond James and Associates.

Good morning, everybody. Just have two quick questions. In your 10-Q for the second quarter you included some cautionary comments about your deferred tax asset. Could you just give us an idea of the size of the deferred tax asset at the end of the third quarter and perhaps another -- just give us an idea of any risk of impairment to or at least an update on the risk of impairment in the future?

Yes, as I mentioned in our capital ratios, the bank's deferred -- net deferred tax assets is about $10.2 million. It's a little bit higher on the consolidated side, but it's $10.2 million. I think it's $10.6 million on a consolidated basis.

And as you might imagine, a lot of banks are going through a lot of discussions, a lot of analytics not only internally, but what their auditors and their tax consultants that they employ them. Obviously we have gone through that at the end of the third quarter as we do at the end of each quarter.

At this point you are looking at our historical numbers as we are required to do, but also looking at some of the analytics, some of the forecasting as we go into the future periods. Currently we feel comfortable and our partners feel comfortable that at least at this point in time that a valuation allowance on our financial statements is not warranted.

But, again, as I did mention, because the FDIC has different rules in regards to the deferred tax asset, we are excluding 100% of that asset in our capital calculations. At June 30 I think we excluded about 90% of the balance, so we just went for the full 100% at this point in time.

Okay, sure. And as far as Congress extending the look back period, when is that expected to come through the pipeline or is there any specific --?

I am not going to put any projections on what Congress does, but there is a bill that is working its way through both the House and the Senate. Currently, we can look back two years and then we have to look forward. The bill that is going through there, the way I understand it, is that the look back period will go back five years.

Certainly, Mercantile, like most banks, if you go back five years versus two years, those three years is primarily net income which helps offset the losses over the last couple of years and certainly helps the analytics in determining whether or not you need a valuation allowance.

Okay, sure. And just one more quick one, revisiting broker deposits. Are there a specific level that you would like to reduce your broker deposits to? I know you have got a significant amount of wholesale funds coming due, but any specific target levels for broker deposits or is it just going to be on a kind of quarter-by-quarter basis evaluating that?

I think we don't have any specific long-term goals. We certainly have some internal targets that we would like to see. But I think as you look at the trends that really started throughout most of this year, and obviously we expect them to continue, is just continue to take a close look at the loan portfolio, determine what we want to keep, and what we would like to see go elsewhere. And, again, just see the normal amortization within the loan portfolio.

Certainly, making every stride to continue to increase our local deposit base. And so with that reduction in our assets, with that hopeful increase, continued increase in local deposits the net amount will be the reduction in the brokered CDs. So it's kind of -- I don't want to say it's a fudge number, but that is really what is going to drive that is the reduction in assets and hopefully some further increases in local deposits.

We are at 58% now. We expect the trend to continue to go down even further, but as I mentioned before we don't think the loan reduction in future periods will be as much as we go forward in future periods. So the 71% down to the 58% is a great number, but I wouldn't expect that number to replicate itself over the next nine months either. But we do expect that number to go down.

We have had -- this is Mike. Just amplifying that we have had $185 million increase in local deposits since the beginning of the year. Combined with the reduction in the loan portfolio that we have talked about has allowed us to drop $334 million in broker deposits off our balance sheet. For a $2 billion bank debt that is pretty significant; we are pretty happy with it.

But to answer probably your question the same way that Chuck did and that is we are constantly looking to get that number even lower. We will continue to come up with the initiatives that we need to come up with to get it done.

Okay, great. Thanks, guys.

(Operator Instructions) Eileen Rooney, KBW.

Most of my questions were already answered. I guess just in terms of the credit quality, I don't think it was in your press release, but I was just wondering what 30- to 89-day past dues look like?

Yes, 30- to 89-day past dues were about $8 million at the end of the quarter and that is about right what they were at the end of the second quarter.

Okay. And then I thought on your second-quarter conference call it sounded like you were a little bit more optimistic on the credit quality and then obviously non-performers kind of jumped up again this quarter. I was wondering, the credits that went bad this quarter were they things that were on the watchlist or maybe just a little bit more color on what happened in the third quarter?

Sure, glad to try to do it. If I sounded optimistic in the second quarter, darn it, I shouldn't have been. I think you did pick up the right tone. I mean, we felt pretty good about things in the second quarter. There weren't a lot of new things coming down the pipe and in fact most of the stuff in the third quarter that trended into NPAs was on the watchlist. We had very few migration from non-watchlisted to NPAs.

But we had one or two large ones that -- one especially which was a company that did some land development that we knew had been troubled for some time. But they had a related business that had been able to carry the day and provide plenty of cash flow over the last couple of years, and that related business took a much more drastic hit during the summer than they had projected or we had projected. So, again, we put it -- at the time we put it on non-accrual. It was current in its payments, but we felt that it belonged there.

I tell you it gets frustrating sometimes because we continue to be very aggressive and we go through spurts where we see some positive things out there. In fact, even this quarter we did see some sales of some ORE. We are seeing more activity on stuff that we own and more bids, and as we have gone into this fourth quarter here we have got some nice indications of some things that look like they are starting to move. But it is still very, very challenging out there no doubt about it.

Okay. What was the amount of OREO that you sold this quarter?

Let me find it here. Bob had a great list of notes here, if I could find it. It is -- well, we had $6.1 million in pay downs in all NPAs during the quarter, not just OREs, but we wrote down another $1.6 million in ORE in looking at values during the quarter. And then we had $11 million in charge-offs to the NPAs for the quarter.

Eileen, this is Chuck. I think I have got that information back in my office with my cash flow information. I didn't bring it with me this morning, so why don't you shoot me an e-mail and I can get that to you.

Okay, sounds good.

Stephen Geyen, Stifel Nicolaus.

Yes, most of my credit questions have been answered. Just a question on the loan portfolio, if you could provide the loan yield or what the change was quarter to quarter?

Stephen, as I mentioned, our asset yield was pretty much -- I look at it quarter to quarter, it's virtually unchanged. So the loan yield has been pretty consistent.

I don't have that right off the top of my head though, so shoot me an e-mail too and I can get that to you. But I know it has been extremely consistent quarter over quarter throughout 2009.

Okay, thank you.

It appears we have no further questions at this time.

Thank you very much for your interest in our company. Things do remain challenging out there, but as Chuck and I and the press release have hopefully conveyed to you there are a lot of positive things that are happening within our company. We look forward to talking again with you next quarter. That will end the call at this time.

Again, that does conclude today's presentation. We thank you for your participation.