Mercantile Bank Corp (MBWM) 2012 Q3 法說會逐字稿

Good day, and welcome to the Mercantile Bank Corporation third-quarter 2012 earnings results conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Karen Keller. Ms. Keller, the floor is yours, ma'am.

Thank you, Mike. 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 third quarter of 2012. I'm Karen Keller with Lambert, Edwards, Mercantile's investor relations firm.

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 the 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 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'd like to turn the call over to Mercantile's CEO, Mike Price. Mike?

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

On the call today are Chief Financial Officer Chuck Christmas, who will provide details on our financial results, followed by Chief Operating Officer Bob Kaminski commenting on asset quality and other operational successes for the quarter.

I trust you have all had a chance to review the announcement of our quarterly results, which, we are pleased to announce, marks our seventh consecutive quarter of profitability. As our bank grows stronger each quarter, we continue to achieve key successes along the way. Net profit continues to increase. Net margins remain strong. There is a continued contraction of our problem assets, and our regulatory capital ratios remain significantly above minimum requirements for well-capitalized institutions.

It's because of this enhanced capital structure and profitability that we were able to announce another key milestone for Mercantile earlier today. This, of course, is our Board of Directors' approval to reinstate a quarterly dividend at $0.09 per common share, which represents a current yield of approximately 2% and is the first dividend paid since a reduced dividend of $0.01 per common share was paid in the first quarter of 2010.

Over the course of the financial downturn, our team worked diligently to protect the value of the Company for our shareholders, and we are pleased to be able to reward you for your loyalty through that difficult time. The resumption of the cash dividend represents another avenue for Mercantile to enhance shareholder return. This is extremely gratifying for the Mercantile team and illustrates the confidence shared by our Board and management in Mercantile's future.

As I mentioned earlier, the Company's continued aggressive approach to resolving our problem assets is producing meaningful declines in our nonperforming loans and other real estate, and delivering coverage ratios that are above those of our peer group. Additionally, the level of loans in our 30- to 89-day delinquent category has remained at virtually zero for well over a year now. There remain some additional costs associated with the remaining nonperforming assets, but we can't help but be pleased with our progress thus far.

As we look forward, we are well positioned to build on these successes. Our markets are competitive, but despite persistent competitive pricing pressures and economic uncertainty, our sales efforts and marketing initiatives, combined with the depth and strength of our knowledgeable calling officers, are allowing us to compete with success against other banks in our markets. This is evidenced by growth in deposits and loan originations, which Bob will touch upon later.

At a community bank, we are a partner with our customers in growing their businesses, and they know that they can rely on us to be a resource in the local market. I'd like to reiterate that business fundamentals remain strong, and as we continue the execution of our business plan, we expect to continue to grow our Company for the long term.

At this time, I'm going to turn it over to Chuck.

Thanks, Mike, and good morning, everybody.

This morning, we announced net income of $2.6 million for the third quarter of 2012, a decline of less than $100,000 from the $2.7 million earned during the third quarter of last year. However, our third-quarter 2012 income before federal income tax expense was $3.9 million, a 28% increase over the $3 million recorded during the third quarter of 2011.

Our net income during the first nine months of this year was $8.5 million, a 37% increase over the $6.2 million earned during the first nine months of 2011, while our income before federal income tax expense during the first nine months of this year was $13.9 million, a 93% increase over the $7.2 million recorded during that same time period in 2011.

The shift in comparison from net results to pretax results is due to the elimination of the valuation allowance against our net deferred tax asset at year-end 2011; thus, starting with the first quarter of this year, we are recording federal income tax expense.

Our 2012 operating results reflect continued improvements in many key areas of our financial condition and operating performance, and are a direct result of the 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 pruned loan portfolio.

The quality of our loan portfolio continues to improve, allowing for a negative provision expense for the second consecutive quarter. In addition, while still elevated, there were further reductions in problem asset administration costs.

Operationally, we have continued to significantly enhance our profitability, strengthen our net interest margin, improve our regulatory capital ratios, and enhance our liquidity position through local deposit growth and 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 well as the reinstatement of a quarterly cash dividend, announced earlier today.

As we said during the second quarter, our improved financial condition and operating performance also provided us the opportunity to repurchase all the preferred stock that we had sold to the Department of Treasury in May of 2009 under the Treasury's capital purchase program as part of TARP. In addition, in early July we repurchased the warrant sold to the Treasury as part of the preferred stock sale transaction. The repurchases were funded via cash dividends from our bank, and although the repurchases did negatively impact our regulatory capital ratios, our ratios remain higher than they were a year ago and our overall capital position is strong.

Given these fundamental improvements and despite economic and regulatory headwinds that continue to face our industry and the economy, we believe we are very well positioned to succeed as a strong community bank and to take advantage of lending and market opportunities.

During the third quarter of 2012, we saw the continuation of many positive trends. An improved net interest margin continues to provide support to net interest income that is being negatively impacted by a decline in earning assets. Net interest income during the third quarter of 2012 was $11.6 million, or 6% lower than the third quarter of last year. Average total earning assets declined by about $145 million, or 10%, during the third quarter of 2012 when compared to the third quarter of 2011, which was partially mitigated by a 17 basis-point increase in our net interest margin during the comparable period.

Our net interest margin during the first nine months of 2012 is nine basis points higher than during the same time period in 2011. The improvement in our net interest margin is 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-costing certificates of deposit and borrowed funds and 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. The lower level of nonaccrual loans has partially offset the impact of lower yields on our portfolio.

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 and have 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 maintain a relatively steady net interest margin over the past several quarters that is well above our historical average, 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 during that time period.

The continued improvement in the quality of our loan portfolio, which provided for a positive impact in our loan-loss reserve migration calculations, allowed us to make a negative provision of $0.4 million to the loan-loss reserve during the third quarter of this year. This compares very favorably to the $1.1 million we expensed during the third quarter of last year and the average quarterly provision amount during the past four years. Our loan-loss reserve was $27.8 million at the end of the third quarter, or 2.68% 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 sweep accounts were up $37 million during the third quarter of 2012 and are up $322 million since the end of 2008. With that local deposit growth, combined with the reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by about $1.1 billion since the end of 2008, including a reduction of $28 million during the third quarter of this year. As a percent of total funds, wholesale funds have declined from 71% at the end of 2008 to 26% at the end of the third quarter.

Nonperforming asset administration resolution costs remain elevated. Nonperforming asset costs totaled $1.6 million during the third quarter of this year, unchanged from the amount expensed during the third quarter of last year. However, during the first nine months of this year these costs have totaled $4.9 million, compared to $6.6 million during the same time period in 2011. We expect further 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 third quarter of 2012, a significant reduction from the $0.6 million expensed during the third quarter of last year, with a $1.4 million reduction during the first nine months of 2012 when compared to the first nine months of 2011. The decline during both time periods primarily reflects a decreased assessment rate due to our improved financial condition and operating performance.

We remain a well-capitalized banking organization. As of September 30, 2012, our bank's total risk-based capital ratio was 14.5%, and in dollars was approximately $53 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 over the last few years has strengthened our regulatory capital position and provided us the ability to repurchase the preferred stock and warrant during the past two quarters without having to access the capital markets or issue debt.

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

Thanks, Chuck, and good morning, everyone.

The major themes for the loan portfolio in the third quarter were continued improvement in asset quality and an intense focus on new client acquisition.

While the loan portfolio showed a decline of $26 million, or about 2% of total assets, from June 30, that statistic does not fully tell the story. Mercantile lenders and commercial sales staff continue to work persistently on building relationships and identifying new loan opportunities. These efforts have resulted in $41 million of both loans to new customers and increases in loans to existing customers during the quarter.

Despite this new loan volume, the portfolio declined primarily due to some larger commercial real estate loans moving out of the bank. Some of this movement was planned pruning of higher-risk and/or lower-yielding loans. Some was caused by commercial projects moving to secondary-market financing sources. Others are moved due to the utilization of cash reserves in the form of payouts. And finally, there were some instances where we saw some very aggressive pricing by our competitors.

While commercial real estate outstandings dropped, C&I lending in the form of utilization of credit lines and new term loans were up a net $6 million in the third quarter. The new credit pipeline remained strong in terms of accepted commitments waiting to be funded, as well as discussions in process with potential new customers.

We are pleased to report continued improvement in our asset quality with a net reduction of over $4.1 million, or 10.3%, in nonperforming assets during the third quarter. The NPA reduction was comprised of principal payments of $1.2 million, sale proceeds and other real estate owned of $1.2 million, loan charge-offs of $1 million, and valuation write-downs of $0.8 million. There were only $0.2 million in loans added to the NPA list in the third quarter.

Net loan charge-offs were $1.5 million during the third quarter and $5.4 million year to date in 2012. The majority of the charge-offs for the quarter and the year were attributable to the non-owner-occupied commercial real estate category.

As an additional note, nearly 90% of the loan charge-offs incurred during the third quarter were reserves specifically allocated at the end of the prior quarter.

Lastly, 30- to 89-day delinquencies continued at negligible levels with only 23,000 in that category at quarter end.

As part of our efforts to grow our balance sheet and our client base, we continue to provide our sales staff with the best array of resources and tools possible. This includes ongoing sales training to our staff to ensure that they are individually prepared to provide the optimal match of Mercantile products to the needs of the client. Additionally, we will continue our commitment to pursue new marketing initiatives to help communicate our relationship banking philosophy, as well as work to develop innovative products and services to the markets we serve.

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

Thanks, Bob. Operator, at this point we would like to open the meeting up to questions.

(Operator Instructions). Stephen Geyen, Stifel Nicolaus.

Hey, good morning, guys.

Good morning.

Bob, you mentioned a couple of different factors that were going into changes in the loan portfolio, one of them being aggressive pricing by competitors. I'm just curious. Is that something that's kind of pervasive, or is it still kind of a one-off where somebody really wants a credit and they're just willing to just really pay up for it?

You know, in situations where you see a little bit of both, it goes in various patterns with particular institutions showing a very aggressive tendency with respect to -- and a variety of types of credits, and then you see someone else popping up and offering very aggressive packages to credits that we would just as soon maybe exit the institution from our bank.

So it's fairly widespread, but there are a couple of players that are showing particularly aggressive tendencies that are really making it challenging from the standpoint of new client acquisition.

But as we talked about many times in the past, our philosophy of relationship banking and the approach we take of value added to the customer is one that we are intent on sticking to, and it definitely resonates with the people we're talking with. And while they're certainly listening to the aggressive pricing that are out there, I think we definitely are getting our victories with clients who are interested in relationship banking with an institution that's in it for the long run and takes that approach in a very consistent basis.

Okay, and regarding the reserves, just curious about the percent of specific reserves versus general reserves?

Yes.

(Multiple speakers) the amount and the percentage?

Yes, Stephen, I don't have that number with me, but I can certainly provide that to you.

Okay. And maybe just a general question, just curious, are NPAs -- regarding the specific reserves, are they pretty much driven by NPAs or would that be including TDRs, or how do you look at that?

Yes, that's a very good point. You know, we used to carry about -- of our reserve, about 15% of the reserve, on average, 15% to 20% was specific reserves. But with the new accounting guidance, obviously, that's been with us for over a year now, or just about a year now, specific reserves have certainly increased quite a bit in relation to TDRs. So, I'll be able to provide that breakdown to you how much is TDRs, how much is nonaccrual, specifically.

Okay, sounds good. And Chuck, maybe just one last question for you. How long do you think he can defend the margin, given, I guess, maybe the changes in the assets and what you're doing with the loan portfolio with hedging and changes in the deposits?

Yes, I think overall we feel pretty good about where we're at and what we've done and how we continue to manage the bank going forward.

Clearly, there's going to be continued pressures on the asset yield, both in the securities portfolio as well as the loan portfolio. I'm sure, like many banks, we continue to have a tremendous amount of liquidity, for us mostly sitting in Fed funds sold and which obviously has a negative impact. So we continue to try to manage that Federal funds sold position as best we can. Obviously, we're out there trying to gain new deposit relationships.

So we think over the long haul, especially if we can start seeing some successes with our sales efforts that Bob touched on, hopefully we can put a lot of that Fed funds sold into loans, which certainly would help offset any just natural pressure that we're seeing in the loan portfolio and the securities portfolio related to just the relatively low interest-rate environment and as well as the competition in the loan portfolio.

We certainly see continued reductions of cost of funds. They are certainly not the reductions that we saw even a year ago or certainly two or three years ago, but our cost of funds were down another seven basis points in the third quarter and we think that there's further reductions to be had.

So I think, overall, obviously a lot depends as we go forward, as you know. I wouldn't be surprised to see some contraction in our margin as we go forward over the next few quarters, but I don't think it will be anything very, very significant. And again, we continue to have our long-range glasses on as well. You know, the match funding, the derivatives that I already mentioned, we think, are a very important part of managing that margin as well, which, again, can have and usually do have a -- when rates don't rise, and that obviously is what we are trying to protect against, can have a negative short-term impact on net margin as well. But we could easily drive up our margin quite aggressively and just watch that go away when interest rates do rise, so we certainly take a long-term approach to that as well.

So yes, there is going to be some compression; don't think it's going to be anything terribly significant.

Great, thanks for the color.

John Barber, KBW.

Good morning, guys.

Good morning, John.

Could you just talk about what drove the decline in the average share count this quarter versus last quarter?

Yes, it's the repurchase of the warrant from the Treasury Department that we completed on July 3, and obviously as we were going through our dilution calculations and as that warrant got into the money, that was having a larger and larger impact on our average diluted shares outstanding, but obviously for the quarter it was only outstanding for two days.

Okay, thanks, Chuck. In terms of the dividend, do you have a target payout ratio?

It's not something we really set up as a target. This is Mike.

We basically every quarter kind of go through with the Board analyzing, obviously, our capital position, what kind of yield, the payout ratio opportunities, and kind of -- not kind of, I should say specifically target what we think is an appropriate dividend. So we really wouldn't feel comfortable nor would it be accurate to say, hey, we have a targeted payout ratio at this point, but we're certainly very happy to get $0.09 a share out there to our shareholders.

Thanks, Mike. And just in terms of how much -- how much cash do you have at the holding company right now?

We average about $0.5 million, John. And you know, which provides us very sufficiently with day-to-day operations, and we have a trust of preferred payment coming up later this week.

But certainly, we don't have any concerns with getting the bank to pay cash dividends as needed at the parent company. There's certainly no restrictions. There's state law restrictions, but that provides for millions upon millions of dollars for capital to go from the bank to the parent company.

So we don't have a need to keep a tremendous amount at the parent company. We turn right around. The parent company has a deposit account at the bank, so it really doesn't go anywhere. So we just manage to have primarily on a quarter-to-quarter basis, looking at what required payments there will be up -- in the upcoming quarter, reimbursements for the bank for certain expenses, that type of thing, and dividend generally once a quarter to take care of that. And that's the way we've always done it.

Okay. And then, switching gears a little bit, I think in the press release you said you had $20 million of loans originated this quarter. Were there any particular portfolios that drove that growth?

No, the -- a lot of the growth that we saw came from a couple different sources. It came from -- actually, it came from several different sources. It came from new utilization of lines of credit by C&I customers, some new term loans to C&I customers, and also some redeployment of those commercial real estate dollars into new owner-occupied CRE projects.

So we talked about in the release and in my commentary it's a repositioning of the movement of some credit out of the non-owner-occupied commercial real estate buckets into C&I and into owner-occupied commercial real estate.

Thanks, Bob. And last one, just on the margin, as Stephen already asked you. But do you know, ballpark, the level of maturities of CDs you have in the fourth quarter, maybe what rates they're rolling off? And also, I think you have $10 million of FHLB advances maturing in 2013, just the timing of that maturity?

Yes, as far as the fourth quarter we don't have a very significant dollar amount maturing on the wholesale side, maybe $10 million to $12 million.

The reinvestment rate on that or the reduction of cost of funds is pretty significant on a rate standpoint, but certainly not a lot of dollars. That goes up quite a bit in the first quarter. I think we probably have about, I'm just off the top of my head, probably about $35 million to $40 million maturing with some pretty aggressive rates there as well, so certainly looking to take advantage of that.

In regards to the $15 million in FHLB advances, $10 million of that was scheduled to mature in December of 2013, another $5 million in January 2014. We actually took care of that in late in the third quarter; you'll see this in our 10-Q filing. We went ahead and renegotiated those two advances for $15 million with the FHLB and extended that maturity out five years.

So I forgot what the average rate was on those, but I think the new rate was about 1.5%. And so, I think it was about half the rate that we were paying on those, and we were able to push out those maturities out to five years, which again reflects our continued goal of trying to match fund fixed-rate commercial loans.

Thanks for the color and thanks for taking my questions.

Daniel Cardenas, Raymond James.

Good morning, guys.

Good morning, Dan.

A quick question on the loan side. I mean, you said you were seeing some aggressive pricing. Is that primarily from larger institutions or is that more from your community bank peers?

It's really from larger institutions, though occasionally you see some of the smaller, more local institutions getting aggressive on a creditor or two in particular. But it is coming from primarily the larger and regional institutions.

Okay, okay, sounds fair. And then, in terms of the Citizens Republic acquisition, are you starting to see any benefit from that? And then also, maybe if you could speak, are there any opportunities for you to acquire talent as a result of the acquisition?

Hi, Dan. This is Mike. You know, we have very little overlap. Citizens wasn't very active in west Michigan, so we haven't seen anything from a direct benefit from that.

It's probably too early to tell as far as talent acquisition goes, although I would probably venture to say we won't see a lot of benefit from that, either mainly because the talent we're always looking for is talent that is especially familiar with west and central Michigan. We may get some -- maybe some benefit from our Lansing area, but we'd have to -- we have to check it out. But it's been a little too early for us to tell, but we'll certainly keep our antenna out.

Okay, fair enough. And then, as you look at the pipelines as they stand right now, is it more C&I in nature, commercial? I mean, what's the mix look like?

Certainly our biggest drive right now is to acquire new C&I-type clients. But if you look through the pipeline, you see a variety of potential credit in there, a lot of C&I, some owner-occupied commercial real estate. We're having some good opportunities there, and also some non-owner-occupied commercial real estate that is of the metrics that are attractive to us in terms of we're building our growth mode and our portfolio.

So, we're looking for certain credit metrics to make sure they fit our template these days, and obviously at a price of the structure that we desire. So we're taking an approach that is a very measured approach, but one that is consisted of clients that fit our banking model.

Okay. And then just quickly on the margin, could you give us the yield on the loan portfolio this quarter?

You know, let me get back to you on that, Dan, because I don't think I have it quite handy here.

Okay, great. Thanks, guys.

(Operator Instructions). Ross Haberman, Haberman Management.

Good morning, gentlemen. How are you? Quick question for Mike Price. Could you touch upon loan demand in general? What sectors of your market are you seeing the best, as well as the least, and do you expect any net loan growth for this calendar year?

Yes, thanks, Ross. Be glad to answer that. We are seeing a much better loan demand now that we've seen in quite some time, I would say probably three or four years, and that goes into not only quantity, but quality as well.

We're seeing some real good demand from the medical side of things. We've had a lot of growth in the medical industry here in Grand Rapids in west Michigan. But we've also seen some pretty varied and across the board on C&I, seeing some nice additional opportunities there as well.

There's a lot of demand for non-owner-occupied commercial real estate, and that's because not many people in the industry, not many organizations and financial institutions, are financing that these days, for obvious reasons. And obviously, we've stepped away from that as well.

So we've got some really nice opportunities out there, and I think Bob has mentioned a few times, you know, we really are -- we're really sticking to our discipline that we got away from a few years ago, along with the rest of the industry, and that is basically if it's not priced right and it's not based upon the relationship and what we can bring as a very strong, what good-sized community bank, we're going to let it walk. And unfortunately, we're seeing some of our larger competitors just saying we don't care what the yield is, we're just going to go in with some absurdly low rate, and we're just getting back to saying, you know, that's just not us.

Now to your final question, will we have net loan growth for the year? Probably not, because we're below zero as far as growth goes through three quarters. Could we have positive growth for the fourth quarter? That's still a possibility. We've got some real good stuff queued up to be booked this quarter, and we'd like to think that we could probably show maybe a small bit of loan growth for the quarter.

But we're really aiming toward 2013 as what we're seeing out there as far as some good opportunities, and we're excited about what we see for the first part of 2013.

Thanks, guys. The best of luck.

Thank you.

(Operator Instructions). Ms. Keller, gentlemen, it appears we have no further questions at this time.

Okay, thank you very much, Mike.

In closing, I'd like to reiterate that our goals remain consistent and our priorities are focused on continuing the profitable growth of our bank, especially our loan portfolio with a focus on C&I business. We want to continue to grow local deposits in much the same very successful manner that we have over the last couple of years.

Protecting the strength of our net interest margin continues to be a top goal of ours. We're very happy with how we, as someone just earlier said, defended that margin. It's hard to defend, but we continue to do it through good discipline and good management.

We want to continue to reduce nonperforming assets and related costs. Clearly anyone that follows our bank has seen a significant reduction in nonperforming assets, and we continue to have that high on our list of things to do. Playing a key role in the economic development of the communities we serve remains important, and certainly maintaining our very strong and well-capitalized position.

We are motivated and dedicated towards continuing our organization along a path of efficient and profitable growth. We remain convinced our long-standing relationships and proven excellence at commodity banking will serve us well in accomplishing this.

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

And we thank you, sir, and to the rest of management for your time. The conference is now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you and have a great day.

Thank you.