Mercantile Bank Corp (MBWM) 2018 Q1 法說會逐字稿

Good day, and welcome to the Mercantile Bank Corporation First Quarter 2018 Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Mike Houston, Investor Relations, Lambert, Edwards & Associates. Please go ahead.

Thank you, Debbie. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the first quarter 2018. 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; Ray Reitsma, President of Mercantile Bank Michigan; 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 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'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'll provide an update on overall performance, loan development, growth initiatives and asset quality, 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 Ray Reitsma, our Bank President; and Bob Worthington, our Chief Operating Officer and General Counsel.

Reflecting the continuous success of our strategic initiatives and a more favorable interest rate environment, Mercantile delivered strong performance in the first quarter of 2018. This was evident in net interest income, a robust net interest margin, controlled overhead costs and sound asset quality. Results were also supported by the collection of interest on certain nonperforming commercial loans and a lower corporate federal income tax rate.

In particular, let me highlight some areas of strategic focus during the quarter and as we look forward to the full year. During the quarter, our net interest margin remained at a healthy level, reflecting ongoing prudent loan pricing and underwriting. We believe these 2 areas of focus will lead to continued healthy margins throughout the balance of 2018 and beyond.

We continue to build momentum and generate noninterest income, with quarter-over-quarter gains in payroll service revenue of 13% and in credit and debit card interchange revenue of 12%. We look forward to additional growth in these product and service offerings during the remainder of 2018 and beyond.

Mortgage banking production is ahead of last year but slightly below our expectations. While purchase activity has increased, the activity is being constrained by a very tight inventory of homes for sale in our primary markets. Prequalification levels are at an all-time high, nearly doubling the level of the first quarter in 2017.

Commercial loans funded to new and current clients during the quarter totaled $111 million, which is consistent with 2017 performance, and a direct result of ongoing sales and relationship-building efforts. During the first quarter, the commercial portfolio contracted $10 million due to an unusually high level of payoffs primarily related to the preservation of credit quality totaling $21 million and sales of assets in a comparable amount by our customers. This net contraction in commercial portfolio was offset by growth in the residential mortgage and consumer portfolio of $3 million. Overall, during the first quarter, total loans contracted by $7 million.

We are pleased with the strength of our loan pipelines, continuing the momentum from 2017, and that our commitment to fund construction projects currently stands at $133 million. We expect to see total loan growth resume and expand over the course of the year.

Our asset quality performance metrics once again reflect a strong portfolio during the first quarter. Total nonperforming assets were $8.1 million at March 31 or 0.3% of total assets. Our lenders and management continue to diligently monitor our loan portfolio, searching for potential signs of stress. The level of past due loans remains nominal and loan relationships on internal watch lists have remained relatively consistent in number and dollar volume.

Total deposits increased $18 million during the first quarter, driven by local deposit growth, while broker deposits were unchanged relative to the prior quarter end. We are pleased with the growth of local deposits. It is as it was mainly driven by new commercial loan relationships and the success of various deposit account initiatives.

Noninterest-bearing checking accounts contracted $36 million during the first quarter, consistent with our seasonal pattern. Dollar funds decreased $14 million relative to the prior quarter, and wholesale funds continued to comprise 11% of the total funding base. Continued growth in our local deposits is a strategic priority.

Turning to the Michigan economy. The positive trend lines continue. Employment in our primary markets has improved compared to the prior year-end, and the real estate conditions in our markets continue to support growth. These favorable trends, coupled with our focus on building and developing value-added relationships, give us the confidence that strong financial results achieved during the first quarter of 2018 will continue in the current year-end and beyond.

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

Thanks, Bob, and good morning to everybody. This morning we announced net income of $10.9 million or $0.66 per diluted share for the first quarter of 2018 compared to net income of $7.6 million or $0.46 per diluted share during the first quarter of 2017.

The successful collection of certain problem commercial loan relationships during the first quarter of 2018 increased reported net income by approximately $1.7 million or $0.10 per diluted share, while the bank-owned life insurance claimed during the first quarter of 2017 increased reported net income by approximately $1.1 million or $0.06 per diluted share. Excluding the impacts of these transactions, diluted earnings per share increased $0.16 or 40% during the first -- during the current year first quarter compared to the prior year first quarter.

Net income during the first quarter of 2018 also benefited from a reduction in our federal income tax rate, which was lowered from 35% to 21% effective January 1 as a result of the enactment of the Tax Cuts and Jobs Act. Our effective tax rate during the first quarter of 2018 was about 19% compared to almost 31% during the first quarter of 2017. We remain pleased with our financial condition and earnings performance and believe we are very well positioned to take advantage of lending and market opportunities while delivering consistent results for our shareholders.

Our net interest margin was 4.06% during the first quarter compared to an average of about 3.80% during the previous 4 quarters. In addition to ongoing benefits from the recent rate hikes from the FOMC, our yield on earning assets during the just-completed first quarter was positively impacted by successful collection efforts on several problem commercial lending relationships.

These efforts resulted in a recording of interest income that added approximately 29 basis points to our first quarter yield on earning assets. Conversely, a higher-than-desired level of on-balance-sheet liquidity, consisting of excess monies on deposit at the Federal Reserve Bank of Chicago, negatively impacted the yield on earning assets by about 8 basis points. Excluding the impact of these particular factors, our net interest margin for the first quarter of 2018 was about 3.85%.

Our cost of funds as a percent of average earning assets increased from 47 basis points during the first quarter of 2017 to 64 basis points during the first quarter of 2018. The increase is a reflection of increased interest rates on certain money market deposit accounts, time deposits and borrowed funds, in large part reflecting the increase in interest rate environment. We recorded $2.3 million in purchase loan accretion and payments received on CRE pool loans during the first quarter of 2018 compared to the $0.5 million guidance that was provided on our conference call in January.

The higher-than-expected level of recorded income primarily reflects the majority of the aforementioned collection efforts, whereby we collected approximately $1.8 million in principal and interest owed on certain purchase-impaired CRE loans. As a reminder, our purchase-impaired CRE pool went into recovery mode during late 2016. As a result, starting on January 1, 2017, accretion income was no longer recorded on loans in this pool, but instead, all payments made by borrowers are immediately recorded as interest income.

We currently expect to receive a minimum of $2.3 million in principal payments on purchase-impaired CRE pool loans in future periods, which again will be recorded as interest income upon receipt. Based on our most recent valuation and cash flow forecast on purchase loans, we expect to record further quarterly interest income totaling about $0.5 million during the rest of 2018.

We expect our net interest margin to be in a range of 3.80% to 3.85% throughout the remainder of 2017. This forecast assumes no further changes in the prime and LIBOR rates. Our interest rate measurements continued to reflect an improved net interest margin in an increasing interest rate environment.

The overall quality of our loan portfolio remained very strong with continued low levels of nonperforming assets and loan charge-offs. Nonperforming assets as a percent of total assets equaled only 25 basis points as of the end of the first quarter. We recorded a net loan recovery of $0.5 million during the first quarter, with charge-offs totaling $0.7 million.

We recorded no provision expense during the first quarter, in large part reflecting the aforementioned net loan recovery and relatively unchanged total loan balance. We expect to record quarterly provision expense of $0.5 million to $1.0 million during the remainder of 2018, in large part reflecting forecasted net loan growth.

Our loan loss reserve totaled $20 million at the end of the first quarter or 87 basis points of total originated loans. This coverage ratio has remained steady for many quarters and no significant changes are expected for at least the remainder of 2018.

We recorded noninterest income of $4.4 million during the first quarter of 2018 compared to $5.9 million during the first quarter of 2017 for a BOLI claim adjusted level of $4.5 million. We recorded increases in virtually every fee income category except mortgage banking. As Bob has already noted, the inventory of new home loans listed for sale throughout our markets, especially in the Western Michigan area, is low and is negatively impacting our new mortgage loan volume.

For the remainder of 2018, we currently forecast noninterest income to total between $4.7 million to $4.9 million during the second quarter, $5.1 million to $5.3 million during the third quarter and then to $4.7 million to $4.9 million during the fourth quarter. We recorded noninterest expense of $21.1 million during the first quarter of 2018 compared to $19.8 million during the first quarter of 2017.

Expected increases in salary and benefit costs comprise the majority of the increase quarter-over-quarter. Currently, we forecast quarterly noninterest expense to total between $21.0 million and $21.5 million during the remainder of 2018 with our effective tax rate remaining about 19%.

We remain a well-capitalized banking organization. As of quarter end, our bank's total risk-based capital ratio was 12.9%, and in dollars, was approximately $86 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. At this point, we'll now take your questions.

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

Just want to start off on the excess liquidity kind of the margin. Just the excess liquidity has been impacting the margin for about 3 quarters now. Just want to get a sense of how much you think of that can come back into the margin over the next couple of quarters and how that ties into your guidance of 3.80% to 3.85% margin for the rest of the year.

Yes. This is Chuck. Good question. We think we're going to work through the excess liquidity during this quarter. That assumes a resumption of our more typical net loan growth expectations. Most of that, monies that we've got sitting at the Fed, will be going to loan funding. We also have some wholesale funding maturities this quarter that we're already releasing. So I think that, again, assuming that loan growth patterns resume, we'll be through our excess liquidity towards the middle of this quarter. As far as how that impacts the margin, my forecasted margin assumes that we are at -- want to be at excess liquidity levels here during the second quarter.

All right, great. That's very helpful. And then one more, just looking at loan growth and commercial originations. They were $111 million this quarter, I believe, $130 million in the year ago quarter. So pretty similar. Just tie up the thoughts on how originations are remaining strong, but you are seeing more competitive pressures, you are seeing more paydowns and how that ties into your optimistic commentary for increasing loan growth throughout the remainder of the year?

This is Bob. As we talked about in prior calls, the payouts are certainly unpredictable. And in this quarter, as I mentioned in my comments, we had a combination of loans being paid off from watch list or nonperforming status, and the rest of the amount of the $40-some-million was asset sales by customers. Those are kind of hard to predict, and we usually don't get too much advance notice of those. But they do happen from time to time. Unfortunately, we had a bunch concentrated in this quarter, but we're very excited about the continued strong pipeline. As I mentioned in my comments, we've got about $130 million of construction funding that we'll fund over the next 12 to 18 months. And then the pipeline of loans committed, accepted by our customers remains very strong. So as you said, our fundings have been very consistent with what we've seen in past quarters if you go back the last couple of years. We expect that to continue going forward. The wildcard has certainly been the payouts. But certainly, on the watch list payout, we're not -- as I said, [as those go] -- as those go, but asset sales by customers are going to happen from time to time especially in this environment. Seeing customers getting nice prices for buildings or for their companies and so those will happen. But again, they seemed to be heavily concentrated in the first quarter of this year. But we look -- very forward to a strong pipeline and continued consistent funding for the rest of the year.

All right, that's awesome. I could just sneak one more in there. Expenses this quarter were a little bit higher than guidance had probably suggested. But with that said, the run rate for the remainder of the year is the same that you guys offered previously. So was the first quarter just kind of a pull-through of some of those expenses you expected to see later in the year, just kind of hit the numbers a little bit earlier?

No. I think we had probably about $200,000 to $300,000 of onetime expenses related to some properties we're no longer going to be using in our operations. And we just needed to rightsize those balances as we negotiate the sales. And so we feel really good about where those balances are now, and we look forward to the sales of those properties here this quarter and next. And so we don't expect any further cost associated with those. But now as we talked about on the first quarter call, some of those investments that we're making, especially in our people as well as our communities, some of those are -- have taken effect -- effective April 1, especially the salary portion to our hourly folks. So there will be a little bit of an offset going on. So no pull-through. There was kind of some onetime items going through in the first quarter that we won't see in future quarters.

Next is Kevin Reevey with D.A. Davidson.

So either Bob or Chuck. It looks like the unemployment rate continues to be at historical lower levels in many of your core markets. Can you kind of talk about if that's having any negative impact on a lot of your commercial borrowers to -- in terms of finding talent and continuing to grow their businesses?

Yes, Kevin. As we talked about previously, it's affecting everybody, all businesses in our footprint, very tight job market. It's basically a full employment-economy type of situation. So that's why we've been proactive with some of the savings that we've generated from the tax rate decrease to be proactive and to get some increases to some of our hourly staff and some other areas because it is such a tight job market, and it's our goal to keep our great employees and our staff intact. But that said, certainly, as we talk to our clients, talk to other competitors in our communities, everybody's having the same problem with trying -- once you have a need to hire a person, to try to be -- get that first onboard and to have a competitive situation to keep them onboard. So it's kind of a good news, bad news situation. The economy of Michigan seems to be doing very well, and that's the endpoint. It's created a little bit of a challenge with the employment situation, but we're working through it. We've got a great staff, and we're very selective about our recruiting process and trying to bring new staff into the bank. And I think we've got a very exciting story to tell. So we're doing a good job there, but it is a very competitive job situation.

Kevin, this is Chuck. I'll add a couple comments, and some of this is just kind of storytelling, but I've heard quite a few stories as I talk around to folks working at different businesses, is that obviously, one of the ways to offset the issues we're having with staffing is to increase productivity through new equipment. And I've heard quite a few stories of businesses starting to order or starting to look at ordering new equipment, something that they really haven't done since really the -- pre the Great Recession and trying to increase productivity, so they don't have to hire that 1 or extra 2 people that they're out there looking for. Obviously, that's how it's going to impact the businesses. But one of the things that could be an impact for us is increased loan demand as hopefully some of those customers come to us and ask us for some additional lending help in purchasing that equipment. So that's something that's going to play out over the next few quarters, over the next few years. But we are starting to hear more and more discussion about going out and buying some new equipment and becoming more productive, more efficient.

And then on the mortgage banking side, given the shortage of housing inventory, particularly in the Western Michigan market, is it safe to assume that the bulk of your mortgage banking is going to -- growth is going to come from outside of Western Michigan given the lack of inventory?

I'll let Ray answer that question. Go ahead, Ray.

Yes, Kevin. I would say that the key there is to not look at different markets, but to reposition as strong as we can away from the refinance market into the purchase market that exists. We've been able to do that. Our pre-qualifications are very high, so between those 2 facts, we feel confident that we'll be able to garner our share of that market in West Michigan that we've successfully repositioned away from the refi market through the purchase market. And as more units come online at some point, we'll be there to reap our share.

Yes. The mortgage pipeline is obviously a very seasonal type of thing, but it's building very nicely right now as we head into the mid-part of April and further into the spring. We're very happy to see that the growth is taking place here and as Ray said, pre-qualification being so high, people are looking to buy. There's no question about it. Even though rates are a little bit higher. I don't think that's going to dissuade people from once they find a house. It's a very competitive situation, but they want to buy and we've got a great roster of customers that are lined up once they find a home to be able to get their loan from Mercantile Bank.

And then one last question. You had some nice linked quarter growth in other fee income. How much of that growth was from basic cross-selling to your existing customer base versus -- I know when we last talked, there was going to be some -- you were looking at repricing certain of your products.

Yes. Kevin, this is Chuck. A vast majority of what you saw in the first quarter is from new growth from existing and new customers. We are starting to put some price increases on certain products into effect but that literally is happening as we speak and part of the second quarter. So what you saw in the first quarter is new growth for us.

(Operator Instructions) Next is Damon DelMonte with KBW.

I guess my first question is regarding loan growth. I think you guys were relatively optimistic for mid- to upper single digits for full year 2018. Based on what you guys are seeing now and based on what happened in the first quarter, are you still comfortable that you can get up to that level? Or has that ratcheted down a little bit?

No, I think -- this is Bob. I think we're still very comfortable with those guidance numbers that we provided and again, can't control the payouts necessarily of the watch list loans we're glad to see go. But I think, in terms of the consistent funding, assuming we have a more normal pattern of a sporadic loan payout, I think we'll feel quite comfortable with the overall objectives that we've established for the year.

Got you, okay. And then, Chuck, could you just repeat the fee income expectations? I didn't get all of those, please.

Yes. No problem at all, Damon. So really, what we have in the second quarter is $4.7 million to $4.9 million, and that's actually for the fourth quarter as well. So that's the second and the fourth quarter. And in the third quarter, which obviously, for mortgage banking tends to be the best quarter, $5.1 million to $5.3 million.

Got you. Okay. All right, that's helpful. And then I guess, could you just give us a little update on how the expansion efforts in Southeast Michigan are going right now?

Yes. This is Bob. The office is continuing to do very well, getting some great opportunities down there in the Detroit area and suburbs. Just right on -- in line with expectations that we established for them and still are contributing to the overall profitability of the bank in a very nice fashion.

Next is Daniel Cardenas from Raymond James.

Just a couple quick questions. As I'm looking at your wholesale funding percentage, you're approximately 11% of total funds. Can you remind us -- is there an internal cap as to how high you guys would like that number to go? And do you think you'll hit that cap in 2018?

Yes. Our internal policy cap, our maximum amount is 15%. And no, we don't think we'll be hitting that in 2018. I think we'll actually see a little bit of a reduction here in the second quarter and then stay relatively flat. So I think we'll probably stay right around that 11% on a rounded basis throughout 2018.

Okay, great. And then maybe a little bit of color on deposit betas, what you're seeing with most recent rate movements on the deposit base right now and maybe some color on competitive pressures on the funding side.

Sure. Now there's always competitive pressures on both sides of the balance sheet and that's never going to wane. I'll bring you through a few of the products. I think the most intense competition -- it has been pretty competitive for the last 12, 18 months but especially so in the last couple of quarters on the public units, especially on the CD side, also on some checking accounts for municipals. The good thing is we have excess liquidity, so we're not -- we're letting some of the higher price or more competitive relationships that we have on the public unit side on the CDs go, so that's helping us out. But very, very intense competition, especially for the larger dollars. I'd say CDs is $1 million or more; very, very intense out there right now. We're seeing more competition on CDs, just general CDs, individuals and businesses. Everybody's been raising those rates for the last 12 to 18 months that the Fed has been raising -- not to the degree that the Fed has raised rates, but we have seen rates -- CD rates increasing pretty steadily. And I'd say, in the last couple of quarters, that competition is getting a little bit more intense. On the nontime stuff, these past couple weeks after the Fed raised rates is the first time we had to touch our money market rates. And so we did touch those a little bit. That is the first time that we've touched those since the Fed did start raising interest rates. Haven't had to touch savings and interest-bearing checking account rates yet. Obviously, we're always looking -- every week, we look at where we are at in regards to our competitive environments. Our goal is to always stay in the top 1/3 of all the banks that we compete with. Certainly, there's those banks that are always very, very competitive, certainly credit unions, especially on the retail side. So we don't ever strive to be #1. That doesn't make sense. But we always want to be in the top 1/3 and making sure that we're always competitive and that our -- the -- as we drive our relationships not only at the loan side, but on the deposit side as well, is that our depositors can be comfortable that we're offering fair rates of return that also produce a appropriate margin for ourselves. So it looks like the Fed is going to raise it another couple of times at least this year, so we'll continue to keep an eye on those deposit rates like we do every week and just see where things go from here, but that's where we've been at so far.

Okay, great. And then maybe a little bit of color as to the sequential quarter drop in your noninterest-bearing deposits. What was that attributable to?

Yes, we always see that in the first quarter, Dan. We have a lot of commercial borrowers that are paying taxes in the first month as well as bonuses. So it's very, very seasonal for us to see that reduction in the first quarter, and then we start seeing that built up for the remaining 9 months and we kind of go through that cycle over and over. But we also in there, we also continue to get really good growth in there, especially from our new C&I customers as we make those loans and bring over those relationships. We continue to see some nice new noninterest-bearing checking account relationships being funded. It just gets hidden a little bit in the first quarter with those tax and bonus payments.

Okay, great. And then just a couple of quick questions on the loan portfolio. The continued reduction on the home equity and consumer loan, can we kind of expect to see additional shrinkage on a go-forward basis? Or do you think that's going to begin to plateau and maybe even build up on -- as we look forward?

Yes. I think the biggest part of that number, and the one that's probably the biggest question is the home equity portion of that. Consumer loans is not a very big portfolio at all, and that continues to reduce probably by $250,000 a quarter or so. The big unknown is the home equity, which is about $50 million, $48 million outstanding. We did see a $3 million reduction from the end of the year to the end of this quarter. That's obviously pretty hard to forecast, what's going to go on there. We're not out there -- like most of our consumer products, we're not out there blasting specials and stuff like that. It's more of an accommodative type product for our existing borrowers and our existing depositors. So I think the short answer to your question is, I gave you a long answer, is it really kind of depends on what those existing lines of credit do as we go forward.

Okay, fair enough. And then, maybe some color on line utilizations? How are those looking, say, compared to this time last year?

Yes, they're about the same. I -- they're right around 50-50 right now. We saw that actually drop in the third quarter and at the beginning of the fourth quarter. I think we were down to about 47%, maybe 46% usage, but we're kind of back up into -- right around 50-50 right now.

Next is Kevin Swanson with Hovde Group.

Can you just update us on your thoughts on the buyback? I think you mentioned in the past, the $35 level is a bit too high, but if your thinking has changed given tax reform.

Yes, that is a great question. We haven't reengaged in buying back any stock. It's been almost 2 years now. We did buy back all that stock 2 and 3 years ago at a nice price of $20 -- a little over $20 on average. We think, from a multiple standpoint, where we're trading $34, $36, it's still a little bit too high. I was seeing some stats actually last night, as a matter of fact, that the average buybacks right now are right around $120, $125 a book, and we're trading closer to $175, $185 depending on the day. So it's a little bit rich right now. And so we want to see that drop off closer to what the peers have been buying it back, say, $125, not to put a line in the sand, but closer to that metric before we would reengage. But we do have existing monies left if we want to go ahead and do that.

Okay. And then you mentioned the investment in people through hourly wage increase. Is there any other significant investments in any of the key businesses or even in the expense side going forward as you kind of think about the impacts of tax reform now?

No, I think right now, we're pretty comfortable with the announcements and the decisions that we made earlier in the first quarter. Obviously, we're always -- whether the tax rates change or anything else is going on, we're always looking to make sure that our employees are well taken care of for many respects, including compensation. We obviously took a pretty big swing at that with all of our hourly employees getting a pay raise to some degree, here effective April 1. We've got some -- we increased our 401(k) match. That was for everybody going forward. We're always looking at investments in our communities. Right away, we increased our budget for charitable giving. In 2018, we're also in the final throes of putting together some retail-type loan packages and programs that can help maybe even some first-time homeowners, also maybe some home improvement type loans for low to moderate income folks. So -- but those are the types of things that we're always looking at, what are the needs of our communities, listening to those folks, what are their needs, working with the different organizations that work within those communities to try and look at the products and services that we offer and how we can best meet those needs of the communities. So we're doing that on an ongoing basis. But at least from what we announced 3 months ago, we don't have anything significantly planned at least in the next couple of quarters.

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

Yes. Thanks, Debbie, and thank you for your interest in our company. We look forward to talking to you again after the second quarter. This call is now ended. Thank you.

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