Mercantile Bank Corp (MBWM) 2011 Q2 法說會逐字稿

Good morning and welcome to Mercantile Bank Corporation's second-quarter 2011 earnings conference call. All participants will be in a listen-only mode until the question-and-answer session of the conference.

Today's conference is being recorded at the request of Mercantile Bank Corporation. If anyone has objections, you may disconnect at this time. I would now like to turn the conference call over to Ms. Karen Keller. Ms. Keller, you may proceed.

Thank you, Jamie. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the Company's financial results for the second quarter ended June 30, 2011. I'm Karen Keller with with Lambert, Edwards, Mercantile's investor relations firm. And joining me are members of their management team including Michael Price, Chairman, President, and CEO; Robert 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. However, before we begin today's call it is my responsibility to inform you 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's business. The Company's actual results could differ materially from any forward-looking statements made today due to the 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 the 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 at www.mercbank.com. At this time I would like to turn the call over to Mercantile's CEO, Mr. Michael Price. Mike?

Thank you, Karen, and good morning, everyone. Thank you for your interest in our Company.

I'm extremely happy to report that the earnings momentum generated in the first quarter of this year has really taken hold and expanded during the second quarter. Our Chief Financial Officer Chuck Christmas, and Bob Kaminski, our Chief Operating Officer, will detail a quarter where we saw a significant increase in profitability, substantial decreases in our nonperforming assets, and good performance in our margin and overhead measurements.

While the nascent economic recovery remains unsteady and uneven, and the cleanup work in our nonperforming assets is not yet over, we are very gratified that the hard work our bankers employed during the past three years has started to really pay off. We feel confident to say that the worst of the effects of the Great Recession are behind us. And while we remain vigilant regarding our asset quality, we look forward to growing the franchise again.

At this time I will turn it over to Chuck.

Thanks, Mike, and good morning, everybody. This morning we announced that we recorded net income of $2.4 million during the second quarter of 2011 compared to a net loss of $0.7 million during the second quarter of last year. This $3.1 million increment expands to $3.9 million if we exclude a federal income tax benefit recorded during the second quarter of last year.

Net income totaled $3.5 million during the first six months of 2011 compared to a net loss of $3.6 million during the first six months of 2010. This $7.1 million improvement expands to $9.1 million if we exclude a federal income tax benefit recorded during the first six months of last year and a one-time investment and loan sales gains recorded during the first quarter of 2010.

The improved operating results reflect improvements in many key areas of our financial condition and operating performance, but especially reflect a significantly lower provision expense and a historically high net interest margin. We are, of course, pleased to be able to report a net profit for the second quarter of this year, our second consecutive profitable quarter after two years of quarterly losses, reflecting improved economic conditions combined with the positive impact of numerous strategies developed and implemented over the past several years.

Declining nonperforming asset levels; a prudent loan portfolio along with home credit underwriting and administration practices; a vastly improved net interest margin; lower controllable overhead costs; an improved liquidity position through substantial local deposit growth and dramatically reduced reliance on wholesale funding; and strong and improving regulatory capital ratios provide us with cautious optimism as we look to our future earnings performance and overall financial condition. Yes, much work lies ahead and many headwinds continue to face Mercantile, the banking industry, and the economy at all levels. However, we believe we are well positioned to succeed as a strong community bank and continue to play a pivotal role within the markets we serve.

During the second quarter of 2011 we saw the continuation of very positive trends we reported during the past couple of years, and I would like to touch on some of them. An improved net interest margin has provided substantial support to net interest income that has been negatively impacted by the decline in earning assets. Net interest income during the second quarter of this year was $13.2 million or 9% lower than the second quarter of last year.

Average total earning assets declined by about $287 million between the second quarter of this year and the second quarter of last year. However, our net interest margin increased from 3.31% to 3.61% or about 9% during the same time period. The improvement is primarily due to the decline in our cost of funds, but also reflects a relatively stable yield on assets resulting from the many strategic initiatives we have successfully implemented within the commercial loan function.

Provisions to the reserve totaled $1.7 million during the second quarter of this year, a substantial decline from the $6.2 million we expensed during the second quarter of last year and well below the average quarterly provision amount during the past three years. For the first six months of this year, provisions to the reserve totaled $3.9 million, significantly lower than the $14.6 million expensed during the first six months of last year.

Our loan loss reserve was $38.7 million as of June 30 or 3.45% of total loans. Despite the improved condition of our loan portfolio, the reserve coverage ratio remains relatively unchanged and is even up slightly from the 3.38% level a year ago.

Local deposit and sweep accounts were up $52 million during the past 12 months and are up $277 million since the end of 2008. Combined with the reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by about $890 million since the end of 2008. As a percent of total funds, wholesale funds have declined from 71% at the end of 2008 to 38% at the end of the second quarter.

Overhead cost reduction strategies have been realized. Salaries and benefits, occupancy, and furniture and equipment costs declined $0.3 million or about 5% during the second quarter of this year compared with the second quarter of last year.

Nonperforming asset administration and resolution costs remain elevated; however, the costs reduced significantly during the second quarter. Nonperforming asset costs totaled $2 million during the second quarter of this year, well below the $2.5 million expensed during the second quarter of last year and the $2.8 million quarterly average over the previous five quarters.

As with provision expense, we would expect a reduction in nonperforming asset administration and resolution costs in future periods as the level of nonperforming assets continues to decline.

We remain a well-capitalized banking organization. As of the end of the second quarter, our Bank's total risk-based capital ratio was 14% and in dollars was almost $51 million higher than the 10% minimum required to be categorized as well-capitalized.

At June 30, our Bank's total risk-based capital ratio was $11.9 million and the surplus was $29 million, and that was a year ago. Those are my prepared remarks. I will now turn over the call to Bob.

Thank you, Chuck. My comments this morning will focus on some of the detail of the Company's asset quality as well as some product and customer acquisition initiatives.

The second-quarter 2011 saw a continued improvement in asset quality metrics of Mercantile's loan portfolio, most notably the 18.6% drop in nonperforming assets from March 31 to June 30. Since March 31, 2010, when NPAs were at a high, nonperforming assets have dropped 47% or $55.7 million.

NPAs totaled $61.9 million at June 30; and that is broken down by the following loan types. $25.5 million in commercial real estate non-owner-occupied; $10.8 million in commercial real estate owner-occupied; $9 million in residential other owner-occupied rental; $8.5 million in residential land development; $3.8 million in commercial non-real estate; $2.2 million in commercial land development; and $2.1 million in residential construction.

Reconciliation of nonperforming assets for the second quarter is as follows. $12.1 million in principal payments; $2.5 million in sale proceeds; $5.4 million in loan chargeoffs; and $700,000 in valuation writedowns in other real estate. These reductions more than offset $6.5 million in NPA additions during the quarter. The net result was a $14.2 million reduction in nonperforming assets since March 31.

Net charge-offs during the second quarter totaled $5.1 million, with $2.5 million of this total coming from residential real estate land development. Another $1.8 million came from residential real estate owner-occupied and rental. The rest of the chargeoffs were distributed from among the other loan type categories. 63% of the quarterly loan chargeoffs were specifically allocated reserves prior to the second quarter.

This quarter was another very productive one in terms of loan recoveries. Recoveries totaled $1.6 million for this quarter and $2.2 million for year to date. This is illustrative of Mercantile's practice of recognizing losses in a conservative manner and then continuing a very diligent collection process, which oftentimes results in some sizable loan recoveries.

Provision expense for the second quarter was $1.7 million. While this provision is significant, it nonetheless represents a large reduction from the quarterly provision expenses being made in recent quarters, as determined by the Bank's [A-triple-O] methodology.

As was the case in the first quarter, the second-quarter provision amount is reflective of the continued stabilization and improvement of the asset quality metrics of Mercantile Bank. Past-due loans 30 to 89 days were once again extremely low during the second quarter at about $200,000.

In the area of new business development, the Mercantile staff remains fully engaged with new customer acquisition activities for loans and local deposits as well as new business opportunities with existing customers. The loan focus is on C&I relationships plus owner-occupied or non-owner-occupied commercial real estate exhibiting appropriate and acceptable risk profiles. The new loan pipeline is as active with quality opportunities as it has been since the outset of the recession.

Commercial lines of credit held steady in the second quarter, reflecting an increased usage by customers of current asset financing availability compared to the reductions that we have seen in these totals during the recession. While the Mercantile loan portfolio did shrink in the second quarter, that contraction was primarily reflective of continued pruning of commercial real estate transactions that did not meet the profile of the characteristics that we desired for the portfolio.

Mercantile continues active in the area of new product development for its commercial and consumer customer bases. In the second quarter Mercantile introduced MercMobile Deposit, which is a mobile remote deposit capture product that consumers can use to make deposits from their smartphones.

Additionally during the quarter, Mercantile established a partnership with Bill.com that will allow us the opportunity to offer our commercial customer a cash flow management tool that will provide automated online customer invoicing and vendor payment programs. This solution can be fully integrated with the businesses' existing accounting systems.

This accounts receivable and payable solution complements the suite of cash management products that Mercantile offers its commercial customers. These product introductions are a continuing illustration of Mercantile's commitment to progressive and value-added relationship banking.

That concludes my prepared remarks. I will now turn it back over to Mike.

Thank you, Bob, and thank you, Chuck. At this point we would like to open it up for any questions.

(Operator Instructions) Terry McEvoy, Oppenheimer.

Thanks, good morning. As we look at a newer Mercantile model or balance sheet -- less commercial real estate, more C&I, and a different funding source in terms of local deposits -- maybe Chuck, could you just talk about how does that impact, call it a more normal net interest margin versus the balance sheet a few years ago? It sounds like the expenses and the infrastructure has been adjusted potentially to take into consideration this newer model. Am I correct in that conclusion?

Yes, Terry. This is Chuck, and Mike will probably have a comment on the last part of that. But I think with regards to the net interest margin, obviously we're in a really, really crazy interest rate environment right now. So it is hard to look out over the next two to four years, or whatever it's going to take to get to more of a normalized interest rate environment, and see how that impacts our margin.

But it would make sense from what you are saying that if we have less of the higher costing products of CDs and have more of the non-maturity deposits like interest-bearing checking accounts and money market accounts and savings deposits, that would help our cost of funds. We certainly believe as we go ahead and reshape the landscape of our commercial -- especially of our commercial loan portfolio, we would think that that would provide assistance to our asset yield as well.

So I certainly don't have the ability to say what our new margins are going to be as we go forward, because of the flux of what the interest rate environment and the economic environment currently is, and exactly where Mercantile ends up in regards to its balance sheet structure. But I think in relation to historical margins we think that we would show an improvement, somewhat similar to what we are doing currently.

Yes, Terry, this is Mike. I think we are very heartened that as we transition to this new look of Mercantile, if you will, we have transitioned to some of the highest margins we have ever had.

And from a cost structure standpoint, obviously we have reduced our footprint with the closing of the two offices a couple of years ago and gone ahead and certainly looked at our staffing levels and all the different functions. As we go and try to look at what Mercantile is going to look like going forward and some of the products and services that we have been offering and we think we will be offering here in the future, we think the footprint both from a physical facilities and a staff appears very sufficient currently.

All right. Then just one other question. The decline in the FDIC insurance premium, is that a function of the derisking of the balance sheet and the improvement in credit that Bob spent some time talking about? And is that sustainable in terms of the dollar amount that came through the income statement this last quarter?

The reduction that we saw, we reported, is totally due to -- or almost exclusively due to the change in the calculation by the FDIC in lowering the assessment rate. It is more of an industrywide reduction than anything Mercantile-specific.

Appreciate it. Thank you.

Stephen Geyen, Stifel Nicolaus.

Yes, good morning. Just a handful of questions. Looking at that first table, the loans secured by real estate. Just curious, Bob, if you could give us some thoughts on the commercial buildings declining from $484,000 to $429,000. Were there some sizable payoffs? Or maybe some thoughts on what you are seeing there this past quarter.

Yes, we did have some sizable payoffs of some loans that, as I mentioned in my commentary, didn't really fit the profile of loans that we are looking for, for the CRE portfolio. Either they were out of market, they were credits that were exhibiting risks that we weren't in the appetite for, or a combination thereof.

So during the course of the quarter you had a couple of sizable payoffs there that certainly accelerated the shrink in that part of the portfolio. But again as we are looking to change the dynamics of our loan portfolio overall, those are the kinds of loans that we are looking to either price in a way that we can get paid for either the risk or the out-of-area situation, or to have them leave the Bank altogether. That is going to be a work in progress as we look to manage those shifts in the overall combination of the loan types in the portfolio.

You guys have done a real nice job reducing vacant land construction both on the residential and the commercial side. I think it's around $75 million, $77 million now. Do you think that is a good run rate near-term? Or do you think there is potential that could drop a little bit more?

It's a pretty good run rate. I think as you might imagine, with loans in that bucket, those are in many cases some of the most distressed loans in the portfolio. So we continue to work with the borrowers in many instances to look for global solutions to getting those assets out of the portfolio and off the Bank's balance sheet.

This quarter we happened to have some pretty good successes there in making that happen. But, as I said, it is a work in progress. While we are seeing continued reductions there, sometimes they will come in larger chunks as we reach some solutions with some larger pieces of land development loans.

Okay. Do you have a percent of line usage? Has it changed significantly in the last couple quarters?

No, that's a great question, Steve. I don't have the specific percentage. But from an overall standpoint what we've see pretty much since the beginning of 2011 is a very steady -- steadiness or stabilization if you will, of the line usages. Where we have been seeing significant declines over the last three years, the total amount outstanding has been pretty much unchanged for most of this year.

Okay. Last question, cost of funds, do you think that might be -- I guess is there potential for that to come down a little bit more? Or is that --?

Yes, I think there is. We still have some higher costing CDs, both locally as well as brokered. And some FHLB advances, although they have maturities in the next year, are certainly at rates that are higher than the current market rates. It certainly seems that any increases in interest rates will be further and further out now.

So I think we will see some declines. Certainly not what we saw over two and three years ago, or even a little bit last year. But I still think there is some still some room for continued improvement with the cost of funds.

Okay, thank you.

John Barber, KBW.

Good morning. Could you just talk a little bit more about the general operating environment you are seeing in Michigan, just in terms of unemployment rates, vacancy rates? Any type of stats like that.

Well, John, this is Mike. I will take a stab at that and let Bob or Chuck enhance my comments. But I think we are seeing a generally -- in the state of Michigan a fairly decent recovery. We had a deep hole to dig out of. Unemployment is coming down but we started up at a higher level than most states.

Fortunately, the Big Three have come around a little bit, and that has helped especially on the east side of the state, get them going again a little bit. But there are still challenges out there.

It is uneven, like in most of the country. You get three or four snippets of good news out there, and then you take one or two steps back.

But generally we continue to see some decent pickup in activity. Unemployment is better but still stubbornly high. Confidence is slowly coming back into the market.

We are seeing customers now and prospects now actually looking to add equipment, buy some more inventory, which is something we hadn't seen for a good two and a half, three years. So those are all positive signs, but in no way would we say -- boy, this is a V-shaped recovery.

You know, I think from the standpoint of the real estate area, the supply-demand continues to be out of whack there. You see a lot more supply than the demand that is there right now, especially in non-owner-occupied real estate.

So residential real estate remains quite challenged as well. Although activity has picked up from where it was, there is still a supply-demand issue. As they continue to slog through that backlog of supply, we continue to see some low values there.

But there doesn't seems to be a floor that has been established and I guess you'd call it stabilization. That is what we will call it. But it's still one of -- some of the biggest challenges remain in that section of the economy.

Okay, thanks, and the last one. I know that part of the Company's strategic initiative involves reducing your exposure to commercial real estate. Could you just maybe ballpark how far along you are in that process? I know you said maybe it is the sixth inning, or I am not exactly sure where.

I don't know if I want to categorize it in terms of a baseball game these days. But in terms of the portfolio, obviously we have got a priority list of ones that we want to shift from the portfolio. The NPA list is a big contributor to the reductions, and some of the commercial real estate is -- those have been some of the most challenged loans that we have dealt with.

But as I mentioned, as some other opportunities come along and some loans mature that aren't necessarily not performing, but they are ones that we just as soon find a new home, there are opportunities there. In other cases, loans that we can live with the risk profile and it is one that presents acceptable action for us, we can price those in a range that gives us an improved margin and lets us get paid for the fact that it is not really the ideal kind of loan that we are looking for in this new environment.

Great, thank you.

(Operator Instructions) Daniel Cardenas, Raymond James.

Morning, gentlemen. Quick question. On the improvements in nonperformers, was that pretty gradual -- or granular? Or was that related to maybe just one or two larger credits?

It was pretty much across-the-board. We did have a couple of nice-sized ones, nice-sized credits in there. But we did move a lot of credits in total as well, big and small.

We are just -- that is probably a big part of the story, and I appreciate you picking up on that. If you look at the reduction of NPAs in the last couple of quarters especially, we are very, very gratified by the velocity of the volume, the results that our team has been able to generate.

So while we'd like to say, boy, we can extrapolate that right out; and three or four more quarters we'll be all down to zero -- we know that is not quite true. However, that being said, we will take a 19% reduction quarter-over-quarter any day of the week.

Excellent. Then on your comments regarding C&I lending, can you comment in terms of what competition is looking like right now? And where is it coming from, primarily? The larger players or smaller players or both?

Yes, this is Mike again, and Bob may have some enhancements to the comments. But that is the real job that we're working very hard on right now, and that is to find good C&I opportunities to sell what Mercantile is all about, which is a very consultative approach and a very relationship-oriented approach.

We are seeing more opportunities out there than we have in a long, long time. Now that being said, I think every bank is looking for good C&I business so the competition is certainly very strong.

We especially have seen some of the big players come in with some aggressive rates -- rates that really in our opinion make very little sense. Rates that we've just determined that we are not going back to those days. We have worked awful hard to get our margin to where it is, where it should be, and we're just going to let those opportunities slide by.

But that being said, we know as a sales team that that means we have got to do an excellent job of allowing those prospects and existing customers to understand the real Mercantile value proposition. Now, we have been very happy that they have seen it generally over the last two or three years. Most of our very, very good customers have stuck with us through some very difficult times.

We are seeing it even in new prospects. We are getting new business, especially over the last couple of months, of prospects who understand that we may not always be the lowest rate in town -- nor do we want to be, nor do we position ourselves that way anymore. But we bring a lot more value with the experienced team that we have, the products and services that we are able to offer, and the stable relationships that we have become known for over the years of running this Bank.

You know, again as we seen in the past from some of the larger banks, they tend to change their focus quite frequently. I think a lot of the businesses, customers in the community, they do recognize that because they have seen the quick about-face by some of the larger players within the last few years.

So as Mike said, the value-added proposition, the relationship banking is really what we are focused on. And our team is executing the plan, and I think that is still a very valuable, valued commodity in the West Michigan marketplace.

Okay. Good. Then just one last question. Can you comment on TARP in terms of your thoughts and getting caught up on the dividend and then potentially repaying it?

Sure. This is Mike again, Dan. That is -- certainly TARP is on the top of the list of things that we talk about with our Board and executive management team. We have a plan with TARP, and we look to execute that plan here as soon as it's prudent to do so.

But there is a lot of inputs to that plan. There is a lot of, I guess, things that we need to talk about among ourselves.

We expect to roll out a plan on TARP as soon as we can, but we really can't get specific as to time. But we can say our general intention is to pay it back either all at once or in segments just as soon as it makes sense to do so.

All right, great. Thank you.

Thank you. At this time we have no further questions. I would like to turn the call over to Mr. Price. Mr. Price, you may proceed for closing remarks.

Okay. Thank you very much, Jamie. Again, thank you to all of you for tuning in this morning and for your interest in our Company. We look forward to talking to you again in the third quarter.

You may disconnect your call. That concludes today's conference call. We thank you for attending today's presentation. You may now disconnect your telephone lines.