Mercantile Bank Corp (MBWM) 2014 Q3 法說會逐字稿

Good morning and welcome to the Mercantile Bank Corporation third quarter 2014 earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Mr. Robert Burton with Lambert Edwards.

Thank you Gary. Good morning everyone. Thank you for joining webcast to discuss financial results for the third quarter of 2014. Joining me are members of management team including Michael Price, President and Chief Executive Officer; Robert Kaminski, Chief Operating Officer; Chuck Christmas, Chief Financial Officer; Sam Stone, Executive Vice President.

We will begin with management's prepared remarks and then open the call 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 plans and objectives of the Company's business.

The Company's actual results could differ materially from any forward-looking statements made today due to the important factors described in the Company's latest Securities and Exchange Commission 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 www.mercbank.com. At this time, I would like to turn the call over to Mercantile's President and Chief Executive Officer, Mike Price. Mike.

Thank you, Bob. Good morning everyone and thank you for joining us to discuss our results for Mercantile Bank Corporation. On the call, Chuck Christmas, will provide details on financial results followed by COO Robert Kaminski, with his comments with regard to loan growth and continuing excellent asset quality.

EVP Sam Stone is also on the call with us today. We remain confident that the assumptions and projects earn back rate of return, merger-related expenses cost save provided when we announced the America merger remain achievable.

I am pleased to report that the transition is going exceptionally well and as an important example operating systems successfully. While we are only three months into a 12-month process, we are very pleased with the progress to date and our initial expectations for merging savings and cost opportunities are being realized on schedule. Over a longer term, we are confident in the direction of economic recovery, as evidenced by the third consecutive quarter of healthy economic-employment gains in our west Michigan markets.

Our business goals remain consistent. We expect to grow market share as a combined franchise that's positioned for long-term growth with the size and scale that compete very effectively in our markets.

We will capitalize our geographically diverse and attractively mixed loan portfolio coupled with balanced core funding that positions the bank for continued expansion. We believe we are well-positioned in the marketplace with our continued strong emphasis on value-added relationship-based banking.

Our continued goal is to deliver effective use of our strong capital position to enhance both profitability and shareholder value. We expect to provide strong attributable returns through both price appreciation and cash dividend policy that balances cash returns with growth opportunities.

We'll continue do this while remaining focused on building our franchise and helping the communities we serve to prosper. Thanks for your attention. At this time, I would like to turn it over to Chuck.

Thanks Mike. Good morning everybody. As you saw this morning, we announced net income of $5.9 million for the third quarter. And net income of $11 million during the first nine months of this year.

On a diluted earnings per share basis, we earned $0.35 per share during third quarter and $1.36 per share during the first nine months of the year. Our third quarter and year-to-date earnings results have been significantly affected by the merger with Firstbank Corporation, which was consummated effective June 1.

In addition to our earnings results which tucked in four months of operation as a combined organization, we recorded relatively large merger-related costs during the first nine months of this year. Merger-related costs totaled $1.3 million during the third quarter and $5.1 million during the first nine months of 2014.

On an after-tax basis that equates to $0.9 million, or $0.05 per average diluted share during third quarter and $3.6 million, or $0.29 per average diluted share during the first nine months of the year. We do expect to expense further merger-related costs totaling approximately $0.4 million during the fourth quarter and then nominal amounts during the first and second quarters of 2015.

As Mike noted in his opening comments, we believe total merger-related costs will approximate projections made at the time of the merger announcement. In addition, we are now starting to realize cost savings resulting from the merger which we also expect to approximate our projections made at the time of the announcement.

The quality of our loan portfolio remains strong, which when combined with recoveries of prior loan charge-offs, continues to provide for negative provision expense to loan loss reserve. In addition, the level of problem asset administration costs remain low.

Nonperforming assets have declined over 92% since the peak level at March 31, 2010, and are currently at their lowest dollar volume since year-end 2006. We are very pleased with our financial condition and believe we are very well-positioned to take advantage of lending and market opportunities and to deliver success as a strong community bank for our shareholders.

Highlights for the past quarter include our net interest margin was 3.95% during the third quarter, a 32 basis point improvement from the second quarter and a 53 basis point improvement from the first quarter. Our yield on earning assets increased 9 basis points during third quarter when compared to the second quarter, primarily subsequent discount accretion record of legacy Firstbank's loan portfolio per purchase loan accounting rules.

We have created a total of $1.3 million during the third quarter with about $0.2 million of that being accelerated due to pay-offs. Our cost of funds declined 24 basis points during the third quarter when compared to the second quarter, following a 10 basis point decline during the second quarter when compared to the first quarter.

A vast majority of decline and the cost of funds during the past two quarters reflects our June 1 merger with Firstbank. We expect our net interest margin to remain relatively steady over the next few quarters.

While the ongoing very low interest rate environment continues to exert compression pressures on our net interest margin, we expect to use cash flows from monthly pay downs on lower yielding mortgage-backed securities and periodic maturities, and calls on lower-yielding yields government agency and municipal bonds, to fund expected loan growths for the remainder of this year and into 2015. A level of this kind of accretion recorded on legacy Firstbank's loan portfolio may cause some volatility in our quarterly net interest margin calculations.

The ongoing improvement in the quality of our loan portfolio, combined with recoveries of prior period loan charge-offs, and the eliminations of and reductions in specific reserves, have produced a positive impact on our loan loss reserve calculation and allowed us to make negative provisions in seven consecutive quarters and in nine out of the last ten quarters. We recorded a negative provision expense of $0.4 million during the third quarter and $3 million during the first nine months of this year.

Gross loan charge-offs are in the first nine months of 2014 totaled $0.3 million; excess was third quarter compared to recoveries of prior period charge-offs totaling $0.2 million. While we did record a very small net loan charge-off for the third quarter, we had recorded a net loan recovery during the previous five consecutive quarters and during seven out of the last ten quarters.

Our loan loss reserve was $20.4 million at the end of the third quarter, or 1.72% of total originated loans. Despite the significantly improved condition of our loan portfolio and reduction of the loan loss reserve in terms of dollars and as percentage of total originated loans, our loan loss reserve coverage ratio [remains substantially] higher than historical averages.

New term loan originations totaled approximately $47 million during third quarter, bringing the total up to $168 million during the first nine months of this year. The new loan pipeline remains very strong. In fact, we have already closed about $20 million in new term loans since September 30.

In addition, we have over $140 million in unfunded commitment on commercial construction and development loans that are in the construction phase and expect to be funded in the next 12 to 18 months.

The loan portfolio is well-diversified. At the end of the third quarter, commercial real estate non-owner occupied loans comprised 28% of total loans, commercial and industrial loans equaled 26%, commercial real estate owner occupied loans were 20%, and residential mortgage and consumer loans aggregated 18% of total loans. As a percent of total commercial loans, commercial industrial loans and commercial real estate owner occupied loans equals 57% at quarter end.

Our funding structure is also well diversified. As of September 30, we had a very well-diversified funding mix with noninterest bearing checking accounts comprising 22% of total funds, interest checking and sweep accounts combining for 22%, savings and money market accounts combining for 23%, and local time deposits also accounting for 23%.

Post-sale funds consisting of broker deposits and FHLB advances represented 10% of total funds at quarter end. We remain a well-capitalized banking organization. As of September 30, our bank's total risk-based capital ratio was 14% and in dollars, was approximately $93 million higher than the 10% minimum required to be categorized as well-capitalized.

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

Thanks Chuck and good morning. As we have discussed in previous conference calls, the nature of our loan portfolio tends to create some uneven patterns of growth. While the second quarter witnessed significant growth in the commercial portfolio, third quarter finished with portfolio totals that were basically level with the previous quarter.

The timing of loan closings and advances continues to be a cause of the swings in growth rates for 2014. For the third quarter, we had over $47 million in new loans to new and existing customers.

Relationship building and new commercial activities that are taking place in all of our markets and we continue to enjoy new opportunities in commercial and industrial enterprises and commercial real estate projects.

The pipeline remains very healthy and additionally, mercantile has approximately $148 million in unfunded construction and development commitments that will be coming on the books over the next 12 to 18 months. We anticipate steady overall growth when viewed by measurements greater than any single quarter.

The internal phase of the integration process continues as most facets of the merger that directly impact customers are now complete. Mercantile staff members are implementing and adjusting to the plans developed by the transition teams.

Our employers are working extremely hard to maintain an environment of best-in-class sales and service for customers and prospects, while balancing the risk management practices that are appropriate for a $3 billion Company. The staff remains energized about the opportunities to offer new products and services to all of our markets in the merged Company.

Asset quality remains strong with net loan charge-offs of $82,000 for the third quarter and recovery position of $553,000 per year to date 2014. The reserve was 1.72% of total loans and originated portfolio at September 30. The portfolio continues to be in good balance between C&I and owner occupied commercial real estate with non-owner occupied commercial real estate.

So in summary, with the third quarter complete, we feel we are well-positioned to continue on with our integration work and relationship development activities with our customers and prospects that have a strong finish to 2014.

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

Thank you Bob and also, thank you Chuck for your comments. Gary, at this time, we'd like to open our conference up for callers for their questions.

We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from Matthew Forgotson of Sandler O'Neill & Partners. Please go ahead.

Good morning. Am I coming through?

Yes you are.

Hi. Okay.

Just a quick question on the purchase accounting accretion this quarter. Can you give us a sense of what the balance was at September 30? I think it was $10.6 million at June 30.

Yes, Matt, I don't have that with me so I will get that to you offline.

Okay. And just in terms of how long the purchase accounting accretion should contribute to the margin, what are your renewed expectations in light of the pullback in long-term rates?

Yes. We'll have to see -- obviously, it's been a crazy couple weeks with the interest rate environment and we'll obviously see where that goes over time. Certainly not enough time right now to get an idea of how that's going to impact not only the purchase portfolio but even our originated portfolio as well. So far we haven't really seen any major impacts there.

We have been expecting that the accretion will primarily be run into our earnings stream over the next primarily three to four years is where we'll see that. Obviously, it's a little bit front loaded as we use level yield, but over a three year, four year period of time, we would see that most of that accretive back into income, obviously reflective of the payments we receive.

Okay. And then as far as expenses are concerned, I guess first, was there anything non-core or lumpy in the expense base this quarter? And can you give us a sense of the overall expense trajectory, say, over the course of the next 12 months, your expectations?

No, the only thing we have obviously highlighted; that was our merger-related costs. And again, we expect about $400,000 here in the first quarter and then just a nominal amount in the first couple quarters of 2015. Excluding that merger-related number, you look at the other numbers, I think that they're pretty well core numbers and a good base for going forward.

Okay, so you think operating census, can it build softly off this level or do you think that they trend down a little bit as the cost savings fall out of the model?

I think that we're just now starting to get the cost saves in there and that's a very good point. We got some of them certainly in the third quarter but the fourth quarter will be the first full quarter that those cost saves will start being realized.

Again, some of those cost saves are based on reduction and professional fees such as legal fees, accounting fees, especially having two publicly traded companies come in. There are definitely going to be some cost savings there but again, we accrue that over a 12-month period of time.

So obviously, we've already adjusted our accrual. So if you try to get to that $5.5 million cost saves number which we think is still accurate, a good approximation, it's going to take some time to get that fully through a 12-month period of time in our income statement.

Okay, and then just lastly, and then I'll hop out. Reserve coverage, as you point out, very strong 172 basis points of originated loans. I guess the question is, how much more negative provisioning should we expect assuming that credit profile holds?

Obviously, that's the million dollar question when it comes to trying to figure out where reserves should be and then obviously plugging in your provision number to get you there. Certainly as you have seen while we're still doing it, I have mentioned still doing negative provisions. Certainly the balance of that or the dollar amount of that negative provision has been coming down and notwithstanding any significant large recoveries.

And I can assure you that we are still working on our charge-offs, notwithstanding anything larger or unusual coming through. It would seem that the provision expense is going to be near zero over future quarters.

But again, a lot that goes into that not only including our originated loans obviously any significant loan growth will take some provision and of course, our recovery experience that we've got. So my crystal ball says what we saw in the third quarter is probably reflective of what we'll see over the next of couple quarters, much closer to zero as we go forward.

Thank you very much.

Thanks Matt.

Next question comes from Stephen Geyen with D.A. Davidson. Please go ahead.

Good morning. Maybe just to follow-on to the cost saving questions. In the presentation of the actual merger agreement, you had mentioned a 60% cost saves or phase-in in 2014 and then the remaining or 100% thereafter. Is that kind of a still good number to use at 60% phase-in in 2014?

I think that 60% number is a good phase-in to use over the first 12 months. When we put that out there, we were expecting a merger to take place obviously on January 1 so we're kind of five months behind, if you will, based on that trajectory.

I think what we were saying is within a 12-month period, we would see 60% of that realized and then 40% soon thereafter. We still -- I think that still makes sense, that 60% number. We just gotta push that back five or six months.

Okay, okay. Great. And then the pay downs loans this quarter, was there anything unusual about it?

No, I don't think anything unusual. We continue to get periodic pay downs on loans that we would like to see leave the bank and not unhappy that they were able to find a different place to go. We still see business owners from time to time selling their businesses and obviously, we get paid off in relation to that.

It's very competitive out there so occasionally we do lose credits to our competitors, especially we try to keep them. We are assuming these are good customers but sometimes the pricing, the underwriting just isn't to the degree that we think is appropriate.

So we step back and go ahead and let those loans go somewhere else. But I don't think there was anything during the quarter that was unusual or different than the previous year and a half or so.

Stephen, this is Mike. To add a little more color on what Chuck said. He is right on.

We did have one moderate sized commercial real estate deal that went to long-term FHA funding but we had expected that and that came to fruition last quarter. But again that isn't anything unusual or unexpected, just it does take some total loans out of the picture.

Do you have any guidance kind of looking at the loans that are out there as far as what might or could go to permanent financing over the next quarter or so?

I don't think there is a whole lot left to that type of stuff. I am sure there is one or two within the portfolio but as both Bob and Chuck have alluded to, the pipeline and activity that we have seen so far in the fourth quarter has been very strong, more akin to what we saw in the second quarter.

Unfortunately, for purposes of financial reporting, we had a really good first week of the fourth quarter in funding. If you go to the customers and say hey, make my numbers look better by doing it a day or two earlier, that would be great. But work is looking very strong and we think first of all, (technical difficulties) as well.

Sure. I guess just a last question, how much of the $47 million in new loans this quarter was C&D loans?

What?

Construction and development?

Yes.

The construction, what that number is per new term loans, those are loans that we would have funded at the table for equipment, real estate, those types of things. That would not have included anything in the construction and development side.

Okay.

We certainly -- Stephen, we certainly closed some of those loans but when you close the loans, obviously we expect the owners and any other outside financing to put their money on the table first. So it usually takes three months to six months after closing a construction loan before we start seeing the draws come out.

That will be a bigger factor going forward as opposed to this past quarter.

Okay. Then actually I just have a follow up on that. $148 million in unfunded loans; how does that compare to some of the prior quarters?

That is definitely growing.

Okay. Thanks for your time.

To the point, that's what I was answering, we did close on some pretty decent sized construction and development loans during the third quarter, which increased that unfunded amount. But certainly anything that closed in the third quarter saw very little, if any, funding to-date so we'll start seeing that likelihood in the fourth quarter and certainly into the first quarter and second quarter. Most of our commercial construction development is a 12- to 18-month funding period.

Okay. Great. Thanks for your time.

Next question comes from Damon Delmonte with KBW. Please go ahead.

Good morning. How are you?

Good morning Damon.

Just to kind of continue on the topic of the loan growth. So as we look into the fourth quarter, if you guys were put a range of the growth, do you feel comfortable saying high single digits maybe low double digits?

No, I think I am not really comfortable putting a number like that out there but as I mentioned in my prepared comments, if you look at the swing between the second and third quarter, if you picked a number that was inclusive of funding of some of the construction development commitments that we have out there, some loans that we have on the pipeline, line draws are always hard to predict.

But I think what we'll see is the fourth quarter being a number that's certainly more than the third quarter. Will it be as high as the second quarter? Probably not. But that remains to be seen.

I think the crux of the matter is we have some really nice opportunities that we are seeing and that we have accepted commitment letters on from our customers and prospective customers and the opportunities are out there.

It's really all a matter of timing, as Mike mentioned. We had a great first couple weeks of the fourth quarter but that's just the timing of it.

Okay. That's helpful. Thanks.

Chuck, just to circle back on expenses, so we, call it, $19.5 million of core operating expenses this quarter, so when you guys look at the cost savings that you are going to generate in the upcoming quarters, are you basically saying it's going to be flat and then any growth that you would normally have would be effectively the cost savings?

Yes, I think when you look at that -- obviously, we're just starting to put our budgets together, our thoughts together for 2015 and certainly, we'll just see some normalized type increases in overhead costs. When you look at the third quarter, there certainly are some cost saves that are going to come through that number, so there would be a reduction there as we go forward.

But again, we also have to look at any normalized cost increases. I think net, we'll definitely see some cost savings but obviously a lot of moving parts. Certainly, we look at firming up our existing company.

For example, when experienced loan officers come available that would fit our platform nicely, we are obviously going to extend offers. So while there is $5.5 million in cost savings there, obviously we are not operating in a vacuum here and there is going to be some movements within our overhead structure as we go about running our Company.

Got it. Okay. Then just lastly on fee income; anything notable this quarter? Are you comfortable with a run rate in that $2.9 million, $3.0 million quarterly rate?

I think we look at, if I break it down, if you look at service charges and other income, I think that's probably a decent run rate. Obviously, I know the other question will be with mortgage bank and income, what rates are doing and how that impacts the level of applications and any refinance activity that comes through.

Certainly rates have dropped the last couple weeks but a lot of volatility out there. It seems like we are seeing a little bit of an uptick but with that volatility, just not sure where that fee income is going to go.

I hate to be evasive but hopefully, we would expect that $2.9 million -- we would hope that, that $2.9 million number would be kind of a base but not knowing really what's going to happen in that mortgage area; it's hard to guess.

Okay. Then I guess lastly on the tax rate, what would be a good effective tax rate to model in?

Probably somewhere around 31% or 32%, somewhere around there, is what we're pulling out.

All right. Thank you very much.

Thank you.

(Operator Instructions)

Our next question comes from John Rodis with FIG partners. Please go ahead.

Good morning guys.

Good morning John.

I guess most of my questions have been answered but Mike, maybe just a big picture question for you, just sort of now that the deal is complete. You've got one quarter under your belt, maybe sort of how are you viewing potential future acquisition opportunities right now?

That's a good question, John. I think we answer it pretty much the same way we have always answered it in the last eight years to ten years. That is, if we see something that makes a lot of sense, we'll certainly vet it and see if it is priced right and fits into our strategic goals.

For a long time we said that, nothing happened and then we met up with Firstbank and put together what we think is a pretty compelling organization when we put that merger together. So it could be one of those things where we do it again in a year or two or it could be one of those things where we don't do it again for six years to eight years.

But one thing is for sure is our experience and planning and putting together this merger has not deterred us from using M&A as growth strategy. As a matter of fact, we have been very encouraged by the hard work of our employees and the focus and the planning that went on by the teams as they went through the integration process and the impact to the customer has been pretty minimal as far as disruption goes.

And at the same time, the range of products and services that they now are able to access has grown substantially. So again, it's one of those things where we knew we needed some time and we are taking that time to digest a fairly compelling and large merger. But knowing what we know and learning what we've learned, even though organic is our stated preferable way to grow, we certainly keep our eyes open for M&A opportunity.

That makes sense, Mike. Would you consider -- I mean, would you look at deals outside of Michigan at this point?

Yes. Our preference would be in our own backyard or in our own state but we certainly would take a look at other opportunities as well.

Okay and I assume mostly contiguous states, nothing --

Yes, I think as you rank order them, contiguous is probably right behind in state. You bet.

Yes. Okay. Thanks guys.

You're welcome.

Next question from Daniel Cardenas with Raymond James. Please go ahead.

Good morning guys.

Hi Dan.

Maybe just some color on competitive factors on the lending side. Is it still primarily pricing where you are seeing the competition or are you seeing changes in structure? And then maybe some color, too, on what you are seeing on competition for deposits right now, if any?

I think on the loan side, the competition has been fairly consistent throughout this year, that you see on some deals, pretty competitively priced situations. And in many more cases than not, our style of banking, our relationship focus and value added to our customers definitely gains us favor and customers, they appreciate and like the approach we're taking with our banking outreach.

Not to say that there aren't deals out there that we, that as Chuck mentioned earlier that we walk away from because they're just priced too thinly for us. We have done a good job of maintaining our discipline with the desire to keep our margin where we desire to maintain it.

As far as risk structure goes, occasionally there is a situation that presents itself that the structure is not quite what we like it but I think again in most cases, we are able to get the structure that we need from a risk stand point. The customer understands that and so structure really hasn't been a huge issue for us. On the deposit side, there is -- most institutions are pretty flush in liquidity and that is not a competitive situation now.

Great. Thanks guys.

This concludes our question-and-answer session. I would like to turn the conference back over to Mike Price for any closing remarks.

Thank you, Gary. Mercantile's momentum is increasing and our team is motivated and dedicated to building on success. As I stated earlier, our long-standing relationships and proven excellence at community bird banking are serving 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.

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