Mercantile Bank Corp (MBWM) 2017 Q4 法說會逐字稿

Good morning, and welcome to the Mercantile Fourth 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. Please go ahead.

Thank you, Brandon. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the fourth quarter 2017. I'm Mike Houston with Lambert Edwards, Mercantile's Investor Relations firm. And joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Bob Worthington, Senior Vice President, Chief Operating Officer and General Counsel.

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 today, you can access it at the company's website at www.mercbank.com.

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

Thank you, Mike, and good morning, everyone. Thank you all for joining us. On the call today, I'll provide an update on loan development, growth initiatives and asset quality. And then our CFO, Chuck Christmas, will provide details on our financial results, followed by a Q&A. As Mike said, we're also joined on the call today by Bob Worthington, our COO and General Counsel.

Mercantile delivered solid performance throughout 2017, which was evident in core profitability, strong loan growth, sound asset quality and controlled overhead costs. The fourth quarter was consistent with this performance, although as we disclosed, a re-evaluation of our net deferred tax asset resulted in increased tax expense during the quarter. This adjustment reduced tangible book value and earnings per share by approximately $0.08. In particular, let me highlight several accomplishments in areas of strategic focus during the fourth quarter and the full year.

The fourth quarter produced total loan growth of $4 million, bringing our full year 2017 growth to $180 million or nearly 8%. During the quarter, commercial loans funded to new and current clients totaled approximately $119 million. This funding activity is consistent in magnitude with the prior 3 quarters, bringing total funding during 2017 to $529 million.

During the fourth quarter, the commercial loan portfolio experienced an unusually high level of payoffs, primarily related to preservation of credit quality and margin.

The contraction of the commercial portfolio occurred within the CRE book as CRE loans declined by $29 million, while the C&I book grew $18 million.

This net contraction was more than offset by growth in the residential mortgage portfolio of $19 million, which in large part reflects our success of strategic initiatives focusing -- focused on increasing our market presence. Included in these numbers is $14 million in loan growth funded by our Troy office, which opened in March 2017.

Our pipelines continue to be solid as they have been throughout 2017. As of year-end, commitments to fund construction projects totaled $154 million, which are expected to be largely funded over the next 12 to 18 months.

We continued to build momentum in generating noninterest income with year-over-year gains in payroll service revenue of 28% and mortgage banking income of 14%, and in credit and debit card revenue of 11%. We look forward to continued growth in these areas of our business in 2018 and beyond.

Our asset quality performance metrics once again reflect a strong portfolio. Total nonperforming assets were $9.4 million at year-end or 0.29% of total assets. Our lenders and management continued to diligently monitor our loan portfolio. Total deposits were up $33 million during the fourth quarter, consisting of an increase in local deposits of $35 million and a decrease in broker deposits of $2 million.

Noninterest-bearing checking accounts grew $40 million during the quarter. Borrowed funds are unchanged relative to the prior year-end, and wholesale funds comprised 11.3% of the total funding base at year-end. Continued growth in our local deposit base remains a strategic priority in 2018. As for the Michigan economy, the positive trend lines we have witnessed for the past year are expected to continue. Employment in our primary markets has improved compared to the year ago period, and real estate conditions continue to be healthy in our markets.

Mercantile is poised to deliver a strong performance in 2018, in light of our key markets demonstrating healthy growth, our financial condition being very strong and our core operating metrics improving. Moreover, we see additional opportunity to participate in the economic strength of our markets by continuing to thoughtfully pursue expansion opportunities as Michigan's premiere community bank.

That concludes my remarks, and I'll turn it over to Chuck.

Thanks, Bob, and good morning to everybody. This morning, we announced net income of $8.0 million or $0.48 per diluted share for the fourth quarter of 2017. During the fourth quarter of 2016, we earned $8.1 million or $0.49 per diluted share. Net income for the full year 2017 totaled $31.3 million or $1.90 per diluted share compared to $31.9 million or $1.96 per diluted share for the full year 2016.

Excluding the impacts of certain noncore transactions, diluted earnings per share during 2017 and 2016 equaled $1.89 and $1.76, respectively. These transactions include a bank-owned life insurance death benefit claim during the first quarter of 2017, the re-evaluation of our net deferred tax asset in response to the Tax Cuts and Jobs Act becoming law in late 2017, the repurchase of trust preferred securities at a large discount during the first quarter of 2016, and accelerated purchase discount accretion on called U.S. government agency bonds during 2016.

We remain pleased with our financial condition and earnings performance, and believe we are very well positioned to continue to benefit from lending and market opportunities, while delivering consistent results for our shareholders.

Our net interest margin was 3.76% during the fourth 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 competitions for loans, there remained some downward pressure on our loan yield.

Our cost of funds, which had remained very stable for the past 2 years, has increased during the past several quarters in large part reflecting higher time deposit rates in money market deposit account special, and somewhat greater reliance on wholesale funds.

We recorded $0.7 million in purchase loan accretion and payments received on former CRE-pooled loans during the fourth quarter of 2017, slightly higher than the guidance provided at the end of the third quarter. Based on our most recent valuations and cash flow forecast on purchase loans, we expect to record further quarterly interest income totaling about $0.5 million during 2018. Please note that this forecast is largely based on scheduled payments and forecasted accretion entries.

Negatively impacting our net interest margin by about 9 basis points during the fourth quarter was the higher-than-desired level of excess overnight funds, primarily reflecting local deposit growth and lower-than-projected net loan growth.

We expect our net interest margin to be in a range of 3.75% to 3.85% throughout 2018. This forecast assumes no further changes in prime or LIBOR rates.

Our interest rate risk measurements continue to reflect an improved net interest margin and an increase in interest rate environment.

The overall quality of our loan portfolio remained strong with continued low levels of nonperforming assets and net charge-offs. Nonperforming assets as a percent of total assets equaled only 29 basis points at the end of 2017, while net loan charge-offs equaled only $1.4 million or 6 basis points of average loans during 2017.

We recorded a provision expense of $0.6 million during the fourth quarter and just under $3 million for all of 2017. Our provision expense throughout 2017 was in large part driven by commercial loan growth and increased allocations relating to periodic changes in our environmental factors. We expect to record quarterly provision expense of $0.9 million to $1.1 million during 2018.

Our loan loss reserve totaled $19.5 million at year-end 2017 or 0.88% of total originated loans. No significant changes from the current level are expected in 2018.

We recorded noninterest income of $4.5 million during the fourth quarter of 2017, slightly higher than the guidance provided at the end of the third quarter. We are pleased with the results of our strategic initiatives involving mortgage banking, treasury management, credit and debit cards, and payroll services, which in aggregate increased $1.2 million or 8.5% from the prior year. And we are looking forward to further enhanced fee income performance in future periods.

For 2018, we currently expect noninterest income to total between $4.4 million and $4.6 million during the first quarter, $4.7 million to $4.9 million during the second quarter, $5.1 million to $5.3 million during the third quarter, and $4.7 million to $4.9 million during the fourth quarter.

We recorded noninterest expense of $19.8 million during the fourth quarter of 2017, similar to what we expensed during the first 3 quarters and within the guidance we provided at the end of the third quarter.

Currently, we expect quarterly noninterest income expense to total between $20.2 million and $20.7 million during the first quarter, and then $21.0 million to $21.5 million during the remaining quarters of 2018, which in large part reflects the expected cost of various employee and community initiatives we are exploring resulting from the reduced federal income tax rate.

We expect our federal -- we expect our effective tax rate to be about 19.5% throughout 2018. We remain a well-capitalized banking organization. As of the end of the year, our bank's total risk-based capital ratio was 12.6% and in dollars was approximately $77 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.

All right, thanks, Chuck. We'll now commence the question-and-answer period.

(Operator Instructions) Our first question comes from Brendan Nosal with Sandler O'Neill and Partners.

Just starting off here, on the tax line, even excluding the roughly $1.3 million related to the DTA impairment, it feels like taxes were a little bit lower than I would have looked for. Was there anything else odd going on in the tax line this quarter?

Yes, Brendan, this is Chuck. One of the things as we're going through our year-end tax calculations, we had been throughout the first 3 quarters of the year accruing taxes at an effective rate of 30.5%. And in doing our calculations, we determined that that was too high of an accrual. Our effective tax rate for the whole year was closer to 29%, so there was some back off in some of the additional accruals that we did in the first 3 quarters.

Got it, that makes sense. And then turning a little bit to the -- to loan growth and the commercial payoffs. First, could you give us some context as to how large the payoffs were in the quarter?

And then second, based on your commentary, it sounds like the payoff pressure was primarily competitive in nature where you guys held your ground on pricing and credit. And if you could just tie up the constructive commentary on the growth outlook with some of these competitive pressures that weighed on overall growth in the fourth quarter, I would definitely appreciate it.

Yes, thanks, Brendan. I think in looking at the payoffs that we received as I mentioned in my comments, they were based on preservation of both credit quality and margin. And I think as we've continued throughout our history is that we remain vigilant to make sure that we preserve the strength of our net interest margin, and saw some situations where competitors were getting a little bit overly zealous as far as presenting packages to clients.

And in the case of commercial real estate, we looked at that bucket and said, "You know, that's something that we're going to maintain steadfast and preserve our margin." Then couple of other situations where we had some loans that were watch-list related that some competitors look to refinance out of our organization and that was a welcome thing from our standpoint as well.

If you look at our fundings, I think our fundings, as I mentioned in the comments, were consistent with what we've done throughout 2017, and over $500 million throughout the year. And as we've talked about in prior quarters, we are going to have that choppiness from quarter-to-quarter as we have varying degrees of levels and timing of payoffs is also varying, timing of various of our loan fundings is going to fluctuate. And so I think in this quarter, we just had a concentration on those payoffs.

But consistent loan funding, which is what we're looking for, and I think is what we're projecting throughout the coming year as well. We got good solid pipeline and it's hard to predict the payout sometimes. But I think in the cases that we mentioned, those payoffs were certainly, in some cases, encouraged. In other cases, we're willing to let the relationship go because of the very competitive loan pressure that we saw from a competitor bank.

Brendan, this is Chuck. And just to add a little bit of color. We get about $40 million per quarter just in scheduled payments on term loans. So that's about $40 million, about $160 million a year that we would expect to get. So the difference between that and the growth would be -- would help account for the payoffs that we got during the quarter.

Our next question comes from Daniel Cardenas with Raymond James.

Just a couple questions here. In terms of the reduced tax rate on a go-forward basis and maybe some color in terms of how you think you'll be applying the additional impact to net income? Is that -- I mean, you had mentioned that part of it looks like it was going to some initiatives on the expense side, but maybe a little bit more color if possible?

Yes. Like I mentioned, our effective tax rate will be about 19.5%, which really, like it traditionally has, takes into account taxes on interest income from our municipal portfolio as well as the increase in cash value on our BOY Program.

We're just in the beginning processes of determining how to invest our moneys. We did send an e-mail to our employees on Friday, indicating the different areas that we are looking at. Some of them are definitely employee related, but some of them also impact what we can do in the community such as charitable giving, those types of things. So we're not ready to talk a lot about specifics to that degree.

But if you looked at -- or if you remember my comments in talking and giving guidance for noninterest expense, the first quarter is a little bit lower than the other 3 quarters. And really what you look at there is some of the initiatives that we have talked about with our employees, we look at a beginning of the second quarter implementation with some of that stuff as we work through the details.

So the increase in my numbers really reflects the investment that we are looking to make with our employees and our communities. And again, working on those details over the next couple months.

Okay, good, good. And then as we look at the most recent rate hike here in late December, how much of that do you think gets passed on to the depositor base?

We're definitely seeing more and more of that. We're actually going to have a pretty comprehensive review of our deposit rates this week. We definitely have been seeing and really over the last few quarters the need to increase CD rates. Our goal on an overall basis is to be in the top third at all times on all deposit products in our markets. And so we've been doing that. We definitely have seen pressure on CD rates.

We're now starting to see it kind of trickle into the money market area. Haven't seen any pressures on any other deposit products to date. But I would say, still the majority of the increases are a positive to the bottom line, but we are definitely seeing some increases to our cost of funds.

Certainly, FHLB advances, our trust-preferred securities, which are more tied to LIBOR, definitely some increasing rates there, which can have some impact on our cost of funds as well.

Okay, okay. And then as I look at your wholesale funding, you are at around 11% of your total base. I mean, where do you guys kind of cap out? At mid-teens? Or is it are you close to your top or how should I be thinking about that?

Good question. It's going to be a little bit different as we go through 2018. Certainly, we have -- as we talked about over the last couple quarters, we've had a pretty high level of excess funds that we basically keep at the Federal Reserve. I guess, the benefit we get there is that the Federal Reserve continues to pay the Fed funds rate. So we are seeing an increased rate that's being paid on those funds.

But certainly, we're about -- currently about $100 million more than our desired level. We certainly expect -- especially this week, we expect to see a lot of our depositors making some tax payments. So we expect a pretty notable decline in those rates here this week. And of course, we have some of our commercial customers not only paying taxes, but starting to pay out year-end bonuses as well.

But I would say, probably the first $30 million to $50 million in net loan growth is going to be funded just by an extinguishment of some of those excess funds to getting that down to the desired level, which is about $40 million to $50 million. And then as we look for the rest of the year at funding that loan growth, that's primarily going to come from the liability side.

We continue to expect good solid growth in noninterest checking, as we have in the last several years. A lot of that comes from continued growth in our C&I portfolio. They typically bring deposits ranging probably 10% to 20% of their loan ask. So we had been and we continue to expect to see growth in that area. Again, want to remain competitive in all our deposit products, so we would expect to see some net growth in those as well.

We do, from a budget standpoint, look to be tapping back into the FHLB advance and maybe some of the brokered market as we get later into the year. But we're at about 11.5% now. I think we peak out somewhere around 13% in looking at our projections. Our policy is no higher than 15%, so well within that.

So I would expect that maybe to come down a little bit here in the first quarter, but then maybe see some increases, some gentle increases in the last 3 quarters of the year.

Okay, fair enough. And then last question, and I'll step back here. Just in terms of your net charge-offs, I mean, the 2017 number was relatively low. How should we be thinking about your charge-off level in 2018?

Yes, that's a good question. It's, obviously, something we think a lot and have a lot of discussion internally when we're going through putting our budgets together, especially as it relates to what our provision expense is going to look like.

We don't see anything from our portfolio perspective and also looking at the economy overall. It looks like the economy will remain relatively steady. We feel really good about how we're administering the credit quality of our loan portfolio.

6 basis points, 5 basis points, obviously, is incredibly low. But we don't see any significant impact as we go in throughout 2018 to that number. So we would look for our provision expense, and I gave you our guidance. Again, a vast majority of that being related to expected loan growth.

Our next question comes from Damon DelMonte with KBW.

So as we look at loan growth kind of heading into 2018. 2017 was a pretty solid year, I think, on a year-over-year basis around 7.5% growth.

How do you guys -- you seem optimistic and positive with your outlook for '18, but how do you think that translates into a full year growth for '18? Do you think something in that 7.5% to 8.5% range is achievable? Or do you think maybe it pulls back a little bit?

I think based on the pipelines and in what we've been able to do from a funding standpoint, and certainly what we're shooting for, I think the wildcard is always the payoffs and as customers sell projects, sell a building, or if you get a competitive pressure that you hadn't expected, that can cause some choppiness as we talked about.

But I think overall, based on what we're seeing in our markets, what we're experiencing with building relationships with new clients in our marketplace, I think we're very much looking forward to that continued strong fundings in 2018 as well.

Okay. And as you look at your footprint and you look at your recent expansion efforts kind of in the southeast part of the state, where do you see the best opportunities for the growth?

I think, certainly, the ones you hit on are there with certainly Kent County in -- here in Grand Rapids area in West Michigan, are our biggest market in the company in terms of market presence and dollars right now are concentrated is certainly a strong opportunity for us.

But as you mentioned, in Southeast Michigan, a continued growing market for us with some new opportunities. Obviously, a very big market that we're making some great progress in. So those are the 2 ones.

But we also see some good opportunities for us in the Kalamazoo market. I think we've got some nice things going on there that we hope to see some good activity coming up. As well as all of our other markets in the central part of the state, we're seeing some new activity there as well. Certainly not to the magnitude as with the other markets, but some nice opportunities nonetheless.

Okay, great. And then kind of along the lines of growth and kind of balancing organic versus M&A opportunities. You guys still have a very healthy capital position, which could be used to support M&A activity. What are your thoughts on possibilities of a deal happening for you guys down the road?

I think as we always answer that question, Damon, we consider ourselves very strong on culture. And as we saw with the merger with FirstBank, it was based on the cultures fitting together. And we certainly have opportunities to look at deals that cross our desk from time-to-time.

And if an opportunity presented itself that presents the -- obviously, the financial metrics that made sense for us, but also a strong management team and culture that was a good fit for Mercantile Bank, we'd certainly take a good strong look at that. But no change from our current philosophy that we've maintained regarding M&A.

Okay, great. And then just 2 quick questions on margin probably for Chuck. I may have missed this, if you said this, but what was the core margin, so ex the fair value of accretable yield?

I don't have the accretable yield number. I do -- I did indicate in my comments, Damon, that it was about 9 basis points of reduction because of our high level of excess overnight funds. I don't have the math in front of me to reflect what the $600,000 or so in accretion did. But it was probably pretty close, I would guess, to what we actually reported.

Okay. All right, great. And then just lastly for the guided range of, I think, you said 3.75 % to 3.85% during the course of 2018. That does not include any rate increases by the Fed, is that correct?

Yes, that's correct.

That's looking at where rates were at the end of the year.

Our next question comes from John Rodis with FIG Partners.

Bob, a question for you just on customer outlook, I guess. Have you seen any meaningful change in how customers are looking at the world from a borrowing perspective over the past month or 2, especially given the passage of the tax changes and so forth?

No. I don't think there has been any significant change that we've detected regarding the events that have happened regarding the tax laws or anything else. I think, our clients remain to be rather optimistic about the coming year.

I think as we've talked about in prior calls, I think they very much look ahead and very prudently plan when expansions will occur when they have new opportunities, and thoughtfully look at the deployment of cash versus borrowings and the entire outlook as far as expansion goes. But I think that we're seeing some customers with some really good opportunity still. The markets continue to be performing well. I think the industries and such that are present in our markets are continuing to perform at a very good level.

And so nothing that presents any concerning signs. I think, probably looking more at the same of what we saw in 2017 from an economic growth standpoint is what we're sensing from conversations with our clients.

I would also add from a line basis. I think we've commented in the last couple of calls that we had seen some slippage in line usage, which historically has been around 50%, and we were seeing that kind of gradually, but certainly steady decline.

I think at the end of the third quarter, we were right around 45% or 44%. We saw a little bit of improvement in the fourth quarter, I think we ended the year at right around 47%, 48%. So hopefully, obviously, that's something that we would like to see is ongoing use of our credit lines, and obviously, providing some additional net interest income from that standpoint.

One quarter doesn't make a trend, but it was kind of nice to see somewhat of that slide that we saw during most of 2017, at least, for 1 quarter subside.

Makes sense, Chuck. Chuck, maybe just 2 other questions for you. Just one, the -- should we expect the securities portfolio to sort of remain range bound? And then two, just as far as capital management too, just thoughts on the buyback just given the level of the stock today?

Yes. Securities, no change. We continue to peg that at 11% of total assets. And we'll continue to -- likely continue to buy what we have been, which is the callable agencies, and then some tax-free municipals issued by entities within our marketplace. Forgot what the other question was.

Just the buyback, Chuck.

The buyback, yes, sorry. We still think that where we've been hanging in on our price is still a little bit high relative to our book value, so where we should be buying back, but we still have $20 million available in our current plan. So that's something that, obviously, we keep on the stove top.

But where we've been trading, we still think it's a -- it's pretty high. But again, we'll continue to look at that and how our stock price performs, obviously, changes in our tangible book, and certainly, our overall capital levels.

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

So -- and last quarter, I know you talked about re-tooling your residential mortgage business and you brought on some additional lenders. Where are you in that initiative?

I think from the development of our platform and our operations back room, I think we're in a really solid shape. I think ready to rock 'n' roll there from a client acquisition and development standpoint.

I think what we've done and what we've been doing is as we see commission mortgage lenders that become available in our markets, we've been bringing those onboard, and we've got some nice additions to our staff in the past 6 months. That will be certainly strong parts of contributing to that new growth in 2018.

And so I think what we're going to see now is a good solid platform, and we're looking to really leverage that platform with the current mortgage staff and any mortgage lenders that would be a good cultural fit for us.

Going forward as we see those opportunities, we're certainly bringing people onboard as they become available. But we feel really good about that area, we've got a really solid staff now, stronger than we've ever had and able to generate some really nice production for us and some nice growth in 2018.

And then I know at the end of last quarter you had about 20 lenders. How many did you have at the end of the fourth quarter?

I don't have the number on top of my head. But I would say, generally in the same ballpark.

Okay, okay. And then are you seeing any competitive pressures on lenders in your market of kind of giving up on underwriting standards in order to grow commercial loans? I know you talked about loan pricing.

Yes, it's certainly heavy on the pricing standpoint. From time-to-time, you do see some institutions that are being a little bit more flexible than we would choose to be on some structuring standpoint. But certainly, the bigger issue has been on the pricing, but you do see some on the credit quality metrics as well.

(Operator Instructions) Our next question comes from Kevin Swanson with Hovde Group.

So many [of you just here] are talking about the potential for some of the tax reform benefits to be competed away. Do you think there is specific types of business or your products that are more or less susceptible to competition?

And then maybe I know you guys mentioned you're kind of in the preliminary stages of talking about investments going forward and maybe just kind of how the competition influences some of your preliminary thoughts on investing in the businesses?

I think from the initial standpoint, I think what we're doing is looking to see where we can make the biggest impact and in the areas that need to be touched. I think those are the kinds of things we're looking at.

As Chuck mentioned, certainly from an employee standpoint and from a community standpoint, looking at some of the things that would be a benefit to those constituencies. And that's where we continue to look at.

I think from a competitive standpoint, I think you were talking about the job market and from a staffing standpoint. Obviously, it's a very competitive job market right now. The unemployment rate is very low. And you get -- everyone is always looking for addition of good talent to their staff, and we're certainly aware of that. We've got some great people on our staff.

But I think the culture that we always talk about here is very important to what makes Mercantile Bank what it is. I think is an important part of our attractiveness to our current employees and then also potential future employees that look to come to work for us. So it's part of the entire package that we look at as far as the Mercantile experience and that includes a lot of things that come with it that are more of the intangible nature.

But I think to go back to your question on the initiatives, we've got a few areas that, as Chuck said, we're looking at, and we're in the developmental stages right now and -- but I think it's something that we feel we can make a nice impact in all those areas.

Okay. And then just one more. So I guess, with the flattening of the yield curve coming more due to short-term rates rising, is there increased potential for credit losses given the higher rate levels? And I guess, maybe does that feed into your underwriting models in terms of credit loss potential and maybe kind of what rate levels you think would lead to increased losses at all?

No, I think -- it's obviously hard to tell on an overall basis is how much is too much from the Fed. I agree with a lot of people as we don't want the Fed to raise too aggressively to put a big halt to whatever economic growth that may be coming, because of whatever is going on in the economy both nationally as well as globally.

As far as -- we have a pretty comprehensive loan pricing model that takes into account, obviously, the overall credit quality of the customer and obviously looking at different attributes. And it certainly does take into account the rate that's going to be charged, which is, again, driven primarily off cost of funds as well as the overall credit metrics.

But we also look at what would this customer look like if we had an increased interest rate environment. And so we've always done that. We've always added a certain level of interest rate increases to the cash flow calculations, and we'll continue to do that. Certainly that level that we pick is somewhat subjective, although it is notable. But that's something that we can always look at. If the Fed is going to get super aggressive, we can go ahead and change that.

But we always look at our portfolio as how does it impact the customer today, what is the debt service coverage today? But we've always kind of shocked it, if you will, by looking at a higher interest rate on that credit and what the debt service coverage would be. In that environment, obviously it's bigger than that, obviously, the overall impact to a customer.

But I think overall, we feel good about how we underwrite. I think we're taking a look at how that can impact. But we'd -- in addition to that, what we need to do is just be very, very -- have our eyes open, continue to meet as we do, continue to be very judicial in our policies and how we underwrite and how we collect on credits.

And again, as Bob talked about before, be willing to let some credits go to competitors, whether they have to just come right in and priced out aggressively a customer or maybe we've had a discussion with a customer that says maybe it's time to part ways and they go ahead and look for a new home.

So there are a lot of different things that go into play. But I think the most important part from my perspective is just making sure that we continue to underwrite properly, continue to have our strong administration practices, which includes pruning the loan portfolio when certain credits rise to the top that need to be pruned.

Yes, Chuck is absolutely right. Knowing your clients, knowing what they're involved with, and as Chuck talked about, stressing cash flow on a client-by-client basis as you analyze the credit to make sure that given potential rising -- continued rising interest rate scenarios that those stresses on the cash flow by an increased interest expense can be absorbed within the confines of their cash flow cycle.

We have a follow-up question from Brendan Nosal with Sandler O'Neill and Partners.

Just a follow-up on the margin. I appreciate the color you guys offered in terms of the NIM drag due to excess overnight funds. Just wondering how much of that 9 basis points drag you have coming back into the margin in the first quarter of 2018 that's built into your guidance of 3.75% to 3.85% margin for the full year?

Yes. I would say, probably, look, I'm hoping to get about half of that back here in the first quarter. As again, we'll first use, as I mentioned, those funds to fund some deposit withdrawals relating to some expected federal tax payments by certain of our customers and bonus payments.

And then so, I think, well, I think we'll get about half of that back here in the first quarter, then we'll start lending that money as we get later into the quarter. Then I would expect that whole 9 basis points to be back into our margin in the second quarter and beyond.

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

Yes, thank you for your interest in our company, and we look forward to talking with you again after the first quarter. Thank you for joining our conference today.

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