Mercantile Bank Corp (MBWM) 2012 Q4 法說會逐字稿

Good morning, everyone, and welcome to the fourth-quarter and full-year 2012 earnings results conference call. 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 that today's event is being recorded.

At this time, I'd like to turn a conference call over to Ms. Karen Keller. Ms. Keller, please go ahead.

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 fourth quarter and full year 2012.

I am Karen Keller with Lambert Edwards, Mercantile's 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 may differ materially from any forward-looking statements made today due to the important factors described in the Company's latest Securities and Exchange Commission filings. The Company assumes no obligation to update any forward-looking statements made during 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'd 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 today. Also on the call today is our CFO, Chuck Christmas, who will be providing details on our financial results. Chuck will be followed by Chief Operating Officer, Bob Kaminski, who will be commenting on asset quality and other operational successes.

Earlier today, we released our fourth-quarter and 2012 full-year operating results, which not only mark the 15-year anniversary of Mercantile Bank Corporation, but also mark a year full of many successes and key milestones. On the earnings front, we continued our positive momentum by posting another quarter of solid profitability, marking the eighth consecutive profitable quarter for us. Our nonperforming assets continued to decrease significantly, as did the costs associated with managing them. Throughout the year, our net interest margin remained strong.

As our bank grew stronger each quarter, we also achieved some other notable accomplishments. We were among the first community bank to exit entirely from the TARP program by repurchasing our preferred stock and common stock warrant in the second quarter. In the fourth quarter, we reinstated our quarterly cash dividend, which has since been increased from $0.09 to $0.10, as we announced earlier today. It is important to note that these were all completed through the use of internally-generated funds and thus avoided potential common shareholder dilution while maintaining our well-capitalized position.

There is a strong sense that 2012 marked an important turning point for our organization. The challenges of the past several years are substantially behind us, and we have successfully transitioned into a stronger company, with plans for growth. Looking forward to 2013, we are encouraged by the range of opportunities in front of us. The ongoing recovery in the Michigan economy is marked by continuing gains in manufacturing and GDP, growth in employment and personal income and a modest improvement in the housing market. Our strong capital position creates opportunities for us to fully participate in these trends as they play out in the coming year, and our primary focus is returned to building our franchise and helping our community prosper.

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

Thanks, Mike, and good morning to everybody. This morning, we announced net income of $3 million for the fourth quarter of 2012, or $0.35 per diluted share. Our fourth-quarter income before federal income tax was $4.3 million, a 46% increase over the $3 million recorded during the first quarter of 2011.

Our net income during all of 2012 was $11.5 million, or $1.30 per diluted share. Our income before federal income tax was $18.2 million for all of 2012, a 79% increase over the $10.1 million recorded during all of 2011.

We believe a pretax comparison provides a better reflection of our improved operating results in 2012 over those of 2011 due to the year-end 2011 elimination of the evaluation allowance against our net deferred tax asset and the resulting substantial federal income tax benefit we recorded at that time. In addition, we started to record federal income tax expense during the first quarter of 2012.

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 prudent loan portfolio.

The quality of our loan portfolio continues to improve, allowing for a negative provision expense in 2012. In addition, there were further reductions in problem asset administration costs during the year.

Operationally, we have continued to significantly enhance our profitability, strengthen our net interest margin, maintain our strong 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 premiums, as well as the resumption of a quarterly cash dividend on our common shares.

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.

2012 was filled with many successes and milestones, including an improved net interest margin continues to provide support to net interest income that has been negatively impacted by a decline in earning assets. Net interest income during 2012 was $46.7 million or 9% lower than 2011. Average total earning assets declined by about $155 million or 11% during 2012 when compared to 2011. This was partially mitigated by a seven basis point increase in our net interest margin during the comparable period.

The 3.67% net interest margin during 2012 represents a historical high on a calendar year basis. The improvement in our net interest margin is due to a decline in our cost of funds, which has more than offset a decline in our yield on assets. The lower cost of funds primarily results from the maturing of higher-costing 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. The lower level of nonaccrual loans has partially offset the impact of lower yields on our loan 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, one that is well above our historical average. This was completed in conjunction with strengthening in our interest rate risk position over the last five years -- over at least the next five years, especially if interest rates were to increase.

The continued improvement in the quality of our loan portfolio and recoveries of prior-period loan charge-offs have provided for a positive impact on our loan-loss reserve migration calculations -- allowed us to make a negative provision of $3.1 million to the loan-loss reserves during 2012. This compares very favorably to the $6.9 million we expensed during 2011 and the average provision expense during the past four years. Our loan-loss reserve was $28.7 million at year-end 2012, or 2.75% of total loans. Despite the significantly improved condition of our loan portfolio, our loan-loss reserve coverage ratio remains substantially higher than historical averages.

Local deposit and sweep accounts were up $76 million during 2012 and are up $365 million since the end of 2008. With the local deposit growth, combined with a reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by over $1.1 billion since the end of 2008. As a percent of total funds, wholesale funds have declined from 71% at the end of 2008 to 25% at the end of 2012.

Nonperforming asset administration and resolution costs remain elevated, but are on a declining trend. Nonperforming asset costs totaled $5.9 million during 2012 compared to $8.3 million during 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 $1.2 million during 2012 compared to $2.8 million during 2011. The decline primarily reflects a decreased assessment rate due to our improved financial condition and operating performance.

We remain a well-capitalized banking organization. As of December 31, 2012, our Bank's total risk-based capital ratio was 14.7%, and in dollars was approximately $55 million higher than the 10% minimum required to be categorized as well-capitalized. Our efforts to rightsize our balance sheet and improve our operating performance over the last few years have strengthened our regulatory capital position and provided us the ability to repurchase preferred stock and common stock warrants during 2012 without having to access the capital markets or issue debt.

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

Thanks, Chuck, and good morning, everyone. As we reported in the press release, and highlighted by Mike and Chuck, the fourth quarter was a very strong quarter for Mercantile in terms of new client acquisition and continued improvement in asset quality. Throughout 2012, our management team has focused on working with our staff to cultivate new client relationships and further develop existing ones. Those efforts yielded a positive outcome during the fourth quarter, and we are very pleased to report the acquisition of a number of great new client relationships, which resulted in the strongest loan growth of the year.

The Mercantile approach to community banking has continued to resonate very strongly with our client prospects, and we understand that development of true long-term relationships in banking takes some time. In that regard, trust, reliability and a consultative approach to offering advice are all hallmarks of our Mercantile Banking team members. The results of their dedicated efforts are demonstrated in our numbers throughout the year and especially in the fourth quarter.

While total loans increased $6 million during the fourth quarter, that does not tell the complete story. Client acquisition efforts generated approximately $64 million in new loans, mainly in relationships new to the bank. These loans consisted of a good blend of commercial, industrial and commercial real estate borrowings.

We have previously discussed the competitive environment in our markets. It is significant to note in most of these relationships a common theme is that Mercantile was able to obtain the customers' business with a very competitive package, but not typically consisting of the lowest rate offered despite the presence of several other institutions vying for the business. These clients were obtained through hard work and establishing the benefits of value-added community banking that Mercantile can deliver.

Our strong 2012 marketing efforts continued during the fourth quarter. Mercantile was able to garner increased recognition in our communities about our banking philosophy, as well as our carefully designed products and delivery channels. In recognition of the 15th anniversary of the Company's founding, in November and December, we celebrated with a special charitable giving program that recognized the efforts of many fine nonprofit organizations in Michigan. Mercantile's growing use of social media was prominent in the communication of these initiatives with our communities.

In the area of asset quality, our lending personnel were able to generate a significant reduction in nonperforming assets during the fourth quarter. Since September 30, NPAs have been reduced on a net basis by over $10 million. The reduction was driven by principal payments on nonperforming loans of just under $7 million and sale proceeds [of ORE] of $4.9 million.

During 2012, NPAs were reduced by 57% from the 2011 year-end totals. The Bank's watchlist is at its lowest level in nearly five years and loans past due 30 to 89 days remained at virtually zero. Our risk asset group personnel continued to work diligently on loans previously written off, and as a result, we produced a net recovery position of $615,000 in the fourth quarter.

Our loan-loss reserve at December 31 was at a healthy 2.75% of total loans. This reserve level continues to demonstrate our conservative approach to analyzing the risk profile of the portfolio. At the beginning of 2012, our migration lookback period for our reserve methodology was eight quarters. We then moved to a 10-quarter lookback period, and in the fourth quarter, we moved it once again to our current policy of 12 quarters.

In conclusion, as we enter 2013, we feel Mercantile is strongly positioned in terms of our market presence, our operational performance and financial condition to accomplish our strategic objectives. This concludes my prepared remarks. I will now turn it back over to Mike.

Thanks, Bob. And thank you, Chuck, as well. Operator, at this time, we would like to entertain any questions.

(Operator Instructions) Stephen Geyen, Stifel Nicholas.

Good morning, guys, and congratulations on the anniversary.

Thanks, Stephen.

Maybe a question on credit, and I think Bob might have touched on this a little bit. When you moved to the 12-quarter lookback period versus I guess it was 10-quarter before, is that the reason for the provision, that little bit higher provision this quarter versus the release or the provision benefit?

Yes, that is one of the contributing factors. There are a lot of moving parts, as you might imagine, with the loan-loss reserve methodology and calculation. But again, stressing the part that we wanted to take a continued conservative approach to our calculation of our reserve, we felt that to go back and grab two additional quarters on top of the two quarters we went back with in the third quarter, to extend that lookback period was the prudent thing to do. Because of the nature of the recovery and some of the sluggishness that we continue to see in various segments of the economy, both locally and nationally, it was the right thing to do.

And because of that, we expensed a provision of $300,000 during the quarter that had the effect of increasing our reserve percentage.

This is Chuck. If I can amplify Bob's comments. If you go back to the negative provision of $3 million we had in the second quarter, that was primarily driven by two events, obviously very positive events. One was we had a net recovery during that quarter of $1.7 million. And then we also had an impaired loan that had a relatively large specific reserve that we collected, and we were able to eliminate that specific reserve.

So it was really those two, prior-period charge-off recovery and the elimination of a relatively large specific reserve, that really drove that $3 million number. Notwithstanding -- excluding that, you can see that we've been very consistent, and again, echo Bob's comments as to how we've handled the level of the loan-loss reserve and the resulting provision expense.

And the third minor thing -- this is Mike, Steve -- we will all chime in on this, I guess this -- is that we also during the course of the year and certainly during the fourth quarter looked ahead as far as we could to any potential TDR situations for the next year or two. And in any situation where we could or if we identified anything that was potentially that way, we made sure we provided for and anticipated that as well.

So I think all those things you just heard from the three of us really contributed to having a slight provision for the quarter. But the word you can just take away from that is, again, conservative. We've been that way for the last two years, and it is really, really paying off, as you can see in the numbers.

Okay, all right. Great. And you talked a little bit about the current conditions in the market as far as pricing. And maybe just if you could provide some color on maybe the terms and conditions in the market. Are you getting the personal guarantees on the credits that you are adding? I think you had about $64 million in the quarter of new credits.

Yes, that is correct. We are continuing to hold to our knitting as far as the structure, not compromising at all the things we are looking in terms of what we feel is a soundly risk-based structure for credits. There are some of them in the market that are willing to go with some relaxed conditions in terms of structure and -- in those situations -- and we let it pass,. But we were getting both pressures from the structure, but more so from the pricing standpoint at this point.

And then last question, just kind of your outlook for maybe the first half of 2013, as far as potential for growing the loans. You had some run-up -- you talked a little about -- to put it into context, you talked about the commercial real estate runoff in 2013, certainly that had some impact on loan growth. Do you anticipate that to continue into -- or excuse me -- that was 2012. Do you expect to continue into 2013, or is that kind of the restructuring of the loan portfolio mostly complete and we can anticipate a little bit more growth in 2013?

If you look at the makeup of the portfolio, there continue to be some real estate credits that -- be it our choice or the customer finding more attractive terms moving out of the bank. And so you will continue to see some of that, in addition to normal portfolio runoff. But we do have a pretty healthy pipeline still. Obviously, we had some nice bookings in the fourth quarter, but lenders are out there, and continue to develop those relationships. And we've got some nice things teed up for the first quarter, and hopefully for the first half of the year and to the rest of the year as well, certainly.

But it is very competitive out there, and it is hard to predict what the competition may or may not do regarding their appetite for being more aggressive or more willing to cut prices and to go with a more skinny margin structure. That happens, and again, we are holding to our knitting, and we know what types of margins we have to get to contribute to our bottom line and we know what structure we want as well.

And, as the fourth quarter showed, we've been able to serve both of those categories -- profitable loans from our standpoint, well-structured loans, and develop the relationships that customers find value into the things we can offer as a community bank.

Okay. Thank you.

John Barber, KBW.

Good morning, guys. Just had a question on your other expenses. It was down to $2.1 million versus $2.6 million last quarter. Could you just talk about what drove that decline?

There are several things in there. I think with any company, there is various other overhead expenses that we kind of budget and straight-line expense that on an even basis throughout the year. Then as we get into the late third quarter and through the fourth quarter, we start shoring that up in regards to our actual costs will be. And when we looked at some of the things that we were accruing -- a couple things come to mind -- marketing and maybe some training -- we were probably a little too aggressive on our earlier accruals, given how much money that we actually did spend during that period.

So that is what most of that is, is just some timing differences. It is pretty cyclical for us. You kind of see that every year as we go through. And certainly again, like our nature is on all things, we try to be conservative in our accruals during the early parts of the year to make sure we don't get backwards on some of those things as we get towards the end of the year.

Thanks, Chuck. And I know it is early in the quarter, but have you noticed any impact from the expiration of the TAG program?

No, it really wasn't a huge issue. Certainly we've had a lot of conversations -- we've had some -- excuse me -- some conversations with some depositors over the years. But we really didn't see much money moving around from different accounts here and there from the beginning. So as we expected, no significant impact in regards to the TAG going away.

Okay. I know Stephen asked about loan growth. I just had a question on the timing in this fourth quarter. It looked like your average loans were down, but the EOP were up. So were most of the loans that you booked in the fourth quarter booked at the end of the quarter?

Yes, right on. You've got it perfect. The vast majority was booked in December.

Okay. And I guess my last question was just -- a bank in Indiana recently expanded into Michigan; as I'm sure you are aware, they purchased 20 branches from Bank of America. Just wondering if you could comment on how you expect that to impact the competitive landscape in your markets.

Well, John, this is Mike. That particular transaction won't have a lot of impact, because as you said, they were Bank of America purchases. Old National bought Bank of America branches in an area of southwest Michigan really that we don't do a lot in.

But I think it is part of a larger equation that is going on here. I think we are going to see much more in the way of mergers and acquisitions and these types of branch sales and transitions that could significantly impact the competitive landscape. And as has been in the past, typically when there is dislocation in any of the markets we are in, we tend to benefit from it. So we are certainly not fearful of it, but we are aware that '13 might be the year that we've been talking about for a couple of years now, where we see more mergers and acquisitions and transactions like that.

Great. Thanks for taking my questions.

You bet. Thank you.

(Operator Instructions) Daniel Cardenas, Raymond James.

Good morning, guys. A couple questions here. Just kind of given the top-line challenges that we are seeing and some improvement that we saw on the expense side, is there any initiatives that you could talk about that could take place in 2013 in terms of additional cost cuts or cost-saving initiatives?

I'll start with that, and certainly let Chuck and Bob add in on any of the areas that I might miss, because they are significant. But as far as expense reductions, we continue to be very, very optimistic; as we were a year ago about 2012, we are about 2013 as well. Because we saw some great reductions in things like FDIC expense. While that won't certainly be to the level it was, we don't expect any increase along those lines.

But other, more tangible things -- we still see great opportunity for us to reduce bad debt expense. That came down significantly for us in 2012. We see no reason, as you saw the massive reduction in NPAs we had during the fourth quarter especially, but certainly for the whole year, that should trend down fairly significantly. And any of those types of related costs.

You know, we've been very judicious in the years past with salary increases, bonuses and that type of thing. We certainly increased those in 2012, but we don't see the same percentage increase for 2013. So that should be well-managed. And the rest of our expenses, pretty much like the history of this Bank for the 15 years we've been around, whether the times have been good or bad, we expect them to remain very, very well-managed.

Okay. So then as we look at an efficiency ratio for you guys, some good improvement on a sequential quarter basis, and I think you guys were around the 66%. Is that kind of where we should expect you to be, or the mid-60%s here for 2013?

Dan, this is Chuck. I think it really goes -- again, to echo Mike's comments -- really what is going to be the driver of that change in any one degree is going to be the bad debt costs. Like Mike said, we don't expect any major changes in any other line items there. And we think the margin will stay relatively steady, and if we can get a little bit of growth like we think we can on the balance sheet, I would think mid to upper 60%s is probably where we will come in during the year.

Okay. And then relating to the margin, what are the levers you can pull? Obviously, it looks like there still might be some room on the cost of funds side. Is it going to be more just debt reduction that helps you maintain a margin, or what are the factors that --?

Obviously, a lot of moving parts there. I think if we can go with the cost of funds first -- it's probably the easier one -- we still have some additional benefits with our cost of funds. Especially here in the first quarter, we do have a relatively large volume of some higher-costing brokered CDs as well as some local CDs maturing here during the first quarter that we will start getting the benefit of during the quarter and obviously a full benefit in the second quarter.

We certainly continue to look at local deposit rates. They are obviously very, very low already. But we were able to, during the course of 2012 and including -- during the fourth quarter of 2012, we were able to put some further, relatively small, but meaningful reductions in local deposit rates that we will start getting the full benefit of during this quarter. And obviously, we'll continue to take a look at that.

So there is still some ability to lower that cost of funds as we go forward, especially here in the first quarter. Certainly not to the degree that we saw two and three years ago. But we had a 10 basis point reduction. If you take it to average earning assets during the fourth quarter, and it was down seven basis points before that and eight basis points. So I think somewhere in there, we will see over the next couple of quarters.

With regards to the yield on earning assets, we certainly feel pressures with the loan portfolio, as well as the securities portfolio. As I mentioned, the loan portfolio, we are booking some nice credits, some well -- very strong financially. They are deserving some relatively low rates compared to where our average rate is on our portfolio.

We do have some fixed rate loans that will be ballooning that we made three, four and five years ago, that if we elect to renew them will probably be a little bit lower rate than where they are at today. And again, Bob mentioned and talked about the competitive nature out there. And again, just the overall -- we are in a very low interest rate environment. So we will continue to see some pressures on the loan yield.

Securities yields, like everybody else, we are getting occasional calls on the callable portfolio we had to put back to work. And certainly we had to reinvest at lower yields than what is coming off. And, as I mentioned, we've got a mortgage-backed securities portfolio that is earning a very nice rate; that is paying off about $1 million a month. Obviously, we are losing that rate. If we have to reinvest, we are losing 150 to 200 basis points on that portfolio.

The good news is, as you saw in some of our numbers probably, we had a relatively high level of Fed funds sold during the quarter. We had, as we mentioned and as you saw, very, very strong deposit growth during the quarter. And while we were able to grow net -- we were able to grow loans on a net basis, as we already talked about, most of that growth did come during the late part of that quarter.

So average Fed funds sold where pretty high, probably about almost $120 million. We see that coming down already; we would expect that to continue to come down throughout the quarter. As I mentioned, we've got a relatively high volume of brokered deposits that are maturing, and we are obviously just letting those funds go.

So what we are hoping is that the decline in average Fed funds sold balance and the positive impact that will have on the yield on earning assets will help offset some of the pressures that we see and that I just talked about on the loan and securities portfolio. But longer-term, we are hopeful that we can keep the cost of funds reduction up to the level that we see any pressures on the yield on earning assets and maintain a relatively steady net interest margin, at least for this year.

As I mentioned in my comments, we are not afraid of and have been using derivatives products that can have a negative impact on a short-term basis. That is something that we are evaluating on a regular basis, and obviously, if we like to do some more of that, that could have a negative impact on the short-term margin. But again, we are not looking to short-term. We are trying to manage that long-term, as well.

Okay, good. And then just one quick question. I know you guys' loan growth is tepid at best. Your capital levels are getting stronger. We've seen a little bit of M&A activity in 2012. Would you guys be willing to participate in that or are you still kind of focused more on capturing organic growth?

That's a good question, Dan. We get asked that a lot. We clearly are seeing more activity in the M&A area than we've seen in a long, long time, and I think it is healthy for the industry.

One of the things that we've said consistently and we stick to that statement is that we clearly make it well-known that our number one goal is always organic growth. But we are very happy that if the right M&A activity came along, we certainly would be well-poised to consider it. And so as we've said throughout our 15 years, we are always open to those types of situations. And because we've done, we think, a pretty darn good job of getting our balance sheet and income statement back in order, we are well-poised to take advantage of any of those opportunities that might come our way in 2013.

Great. Thanks. Good quarter, guys.

Thank you, Dan.

At this time, I am showing no additional questions. I'd like to turn the conference call back over to Mr. Price for any closing remarks.

Thank you very much. We have accomplished much in our first 15 years, and although our team is justifiably proud of those achievements, we look forward to more and loftier milestones in the next 15 years. Our dedicated team 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 for joining us this morning and for your interest in our Company. We look forward to talking with you again after our first-quarter results. At this time, that finishes the call.

Ladies and gentlemen, the conference call has now concluded. We thank you for attending today's presentation. You may now disconnect your telephone lines.