Mercantile Bank Corp (MBWM) 2015 Q1 法說會逐字稿

Good morning and welcome to the Mercantile Bank Corporation first quarter 2015 earnings results conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Bob Burton. Please go ahead.

Thank you, Kate. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the Company's financial results for the first quarter of 2015. I'm Bob Burton with Lambert, Edwards, Mercantile's investor relations firm; and joining me are members of their management team, including Michael Price, President and Chief Executive Officer, Robert Kaminski, Executive Vice President and Chief Operating Officer, Chuck Christmas, Senior Vice President and Chief Financial Officer and Sam Stone, Executive Vice President.

We will begin the call with management's prepared remarks and then open the call up to questions. However, before we begin today's call it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the Company's business. The Company's actual results could differ materially from any forward-looking statements made today due to the important factors described in the Company's latest Securities and Exchange Commission 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, which is 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, and good morning, everyone. Thank you for joining us to discuss our first-quarter 2015 results for Mercantile Bank Corporation. On the call today, our Chief Financial Officer, Chuck Christmas, will provide details on our financial results followed by Chief Operating Officer, Bob Kaminski, with his comments regarding growth initiatives, merger and integration, and asset quality. The Executive Vice President, Sam Stone, is also on the call with us today.

Hopefully, you have all had a chance to review our earnings release. We reported $0.39 per share compared with $0.41 a year ago. While the first quarter of 2014 contained a $1.9 million negative provision benefit equivalent to $0.14 per diluted share, that benefit declined to $400,000 or $0.02 per diluted share for the current quarter. That being said, the reported results were in line with management expectations and are a very encouraging start to 2015.

We have fully realized the level of initial efficiencies we projected at the time of the merger with Firstbank, which equates to approximately $1.4 million per quarter. Although the low interest rate environment continues to weigh on net interest income results, we saw sustainable above average performance in net interest margin, which was in line with our expectations for the quarter and year and underscores a key benefit of combining the deposit base of legacy Firstbank with the larger market exposure of Mercantile.

Improving the earning asset mix is a primary driver of our post-merger profitability strategy. First quarter results indicate this strategy is working as expected. Our loan portfolio continues to grow as we originated approximately $100 million in loans during the quarter.

We look for continued loan growth in the mid to upper single digits over the coming year. Bob Kaminski will comment on this and the strength of our loan pipeline in a moment. As a result, both ROAA and ROAE improved over the fourth quarter and are tracking in line with our expectations.

As part of our strong capital position and our commitment to shareholder return, we earlier today announced a quarterly cash dividend of $0.14 per share. We also initiated our previously announced share buyback program during the quarter.

Looking forward to the remainder of 2015, we see further opportunity to participate in the continuing economic recovery of Michigan as Michigan's premier community bank. Our business activity levels reflect the overall continued gains in employment and business expansion that are being reported for Michigan, and particularly, the Grand Rapids market. The area's economic indicators remain positive, suggesting growth will continue through the coming months.

At this time, I would like to turn our call over to Chuck.

Thanks Mike and good morning, everybody. This morning we announced net income of $6.6 million for the first quarter of 2015 or $0.39 per diluted share. During the first quarter of 2014 net income was $3.6 million or $0.41 per diluted share. Although we recorded a negative provision expense in both the first quarter of 2015 and 2014, the negative provision expense during the first quarter of 2015 equated at $0.02 per diluted share compared to $0.14 per diluted share during the first quarter of last year.

We are pleased with our financial condition and earnings performance for the first quarter of 2015. We believe we are very well positioned to take advantage of lending and market opportunities to enhance our strong position as Michigan's community bank while delivering consistent results for our shareholders.

Our net interest margin continues to reflect the benefit of the Firstbank merger. We recorded a net interest margin of 3.83% during the first quarter of 2015 compared to 3.42% during the first quarter of 2014. The majority of improvement reflects Firstbank's lower cost to funds in the purchasing accounting entries related to fair value adjustments associated with the merger.

Our net interest margin improved by 4 basis points during the first quarter of 2015 when compared to the fourth quarter of 2014. Although our yield on loans declined by 6 basis points primarily due to the ongoing very low interest rate environment, our yield on earning assets increased by 2 basis points due in large part to funding loan growth with cash flow from lower yielding securities and other interest bearing assets. Our cost of funds declined by 2 basis points during the first quarter of 2015 when compared to the fourth quarter of last year.

We recorded loan discount accretion totaling $1.4 million during the first quarter of 2015. Based on our most recent valuations, we currently expect to record further loan discount accretion totaling about $1.2 million per quarter during the remainder of 2015. Actual accretion amounts recorded in future periods may differ from our forecast due to a variety of reasons, including periodic reestimations and the payment performance of the acquired loan portfolio.

We recorded timed deposits and FHLB advance amortizations totaling $0.6 million during the first quarter of 2015. We expect to record further amortizations totaling $0.6 million during the second quarter of 2015, and then a final $0.2 million during the third quarter of this year. As we noted in prior merger related FCC filings, these particular fair value adjustments will be completed at the end of July.

We have also recorded trust preferred security amortizations since the merger was consummated, totaling $0.2 million during the first quarter of this year. Unless we call all or part of our trust preferred securities, which we currently have no plans to do so, we expect to record further amortizations totaling that $0.2 million per quarter into the year 2036.

We expect our net interest margin to be in a range of 3.8% to 3.85% during the second quarter and that decline slightly to a range of 3.75% to 3.8% during the third and fourth quarters of this year. The primary reason for the anticipated decline is the aforementioned elimination of a timed deposit and FHLB advance amortizations in July. While the ongoing very low interest rate environment continues to exert compression pressure on our net interest margin, we expect to continue to use low yielding excess overnight investments, and cash flows from monthly pay downs on lower yielding mortgage backed securities, and the periodic maturities and calls on lower yielding US government agency and missile bonds to fund a large portion of our expected loan growth throughout the remainder of 2015.

The overall quality of our loan portfolio combined with the recoveries of prior-period loan charge-offs and the eliminations of and reductions in many specific reserves, have produced a positive impact on our loan loss reserve calculation and allowed us to make no or negative provisions in nine consecutive quarters in 12 out of the last 13 quarters. We recorded a negative provision expense of $0.4 million for the first quarter of 2015. Gross loan charge-offs totaled $0.5 million during the first quarter, while recoveries of prior period loan charge-offs totaled $1.9 million resulting in a net recovery of $1.4 million for the quarter.

Our loan loss reserve was $21.1 million at the end of the first quarter, or over 1.5% of total originated loans, and remains higher than our historical averages. We recorded non-interest income of $3.7 million during the first quarter of 2015, recording improvement in most of the income categories. During the first quarter, we recorded $0.2 million related to interchange income on credit and debit cards, reflecting a one-time change in the timing of receipt of such income.

With the caution that mortgage banking income can be difficult to forecast, we continue to expect non-interest income to come in around $3 million to $3.3 million per quarter during the remainder of 2015. We recorded non-interest expense of $19.2 million during the first quarter of 2015 and are now realizing all of the cost saves associated with the merger.

We are currently projecting quarterly non-interest expenses to total in a range of $18.8 million to $19.1 million during the remainder of 2015. Our effective tax rate for 2015 is expected to be around 31% to 32%.

We remain a well capitalizing banking organization. As of March 31, our bank's total risk-based capital ratio was 14.1% and in dollars was approximately $100 million higher than the 10% minimum required to be categorized as well capitalized. Those are my prepared remarks. I will now turn the call over Bob.

Thanks, Chuck, and good morning. The first quarter produced strong commercial loan funding with nearly $100 million in advances to new and existing customers. While all of our regions produced some new loan relationships, loan activity was most significant in the Grand Rapids market. This level of loan funding is reflective of the solid loan pipeline that we have maintained in our lending groups over the past several quarters.

Within the first quarter, we saw most of our loan funding taking place during the months of January and March. Our loan officers and customer contact staff continue to effectively perform client acquisition activities that are the core of our relationship banking strategies and will serve us well in the coming months and quarters ahead.

While new lending activity was substantial, there were numerous payoffs that had the effect of tempering the net loan growth during the first quarter. These payoffs occurred due to a variety of situations. Borrowers who sold their businesses or the assets backing the bank loans, higher risk rated loans that moved out of the bank, and borrowers who were moved by other lenders with interest rates much more aggressive than our pricing and risk models could justify.

Competition remains quite intense for loans in all of our markets, but Mercantile continues to operate its business model determined to gain new customers based on a consultative, mutually beneficial, relationship banking approach while maintaining integrity of the bank's net interest margin. With a strong pipeline, we are convinced that this style of banking continues to resonate well with our prospects and customers.

Asset quality remained very solid during the first quarter. Our lending staff and risk asset group continue to promptly identify and address any emerging potential problem loans, working with borrowers to deal with the issues that may be causing the increased risk. We have also had ongoing success with recoveries on loans previously charged off. The bank continues to maintain a good balance in the commercial portfolio between non-owner occupied commercial real estate and commercial industrial loan plus owner occupied commercial real estate.

While we are engaging new prospects in all loan categories, it is the commercial and industrial loan packages that present us with the greatest opportunities to develop the fullest and most complete banking relationships. Since the start of the year, we have deployed two additional treasury management sales staff members in our central Michigan markets to seize new opportunities created by the merger, especially C&I relationships. Customers and prospects continue to respond favorably to our calling efforts and, most specifically, about our cash management products as well as our payroll processing services.

Mortgage banking activity was strong during the first quarter. We continue to develop the structure and staffing in the Grand Rapids and Kent County markets. We see significant opportunities with an increased focus to build our retail mortgage presence in this market.

One of our strategic initiatives in 2015 is the continued development of our internal training. As such, one of our senior managers has accepted the position of Director of the bank's Training and Communication functions. This individual will be responsible for analyzing all the training needs within the organization and then developing and coordinating internal and external training programs to fulfill these needs.

Finally, during our conference call in January, we outlined several key initiatives in 2015 to create some non-interest income opportunities, generate some cost savings and allow us to identify some additional efficiencies that will help us better serve our customers. We continue to make good progress in all of these areas. Those are my prepared comments. I'll now turn it back over to Mike.

Thank you, Bob; and thank you, Chuck. At this point, Kate, we would like to open the call up for questions.

We will now begin the question and answer session.

(Operator Instructions)

The first question is from Matthew Forgotson of Sandler O'Neill. Please go ahead.

Hello, good morning all.

Good morning, Matt.

Just as far as expenses are concerned, was there any outside snow removal or other seasonal expense that we might be inclined to pull out? And can you also talk about your comfort with expenses reverting to that $18.7 million, $19 million range?

We had to pull our [workats] again this year, but there was certainly some snow removal. But of course, now the grass is getting green, we will have to start cutting the grass. That's all budgeted; and while it has some impact on a quarterly basis, it's certainly not overall material.

As I mentioned in my prepared remarks, that range -- we still feel pretty good about. I think we should be able to hit that. Certainly, as has been mentioned, we do have some initiatives that we're starting to put in place now -- some of those of which should have a positive impact on overhead costs. Those are not budgeted. And while it would take a little while to spool all those up and get the full benefit of, here in the second quarter we should -- we fully expect to start seeing the benefit of that, and we will comment on that in further calls.

Okay. So it sounds like, if I'm reading it correctly, since that's not budgeted, you're suggesting that the expenses could even fall modestly below the low end of the range if all goes out as planned. Is that correct?

(Technical difficulties) Matt, that'd probably be a little bit aggressive to say that would fall out the bottom of the range. I would say it would get maybe closer to the bottom of the range, but I don't think it would fall below that.

Okay.

Not in the next couple quarters.

As far as capital return is concerned, I think you've laid out a longer term conceptual target TCE ratio of about 8.5% or so. With balance sheet seemingly kind of muted this year, can you talk about how we get there? Or are you going to -- vis-a-vis share repurchase or dividends -- just your approach on those levers?

Certainly, we would like to use that all up with loan growth. And like you said and like I mentioned, a lot of that loan growth is going to come right on the balance sheet. So total assets aren't going to change by all that much. But certainly that would behoove our net interest margin and net interest income, as we take those monies out of lower-yielding investments and in overnight funding, to put that into loan portfolio.

Certainly, that's obviously what we'd want to do and strive to do. We did increase the cash dividend up to $0.14 in the first quarter; kept it unchanged. Still we think a relatively strong 2.8% yield based on our current stock price. So we will continue to talk with our Board of Directors about cash dividends, whether we -- what we do with our normal quarterly cash dividend; is there potentially down the road a chance of a special dividend? That is certainly in the cards. No plans to do so currently. Obviously, we put into play our stock repurchase program up to $20 million over the next few periods. Then, obviously, we will see how our stock performs there and how we incorporate that plan into fruition and put that into play. So, we are looking at all of those different items, obviously.

I'm sure sooner or later somebody will ask Mike about M&A. That remains a possibility, nothing imminent. But that remains a possibility as well. So we're looking at all of those different things. And certainly, we're in a very strong capital position to grow the Company in several different ways and at the same time manage that capital level through dividend stock repurchase programs and those types of things.

Thanks very much.

Thanks, Matt.

The next question comes from John Rodis of FIG Partners. Please go ahead.

Good morning, guys.

Hey, Chuck, I just wanted to make sure I heard you correct on the operating expenses. Did you say $18.8 million to $19.1 million per quarter going forward?

That is correct.

Okay. Maybe you mentioned as far as capital allocation, Chuck, you talked about the buyback; and you bought, it looks like, roughly 100,000 shares in the quarter. Can you just talk about what you guys are thinking for the remainder of the year as far as pace of activity?

I think, John, for the most part -- I'll start and then let other people jump in -- I think for the most part we're -- certainly, going to have to look and see how our stock performs. And obviously, if the stock goes down, we will probably have a bigger appetite. If the stock goes up, maybe less of an appetite. But you know, kind of looking at that as a relatively longer-term solution. It is not something we put into play in the first quarter thinking we were going to use it all up in a week, or the quarter, or something like that. But more of a medium- to longer-term program that we can put into play depending on what the stock price is doing.

Okay, just to be more or less opportunistic, I guess?

Yes, you said it much quicker than I did.

This is Sam, John. We did about 10% of the program in the first quarter. And we have the capital capacity to complete the program in this year. But the pace at which we go depends on a lot of things, including trading volume in the market and how many blocks show up. And if there are block sellers we're likely to do more than if there aren't. So, a lot of things factor into the pace that we move at. We're not trying to be the driving force behind the stock price. We like to see the market set the stock price.

Okay, makes sense.

Maybe, Chuck or Sam, another question for you guys. The securities portfolio continues to trend down. I was just wondering, do you see it going meaningfully below, say, $400 million?

This is Chuck. I got to see where we're at right now.

$413 million at the end of the quarter.

It's going to be actually under $400 million by the time we get to the end of June, John. We have got about $13 million in municipal bonds that are either going to mature or get called on May 1. I think most people know that May 1 and November 1 tend to be pretty busy times in our municipal bond portfolio. We'll be under $400 million by the time we get to June.

So, yes. That's part of the plan. Again, we plan on just a run-off of the portfolio, whether that be paydown to mortgage backeds, which is about -- runs about $2 million a month. The aforementioned on municipals -- May will be busy. There will be periodic maturities and I'm sure some more calls coming in that portfolio. And then, as you might expect, over the last couple of months especially, we've seen a pickup in calls on our longer-term agency callable bonds.

So that is all good, because, again, we planned on that to fund our loan growth. We are sitting pretty high right now with interest-bearing deposits, as you can see on our balance sheet, which is our Federal Reserve account -- much higher than what we want that to be. We look at our Fed account of those interest bearing deposits in our Fed funds. We want to keep that around $50 million, so we are about double where we want to be right now.

Part of that is, a good part of that reason for that's higher, is that we've had really strong deposit growth during the first quarter. We typically, especially legacy Mercantile, saw reductions in deposits in the first quarter as businesses paid bonuses and taxes out, and we've seen some of that. But especially towards the end of the first quarter, we saw strong increases, especially in our non-interest bearing business deposit accounts. So it's always kind of good news-bad news that you have more excess overnight funding than what you want, but for the most part that reflects ongoing increases in our deposits.

Over time -- hopefully sooner than later -- we will be able to put those monies into the loan portfolio combined with the normal run-off of the securities portfolio. We certainly have the ability, if the opportunity comes, that the bonds that are going to mature later in 2015 and certainly, 2016 and 2017. We can certainly sell those with a pretty nominal gain or loss, because it would be so close to maturity, and accelerate that reduction. Overall, we want our securities portfolio to get down to around 10% or 11% of assets. So we will be far and well under that $400 million fare you've talked about by the time it's all said and done as we reallocate and restructure, if you will, our earning assets.

Chuck, just as far as getting down to 10% to 11%, is that by, say, year end 2015? Year end 2016? What's a good timeline?

Unless we saw a huge net loan growth, it won't be a 2015 event. But if we continue to get loan growth like we think is going to be happening, and obviously, the big question is always the payoffs. Maybe by the end of 2016. I do not think it would be before then. But if we have got the great loan growth, and it's meeting our pricing and underwriting guidelines -- again, I would not hesitate to sell bonds prior to maturity to accelerate that remix.

Okay, makes sense. Thanks, guys.

You bet.

The next question is from Damon DelMonte of KBW. Please go ahead.

Hello, is your phone on mute?

I'm sorry about that. Can you hear me now?

Yes.

Okay, thank you.

Chuck, can you clarify your comments on the margin outlook? I think you had said you are looking for 3.80% to 3.85% in the second quarter. Could you just repeat what you were looking for, for the back half of the year?

This is probably like a 3.75% to 3.80%. We have to lose some of the benefit of those merger-related entries going through as a reduction of interest expense. Again, we continue to see, like everybody, compression on loan yields. But again, that remix of our earning assets will help offset that. So that's how we get trending down just a little bit to where we are now. So 3.75%, 3.80% -- it seems to make sense to us.

Okay, great. Can you guys provide a little color or a little update on the large commercial credit that had gone non-performing last quarter? I know you made mention of it in the press release, but any update as to where that stands? And what the outlook over the next couple quarters is for that credit?

This is Bob.

Beyond what we stated in the press release, as we mentioned, we feel we made some good progress toward the resolution of the credit during the first quarter. We think we will have some more information about it in the second quarter. But no additional update at this point in time.

Okay, that's helpful.

And then, I guess, lastly -- mortgage banking, you said volumes remained healthy this quarter. What were the volume and the gain on sale this quarter versus last quarter?

Good question. I know I do not have that in front of me. Sam, have you got that?

Yes, I think I have it. We were pretty flat. We were 688,000 in the first quarter compared to 691,000 in the fourth quarter.

I thought that the first quarter was pretty conclusive with the fourth quarter. At least the way it looks now is that the second quarter should be relatively similar to the first quarter. I mean, obviously, it's early in the quarter, but I know we had a pretty strong pipeline going into the quarter.

Okay. And although the dollar amounts in the gain on those loans is similar, how's the volume? I'm trying to back in to what the gain on sale margin is. Are you seeing better or worse spreads?

The margin's holding up well. I do not have those volume numbers with me at this time.

Okay. Okay, thanks. That's all that I had for now.

Thanks, Damon.

The next question is from Mat Schaefer of D.A. Davidson. Please go ahead.

Hello, good morning.

Good morning.

Could you guys remind us -- the 3.75% to 3.80% range in the second half of the year -- is that dependent on the Fed at all?

It includes a couple of 25 basis-point increases, because we built that into our budget. But I will tell you, and as we continue to talk about it and report it in our filings, any increases from the Fed would have a modest improvement in net interest income. I don't think it would -- we're not looking at more than a 5 basis-point move on the front end of our margin. I think whatever the Fed does, whether they do nothing or maybe up to a couple 25 basis-point increases, we're still comfortable with that range.

Okay, great. All my other questions have been answered. Thanks.

Okay.

(Operator Instructions) The next question comes from Daniel Cardenas of Raymond James. Please go ahead.

Good morning, guys.

Hello, Dan.

Still a couple of housekeeping questions for me.

In the first quarter margin -- did that have any, was there any benefit from interest recapture? I saw your credit quality improved. You had recoveries for the quarter. Just wanted to see if there was any impact on the improved credit quality on the margin this quarter?

No. While we got the recovery, I think the interest income that we got associated with that recovery was about $50,000, Dan. So we'll take every dollar we can get, certainly. And we got some -- in addition to that, we got some recovery of some prior legal bills that we had expensed. But from a margin perspective, it's pretty core margin.

Good. And then, with the $100 million in commercial loan originations during the quarter, maybe some color on what the average size was and how that compares to your legacy portfolio?

The average size was right in our sweet spot. Probably in the range of a couple of million, $3 million. That consisted of a wide spread from some bigger loans in our Grand Rapids area to some smaller loans in our more rural markets. But good to see some origination activities taking place in all of our markets, although as I mentioned in my comments, the majority of the growth took place in Grand Rapids. But we are encouraged by the activities in response to our calling efforts at all of our markets.

The wild card has been, as I mentioned, is the payoffs; and disappointed to see those were higher than we had planned. It does point to our disappointment regarding net interest margin. Not wanting to get into the bidding wars on some credits where customers are merely after the lowest rate. But with that strategy, we're able to generate $100 million in loan originations, which can't be understated.

Great, got you.

And then you may have said this in the call; I may have missed it -- but any color as to what the approximate yield or the average yield on these commitments looks like?

I don't think any of us has that in front of us. Certainly we are looking right around prime, I would say, on average. Obviously, that's going to be a factor, especially on the grade of the credit. But prime plus a quarter, I would guess, is kind of a good standard.

Any change in line utilizations this quarter versus last quarter?

Not in existing line utilizations. But one of things that we have seen is that the credits that we have extended over the last few quarters, we are seeing those funded up as we had expected. So we put a lot of C&I, new C&I customers into the bank over the last few quarters. And we are seeing growth in lines of credit in total outstandings because of that. But overall, line utilization has stayed pretty consistent.

Okay, and then last question. As I look at your capital -- your regulatory capital ratios -- was there any impact this quarter from H[U]E CRE? I'm just looking to get a sense for why the numbers, the ratios anyway, declined on sequential quarter basis.

Yes, Dan. There were certainly some moving parts, and we are all sitting here with our professional vendors trying to figure out exactly what the FDIC was doing and Bob and Peter were doing to us. There were definitely some moving parts there. And probably the biggest impact there was what they call the high volatile CRE, which are construction loans that meet certain definitions, with primarily paydowns and equity into the projects. I think we had about $60 million of that reported.

Of that $60 million, historically, would've been 100% risk weighted. Now, it's 150% risk weighting, so there's an increase there. The other bigger increase that we had is that lines of credit, unused lines of credit under year on the commercial side, now have to get risk-weighted at 20%. And that used to be 0%, and I do not have a calculation in front of me. But I think that was around $70 million of added risk-weighted assets. So there's about $100 million right there between those two items. Those were the biggest items that we had.

Okay, good. Thanks for the color. Good quarter, guys.

Thank you, Dan.

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

Thank you, Kate, and thank you all for your interest in our company. We look forward to talking again with you next quarter. At this time we'll end the call.

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