Mercantile Bank Corp (MBWM) 2016 Q3 法說會逐字稿

Good morning, everyone and welcome to the Mercantile third-quarter 2016 earnings conference call.

(Operator Instructions)

At this time, I would like to turn the conference call over to Mr. Bob Burton. Sir, 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 third quarter of 2016.

I'm Bob Burton with Lambert Edwards, Mercantile's investor relations firm. 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; and Chuck Christmas, Executive Vice President and Chief Financial Officer. We will begin the call with management's prepared remarks and then open the call up to questions.

However, before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the Company's business. The Company's actual results could differ materially from 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.

Thank you, Bob, and good morning, everyone. Thank you for joining us to discuss our third-quarter 2016 results for Mercantile Bank Corporation. On the call today, our CFO Chuck Christmas will provide details on our financial results followed by COO Bob Kaminski with his comments regarding loan development, growth initiatives and asset quality.

Despite industry-wide questions regarding loan and earnings growth, Mercantile has delivered another strong quarter of financial performance in 2016. Against both internal and external expectations our financial metrics are healthy and either stable or improving. We are particularly pleased at the resilience of our West Michigan, markets as evidenced by new loan activity.

I said last quarter, and it continues to be true today, that Mercantile is certainly firing on all cylinders. As a result, our management team is looking forward to strong performance in the fourth quarter and into 2017. In particular, let me highlight several accomplishments in areas of strategic focus that underline our optimism.

New commercial loan growth continued strong at $131 million for the quarter, continuing our outlook for high single-digit percentage growth for the year. Our strong relationship teams are leveraging Mercantile's excellent reputation for business banking. We are encouraged by the outlook for the rest of the year, particularly in light of our committed pipeline. Bob will detail our activities, the health of our markets and the strengths of our customer base in his comments in a moment.

Non-interest income, led by fee income and residential mortgage activity, was stronger than forecast. Chuck will touch on this further in his comments.

Net interest margin stayed steady against our guidance. We remain very pleased with the strength and stability of our core net interest margin, reflecting our continued focus on loan pricing discipline. It is worth noting that our net interest income is expected to benefit from any further rate hikes initiated by the Federal Open Market Committee.

We continue to experience pure leading asset quality, which is reflected in the very low level of nonperforming assets, representing only 0.2% of total assets. As we said in the earnings release, past due loans are nominal. The bank is in an extremely strong position here.

As evidence of our strong capital position, and demonstrating our continuing commitment to shareholder return, we earlier today announced a quarterly cash dividend of $0.17 per share for the second quarter, providing an annual yield of about 2.5% based on our current share price. In addition, our Board of Directors declared a special cash dividend of $0.50 per share in recognition of our robust capital position. While we did not make any purchases under our active stock buyback program during the third quarter, we have purchased 168,000 shares year to date.

Lastly, we are gratified to see increased market recognition as Michigan's community bank. The consolidation that has taken place in the Michigan banking industry in the past year has allowed Mercantile an even better opportunity to differentiate itself from our competitors.

The initial announcement of our planned management transition in January of 2017 has been well-received. And we also recently announced a number of internal promotions, which demonstrate the depth of the Mercantile team. Customers, communities and employees continue to take notice of our commitment to excellence.

Looking forward, we see additional opportunity to participate in the economic strength of our markets as Michigan's premier community bank. Our business activity levels indicate that the overall continued healthy employment and business expansion that are being reported for central and western Michigan will continue, particularly within our largest markets. The area's economic indicators remain positive, suggesting growth will continue through the coming months.

At this time I'd like to turn the call over to Chuck.

Thanks, Mike, and good morning, everybody. This morning we announced net income of $7.8 million for the third quarter of 2016, and net income of $23.8 million for the first nine months of the year. On a diluted earnings per share basis we earnings $0.48 per share during the third quarter and $1.46 per share during the first nine months of the year.

Our earnings performance during the third quarter of this year reflects a 7% increase in diluted earnings per share when compared to the third quarter of 2015, and a 19% increase in diluted earnings per share during the first nine months of this year when compared to the same time period in 2015. We are very pleased with our financial condition and earnings performance for the third quarter and believe we remain very well-positioned to take advantage of lending and market opportunities by delivering consistent results for our shareholders.

Our net interest margin was 3.76% during the third quarter, continuing a relatively stable trend during the past nine quarters. The stability of our net interest margin primarily reflects the growth of the loan portfolio as a percent of average earning assets during this time frame, in large part by funding a majority of our net loan growth with monies from the lower yielding securities portfolio.

Average loans represented about 85% of average earning assets during the third quarter of 2016, compared to 83% during the third quarter last year. As we move forward, we expect loans to comprise around 86% of earning assets, with investments and overnight funds at 2%.

Primarily reflecting the ongoing very low interest rate environment and competitive pressures, our yield on total loans has generally been on a declining trend. However, our yield on total earning assets has remained in a relatively tight range due to the earning asset reallocation strategy, which, combined with a steady cost of funds, provides for a stable net interest margin.

Our net interest income and net interest margin throughout the first nine months of 2016 were positively impacted by calls on US agency bonds that had been purchased at a discounted price. Accelerated discount accretion totalled $0.4 million during the third quarter and $2.2 million during the first nine months, adding 6 basis points to the third-quarter net interest margin and 10 basis points to the net interest margin during the first nine months.

I would add that during the third quarter an elevated level of overnight funds offset the 6 basis point benefit from the accelerated discount accretion. We recorded loan discount accretion totaling $1 million during the third quarter, a little lower than most previous quarters as well as the guidance provided in July. Based on our most recent valuations, we currently expect to record further quarterly loan discount accretion totaling about $0.8 million during the fourth quarter and then about $1 million during the first quarter, $1.2 million during the second quarter, $1.6 million during the third quarter, and $1.4 million in the fourth quarter of next year.

Accretion during 2018 is expected to average around $0.3 million per quarter. 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.

Overall, we remain very pleased with the performance of the acquired portfolio. In fact, we have reclassified $4.6 million from unaccretable to accretable during the first nine months of 2016.

We expect our net interest margin to be around 3.75% during the next five quarters. This forecast assumes no changes in the federal funds and prime rates. Our interest rate risk measurements continue to reflect an improved net interest margin in an increasing interest rate environment.

The overall quality of our loan portfolio remains very strong. Nonperforming assets as a percent of total assets equaled only 18 basis points as of September 30, 2016. Gross loan chargeoffs totaled $0.4 million during the third quarter of 2016 and $1.2 million for the first nine months of the year.

Recoveries of prior-period loan chargeoffs equaled $0.2 million during the third quarter of 2016 and $0.8 million during the first nine months of the year. Net loan chargeoffs as a percent of average loans equaled only 3 basis points during the third quarter as well as the first nine months on an annualized basis.

We recorded a provision expense of $0.6 million during the third quarter of 2016, bringing the total amount for the first nine months of the year up to $2.3 million. The provision expense during 2016 has been primarily driven by our loan growth, as well as a second-quarter assessment change in our economic and credit concentration environmental factors, the latter equating to about $0.5 million provision expense during that second quarter. We expect to record quarterly provision expense of $0.5 million to $1 million during the remainder of 2016 and into 2017.

Our loan allowance reserve totaled $17.5 million as of September 30, 2016. The reserve for originated loans equaled 0.93% of total originated loans at quarter end, virtually unchanged since the year-end 2015.

We recorded non-interest income of $5.3 million during the third quarter of 2016, compared to $4.3 million during the third quarter of last year. We experienced a $0.3 million increase in service charges on deposit accounts compared to a year ago, in large part reflecting an ongoing project to ensure that all depositors are at a product that best meets their needs and is priced appropriately, as well as higher cash management fee income due to increased usage.

We recorded a $0.2 million increase in mortgage banking activity income, primarily reflecting the positive impact of the expansion of our mortgage banking operations in the Grand Rapids market and other strategic initiatives within our mortgage banking platform, which more than offset the benefits of a boom in refinance activity during the third quarter of last year. We also recorded a $0.4 million reimbursement related to certain medical insurance premiums charged in prior years.

With caution that mortgage banking income and recoveries on certain acquired chargeoff loans can be difficult to forecast, we expect non-interest income during the fourth quarter to be in a range of around $4.5 million to $4.8 million. We recorded non-interest expense of $19.7 million during the third quarter of 2016, unchanged from the third quarter of 2015. We are now realizing the expected cost savings associated with our efficiency program announced in late 2015, which has helped to mitigate increased insurance and stock-based compensation costs. We currently expect non-interest expense to total between $19.5 million and $19.8 during the fourth quarter, with our effective tax rate remaining around 31.5%.

We remain a well-capitalized banking organization. As of quarter end, our Bank's total risk-based capital ratio was 13.1%, and in dollars was approximately $84 million higher than the 10% minimum required to be categorized as well-capitalized. The impact to the Bank's total risk-based capital ratio from the $0.50 per share special dividend, as the Bank will be funding the special cash dividend with a cash divided to the Parent Company, is about 30 basis points to our capital ratios.

As part of our current $35 million common stock repurchase program, we have repurchased about 956,000 shares, or nearly 6% of the total shares outstanding at year end 2014, for $19.5 million for an average cost of $20.38. We did not repurchase any stock during the third quarter. Funding from the stock repurchase program has generally been provided via cash dividend from our Bank, and any further stock purchases would likely be funded in a similar manner.

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

Thank you, Chuck, and good morning. The third quarter produced net loan growth of $26 million, advancing the year-to-date growth number to $128 million. During the quarter, commercial loans funded to new and current clients totaled $131 million. For 2016 year to date, commercial loan fundings have now surpassed $400 million.

Our pipelines continue to be solid, as they have been throughout 2016. Competition remains heavy in all of our markets with other financial institutions trying to obtain new business through aggressive rates and structure. Our bankers have generated excellent opportunities from clients who value Mercantile's client acquisition and customer service approach.

Our consultative relationship building efforts continue to be well-received by our clients and prospective clients, and that is reflected in our 2016 growth. Quality relationships take time to properly develop, as our lenders become familiar with the prospective client businesses and establish a high level of knowledge and trust.

As Chuck reported, we continue to gain momentum with production, operational excellence and product array in our retail mortgage area. Newly hired mortgage lenders in our metro markets are building their pipelines, and changes to our processes are continuing to manifest themselves in efficiency and improved customer experience. We look forward to growth in this area of our business for the balance of 2016 and beyond.

With respect to asset quality, performance metrics once again displayed improvement during the third quarter. Total nonperforming assets dropped below $5.5 million at September 30, which includes other real estate owned at less than $1 million. Our lenders and management continue to diligently monitor our loan portfolio to provide for the earliest identification of potential problems, potential signs of stress, as well as any other concerning trends in our asset quality.

In view of reports concerning inappropriate sales activities at one of the nation's largest banks, we have spent some time with our staff contrasting the activities that have been detailed in the news reports with client acquisition protocol at Mercantile. Our department heads and managers continually coach team members on the principles of effective customer needs analysis so that all Mercantile clients are placed in the appropriate products and services consistent with their financial situation and future financial objectives.

And, finally, as for the Michigan economy, the positive trend lines we have witnessed for many quarters continue. The state's unemployment ticked downward in the third quarter, down to 4.5% compared to 5.1% a year ago.

Michigan's unemployment rate remains at a level below the national average. Employment in the state has been steady throughout 2016. Additionally, the real estate conditions in our markets continue to be healthy.

Those are my prepared comments and I'll turn it back over to Mike.

Thank you, Bob, and thank you, Chuck. Operator, at this time we would like to open the call up to questions.

(Operator Instructions)

Our first question comes from Damon DelMonte from KBW. Please go ahead with your question.

Good morning, guys, how you doing? My first question just relates to the margin, so probably directed at Chuck. I think you had said that over the next four or five quarters you think the margin can be around the 3.75% level. Is that an average level over that period of time or is that like a flat level that you expect to maintain?

It's probably more of an average. Obviously, as I pointed out, the forecasted discount accretion that's going to be coming into our net interest income stream is a little bit choppy. And obviously there's going to be other things that are going to be taking place.

So, I would say it's more of an average. But I'd also back that up and say I don't expect huge swings in our margin on a quarter-to-quarter basis. So, I would expect that each quarter the margin will be relatively close to that average.

Okay, that's helpful. And then with regards to loan growth, I think you guys noted that you have around $113 million of construction-related loans that still have to fund. What does the pipeline look like as far as those coming on to the books?

This is Bob. The pipeline, as I said, remains solid, as it has throughout the entire year. We do have that steady stream of construction loans that are on the books and will continue to fund over the course of the next several quarters, as well as we have ongoing opportunities in all of our markets for C&I type credits and other types of projects our clients and prospective clients are engaging and entertaining in.

So, more of the same that we've seen throughout 2016 in terms of the opportunities that are out there for our lenders and the ability to bring new clients on board. We expect more of the same in the quarters to come.

Okay. And then with regard to the Chemical/Talmer deal, have you seen much disruption in the marketplace now that's been completed? And are there any areas of opportunity that you're currently focusing on as a result of that?

This is Bob again. I think the biggest opportunity that we've had -- and I think we've mentioned this on prior calls -- is that, coincident with our building up of our retail mortgage area, we've had some great opportunities through disruption at some of the other banks, some of the acquisition and mergers that we've seen in our markets with mortgage personnel, both operational people as well as commissioned mortgage lender.

And that's continued to be strong throughout the last couple of quarters. That's been our greatest opportunity that we've seen as a result of some of the changes with the mergers and acquisitions in the markets that we're in.

Okay. Great. Thanks. That's all that I have for now.

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

Good morning, guys. Chuck, just to confirm, and I'm pretty sure this is right, but the discount accretion that you laid out over the next few quarters or next year or two, that's included in your 3.75% margin, correct?

That's correct.

Okay. And then, guys, when you look at loan growth going forward, is it fair to say that you would expect fourth-quarter growth to be more in the range of the second-quarter level versus the third-quarter level?

As we've stated the last couple of quarters, commercial loan growth funding is hard to predict. And that's why you've seen the patterns that we've established throughout 2016. The second quarter was really strong. I think, with that, the third quarter looked more like the first quarter.

But if you look at the overall growth over the course of the year, I think we're still looking to be in that upper single digit type of growth range. But it's hard to say in the narrow range of every three months as to what that growth may look like coming onto the books. And then you get the dynamics of potential payoffs that occurs as well. So, it's hard to predict in the range of any one quarter, but I think over the course of four quarters, you're looking at that consistent growth that we've talked about.

John, this is Mike. If you were to use that second quarter as the high end of the range and this last quarter as probably the low end, it would probably be somewhere in there, trying to narrow it down for you as much as we could. But Bob is right, timing is sometimes a little fickle as far as when these things come on and how robust they fund.

I understand. Mike, maybe just a question for you on the special dividend. Just curious how you weighed paying a special dividend versus maybe just being more aggressive on the buyback plan during the quarter or the next couple of quarters.

It's a great question and it's certainly a question that management and the Board spend a lot of time considering. And the fact of the matter is, and it's pretty obvious, we have an awful lot of capital and we felt very strongly that we needed to deploy the capital in one way or another.

As we looked at the recent run-up of our stock price, which we thought was well-deserved, but it makes the buyback a little less attractive, and pointed the overwhelming -- not overwhelming, but the final decision to do a cash dividend, is the one that made the most sense at the current time. And as Chuck has already covered, and the release covers, as well, we still end up in a very strong capital position.

Okay. And does the special dividend -- are you trying to send any signal about any future M&A opportunities or anything like that?

We're pretty good about not sending too many signals about things. We try to be pretty straightforward. I appreciate the question but I think, clearly M&A, you can certainly infer from the fact that if there was an M&A deal that was imminent you probably would have seen that. So, I think that's fair to say.

But I think going forward we continue to have the same marching orders we've had from our Board, which is continue to vet all potential M&A activity to see if it makes any sense, and if it did, as the First Bank deal did a couple years ago, to go forward with it. But since there wasn't anything imminently going to happen, we did look at the buyback dynamics at $26, $27 per share, we felt the special dividend, cash dividend, made the most sense.

Okay. Mike, just curious, will you be joining us on future calls now that you'll be stepping down from day-to-day stuff in January?

Yes, at least for a while in my role as Executive Chairman. Certainly Bob will be running the show. I guess this would be my last official call as CEO, as I start to think about it. But I'll certainly be around and try to keep my mouth shut and only add when Bob wants the addition. But I'll be around for a while on these calls and look forward to next year, especially, as being a really strong year.

Okay. Either way, good luck. I appreciate everything. Thanks, guys.

Our next question comes from Matthew Forgotson from Sandler O'Neill. Please go ahead with your question.

Good morning, all. Just a question on the margin. Does the 3.75% average over the next four quarters, does that include any rate hikes?

No. It does not.

Okay. And, Chuck, I wonder if you can just give us a little bit of detail on the sensitivity of the balance sheet to a 25 basis point move in rates. Can you offer what that might contribute to the net interest margin?

Yes, I can put it in dollars, Matt. I didn't calculate it on a percentage basis but if I give you the dollars you can do the math. The way that we look at our floating rate portfolio now, and taking into account -- let me back up.

Probably about 75% of our floating rate portfolio -- and I'll take one step further back -- half of our commercial loans are floating and half of those are fixed. Of the floating rate loans, 75% can float if we get another increase in the prime rate or the 30-day LIBOR. And then over the next 50 basis point increases, virtually all of the portfolio can float as it comes off of our floors.

So, if we give 25 basis points, that's about $175,000 a month in additional interest income from those loans. And, so, if we got another 25 basis point on top of that, we would get yet another $175,000 per month plus a little bit more as some of those loans start leaving their floors.

Okay, thank you. Just wondering about the build-out in mortgage banking. Clearly really nice momentum here. How staffed up are you relatively to where you ultimately want to be?

This is Bob. I think we're pretty well along the track as far as staffing. And what we're looking for now is that if you have successful lenders that become available in any of our markets, especially our major metro markets, that have shown the ability to generate good mortgage volumes over the course of several years, those are situations that we're probably going to take a serious look at. And those would be commission mortgage lenders, and the ability to impact the bottom line would be a fairly significant.

But I think the infrastructure that we have in place in terms of the operational staffing is pretty well set, and future additions would be along the lines of commission mortgage personnel on the sales side.

And can you remind us how much in origination volume you did during the quarter and what that purchase/refinance mix looked like?

I don't have that information at my fingertips right now. Chuck, do you have any --?

I'm going by memory here. I know the majority of it was purchased, although some refi activity was there but don't know exactly on the production numbers. And, of course, that tends to be very seasonal anyway, and obviously the build-out with hiring additional lenders, primarily during the second quarter but also some third quarter, as well.

Even if I gave you the numbers I'm not sure how useful that would be in forecasting as we go forward. But certainly, with the build-out we've done throughout this year, as Bob has laid out, we don't really expect any significant changes in mortgage rates as we get into 2017. Certainly we would expect 2017 to be a higher level of income than what we saw in 2016, which, of course, has been a good year for us, as well.

Some additional color on that is that it was about 60/40 purchase/refi. What is exciting for us about that is I think it shows -- and Bob's been talking about this for a few quarters -- is the momentum that we've built. We've gone from really relying on the refi market to really float that mortgage balloon, if you will, to now having a really nice group of lenders who have established relationships to get a lot of that new purchase in, as well. But like Chuck and Bob, I can't remember what the exact dollar amount was funded but it was about a 60/40 split, if I recall right.

That's fine. And, just lastly, in terms of looking forward in terms of commercial growth, can you just give us what the commercial pipeline was? I guess you were around $200 million or thereabouts at June 30.

Yes, the pipeline has been pretty consistent throughout the course of the year. As I mentioned on maybe a couple of previous questions, trying to forecast the funding of those loans out is a little bit of a challenge. We do have the steady stream from the construction loan fundings, and that continues.

As far as the C&I funding, that's a little bit hard to forecast. But I'll wrap it up by saying the pipeline has been pretty steady throughout the course of the year. There's continual ebbs and flows in that but it's been pretty steady.

Thanks very much.

(Operator Instructions)

Our next question comes from Daniel Cardenas from Raymond James. Please go ahead with your question.

Good morning, guys. Just going back to the special dividend, given your robust capital position and really the nice run up in the stock price, which is probably sustainable, what's the likelihood of seeing additional special dividends going forward?

Dan, that's a good question. Appreciate you asking that. We really haven't discussed with the Board or within our management team of any additional special dividends -- hence the name special. But appreciate the question.

Okay. And then maybe for Bob, as we looked at loan growth in the quarter, could you give us a little bit of color as to what paydowns and payoffs look like in 3Q?

The paydowns continued consistent with what we had in previous quarters, I think. There wasn't anything too noteworthy that happened during the third quarter. But, again, some of these things are a little bit more difficult to predict as a client all of a sudden decides to sell a project and pay off the underlying loan on that, or a company decides to sell their business. That happens from time to time.

So, those things pop up and ding the growth side a little bit, obviously. But during the third quarter there wasn't anything noteworthy that jumped out, that stood out as far as impactful.

Okay. And then looking at wholesale funds, it looks like you guys are up year over year. Is there a cap that you guys really don't want to go above a percentage basis of total funding?

Dan, this is Chuck. We're right about 10% now and what we do is we look at broker deposits as well as our FHLB advances and take that as a percent of our total funding. We're at 10%. You're right, we were around 7%, 7.5%, I think, at the beginning of the year.

We did bring on, I think, $110 million in FHLB advances, primarily during the second quarter when we had that very strong loan growth. So, we used that. But we're also using the FHLB advance ability to replace any runoff on brokered CDs that we still need the monies, pretty much, for the most part, getting out of the broker market CD. We have sufficient capacity at the FHLB to do that, as well as fund any additional loan growth that we need to from that side of things.

We're about 10% now. Our internal policy is 10%. We don't really want to get above that. That's what we're striving to do. We continue to see really good deposit growth from both the personal and business side of things.

We think we can continue to hold that, either at or below 10% as we go forward. But I would also say I think that, as an executive management team, if we had really strong prudently underwritten loan growth to take advantage of, and we needed to maybe go a little bit above that 10%, I think we would be comfortable in doing that if the circumstances were to dictate it.

But that would probably be a temporary increase, right? Would the goal be to work back towards that 10% over time?

That would be our goal, yes.

All right. Great. Good quarter. Thanks, guys.

Ladies and gentlemen, at this time I'm showing no additional questions. I would like to turn the conference call back over to the moderators for any closing remarks.

Thank you very much. We would like to thank everyone on the call today for your interest in our Company, and we look forward to talking with you after the year end. This should end the call.

Ladies and gentlemen, that does conclude today's conference call. We thank you for attending. You may now disconnect your lines. Thank you.