Mercantile Bank Corp (MBWM) 2012 Q1 法說會逐字稿

Good morning and welcome to the Mercantile Bank Corporation first-quarter 2012 earnings results call and webcast. All participants will be in a listen-only mode. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Karen Keller of Lambert, Edwards & Associates. Please go ahead.

Thank you, Andrew. 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 first quarter 2012. I'm Karen Keller with Lambert, Edwards, Mercantile investor relations firm, and joining me are members of their management team, including Michael Price, Chairman, President and Chief Executive Officer; 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 forward-looking statements made due to the important factors described in the company's latest Securities and Exchange Commission's 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, www.mercbank.com. At this time I like to turn the call over to Mercantile's CEO, Mike Price. Mike?

Thank you, Karen, and good morning, everyone, and thank you for joining us to discuss our first-quarter 2012 results and other recent developments for Mercantile Bank Corporation.

On the call today, our CFO, Chuck Christmas, will provide details on our financial results, followed by COO Bob Kaminsky and his comments regarding asset quality and other operational successes for the quarter.

Hopefully you've all had a chance to review the announcement of our quarterly results, which continued our string of five consecutive quarters of positive earnings and built upon the momentum gained from last year.

This quarter was once again highlighted by a substantial increase in net profit, further decline in nonperforming assets and continued expansion in net interest margin. We continue to make progress towards the improvement of our asset quality, and as a result of these diligent efforts, we did not record a provision expense in the first quarter.

In addition to these first-quarter 2012 highlights, on April 4 we announced the repurchase of half of the 21 million nonvoting preferred stock issued to the United States Treasury as part of our participation in TARP. This was a milestone in of itself, but we are also extremely proud of the fact that we were able to accomplish this through internally generated cash flow and without the need to access outside capital. This is a testament to how we have managed through the challenges of the great recession and our subsequent recovery while maintaining our commitment to protect shareholder value.

With the repurchase of half of our outstanding preferred shares under TARP, our Tier 1 leverage capital ratio will be reduced by approximately 75 basis points. But even with this minor reduction we will remain well-capitalized for regulatory purposes.

We are also able to shift our focus and dedicate more of our efforts towards building our franchise and helping our communities prosper. We entered 2012 well-positioned to continue our success as a major competitor in our markets. We remain convinced our relationship-based approach will aid our efforts to gain market share, remain valued partners to our customers and add long-term value for our shareholders.

Our bank continues to grow stronger each quarter as evidenced by our significant improvement in profitability and increased net interest margin. We are pleased with our accomplishments.

However, we recognize there is still work to do. Our plan is to continue our work to reduce nonperforming assets, protect our net interest margin and reduce costs, all while maintaining our well-capitalized position. At this time I'm going to turn it over to Chuck Christmas.

Thanks, Mike, and good morning to everybody.

As you saw this morning we announced net income of $2.6 million for the first quarter of this year, a 135% increase over the $1.1 million earned during the first quarter of last year.

Our first-quarter 2012 income before federal income tax expense was $4.1 million, a 192% increase over the $1.4 million recorded during the first quarter of 2011.

As a result of the elimination of the valuation allowance against our net deferred tax asset at year-end 2011, starting with the first quarter of this year we are now recording federal income tax expense.

The first-quarter operating results reflect continued improvements in many key areas of our financial condition and operating performance. They are a direct result of numerous strategies developed and implemented over the past several years as well as modestly improved economic conditions. Our dedicated efforts to hone credit underwriting and administration practices have contributed to the significant decline in our nonperforming asset levels and a prudent loan portfolio.

The quality of our loan portfolio continues to improve, allowing for further reductions in provision expense and problem asset administration costs.

Operationally, we have significantly enhanced our profitability, strengthened our net interest margin, significantly improved our regulatory capital ratios, and enhanced our liquidity position through substantial local deposit growth and dramatically reduced reliance on wholesale funding. In addition, our improved financial condition and operating results have led to a significant reduction in our FDIC insurance assessments.

As we announced on April 4 our improved financial condition and operating performance also provided us the opportunity to repurchase $10.5 million or 50% of the preferred stock that we had sold to the Department of Treasury back in May 2009, under the Treasury's capital purchase program, which was part of TARP.

Given these fundamental improvements and despite economic and regulatory headwinds that may continue to face our industry and the economy, we believe we are very well positioned to succeed as a strong community bank and continue to play a pivotal role within the markets we serve.

During the first quarter of this year we saw the continuation of many positive trends. An improved net interest margin provided substantial support to net interest income that has been negatively impacted by a decline in earning assets.

Net interest income during the first quarter of this year was $11.9 million or about 12% lower than the first quarter of last year. Average total earning assets declined by about $225 million, or 15% during the first quarter of 2012, when compared to the first quarter of 2011, which was partially mitigated by a 9 basis point increase in our net interest margin during the comparable periods.

The improvement in our net interest margin is primarily due to a decline in our cost of funds, which has more than offset the decline in our yield on assets.

The lower cost of funds primarily results from the maturity of higher costs in certificates of deposit and borrowed funds as well as reduced rates paid on local deposits.

The lower yield on assets primarily results from a lower loan yield, reflecting improved borrower financial performance and increased competition, and a lower securities yield, reflecting US agency call and reinvestment activity, as well as principal paydowns on higher-yielding mortgage-backed securities.

We have been able to partially offset the impact of lower yields on our loan and securities portfolio by lowering the level of our federal funds sold.

We remain dedicated to maintaining a strong and steady net interest margin. For example, to the extent possible we are match funding fixed-rate commercial loans, as well as having entered into certain derivative interest rate contracts. While these and other strategies generally have a negative impact on shorter-term net interest income, we have been able to achieve a historically high and relatively steady net interest margin while at the same time strengthening our interest rate risk position over at least the next five years, especially if interest rates were to increase.

The continued improvement in the quality of our loan portfolio, combined with lower loan charge-offs and the resulting positive impact that has on our loan loss reserve migration calculations, allowed us to make no provisions to the reserve during the first quarter of 2012. This was a substantial decline from the $2.2 million we expensed during the first quarter of 2011, and well below the average quarterly provision amount during the past four years.

Our loan loss reserve was just under $31 million at the end of the first quarter or about 2.94% of total loans. Despite the significantly improved condition of our loan portfolio our loan loss reserve coverage ratio remains both strong and substantially higher than historical averages.

Local deposit and [super] accounts were down about $10 million during the first quarter 2012. However, they are up about $280 million since the end of 2008. The decline during the first quarter was not unexpected as we regularly see a decline in business deposits during that time period as businesses fund tax payments and bonuses. Our retail deposits were steady during the quarter.

With the local deposit growth, combined with the reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by about $1.06 billion since the end of '08. As a percent of total funds, wholesale funds have declined from 71% at the end of 2008 to 29% at the end of the first quarter of this year.

Nonperforming asset administration and resolution costs remain elevated. However, the costs continued to decline during the first quarter.

Nonperforming asset costs totaled $1.3 million during the first quarter of this year, well below the $3.1 million expensed during the first quarter of last year.

We expect continued reductions in nonperforming asset administration and resolution costs in future periods as the level of nonperforming assets continues to decline.

FDIC insurance assessments totaled $0.3 million during the first quarter of this year, a substantial reduction from the $0.9 million expensed during the first quarter of 2011. The decline reflects a decreased assessment rate due to our improved financial condition and operating performance, as well as the implementation of the FDIC's revised risk-based assessment system on April 1 of last year.

We remain a well-capitalized banking organization. As of March 31, 2012, our banks total risk-based capital ratio was 16.1%, and in dollars was approximately $72 million higher than the 10% minimum required to be categorized as well-capitalized. Our efforts to right size our balance sheet and improve our operating performance of the last few years have enhanced our regulatory capital ratios.

As announced on April 4 we repurchased $10.5 million of the preferred stock we had sold to the US Department of the Treasury.

To fund the repurchase the bank paid a cash dividend of about $10.5 million to the parent company. Had those transactions been consummated at the end of the first quarter, the Bank's total risk-based capital ratio would have been 15.2% and the amount of excess over the 10% minimum threshold would have been about $62 million.

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

Thank you, Chuck. My comments this morning will focus on client acquisition and business development activities, as well as credit quality in the loan portfolio.

We are pleased to report nice progress on both fronts during the first quarter. Although the loan portfolio did show some additional contraction we continue to be encouraged by client acquisition activities, which are the result of some ongoing initiatives. As we have mentioned previously, a major focus of the senior management has been the promotion of Mercantile as a relationship-driven community banking organization. The sales staff has taken on this mission with extreme passion and their efforts are starting to bear some fruit.

In the first quarter we saw new loan volumes in owner-occupied commercial real estate of $23 million, and non-owner occupied commercial real estate of $14.3 million, and commercial industrial lending of $13.4 million.

The pipeline remains solid as we continue to generate new commercial loan opportunities directly from our relationship banking focus and strategic initiatives.

While we are engaging -- while we are engaging some great new clients, the market still remains very competitive with some banks continuing to lead with low-priced banking. Mercantile remains committed to providing our markets with value-added, mutually beneficial relationship banking with competitive rates. We believe this is the key to building long-standing client loyalty.

In the first quarter we have launched some new marketing and media initiatives, focusing on both business and personal banking. We developed a media campaign featuring some present Mercantile commercial banking clients as well as some other adds highlighting some of our technology-driven consumer products.

On the sales front, we have bolstered our staffing in the cash management department, created additional momentum for our client acquisition efforts, including responsibility over our robust arsenal of innovative product offerings such as pay roll processing, cash management capabilities, remote deposit capture, mobile banking and accounts receivable and payroll -- and payable processing.

On the asset quality front, Mercantile saw a good reduction in nonperforming assets in the first quarter. The March 31 total of $52.2 million represents a reduction of nearly $8.2 million from December 31 2011, and a reduction of over $23.9 million from the NBA total of $76.1 million from a year ago.

The reconciliation table of NPAs for the first -- for the quarter illustrates the next activity we had regarding NPA disposition.

The combination of sales proceeds, principal payments, loans returned to performing status, valuation write-downs and charge-offs of $17.8 million more than offset NPA additions of $9.7 million during the quarter.

The NPA additions can be characterized primarily as previously identified watchlist credits with defined weaknesses, where the bank is pressing for a resolution in order to move the assets off the bank's books.

Activity on other real estate properties continues to be very encouraging with showings and offers tended to the bank on the increase.

Prices on closed sales have also been very near the carrying values on most properties and we continue to experience gains on a fair number of transactions.

The watchlist also continued to recede in the first quarter. This is especially encouraging in view of what we feel is a conservative posture regarding potential problem loan identification, as well as the process whereby loans are upgraded as credits improve.

The current watchlist totals are at the lowest level since the latter half of 2008, illustrating the strong progress we have made over the last three years.

Thirty- to 89-day delinquencies remain at a very low level, finishing the quarter at $78,000.

Those are my prepared remarks. I'll be happy to answer any questions during the Q&A session, and I'll now turn it back over to Mike.

Thanks, Bob, and thank you, Chuck, for your remarks as well. And, Andrew, if we could open it up to questions at this time.

(Operator Instructions). Stephen Geyen, Stifel Nicolaus.

Hey, good morning, guys and nice quarter.

Mike, maybe just some additional thoughts on the outlook for growth -- Bob provided some information on where you're seeing growth in CRE, C&I. Maybe the question being you're seeing some growth but yet the overall value of the loan portfolio is declining. When do you see a turning point?

Yes, that's a good question. To kind of echo what Bob said in his remarks, so, we've been very encouraged recently, probably the last three or four months especially, with some of the potential new customers that we have lined up to bring into the bank. And we're seeing that a little bit already in the last month or so, some new credits come on.

I would expect from the way it kind of feels out there right now that this quarter, the second quarter here, will probably be maybe a break even or a slight gain in the portfolio. And we'd like to think the way things are going now, the third and fourth quarter would also be slight gains.

We don't think it's going to be a huge growth scenario for us, but we are pretty happy that between the strategic initiative to really weed out a lot of the problem CRE, which is still happening but at a much lower rate, and a lot of the strategic initiatives we've had to bring in some new business, to start really work together to kind of slow that reduction in portfolio down and turn it around.

The reason why it's not going to be a faster growth rate, quite honestly, is we continue to guard credit quality and our interest -- net interest margin we're -- very, very closely. And I think Bob has alluded to that a little bit.

And we talked about in previous calls is a very competitive market out there. We have some of the larger players especially pricing loans at levels that we just don't think are sustainable, profitable or wise. So the business that we are getting which we are encouraged is really business that values the relationship, and it's good long-term business for us as we look to the future.

Okay, great. Chuck, maybe a couple questions for you. I'll start off with the net interest margin. A large portion of the gain this quarter or increase this quarter was -- it sounds like driven by the deposit repricing. Maybe give us some ideas or thoughts on what's still out there for 2012.

Yes, great question, Stephen. I think what you saw in the first quarter, we think we'll see a continuation on through most of the rest of this year, assuming that the overall interest rate environment does not change.

We still have, especially in the second and in the third quarter, a little bit some pretty good repricing opportunities, notwithstanding, as I mentioned, we continue to be very diligent, to the extent possible, to match fund. While the new loans that we are bringing on that Mike and Bob had touched on are typically doing the fixed rates, are taking advantage of some very, very low rates, and we typically balloon them in five years, so we are getting a lot of 4.5, 4- or 5-year money into the bank when we do have to go out there in the wholesale area.

Obviously, that's probably 100 basis points more than what we view say for on a one-year CD, but obviously if rates start going up we would see any benefit there quickly disappear.

So, but even going out a little bit longer, the overall average rate on wholesale fundings is still lower than what's maturing. And we have a pretty decent volume of maturities coming up in the second and into the third and fourth quarters as well, but not as much as the second.

We still expect to see some compression within the commercial loan portfolio, especially yield. Obviously rates are lower, so loans that may be coming off balloons are generally getting repriced at lower rates.

Certainly it's competitive out there. And a lot of the improvement we are seeing in our existing customer base, why they were reducing with their operating performance we were certainly asking for them to pay higher rates over the last few years. And now that they have improved they certainly are deserving of some lower rates. So we are repricing the portfolio from that standpoint as well.

And certainly the securities portfolio, like all banks, rates are incredibly low and have actually gotten quite a bit lower say from where they were even just a year ago. So certainly seeing some call opportunities there. And we don't have to put all the money back to work because our collateral requirements aren't as big. But when we do we certainly are losing some yield there as well.

So, again, I think -- in summary I think there's opportunities to continue to keep the margin steady, relatively steady. But, again, make sure that we are very guarded, as Mike said, about protecting that net interest margin. We have worked hard to get it up to where it is, and we certainly want to keep it there. And we are not going to sacrifice short-term income at the expense of long-term management (technical difficulty)

Okay. And there is some higher variable expense or other expenses up a bit over 4Q, and I guess if we look back a little further, the 3Q. Was there anything in there that drove that number?

No; I think if you look at the first-quarter number, it's a pretty decent core number to work with.

One of the things that happens in the fourth quarter of every year is something that's cost that kind of gets thrown out throughout the year, but they kind of come in chunks, such as advertising expense, marketing expense, training, that type of stuff.

From an expense standpoint we kind of estimate what it's going to be for the whole year, and we straight-line that. And traditionally what we've seen is when we get into the fourth quarter we are a little more -- on purpose we're a little more aggressive with our accruals in the first part of the year. And then we back off some of those accruals as we see we are not going to expense the full budgeted amount. And that's really what you see for the most part in the fourth quarter of last year.

Okay. And maybe a couple questions for Bob. Net charge-offs, nonperforming assets dominated the -- I guess were dominated by non-owner occupied CRE, and you provided us some nice color on -- in your commentary about -- I'm just curious about what trends you were seeing as far as watchlist is -- new credits, the inflows and maybe some upgrades, as well.

Yes, that's what we have definitely seen.

As I mentioned in my comments the watchlist has continued its downward march from where it had been back in the last couple of years. The new additions to the watchlist have been relatively minor in scope and magnitude in terms of size in the portfolio and then from a variety of types of customers that maybe have held on but have struggled with gaining some momentum as the economy picks up.

The additional NPAs I talked about were mainly driven by us pressing forward resolution on some watchlist credits that were a larger size in nature and wanting to get these things moved ahead and disposed of one way or another.

We want to continue to drive that NPA number down, and I think by not just sitting -- kicking the can along with a variety of credits that continue to struggle, we are pushing for resolution to get the things moved out of the bank. So very encouraged by the fact that the additions to the watchlist have been very, very small and low in terms of magnitude. It's just more the pipeline of problem loans working through the snake and out the door of the bank. And the NPA bucket is obviously the last one they stop in before they are out the door. So we are very encouraged by what we are seeing there.

Okay, thank you.

John Barber, KBW.

Good morning, guys. Bob, maybe you could just build off the comments you just mentioned. Is the preferred disposition strategy still to work through your problem loans organically as opposed through bulk sale?

Absolutely. Absolutely, yes. That's been our strategy over the last several years, and it will continue to be our strategy. I think we have had some good successes as we talked about with our disposition of other real estate. We are in a good place in terms of our valuation, but continuing to see some gains on sale, so the values we feel we are very confident about in terms of not having any much further loss exposure there.

And so our strategy is to continue to push hard to get those out of the bank because we are not in the business to own real estate and to manage real estate. It's -- and as you've seen we've got some great successes in the first quarter to follow up on 2011.

Great, thanks. And I guess longer term and maybe post-TARP, where do you feel comfortable running your capital ratios; I guess what type of cushion would you like over the well-capitalized minimums?

That's a really good question, John. When you find out the answer from the regulators, let us know; will you do that?

But you know it's still somewhat stressed out there from the economy. We've certainly seen some modest improvements and manufacturers doing pretty well in our markets. But certainly from a commercial real estate and certainly residential real estate as well, it still stressed. So we certainly plan on operating with a little bit higher level of capital than I think we certainly want to as we go forward. So we'll just have to kind of see how things play out from an economic standpoint; our certain -- obviously our own financial condition, operating performance.

Certainly we'll be looking and talking with our regulators as all banks will, as far as what they are going to be comfortable with. But we certainly believe we've got a very, very strong capital position. We certainly -- we'll be having conversations with the regulators in regards to the other half of TARP as we move forward.

And that will have a negative impact on the capital ratios. But we are making money again, as Mike mentioned in his comments about growth. We expect some growth as we go forward, but it's not going to be incredibly robust, given all the environmental things that are out there. So I think we've got a very, very strong capital position. We certainly want to lower that as we go forward. It's kind of just more of a wait-and-see as we do go forward.

Thanks, Chuck. And last one, you're still working through some of your CRE exposure. I've heard regulators talk about maybe focused metric as looking at CRE as a percentage of total capital and wanting that below say 300%. Is that consistent with conversations you've had with your regulators? And also do you have an internal target?

You know, we certainly have some concentration of strategies that we look at in our portfolio and some of the movement in the portfolio has been to get some of the higher-risk CRE out of the bank. But as I mentioned in my comments we also have some new loan bookings in the area of CRE that was very, very strong in nature.

So I think while we all have our concentration limits, I think on a micro basis, looking at individual loans and the credits that make up those concentration buckets to see what are the strengths, what are the guarantors and the overall global cash flows of these borrowers so that your risk is reduced from where it was back three or four years ago, when you had some perhaps more higher-risk CRE on the book. So it's a matter of making a shift and looking at the strategies to position that CRE when you do, do it, so it's lower risk and it has more staying power in terms of withstanding economic downturns.

Great. Thank you very much.

(Operator Instructions). Daniel Cardenas, Raymond James.

Good morning, guys. A couple questions, just kind of sticking on the credit quality side. In the press release you mentioned that you saw a decline in loan rating downgrades and an increase in the upgrades. Was that an equal amount of increases and decreases, or was it more heavily weighted towards the increases?

You know, if you look back over the last -- going back to the start of 2011, each month each quarter, we've been encouraged to see that the level of the upgrades has outweighed the level of the downgrades. And we do have downgrades; those are credits that we've been keeping a close eye on that we felt comfortable keeping them off the watchlist. But again, taking a more conservative approach, we tend to lean towards if there is continuing weakness or lack of improvement then we will take a conservative approach and put it on the watchlist.

But those have been very, very few in number compared to the level of upgrades and the level of NPAs coming off the list and out of the bank. So that's been that balance for about the last year and a half now, and we are very encouraged by trends that we have seen so far in 2012 to continue that trend.

Okay. So then the upgrades that you are seeing, is that as much a function of the economy and these guys just becoming better operators, or -- what's kind of the catalyst on these upgrades?

Really it's been across the board. I think you see some customers that are taking advantage of some new opportunities with the improving economy. I think you see some companies that have maybe mitigated their risk with the challenges they face, and so they've improved their operational performance. I think some companies have better positioned themselves in terms of diversity of what they do in terms of their sales of their products they produce, so it's been pretty much a mixed bag of credits across the board, some taking advantage of opportunities presented to them, others benefiting by the economy, others making their own opportunities. So it's been a good -- it's good to see that it's pretty widespread diversity in terms of the reason for the upgrades.

Okay, good, good. And then maybe you mentioned this but I missed it. In terms of the charge-offs that you guys had this quarter, how much of that had specific reserves against it?

Yes, this is Chuck. It's about 55% had specific reserves against it at year-end 2011.

Okay. All right. And then in terms of the comments that were made earlier regarding some of the new client acquisition activity, are these new clients coming from bigger financial institutions, smaller?

In terms of the new business opportunities?

Correct.

It's coming from across the board. I think we are seeing -- as we've mentioned all along, our approach is relationship banking. And I think as our salespeople are out there, meeting with our prospects and talking to their prospective clients, it's a process. And that process in some cases takes a long time by the nature of the relationship that's being considered, by other metrics of the relationship with their existing bank.

But what really sells us at the end of the day is our people can add value to the client. And once the client has a chance to experience that, get to know their loan officer or the treasury salespeople or branch person, they see the things that Mercantile can bring to the table in comparison to their existing bank. And so we are seeing those opportunities come from both big banks and small banks.

And that's really our approach, is to hook up with those types of clients that are interested in that relationship banking and look at their banker as a trusted advisor as opposed to someone who just can offer them low rates on the loan side and high rates on the deposit side.

Okay. And then just last question in terms of pricing, is more of the competition coming then from the larger guys?

Yes, this is Mike, Dan. That's what we are seeing. It's competitive out there across the board, but I think some of the large banks especially are in a pretty big push to show balance sheet growth, and they are out there with some extremely low pricing, LIBOR-based pricing, that we just have dedicated ourselves to the idea that we are not going there.

And we don't need to go there with -- with strong relationship-type client acquisition and strong relationship-type banking. So we've seen a lot of deals where we have just walked away from it because the pricing just doesn't make sense. We've worked really hard to get the margin back to where we wanted it and where it should be, and we are not going back.

Okay, great, thank you. Good quarter, guys.

(Operator Instructions). This concludes our question-and-answer session. I would like to turn the conference back over to Michael Price, President, Chairman and CEO, for any closing remarks.

Thank you, Andrew. Our goals have not changed. And our priorities remain focused on growing our local deposits, shifting our loan portfolio towards more profitable lines of business with a special focus on C&I lending, reducing nonperforming assets and related costs, and maintaining our well-capitalized position.

Our dedicated team here at Mercantile is motivated to build on our success, and we remain convinced our long-standing relationships and proven excellence in community banking will serve us well as we continue on the path of achieving efficient and profitable growth.

Thank you to all of you for joining us this morning, and for your interest in our company. We look forward to talking with you again soon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.