Mercantile Bank Corp (MBWM) 2010 Q1 法說會逐字稿

Welcome to the Mercantile Bank Corporation first-quarter earnings conference call. 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 filing. The Company assumes no obligation to update any forward-looking statements made during this call.

If anyone does not have -- or if anyone does not already have a copy of the press release issued by Mercantile today, you can access it at the Company's web site, www.mercbank.com.

On the conference today for 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 management's prepared remarks and then open the call up to questions.

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

Thank you, Karen, and good morning, everyone, and welcome. While we are beginning to see some positive signs in our marketplace, and especially within our other real estate-owned portfolio, the distressed economic conditions negatively impacted our quarterly loan loss provision and thus our overall results.

Bob Kaminski will detail the entire dynamics of our loan portfolio in the provision for loan losses during his comments.

While we suffered another loss quarter, the significant improvements in net interest margin in overhead that were initiated in 2008 and 2009 continue to help mitigate the effects of the elevated loan loss provision costs. We expect these improvements to continue and allow our bank to weather the storm. Chuck Christmas and Bob will detail these actions in their comments.

While our improvements were not robust enough to completely counteract the high loan loss expense, they are continually improving and allowing us to maintain our well-capitalized position.

At this time, I will turn it over to Chuck Christmas.

Thanks, Mike. Good morning, everybody. This morning we announced that we recorded a net loss of $3 million during the first quarter of 2010 compared to a net loss of $4.5 million during the first quarter of 2009. On a pretax basis, which we believe provides a more accurate comparison given the establishment of evaluation allowance in our deferred tax asset during the fourth quarter of 2009, and the issuance of preferred stock during the second quarter of 2009, our net loss during the first quarter of 2010 was $3.1 million compared to a net loss of $7.3 million during the first quarter of 2009.

While we are, of course, disappointed with the net loss, we are encouraged by the 58% improvement on a pretax basis as well as with the continued improvement in many key areas of our financial condition and performance.

Our financial performance during the first quarter of 2010, like that throughout 2009 and 2008, was impacted by significant provision expense as we needed to increase our loan loss reserve in light of the quality of our loan portfolio and to cover net loan losses. Unfortunately, continued state, regional, and national economic struggles have negatively impacted some of our borrowers' cash flows and underlying collateral values, leading to increased nonperforming assets, higher loan charge-offs and increased overall credit risk within our loan portfolio when compared to the historical norms.

From the time we sensed economic weakness over two years ago, we have been working with our borrowers to develop constructive dialogue, which has strengthened our relationships and enhanced our ability to resolve complex issues. With the environment for the banking industry likely to remain stressed until economic conditions improve, credit quality will continue to be our major concern. We will remain relentlessly vigilant in the identification and administration of problem assets.

Unfortunately, provision expense as well as nonperforming asset administration and resolution costs will likely remain higher than historical levels, dampening future earnings performance. But during the first quarter of 2010, we saw the continuation of very positive trends we reported throughout 2009 as well, and I would like to touch on some of them with you this morning.

Despite a reduction in our total earning assets, an improved net interest margin has provided for increased net interest income. Net interest income during the first quarter of 2010 was $2.5 million higher. That is an increase of 21% from the first quarter last year.

Our net interest margin during the first quarter of this year was 3.25% compared to 2.28% in the first quarter of 2009, an improvement of 97 basis points or over 42%. The improvement is primarily due to a significant decline in our cost of funds and we expect a continued reduction in our cost of funds during 2010, although at a slower pace than during the past several quarters.

During the remainder of 2010, we have about $430 million in wholesale funds maturing at an average rate of 1.80%. During the first quarter, our average rate on new wholesale funds was about 1.1%.

Also contributing to our improved net interest margin has been a very stable yield on assets. The loan pricing initiatives we have undertaken within the commercial loan function have almost completely mitigated the negative impact of the increase in nonaccrual loans.

Overhead cost reduction strategies are becoming realized. Excluding nonperforming asset administration resolution costs as well as FDIC insurance premiums, our overhead costs declined by about $1.2 million during the first quarter of 2010, compared to the first quarter last year. Nonperforming asset administration and resolution costs totaled about $2.5 million during the first quarter of this year, compared to $1 million last year. During the first quarter of this year, valuation write-downs on foreclosed properties and property tax payments both totaled about $0.8 million with legal expenses totaling $400,000.

We remain a well-capitalized banking organization and our regulatory ratios increased during the first quarter of this year, despite our net loss. At the end of the first quarter of 2010, our bank's total risk-based capital ratio was 11.2%, and in dollars, was over $20 million higher than the 10% minimum required to be categorized as well-capitalized. At year-end 2009, our bank's total risk-based capital ratio was 11.1% and the surplus was about $18.5 million.

Local deposits and [soup] accounts were up over $7 million during the first quarter of this year and up about $219 million since the beginning of 2009. Combined with the reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by about $475 million since the beginning of 2009. As a percent of total funds, wholesale funds have declined from 71% at the beginning of 2009, [to 155]% at the end of the first quarter of this year.

Our loan loss reserve totals $50.1 million. That is an increase of $2.2 million from the beginning of the year and an increase of $18.2 million from the end of the first quarter of 2009. As a percentage of total loans, the loan loss reserve was 3.35% at the end of the first quarter this year, compared to about 3.1% at the end of 2009 and about 1.8% at the end of the first quarter last year.

Although the increase was accomplished through a high provision expense, the higher loan loss reserve level provides additional cushion for potential loan losses.

Those are my prepared remarks. I will now turn it over to Bob.

Thank you, Chuck, and good morning. My comments today will discuss the asset quality performance during the first quarter. You'll find numerous tables containing all of the asset quality information in our press release, so I will focus this morning on some of the key points.

March 31, 2010 brought a $5.9 million increase -- net increase -- in nonperforming assets over December 31. That net number was the result of the addition of $23 million in new nonperformers and offset by principal pay downs of $4.2 million, sale proceeds on assets of $5.1 million, charge-offs and valuation write-downs of $7 million, and loans returning to performing status of $800,000. Also included in the nonperforming total was an increase of $3 million, attributable to loan restructurings where the bank is working with distressed borrowers to provide some relief with some loan modifications.

While commercial real estate administration and problem loan disposition continues to be quite challenging, as these numbers seem to indicate, we are starting to see increased increase and activity in the movement of some troubled commercial real estate. Net charge-offs during the quarter were $6.2 million compared to $10.9 million in the fourth quarter of 2009 and $5.6 million in the prior year quarter. Over half of the charge-offs in the first quarter or $3.7 million was attributable to commercial real estate and development, while another $1.5 million was for residential real estate and development. The remaining $1 million was attributable to commercial loans.

Provision expense for the quarter totaled $8.4 million. The major [collocations] of that provision among the various loan types show $3.7 million, covering land development and construction; $5 million allocated towards owner-occupied and non-owner-occupied commercial real estate; $700,000 covering commercial and industrial loans; and finally, a benefit of $1.2 million was derived from recoveries and portfolio shrinkage.

Loan delinquencies in the category of 30 to 89 days past due totaled $12.8 million from March 31. $12.1 million of the total is derived from two watch credits that are in various stages of workout negotiations. I will note that of that $12.1 million, $8.1 million is not contractually current as of April.

A key strategic initiative for Mercantile has been the reduction of commercial real estate and development loans. Since January 2009, land development and construction outstandings have been reduced $103 million while owner-occupied and non-owner-occupied commercial real estate have been reduced another $69 million.

As I mentioned, much more information is included in the press release but I will be happy to answer any questions in the Q&A session. Now I'll turn it back over to Mike.

Thanks, Bob, and thanks, Chuck, for your comments. Karen, we would like to open it up for questions at this point.

(Operator Instructions). Steve Geyen of Stifel Nicolaus.

Hello, this is Steve Geyen. How are you doing today?

Hi Steve.

Question on the decline in local certificates of deposits. Just wondering if that was due to a pricing change or a change in kind of the plans? In previous quarters, you guys had talked about possibly pricing up a little bit to gain those CDs and potentially the relationships as well, and just wondering what your thoughts are on?

Yes. One of the things that we had done in the first quarter of 2009 is we ran a special CD campaign that would happen to be a one-year term and we raised, I think, about $65 million through that campaign in generating local depo -- local certificates of deposit. Those matured primarily in February and March of this year. And a lot of those monies, we retained, I think, about 70% in total.

A lot of that retainage actually went into interest-bearing checking accounts. We have a pretty attractive what we call executive banking, which is an interest-bearing checking account as well as into the money market accounts. So that's the reason for most of that movement.

Okay. And in relation to the broker deposits, is it more of a pricing issue? Did that decision go with broker deposits, an increase in broker deposits versus local deposits, CDs?

The increase in the broker deposits, although when you net out the reduction in FHLB advances, it mitigates that. We continue to elect to maintain a relatively high level of on balance sheets liquidity -- primarily Fed funds, and we also have a money market account at another correspondent bank.

And if you just kind of compare actual balances to actual balances during the first quarter compared to year-end 2009, you see, we didn't have a lot of Fed funds sold on the actual year-end date. So we built that up primarily in January and ran with a pretty high level of Fed funds. So we just continue to look at our on balance sheet liquidity in light of the economic as well as the banking conditions, as well as that of ourselves, and at this point in time, continue to maintain a relatively high level there.

Okay and a question for Bob. Just wondering about the pricing in the [OREO] as far as were there any markdowns. And if you could talk a little bit about the flow in and out of OREO? It looks like the OREO was down a bit from the fourth quarter.

Yes. It's a -- we had a large re sale in the first quarter. It was good to see and really the focal point of my comments about being some (inaudible) in activity in the [ROE] account. As you might imagine, there's a lot of multi-activity there. We have some properties come in, some properties going out. We are continuing to evaluate those properties each and every month to make sure that we've got accurate balance based on the market value that we're carrying on our books.

But during the first quarter I'm very pleased that we saw a number -- besides that large sale, we saw a number of sales of some small properties throughout the quarter, both on some commercial properties, some residential properties in amounts that made us approach that comment there about the activity in the market place. And there continues to be some offers and some interest as we head into the second quarter.

So whereas six months ago, nine months ago, a year ago, there was not a whole lot of interest in bank-owned properties, we are starting to see some activity and some movement there, as I indicated.

Okay and last question on credit. Just wondering about TDRs. What portion of net charge-offs came from TDRs? Or were connected to the TDRs?

Yes, I don't think there -- in the first quarter, there were no percentage of charge-offs coming from TDRs.

And last question. The net interest margin, really nice improvement. Just curious, you mentioned, Chuck, that there was about $430 million maturing -- of CDs maturing in 2010. Is that more weighted to the first half, last half of 2010? If you could provide just a little more color --.

Yes. That also --. That's not only broker CDs, but also FHLB just to be clear on that. It's pretty well weighted throughout the rest of the nine months fairly equally. Maybe a little bit more in the second quarter than the third and fourth, but not materially.

Okay. Thank you.

Dennis Klaeser of Raymond James.

Good morning. First, on your capital levels, I noticed and you commented on -- in your prepared remarks -- that your regulatory capital ratios actually increased despite the loss. And you have a fair amount of push over at the well-capitalized threshold. I'm wondering if you've talked to the regulators about what your sort of appropriate target capital levels should be with and without TARP capital?

We haven't had any specific discussions with regulators about being a TARP recipient or not. They obviously do their annual examination, which we continue to enjoy and there's -- from our discussions to date, our level of capital has seemed sufficient. Obviously they have concerns about our net losses, but are pleased with the fact that notwithstanding the [DTA] valuation allowance at the end of the fourth quarter of last year, that we are able to actually increase our regulatory capital ratios and keep them, obviously even the risk-based ratio, above 11% despite their earnings performance.

So they seem to be satisfied with where we're at and what we are able to do, given the current financial condition.

This is Mike. I would just add to that. I think one of the things that we constantly are pointing out is that, obviously, it's been a very difficult couple of years for many, many community banks throughout the country. And we certainly have felt what's going on in the economy, but if you go back to two years ago, the end of the first quarter 2008, our -- for example, our total risk-based capital was 11.18%. And despite all the things that have happened to us and the difficulties that we've had, at the end of the quarter, our total risk-based capital was 11.21%.

So we've done the things we had to do. Some of them were very difficult, some of them were very painful, but -- and, obviously, being a TARP recipient has helped. But some of the initiatives that we put -- started just about two years ago have really allowed us to weather the storm and fight some -- fight through this very difficult environment.

And to add to that as well, Dennis, as you know, it was great to get the TARP proceeds from a capital ratio standpoint in the second quarter? We added -- we had downstreamed -- with the $21 million, we downstreamed $19 million of that to the bank as a capital injection, but of course had to do DTA valuation allowance in the first quarter, which pretty much equaled what we had to do with the proceeds on the TARP.

And obviously, we don't get to show that benefit going forward because any benefit derived from a net loss from operations we just have to increase our valuation allowance. So from a long-term standpoint, we are obviously hoping to get to back to profitability as soon as possible. And with that brings the idea that we are going to have -- that we would be able to start reducing that valuation allowance, which would certainly benefit our capital ratios.

We [can], obviously -- back in the fourth quarter Congress approved the regulations allowing banks to go back by five years in their carryforward analysis. I think, I'm sure as you know -- (multiple speakers).

TARP recipients didn't get that benefit. So, obviously, we are looking to return to profitability and start reversing that valuation allowance which is well over $20 million now which, obviously, would benefit and obviously not only earnings, but our capital positions going forward as well. So that is certainly out there, hopefully not in the near too-distant future.

Sure. Just overall your -- the decrease in your loan balances are the past few quarters has helped the capital ratios. When you look forward, do you see the overall loan balances continuing to decrease in size? And at what point do you think that would stabilize and start increasing again?

That's a very good question. We were just talking about that in our management meeting this morning and we expect our commercial real estate balances to continue to decline.

That is a stated goal that we have had. And that has continued to march on.

An interesting change that's happened really only in the last month or two is that we started to see our C&I customers utilize their lines of credit more. And that overall is a very good sign because we've really been in a two-year decline where our customers have just not needed their lines of credit because volumes have been down. And so we're starting to see reflection of the increase in economic activity, increases in the C&I lines of credit.

So that has a tendency then to start to flatten out as far as the loan balance decline goes, which is kind of where we expected. About two years ago, we kind of thought to ourselves in looking out that if we could get the total assets of the bank, mostly through shrinking the loan portfolio, from about $2.2 billion to about $1.8 billion, that seemed to be about the right number.

And there was nothing real scientific in that although there were some very good thoughts looking at what we needed to do as far as reducing commercial real estate. And it is kind of where we're headed. And so we would expect that to continue in the next couple of quarters.

And I think what you'll see -- this is Bob. I think what you'll see, continue to see, is a shift in the mix of the portfolio away from the commercial real estate and as the economy improves, a shift towards the Texas C&I relationships that we want to further foster.

Sure. Within the broad category of commercial real estate or loans secured by real estate, you've got the various categories of land loans, of vacant land in the land development in both commercial and residential. And those balances have not changed a great deal over the past quarter or two.

Could you give an outlook on that part of the portfolio? How much of that sort of is up for renewal over the near term? And what are the sort of trends in terms of underlying values of those properties?

Yes. You look at the trends in those buckets, they're really have come on quite a bit over the last year. And obviously the rate of production has slowed a bit the last couple of quarters, but there's some production there.

And you have some construction relationships that have concluded. The products are completed. And those are being moved from commercial real -- the development and construction buckets into the amortizing buckets. You have some relationships there, whether it is some development activity where the -- or the principles and the guarantors are obviously providing significant support for the developments, as the economy hopefully improves and starts to be some additional activity in terms of movement of those pieces of real estate for sale.

So if you look at the reductions we've made over the last 12 months, the last 18 months, there's been quite a significant percentage of that portfolio. I don't think it will ever be zero necessarily, but I think you'll start to see, as there continues to be some movement there, shifts in terms of sales, in terms of liquidation on those parcels as well as shifting to amortizing type real estate loans.

And then just one final question. Your reserve building, obviously, has been very significant over the past year, the -- I particularly look at the loan loss reserve to total loan ratio which, I think, has nearly doubled year over year. And it has increased quite a bit over the last two quarters.

What is your outlook for that particular ratio? Do you see a need to continue to build that ratio or will that peak out here at some point?

We would like to think that, as you know, we at the -- subsequent to year-end we went back and really looked at conditions in the portfolio and we beefed it up even more. And we would like to think that we did a very good job of identifying where we needed to be.

And even more importantly as we look out over the last few months and we look out over the next couple of months, we are seeing more positive signs than we have seen in probably two years. So the prediction of where that is going to be, you know, we pledged that we are going to keep it where it needs to be, and if it needs to go what we will do it. But I would tend to think that because we been pretty aggressive with reserve building in the last few quarters especially, as you pointed out, that we would like to think with some of the positive things we are seeing out there in valuations and in the economy, in general, that we aren't going to need to be quite as aggressive over the next few quarters.

Yes. I think in my mind is the reserve will move directionally consistent with the metrics of the portfolio.

Okay, thanks, guys.

(Operator Instructions). Terry McEvoy of Oppenheimer.

Good morning. Thanks. Could you just talk about the discussion that goes into deciding whether you should or should not pay the TARP dividend? Obviously, you guys have had a tough couple of quarters where you've had operating losses and whether that plays into that type of discussion.

And then as part of that, I believe over the years you participated in some pooled trust preferred. Have you deferred the dividends on any of those securities?

We have not deferred the dividends on the trust preferred, the $32 million that we've got which are, as you correctly stated, in the pools. Obviously we continued to pay the dividends on the TARP as well.

It is certainly something that we talk about and think about as we look at our capital levels, look at where they currently are and look at our projections, obviously, look at bottom-line earnings performance. You know, it is our belief that as long as we can show at least steady if -- and, obviously, we continue to show improving capital ratios -- that we will continue to expect to pay interest on both the TARP as well as the trust preferred.

But it is certainly in the mix and is certainly, again, something that we look at at least on a quarterly basis and put that in context with our earnings performance -- expected earnings performance and then, obviously, the impact of the capital ratios.

And at Mercantile, is there any restrictions at all on utilizing the brokerage CD market for you guys?

No.

And then I guess the last question was in terms of the OREO sales that happened in the first quarter, could you just talk about where those sales occurred versus where you were carrying those assets? Was there a major discrepancy there, as well as some of the smaller transactions that were mentioned as well?

I think the way we handle our business assets in ORE is that we do monthly valuations to make sure that the number is correct. And I think where the bottom line number ended up when we sold the properties was pretty accurate. Obviously over the course of the last six months to a year, to get us to that point, we absorbed some pain and had some write downs there.

But I think the fact that properties were sold pretty much where we had pegged in the account when the sales took place, I think it showed that we have been pretty much on the mark with the evaluations of the properties in the portfolio.

Appreciate it. Thank you.

Steve Covington of Stieven Capital.

Good morning. Thanks for taking the question. I guess, Chuck, you touched on this a little bit about the NPA expenses. And I know it's in the reconciliation, you had $900,000 in valuation write-downs, but was there anything else unusual within that nonperforming asset expense category? And what do you think a good number is to look for going forward?

Yes. That one's pretty hard to get our arms around as there was a lot of obviously different dynamics going on in there. One of the things that happens in February of every year is to make sure that we protect our first lien positions against tax liens, property tax liens.

And so we did have to -- I think, about $600,000 or so -- make some property tax payments. Again about $600,000 in February to protect our lien, our first lien positions. So we went ahead and did that.

So from the property tax standpoint, we are hoping that the first quarter is a little bit higher than the rest of the quarters will be just because of that annual event. But whether it be continuing to pay property taxes, of course, the legal bills and the write-downs, it is certainly going to be elevated like our provision expense. And of course, these come a little bit later as everything works its way through the snake, as we like to say.

So I really don't know, Steve, to give you a really hard number, it's certainly going to be -- I am certainly hopeful that it is smaller in the first quarter as we go forward. But it is really hard to peg a number.

And then I guess on the capital side -- well, before we get to that, I guess that, number one, I just wanted to kind of make sure that I totally understand the growth in the net interest margin. Was there anything unusual that flowed through the net interest income line item or was that -- it was all pretty sustainable margin?

Yes. Good question. The first quarter was there was no one-time events in the first quarter and in fact, as I mentioned or briefly discussed before, we continue to keep a pretty high level of Fed funds. So we can certainly improve that margin a little bit by a handful of basis points if we got Fed funds down, but we continue to look at the volatility in the marketplace and think that keeping that Fed funds elevated a little bit makes a lot of sense.

But to answer your core question, there's nothing one-time in the first quarter.

And then lastly on the capital side, you have seen a handful of companies at least initiate discussions or go ahead and exchange TARP preferred for either some other type of convertible preferred or trust preferred. Is that something that the management and the Board is considering or is there anything you can comment about that?

We haven't talked a lot about that yet at the Board level. It's something we continue to kind of watch as possibilities, but we haven't gotten into any serious discussions.

But that being said, like you've seen the performance of this organization over the last couple of years. All things are discussed from time to time as far as capital strategies and profitability strategy, asset quality strategies. So it is something that is -- I think Chuck used the term earlier on another issue, it is in the mix.

Okay. Thanks, guys.

Thank you, sir. And we have no further questions in queue. I would like to turn things back to Mr. Price for any further comments.

Thank you, Karen. Thank you, again, for your interest in our Company. Again while -- although, as Chuck mentioned, we are not happy with the loss, we continue to make tremendous progress in increasing net interest margin, controlling overhead, reducing our wholesale funding reliance. And for the first time in a long time, I think we feel better about what we're seeing out there on an asset quality side. Still a lot of work to do, but we are a lot stronger from our core operations to withstand the storm and look forward to coming out of it as quickly as we can.

With that, we will end the call. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great afternoon.