Mercantile Bank Corp (MBWM) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Third Quarter 2017 Earnings Results Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mike Houston, Investor Relations counsel of Lambert and Edwards. Please, go ahead.

Thank you, Rachel. 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 2017. I'm Mike Houston with Lambert, Edwards, Mercantile's Investor Relations firm, and joining me are members of the management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, President of Mercantile Bank Michigan.

We'll 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 this morning, you can access it at the company's website at www.mercbank.com.

At this time, I'd like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski. Bob?

Thank you, Mike, and good morning, everyone. And thank you all for joining us. On the call today, I will provide an overview of performance for the third quarter, including comments on loan growth, profitability and asset quality. And then our CFO, Chuck Christmas, will provide details on our financial results, followed by Q&A. As Mike said, we're also joined on the call today by Ray Reitsma, Mercantile Bank's President.

I'm proud of the consistent performance we've delivered throughout 2017, which continued in the most recent quarter as sustained strength in core profitability, solid loan growth, sound asset quality and controlled overhead costs produced earnings per share of $0.51. Mercantile remains on track to deliver a strong year of financial performance, consistent with our guidance. In particular, let me highlight several accomplishments in areas of strategic focus during the quarter.

Commercial term loans funded to new and current clients totaled $128 million, contributing to an overall annualized loan growth rate of almost 10% over the first 3 quarters of the year. This is consistent with our outlook of high single-digit growth for the year as a whole. Mercantile continues to benefit from a strong Michigan economy as well as active and successful lending teams in our markets. Our loan pipelines remain solid, which gives us confidence in the sustainable opportunities for growth that we see over the remainder of 2017 and into 2018.

Mortgage loan production was also on track for the quarter as our residential mortgage loan portfolio grew nearly 7%, marking the sixth consecutive quarter of growth in that portfolio segment.

During the third quarter, we saw solid performance in core fee generating areas, including credit and debit card fees, mortgage banking activity income and payroll processing revenue. Although our cost of funds has trended upward over the past few quarters, our net interest margin has performed well, reflecting an increasing yield on earning assets. Based on our balance sheet structure, additional tightening by the Federal Open Market Committee should positively impact our net interest margin going forward.

We continued to experience peer-leading asset quality, which is reflected in the very low level of nonperforming assets, representing 0.3% of total assets. As evidence of our strong capital position and demonstrated continued commitment to shareholder return, we earlier today announced a quarterly cash dividend of $0.19 per share for the fourth quarter, providing an annual yield of about 2.1% based on our current share price. Our outlook is that the overall healthy business and employment expansion being reported for Michigan will continue, particularly within our largest markets.

Looking through the fourth quarter of 2017 and into the coming year, we remain encouraged by our growth opportunities. Our key markets are demonstrating healthy growth, our financial condition continues to be very strong and our operating metrics continue to reflect the positive effects of our strategic initiatives. Moreover, we believe that our relationship banking approach will continue to provide additional opportunity to participate in the economic strength of our markets as Michigan's premier community bank.

That concludes my prepared remarks. At this time, I'll now turn it over to Chuck.

Thanks, Bob, and good morning to everybody. This morning, we announced net income of $8.3 million or $0.51 per diluted share for the third quarter of 2017. During the third quarter of 2016, we earned $7.8 million or $0.48 per diluted share. Net income for the first 9 months of 2017 totaled $23.3 million or $1.41 per diluted share compared to $23.8 million or $1.46 per diluted share during the first 9 months of 2016.

Excluding the impacts of certain noncore transactions, including a bank-owned life insurance death benefit claim during the first quarter of 2017, repurchase of trust preferred securities at a large discount during the first quarter of 2016, an accelerated purchase discount accretion on called U.S. government agency bonds during the first 9 months of 2016, diluted earnings per share during the first 9 months of 2017 and 2016 equaled $1.34 and $1.27, respectively. We remain pleased with our financial condition and earnings performance and believe we are very well positioned to continue to take advantage of lending and market opportunities while delivering consistent results for our shareholders.

Our net interest margin was 3.83% during the third quarter, continuing a relatively stable trend. Our loan yield has benefited from the recent rate hikes from the FOMC, with each 25 basis point increase in the federal funds rate equating to about a 9 basis point increase. Although interest rates have increased in recent periods, the overall interest rate environment remains low and when combined with strong competition for loans, there remained some downward pressure on our loan yield.

Our cost of funds, which had remained very stable for the past few years, has increased during the past 2 quarters in large part reflecting higher time deposit rates, a money market deposit account special and higher reliance on wholesale funds. We recorded $1.8 million in purchased loan accretion in payments received on former CRE pooled loans during the third quarter of 2017 compared to $0.6 million guidance figure I had provided at the end of the second quarter. The higher-than-expected level of income equates to about 15 basis points of our third quarter net interest margin. In large degree, the higher level of income reflects a change in the accounting treatment for our pool of purchased CRE impaired loans to the cost recovery methodology as of year-end 2016.

As a reminder, as of year-end 2016, payments received since the merger lowered the recorded investment on this particular pool to 0. In accordance with cost recovery methodology, accretion income is no longer recorded on this pool, but instead all payments made by the borrowers are immediately recorded as interest income. Payouts of several credits that were formally in the CRE impaired loan pool during the third quarter accounted for a majority of the higher-than-expected level of income. We currently expect to receive a minimum of about $4 million in principal payment on these particular loans in future periods, which will be recorded as interest income upon receipt.

Based on our most recent valuations and cash flow forecast on purchased loans, we expect to record further quarterly interest income totaling about $0.6 million during the fourth quarter of 2017 and into 2018. Please note that this forecast is largely based on scheduled payments and forecasted accretion entries.

Negatively impacting our net interest margin by about 7 basis points during the third quarter was a higher-than-desired level of excess overnight funds, primarily reflecting inflows into money market deposits and lower-than-projected net loan growth. We expect our net interest margin to be in a range of 3.70% to 3.80% throughout the remainder of 2017 and into the early portion of 2018. This forecast assumes no further changes in the prime and LIBOR 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 strong with continued low levels of nonperforming assets and debt loan charge-offs. Nonperforming assets as a percent of total assets equaled only 32 basis points as of the end of the third quarter. Of the $3.3 million net increase in nonperforming assets during the third quarter, nearly 1/2 is associated with a transfer of a bank-owned facility that is no longer being considered for use as a bank facility to the other real estate category. We expect to sell the facility within the next 6 months at a price that approximates its current carrying value.

Net loan charge-offs equaled only $1.1 million during the first 9 months of 2017 or 6 basis points as an annualized percentage of average total loans. One commercial loan relationship accounts for about 1/2 of the net loan charge-offs and gross loan charge-offs recorded in 2017.

We recorded a provision expense of $1.0 million during the third quarter, in large part driven by an increased allocation relating to a change in our economic conditions, environmental factor as well as commercial loan growth. We expect to record quarterly provision expense of $750,000 to $1 million during the fourth quarter of '17.

Our loan loss reserve totaled $19.2 million at the end of the third quarter or 0.88% of total originated loans. No significant changes from the current level are expected for the remainder of 2017.

We recorded noninterest income of $4.6 million during the third quarter, at the higher end of the guidance I had provided at the end of the second quarter. We are pleased with the results of our strategic initiatives involving mortgage banking, treasury management and payroll services and look forward to enhanced fee income performance in future periods. We currently expect noninterest income to total between $4.1 million and $4.3 million during the fourth quarter, a decline from the third quarter results due to seasonality in mortgage banking.

We recorded noninterest expense of $20.2 million during the third quarter, similar to what we have expensed during the first and second quarters and within the guidance we provided at the end of the second quarter. Currently, we expect quarterly noninterest expense to total between $19.8 million and $20.2 million during the fourth quarter, with our effective tax rate to remain just under 31%.

We remain a well-capitalized banking organization. As of quarter end, our bank's total risk-based capital ratio was 12.5% and in dollars was approximately $74 million higher than the 10% minimum required to be categorized as well capitalized.

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

Thank you, Chuck. This time, we'll now take your questions.

(Operator Instructions) The first question comes from Matthew Forgotson with Sandler O'Neill + Partners.

Bob, I was wondering if we can just start high level, if you could just tell us what you're seeing across your markets. Talk to us a little more about the loan pipeline and then expectations for growth in the fourth quarter.

Well, we said loan pipeline remains very strong. We expect performance to continue as compared to our guidance. Very competitive landscape continues to be in all of our markets from a pricing standpoint, from a structural standpoint. And our key approach is to remain very disciplined and continue with our relationship banking approach. And as we've seen through the first 7 -- for the first 3 quarters of the year, that's performed very well for us.

And I think our clients know what to expect from us, and the consistent performance is the key. Building relationships in all of our markets continues to be our hallmark, and we continue to see that through the fourth quarter and into next year. As I said, our pipeline remains nice and strong. We see some good opportunities in all of our markets despite the strong competition.

Okay. And in particular, could you just comment a little bit about the southeast office, how it's doing and the traction you're generating in that market?

Yes. They are doing very well. They continue to -- continue building relationships there and introducing the commercial loan and consumer customers to Mercantile Bank and our relationship banking approach as we do in all the rest of our markets and continue to gain good traction in the Southeast Michigan market as well.

Okay. And then, Bob, just staying with you, I guess, you mentioned on last quarter's call that the M&A environment was relatively quiet. Can you give us just your most recent thinking on M&A?

As we've always talked about here at Mercantile Bank, our approach to M&A activity is -- culture is extremely important just as it is through all the other things that we do as an organization. And we see opportunities from time to time, and we look at those opportunities. And obviously, while the numbers have to make sense certainly, culture is extremely important to us. And that will be the approach that we take going forward as well as we look at M&A opportunities that may come across our desk from time to time.

Okay. All right. I guess just lastly and then I will hop out. At this time last year, with similar levels of capital and liquidity, you declared a $0.50 special dividend. Just wondering if that's still on the table or if you're more inclined to keep your powder dry to support growth and maybe even some M&A.

As we positioned it last year when working with our board, decided that, that was an appropriate action to take and we called it a special dividend and it was precisely that. And so the expectations that, that will continue are not necessarily the case. We will continue to evaluate our capital position and the whole gamut of options for us as a company, and we will continue to do that going forward. But as far as the dividend last year, it was special, and that's how we'll continue to treat that.

The next question comes from Kevin Reevey with D.A. Davidson.

So on your commercial loan originations, was there any particular region that contributed to the growth than any other region?

Well, certainly, our major markets were the biggest drivers of the growth as they typically are because that's where the biggest opportunities are. But I think the opportunities were sprinkled about all of our markets. We saw some nice opportunities everywhere. But certainly, the major metropolitan markets were the lead driving force for the biggest thrust of the loan growth, which they typically are for us.

And what was the aligned utilization rate at the end of the third quarter? And can you remind us where it was at the end of the second quarter?

Yes, Kevin, this is Chuck. We saw a little bit of a dropoff, quite frankly, in some of our line utilizations during the third quarter. They've been holding right around 50% if you look at our gross commitment compared to our average balances outstanding. It didn't drop tremendously, but with some additional lines booked during the quarter and the line usage down, the percentage dropped a little bit. So first time in quite a while, we haven't seen our lines of credit actually increase.

And then -- and, Chuck, maybe you can help me. I noticed your loan originations were also down. I think it was $128 million this quarter versus $152 million. Was there something unusual in the second quarter that didn't occur in the third quarter and responsible for the linked quarter decline?

Yes, Kevin, I think we always talk about is being heavily commercial loan driven, on a quarter-to-quarter basis, we are going to see some volatility. So we typically see that. There's really not any seasonality to that as far as weather, obviously, we see that in the mortgage area. But it just kind of happenstance as to -- as our lenders work with borrowers and putting packages together and going through the approval process. Where that may fall in with the calendar cycle, it just -- there's really no correlation there except for the fact that we report at the end of each quarter.

When you look at the numbers quarter-to-quarter, the $128 million we did this quarter, I think, is pretty close to average. Having said that, our second quarter number was probably a little bit on the high side of what we typically do. But again, there's really no specific reason for that except just as things are working their way through our processes and approvals and doing our appropriate underwriting.

The next question comes from Damon DelMonte with KBW.

So my first question, just relating to the margin. Chuck, could you kind of help frame out the actual -- the core margin this quarter versus last quarter? I know you were targeting around $600,000 of accretive yield impact, but obviously, it came in higher. So if we were to kind of zero that out to a core level, what would you put that at for this quarter?

I'd put it into the mid-370s. And again, that takes into account the fact that we did record a higher level of purchase accounting stuff. But we also had, as I mentioned, some pretty high level of overnight funds sit at the Federal Reserve. So if you kind of back out -- if you back out the excess liquidity and you put the purchase income kind of down to more of our guidance, I think that put us right around 375, give or take a couple basis points.

Okay. And the excess liquidity, was that due to an inflow of shorter-term deposits?

Yes, I think it's a combination of we did put a money market and deposit account special together for some higher balances and new money to the bank. And so we saw an influx of funds from that perspective. And then also, as I mentioned, and again, it kind of goes back with my answer to Kevin, on loan originations, we really see the same thing on payoffs as well. And generally, most of our payoffs happen because we've asked folks to leave the bank or they're selling the collateral, especially on the real estate deals. The payoffs tend to be volatile from quarter-to-quarter as well.

And one of the things that we saw in the third quarter, while, again, the loan originations were pretty much on average, we did see a relatively high level of payoffs, obviously impacting our net loan growth but also impacting our liquidity. So a combination of deposit influx as well as not utilizing as much funds on the loan side as we, on average, do caused the excess overnight funds at the fed. We also traditionally do see a pickup in deposit accounts, especially from our commercial customers in the latter half of the year as they start building reserves for bonus and tax payments as well. So that's something that we're always mindful of as we're going through and planning our liquidity.

Okay. So the pressure you saw on the funding side for deposits, that was more driven by account specials and marketing efforts that you guys have done? Or is that more attributable to just general pricing pressures across the market?

I would say all that. I think we're all seeing CD rates rise, and I think those are primarily driven by the increase in the fed funds, our rate. But there's definitely some competition out there, there always is. We're in a highly competitive -- all of our markets are highly competitive. So we try to always be in the top 1/3. When we're looking at what our competitors are doing, we always try to be in the top third, closer to the top, excluding any -- some of the crazy stuff credit unions are doing out there. And so we've been very, very consistent with that. And so as market rates have moved up, we definitely have seen some CD rate movements. But again, we're like in the top third, and there are some, let me say, very aggressive campaigns out there from some. So that's taken place.

Our trust preferred is tied with 90-day LIBOR, so those have been repricing upwards as well. The money market, again, we didn't touch our existing money market rates. We created a couple high-balance tiers for new money, and that's what I was talking about before. But if you look at savings rates, you look at interest-bearing check and you look at our traditional money market accounts, we have not yet had to touch those, and we're right where we want to be in regards to the market. And we continue to see some good building in those deposit accounts at the rates that they're at.

So I'd say, the -- for the most part, I think it's just the increase in the market rates, the fed funds rate, that's impacting CD rates and our trust preferreds, and then the special -- I don't want to overplay the special too much. We don't traditionally do specials here, so it gets a little bit more play than otherwise it would. But I think as rates have gone up, we're going to -- everyone's going to see an increase in cost of deposits. It's just a matter of magnitude and how a bank's balance sheet is structured on different types of deposits.

And I think our approach, just as they do on the lending side, is based on relationships, and we've been quite pleased that some of the relationships that we've garnered on the deposit side, maybe customers who don't have necessarily borrowing needs right now, but they like our approach to banking and are moving some deposits over here as well as continuing to work with existing -- our existing client base on making sure that we have as many of their deposits as we can. They maybe have their loan relationship with us. Maybe there's some personal deposits or other types of corporate deposits that they can bring our way in. Our folks have done a nice job in garnering those types of relationships on the deposit side as well.

Yes. And I will just add to that, we continue to see steady, very, very nice growth in noninterest-bearing checking accounts, and that's really driven by the growth on our loan side as we continue to get some really nice C&I credits into the bank. Obviously, they typically come with some very nice operating accounts, maybe 10% to 20% self-funding. So we're very pleased with that aspect as well.

Those C&I relationships that Chuck referred to are also great opportunities for us on the treasury side because those folks generally have the need for maybe more sophisticated cash management types of products and services. And our treasury folks work with them on being able to enhance the relationship with those types of activities as well.

Okay. Great. And then you guys noted in the release that unfunded commitments on commercial construction, development loans was $163 million, which is up from $111 million last quarter. As these credits become funded and hit the books, are those generally 12- to 18-month credits that are somewhat temporary? And then do they generally go to perm? Or do they -- are they generally financed away after that?

No. They generally -- there's 2 ways of doing it. One is you can do the construction loan and then refinance it at the end of the construction period, which, on larger construction projects, are going to be 18 to 24 months. Sometimes we do a construction permanent loan at one time at the initiation of construction. But a vast majority of the projects that we finance the construction, we also end up doing the permanent financing as well, whether that's a combined construction perm loan or do the permanent loan at the -- after the construction is completed. But we try not to do too many deals on the construction side if we know we're not going to get the end financing. It's hard to get an appropriate rate for the risk during the construction period just because of the market that's out there, and certainly, we much prefer to have the permanent loan as well.

Okay. Great. And then just lastly, as you look into the fourth quarter, Bob, you kind of reiterated the guidance for loan growth. So we're talking somewhere in the kind of mid-single-digit range here for the fourth quarter and then carrying into 2018?

Yes, that's what we're looking for right now, yes.

The next question comes from John Rodis with FIG Partners.

Bob, maybe just a follow-up to your last comment because in your commentary, you talked about high single-digit loan growth for 2017, and then I think you were just talking about mid-single-digits. So can you clarify that? I just want to make sure I heard that correctly.

That's for the fourth quarter. I think we'll get -- for the year as a whole, we'll be high single-digit. Obviously, a lot of moving parts to that as we often talk about. The funding side is probably the most predictable part of it. The less predictable parts of it are what payoffs you might get through a customer selling assets or line activity. As Chuck mentioned, we were down a little bit for the third quarter. So that's what makes the prediction part of it a little bit more challenging than just as a pure funding component. But from the funding side of it, we're very pleased with the level of the pipeline. The pipeline is as robust as it has been, and that's what we look for going forward. And the wildcards will be, obviously, the less predictable factors.

So -- I'm sorry, so mid-single-digit annualized for the fourth quarter is what you're saying. Correct?

Yes.

Okay. That makes sense. Could you guys just maybe talk about the buyback? You still got about $15 million left. You haven't bought anything in a while. And I think, last quarter, you said you'd look to be opportunistic. Is that still the right way to think about things?

Yes, John, this is Chuck. That's exactly what we want to be. We bought back about $20 million worth of our shares a while ago now. The average price was $20, $21, somewhere in that range. So, obviously, as we trade today at $35, that played out very, very well for us. We like the price of $35, certainly. Like any company is going to say, they want it to be higher. But when we look at that as a premium over our tangible book, it's up there from a buyback standpoint. So we have elected to kind of just stay on the sidelines for now.

Obviously, the buyback is not just about price, it's also about managing our capital. And we want to make sure that we've got sufficient dry powder to manage any growth that we do have on our balance sheet. And it's already been said a couple of times now that we do have a very, very extensive pipeline, a lot of construction loans to fund and there's still a tremendous amount of call activity that's going on out there. So we want to make sure that we have an appropriate level of capital to fund that loan growth, to make sure that some of the administrative-type ratios that we look at, concentrations, a lot of that stuff we always put against capital. So we want to just make sure that we are at where we want to be in regards to our growth, the type of growth and the overall structure of our loan portfolio, especially in relation to our balance sheet and our capital position.

So I think you're right. It's a long-winded question -- answer to basically say, yes, you're right, it's very opportunistic. We certainly stand ready to go ahead and utilize that established line from our board if, in fact, it makes sense going forward, whether that's because loan growth expectations or certainly our stock price.

Okay. And then, Chuck, maybe just one other question for you and I'll be done. Just the increase in nonaccrual loans this quarter. I know it's off low levels, but can -- it went from $6.5 million to $8 million roughly. That wasn't the building, was it?

No. The building went into ORE. We had -- the increase in nonaccruals is primarily just one relationship -- C&I relationship that we've got. And obviously, from time to time, a bank is going to have some of its credits go sideways. And obviously, we saw some trouble with that one credit. And as we always do, take the conservative route, put it in nonaccrual and then start working with the borrower to try to correct the situation.

But big picture, you guys still feel good about credit quality, right?

Yes. And I guess that's what I was going to follow up on, John, is it's primarily a one-off. It happens from time to time, but it's certainly not indicative of anything that's systemic. On an overall basis, we continue to be very pleased with the overall quality of our loan portfolio.

Yes. Just to underscore Chuck's comments, we're very pleased with the quality -- the asset quality of the portfolio. And as Chuck also said, I think we tend to, as we always have, take a fairly conservative approach to our treatment of problem loans. And as you can see by the level of recoveries that we typically have, I think it's reflective of that more conservative approach that we'll take a charge-off and then some recoveries come in later, and we've experienced that again, not only in the third quarter but throughout this whole year.

Yes. And I don't want to get too much into the weeds, but if you look at our numbers this year, there was 1 quarter that we had a particularly high level -- relatively high level of charge-offs. And we've already received some pretty significant recoveries on net charge-off, both in the third quarter, which you've seen the numbers, but also here early in the fourth quarter, we've got some additional recoveries coming back. So it makes the swings a little bit larger, but that's just our style of banking. When we see a problem, we identify it, we record it properly and we aggressively get on it.

Makes sense. You guys are right. I mean, your charge-offs are going to be, what, probably below 10 basis points again this year, so that speaks for itself.

(Operator Instructions) The next question comes from Daniel Cardenas with Raymond James.

Just -- most of my questions have been asked and answered. Just one quick question. On the provision expense, we saw this $0.25 million. What portion of that was related to loan growth? And then what portion of that was related to the change in economic conditions that you mentioned in your prepared remarks? And then a follow-up on that, just maybe what are the change in economic conditions that you guys are seeing that are causing you to perhaps set aside some additional provisions?

Yes. The change in economic conditions was about $650,000, and that's an environmental. That goes through at every type of loan that we've got. That's -- sometimes the environmentals only touch certain aspects of our portfolios, but changing economic conditions impacts all of them. So again, it was about $650,000.

The other $350,000, there's obviously lots of stuff going on there. Certainly, loan growth is going to be part of it, but obviously, upgrades, downgrades, those types of things, changes in specific reserves, payments on nonaccruals, those things are going to make up the other things.

It's interesting because changes in economic conditions, we actually upgraded that allocation earlier this year. I believe it was the first quarter. And obviously, there was a lot of very positive news, very positive optimism. I won't get into the reasons why. Everyone has their own opinion as to that. But there was no doubt that optimism was up and -- in lots of different metrics. And so we went ahead and changed that one. I think -- again, I think it was the first quarter. But I think we've seen, in many aspects, that optimism kind of waned off -- wane, I should say, and die off a little bit. So we're kind of right back to where we were basically 12 months ago.

And again, obviously, we look at our environmentals, all of them at the end of each quarter, and make changes where we think are appropriate. And we try not to do them, have wild swings quarter-to-quarter. We really look for general ongoing trends and make changes at that point in time. But I think that the optimism that we saw at the beginning of the calendar year certainly isn't what it is today, and we thought kind of reversing engines on that particular one made sense.

Okay. So it sounds like maybe just a more cautious outlook on the overall operating environment. Doesn't sound like you're perhaps expecting your charge-off levels to bounce off of these low levels that we've seen here over the last several years. And is that -- am I reading that correctly?

Yes. And I appreciate the follow-up question, yes. I want to make sure that we're all clear on that, that the downgrade, if you will, in changing economic conditions is not an indication that we are concerned about the economy overall and how that's going to impact our borrowers or, certainly, what we see in the condition of our borrowers. The economic condition is still positively rated within our allocation paradigm. It's not just as highly rated as it was prior to that. But again, as we mentioned, we're very, very pleased with the loan portfolio and don't see anything systemic that reflects any type of downturn.

And as a further follow-up, I wanted to just clarify, too, that the change, the environmental effect that Chuck referred to is not reflective of our view of the Michigan economy or the strength of the economies in our local markets that we're seeing. I think it's more of on a broader scale than that from a national standpoint.

Okay, good, good. That makes sense. And then just a quick question about the loan growth that we saw in this quarter. Geographically, was that concentrated in any one area? And what -- if possible, can you give footings on the Southeast Detroit initiative, what you're seeing in terms of loan balances and deposit balances?

As we said a little earlier, I think our major metropolitan markets certainly contributed the majority of the loan growth that you saw and certainly represent the biggest part of the pipeline that we see, although we are seeing some good traction and some good opportunities in all of our markets, including some of the small community rural markets as well. As far as Southeast Michigan, we're very pleased with their activities and the relationship building that's going on in that market. And they're introducing Mercantile Bank and -- for both the loan and deposit side, and we're very pleased with what they've done so far and what the pipeline shows that they've got projected for continuing to build relationships and bringing in new clients into the bank in the coming year.

And I would add for the southeast is they're at a size now that on a monthly basis as we go forward, as we speak now, they're pretty much broken even. So we're very pleased with an office that we created primarily in March has already reached the size that they're breaking even, and obviously, we expect ongoing growth and ongoing and improved profitability as we go forward.

Okay. And would you guys be looking to expand further into that Southeast Michigan portion of your franchise? Or is it...

I think if you look at our approach -- I'm sorry?

Or is it too soon right now to make that call?

I think our approach that we've taken since we opened a Mercantile Bank here in Grand Rapids is that we're going to be one of small presence as far as bricks-and-mortar and through relationship banking. And I think with the new technologies and the ways that clients can interact with the bank, you don't need to have as big of a physical presence as you certainly did in many years past. And so I think that approach will serve us well in Southeast Michigan just as it has in Grand Rapids and Kent County.

Next is a follow-up question from Kevin Reevey with D.A. Davidson.

Bob, where are you in terms of your strategic initiatives with respect to your residential mortgage business? Is that pretty -- are you pretty much -- is that pretty much completed? Or are you still adding lenders in that business?

It's a good question. I think we continue to build the machine there. If you look at the opportunities that we're seeing now is we have a much bigger profile in the residential mortgage area. We're finding that the residential mortgage lenders, especially in our more major markets, they see us as an attractive landing spot. So we have had some great opportunities to get some high-performing mortgage lending personnel over the last year. And we're hopeful that will continue.

And as the opportunities present themselves, if someone wants to join our team that has a loyal following of experience in their particular market, then we'll certainly take a look at that. But I think as far as the revamping of our -- retooling of our mortgage process, I think that part of it has created a great platform for these lenders that are coming on board to be able to service their clients in a very high-quality fashion.

And how many lenders do you have as of right now dedicated to residential mortgage lending?

I don't have the number off the top of my head. Perhaps 18 to 20.

This concludes our question-and-answer session. I would like to turn the conference back over to Bob Kaminski, President and CEO, for any closing remarks.

Yes. Thank you for your interest in our company, and we look forward to talking to you again after the fourth quarter. This concludes our call.

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