Mercantile Bank Corporation Q4 2008 Earnings Call Transcript

Jan.14.09 | About: Mercantile Bank (MBWM)

Mercantile Bank Corporation (NASDAQ:MBWM)

Q4 2008 Earnings Call

January 14, 2009 10:00 am ET


Michael Price – President & CEO

Robert Kaminski – EVP &COO

Charles Christmas – EVP & CFO


Jon Arfstrom - RBC Capital Markets

Terry McEvoy – Oppenheimer

Brad Vander Ploeg – Raymond James

Eileen Rooney – KBW

Daniel Cardenas - Howe Barnes Investments

Stephen Geyen – Stifel Nicholaus


Welcome to the Mercantile Bank Corporation fourth quarter earnings conference call. (Operator Instructions)

Before we begin today’s call I would like to remind everyone 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 or its management, statements on economic performance and statements regarding the underlying assumptions of the company’s business.

The company’s actual results could differ materially from any forward-looking statements made today due to 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 this 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 web site

On the conference today for Mercantile Bank Corporation we have Michael Price, Chairman, President and Chief Executive Officer; Robert Kaminski, Executive Vice President and Chief Operating Officer; and Charles Christmas, Senior Vice President and Chief Financial Officer.

We will begin the call with management’s prepared remarks and then open all the lines to questions. At this point I’d like to turn the call over to Mr. Price; please go ahead sir.

Michael Price

Good morning everyone and welcome to the conference call. As expected the unrelenting economic pressures that continued throughout out country during the fourth quarter impacted the profitability of our bank as we expected probably impacted most banks to some degree.

While we are disappointed that non-performing assets continue at elevated levels we remain confident that our loan administration is mitigating this situation in very meaningful ways. As we analyze our 2.60 non-performing asset ratio in light of the severe recession we are experiencing, we believe our overall loan administration has prevented a far more dire situation.

The quarter has some very positive developments. Many of the loan pricing initiatives implemented in previous quarters had significant positive impact on our margin. Charles Christmas will expand upon this issue in his comments in a moment. Robert Kaminski will, as in most recent quarters give an expanded overview of the dynamics of our own portfolio for the fourth quarter. We will then have a question-and-answer period to complete the call.

At this time I’d like to turn it over to Charles.

Charles Christmas

Thanks Michael and good morning everybody. What I’d like to do as typical is to give you an overview of Mercantile’s financial condition and operating results for the fourth quarter of 2008 and all of 2008, highlighting the major financial condition and performance balances and ratios.

We recorded a net income of $0.3 million or $0.04 per share during the fourth quarter of 2008 compared to net income of $0.1 million or $0.01 a share during the fourth quarter of 2007. While this past quarter represents a decline in net income from the $1.1 million recorded in the third quarter of 2008 it was a significantly improvement from the net loss of $2.6 million recorded during the second quarter and a net loss of $3.7 million recorded during the first quarter of 2008, due primarily to a much smaller provision expense and an improved level of net interest income.

We recorded a net loss of $5 million or $0.59 per share for all of 2008 compared to net income of $9 million or $1.06 per share for all of 2007. The decline in net income is primarily the result of a significantly higher provision expense and a substantially lower level of net interest income. The higher provision expense in 2008 versus 2007 primarily reflects the negative impact of a state, regional, and national economic struggle on some of our borrowers cash flows and the reduction of underlying collateral values which culminated in significantly higher levels of net loan charge-offs during 2008.

The lower level of net interest income in 2008 versus 2007 primarily reflects the impact of the steep decline in interest rate that began late in the third quarter of 2007. With our near-term asset sensitive position whereby we have a higher magnitude of assets subject to repricing when compared to the level of liabilities subject to repricing, combined with an increased level of non-performing assets at a very competitive banking environment we experienced a decline in the level of net interest income which more then offset the growth in earning assets.

More recently however the level of net interest income has increased significantly and it is a trend we believe will continue in future periods. Net interest income during the fourth quarter of 2008 totaled $12.5 million, a decline of $0.6 million from the level during the fourth quarter of 2007. However it is $0.08 million higher then the third quarter of 2008 and $1.9 million higher then the second quarter.

Net interest income during all of 2008 totaled $46.2 million, a decline of $9.3 million from the level earned during all of 2007. Average earning assets equaled $2.12 billion during the fourth quarter of 2008, an increase of about $110 million from the level of average earning assets during the fourth quarter of 2007. As usual the growth in earning assets was led by an increase in total loans.

Our net interest margin during the fourth quarter of 2008 equaled 2.4%, up from the 2.3% margin during the third quarter of 2008 and the 2.15% margin during the second quarter of 2008. The net interest margin was 2.64% during the fourth quarter of 2007. The decline in our net interest margin since the third quarter of 2007 primarily reflects the steep decline in market interest rates that started in late summer 2007.

With about 60% of our loans tied to floating rates we experienced a significant decline in our yield on assets. Our asset yield is down about 165 basis points over the past 16 months led by 190 basis point decline in our yield on our loan portfolio. However our loan yield has recently stabilized as a result of several pricing initiatives we implemented in 2008 and given the market’s expectations for the prime and LIBOR rates to remain low and unchanged for most, if not all of 2009, we currently believe the yield on our loan portfolio will remain relatively stable for at least a large part of 2009.

We have also seen a significant reduction in our cost of funds but just not to the degree of the decline in our asset yield to date. While our asset yield has gone down by 165 basis points over the past 16 months, our cost of funds has declined by about 115 basis points.

Although deposit and borrowing market rates have declined our relatively high reliance on fixed rate certificates of deposit and federal home loan bank advances result in a lag reduction in our cost of funds with about $1 billion in relatively high rate wholesale funds scheduled to mature during 2009 including about $350 million during the first quarter alone, we do expect our cost of funds to continue to decline throughout 2009.

These maturing funds carry interest rates that generally range about 100 to 200 basis points above current interest rates dependent on the term. A relatively stable yield on assets combined with a continued reduction in our cost of funds did provide for improvement in our net interest margin and net interest income throughout 2009. The extreme volatility in financial markets makes it very difficult to forecast net interest income and the net interest margin with any precision however we believe that quarterly improvements will be meaningful and will have a significant impact on our profitability.

The provision expense during the fourth quarter of 2008 totaled $4 million an increase from the $1.9 million expensed during the third quarter of 2008 but a decline from the $6.2 million expensed during the second quarter and the $9.1 million expensed during the first quarter. During the fourth quarter of 2007 the provision expense totaled $4.9 million.

The provision expense for all of 2008 totaled $21.2 million an increase of $10.1 million from the $11.1 million expensed during all of 2007. Our loan loss reserve totaled $27.1 million at year-end 2008 or 1.46% of total loans. Our loan loss reserve equaled 1.58% of total loans at the end of the third quarter and 1.73% at the end of the second quarter of 2008.

The reduction in the coverage ratio primarily reflects charge-off of specific reserves established in prior periods especially during the first and second quarters of 2008. Robert will have specific and more detailed commentary on asset quality later during the call.

Non-interest income totaled $1.8 million during the fourth quarter of 2008 an increase of $0.3 million or 18% from the $1.5 million earned during the fourth quarter of 2007. Non-interest income totaled $7.3 million for all of 2008 an increase of $1.4 million or about 24% from the $5.9 million earned during all of 2007.

We recorded increases in virtually [all of] the income categories. During all of 2008 compared to all of 2007 service charge income was up about $0.4 million, mortgage banking activity income was up about $0.2 million and bank owned life insurance policy income was up about $0.5 million.

Non-interest expense totaled $10.5 million during the fourth quarter of 2008 an increase of $0.5 million over the $10 million expense during the fourth quarter of 2007. Non-interest expense totaled $42.1 million during all of 2008 and increase of $3.7 million over the amount expensed during all of 2007. Adjusting for the one-time expense during 2007 associated with the retirement of our former Chairman and CEO, the increase in 2008 over 2007 totaled $4.9 million. The majority of the non-interest expense growth during all of 2008 when compared to all of 2007 related to costs associated with the administration and resolution of problem assets including legal costs, property tax payments, appraisals, and write-downs on foreclosed properties.

These costs totaled $3.3 million during 2008 an increase of $2.2 million when compared to 2007. One other expense item of note is higher FDIC insurance premium assessment, an increase of $1.2 million during 2008 when compared to 2007.

Our funding strategy has not changed significantly as we continue to try to grow local deposits and bridge the funding gap of [inaudible] funds namely brokered CDs and federal home loan bank advances. Our average wholesale funds to total funds during the fourth quarter of 2007 equaled 69%. That compares to 67% during the third quarter of 2008 and 60% in the fourth quarter of 2007.

The increase in wholesale funds reflects a combination of asset growth, the reduction of local funds primarily jumbo CDs. The reduction in our local funds is due to a variety of factors including depositors having less funds available for deposit especially public units, depositors making decisions based on FDIC insurance limitations, and very high rate offerings on CDs by our competitors.

Some of our competitors are currently offering CD rates that are 150 to 200 basis points above brokered rates. In fact in order to simply be competitive our stated CD rates currently average about 100 basis points above brokered CD rates. The brokered CD market remains very liquid and we continue to raise funds as needed at very reasonable costs.

Reducing our reliance on wholesale funds is a top priority for 2009 and we will be devoting significant time and efforts to increasing the level of local deposits as we move forward. We remain in a well-capitalized position per bank regulatory definitions with a consolidated total risk base capital ratio of 10.9% and a bank total risk base capital ratio of 10.8% as of year-end 2008.

The bank’s total regulatory capital equaled about $226 million at year end 2008 approximately $16.7 million in excess of the amount needed to provide for the 10% minimum well capitalized total risk base capital ratio.

That’s my prepared remarks. I’ll certainly be happy to answer any questions later on but now I’ll turn it over to Robert.

Robert Kaminski

Thank you Charles and good morning everyone. My comments this morning as usual focus on the bank’s asset quality. I’ll start with a review of the asset quality headlines from the past several quarters.

As you may recall in the second half of 2007 we witnessed a deterioration in residential real estate development and construction portfolio loans. In the first quarter of 2008 there was continued deterioration of residential real estate plus we identified some deterioration in commercial real estate, and C&I loans.

In the second quarter of 2008 there was continued deterioration of commercial real estate loans plus previously identified as distressed including some significant charges taken for degradation of real estate property values.

In the third quarter of 2008 some previously identified [impaired] losses were charged off. Additionally the bank identified some loan upgrades and experienced some pay offs that helped offset the reduced influx of new problem loans.

In the fourth quarter of 2008 we saw continued stresses on real estate values including commercial real estate. Real estate values continue to be depressed causing the need for additional loss reserves. Auto industry uncertainties are placing some stress on the C&I segment of the portfolio. New non-performers were mainly those watch credits previously identified with weaknesses however management and staff continued to deploy various monitoring techniques to ensure appropriate risk portfolio assessment.

The staff is working extremely hard to dispose of other real estate and repossessed assets and we have good plans in place to move the assets of troubled borrowers once we gain control of those assets. Our lending personnel continued to work closely with all borrowers to watch for signs of any problems and act very quickly to try to mitigate risk and solve issues as they occur.

I want to give you some statistics on the portfolio itself, at year-end we had a total loan portfolio of $1.856 billion which represented about a $14 million decrease from where it stood at the end of the third quarter. Some stratification of the portfolio by loan type is as follows.

As I mentioned we had a portfolio total of $1.856 billion broken down, we had land development and vacant lot loans totaling $128 million, we had one to four family construction portfolio totaling $46 million, we had commercial construction of $89 million, one to four family including rental of $140 million, multifamily loans $47 million, commercial real estate owner-occupied loans $369 million, commercial non-owner-occupied portfolio $513 million, commercial and industrial loans $507 million, and other individual miscellaneous loans totaling about $17 million, for a total of $1.856 billion.

Our loan loss reserve at the end of the year totaled $27.108 million which was 1.46 of the portfolio. As Charles mentioned that was down from third quarter. That decrease represented a charge-off of previously identified impaired loans totaling about $2.4 million at the end of the year.

Review of non-performing assets is as follows. At the end of the year we had total non-performers of $57.400 million broken down as follows; land development residential lots $14.3 million, commercial land development $2.2 million, we had one to four family construction $11 million, we had one to four family construction of $4.2 million, commercial owner-occupied real estate $6.5 million, commercial non-owner-occupied real estate $14.1 million, and finally commercial and industrial totaling $5.1 million, again totaling $57.4.

Further stratification of the change from the third quarter is as follows. At the end of the third quarter we had total non-performers of $47.8 million, we had new non-performers during the quarter of $20 million, we had paydowns and sales of assets totaling $4.0 million, we had charge-offs of $6.4 million, again showing a net total for the end of the year $57.421 million, a net increase of $9.6 million.

Past due loans under 90 days at year-end totaled $2.6 million compared to $6.3 million at September 30. The majority of these loans in this bucket, the reduction in this category represented a move of some loans to non-performing status and less loans going into this bucket showing a net reduction from quarter to quarter.

Net charge-offs for the quarter totaled $6.4 million. Of that amount as I mentioned $2.4 million was impairments reserved at the end of the third quarter, $2.0 million was for new reserves to those impaired loans and $2.1 million was newly identified losses. A break down of the net charge-offs is as follows; land development and vacant lot loans portfolio $1.3 million, one to four family construction $45,000, one to four family including rental $1.142 million, commercial owner-occupied $162,000, commercial non-owner-occupied $2.491 million, commercial and industrial $1.236 million, and other miscellaneous losses $2,000, for again a net charge-off total of $6.4 million.

Regarding the provision as Charles mentioned we had a fourth quarter provision of $4.0 million. The break down of that provision by loan type is as follows; land development and vacant lots $489,000, one to four family construction $784,000, commercial construction $30,000, one to four family including rental $885,000, commercial owner-occupied $303,000, commercial non-owner-occupied $1.1 million, commercial and industrial $275,000, and other miscellaneous loans to individuals $73,000, again for a net provision allocation total for the quarter of $4 million.

Those are my prepared remarks on the analysis of the portfolio and I’ll now turn it back over to Michael Price.

Michael Price

Thank you Robert and thank you Charles, at this time we would like to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Jon Arfstrom - RBC Capital Markets

Jon Arfstrom - RBC Capital Markets

Can you talk about what percentage of your loans are currently at floors?

Charles Christmas

Its interesting because one of the initiatives that we’ve done is, a vast majority of our commercial loans that are tied to prime are actually tied to Mercantile Bank prime and we during the fourth quarter did not lower the Mercantile Bank prime, the last couple of rate moves by the Federal Reserve.

So we’ve kind of artificially put floors into our loans but by not lowering our prime during the fourth quarter we’ve essentially created the fact that those loans tied to Mercantile prime which is the majority of our floating rate loans are in fact artificially at floors.

Michael Price

And at the same time we continue as loans mature and we grind through the portfolio and the normal renewal phase which is really starting to ramp up here in the next couple of months, we continue to put floors in every new note that has a floating rate component.

Jon Arfstrom - RBC Capital Markets

How has that been received specifically the Mercantile prime and then also the new floors that are being put in place?

Michael Price

Its been received extremely well. We talked about the strategy for a long time among our management team and our strategic planning team and our employees have done an excellent job of talking to our customer and saying, look these are very unusual times, the rates are artificially low, if you will and the standard economic model sense a year ago if you were a prime rate customer you were paying 7, 7.5, now you’re down into the 4’s.

At the same time we want to be fair to our depositors and we’ve cut the deposit rates significantly over that period of time and we really just didn’t feel like to stay competitive on a deposit side that we wanted to knock those down any more. And our customers were very understanding. They understand its important to them to have a healthy bank, a profitable bank, to work with them as partners and they felt what we were doing is very reasonable and so we’re very gratified by that but we will continue to monitor that situation as conditions change and as we go through this very interesting time of our economic cycle.

Jon Arfstrom - RBC Capital Markets

You talked about deposit competition and some of the irrational pricing on deposit, would you characterize that as in-state competitors, out of state located competitors or both.

Charles Christmas

A combination of both. We have seen it from both of those.

Jon Arfstrom - RBC Capital Markets

And you’ve seen that gap widen or narrow or has it stayed the same.

Charles Christmas

I think during the third and fourth quarters it was widening. I think over the last few weeks we’ve seen a little bit of some of those specials coming down. So hopefully that’s a trend that will continue but its still pretty significant.

Jon Arfstrom - RBC Capital Markets

In talking to a lot of your lenders and clients, obviously a pretty material change in the economy late in the third and early in the fourth quarter, just curious what your reaction is to that as a lender and how you work to stay ahead of that because it seems like some of the banks we’ve talked to may not have that reflected in some of their thinking and I’m just curious if you feel like you’re ahead of the curve on that.

Robert Kaminski

That’s absolutely right, what we’ve done is and for the last five quarters practically we’ve tried to be very nimble in working with our borrowers and trying to anticipate where the weakness is and where the stress points in the economy are and how those will be impacting our customers. In fact our loan portfolio, we’ve worked hard with our lending staff to look at those stress points and do analysis of the portfolio to identify loans that have characteristics that reflective of those stress points and I think we continue to do that.

We continue to double back and make sure that we get current financial statements each month on our customers to look at how the performance is headed, look for signs of further deterioration and try to be a partner for those customers to try to help both us and them maneuver through these tough times and so it’s a situation that requires again the bank to be very nimble for us to have frequent communication with our customers and to try to anticipate where problems are going to occur in our region and in our economy and how that will impact the portfolio and then try to do some things from a structure standpoint from some enhancements of collateral support standpoint to buffet the loans as those enhancements may become available.

Jon Arfstrom - RBC Capital Markets

You talked about the ability to move foreclosed real estate and just curious if prices are firming at all, if the number of buyers coming into the market has increased at all.

Robert Kaminski

It really depends upon the specific type of collateral. I think from a residential real estate standpoint I think that continues to be a challenge for the entire market. From a commercial real estate standpoint its really property specific as you have properties that buyers may find attractive those prices are fairly stable and surprisingly so.

There are those that may not be so attractive reflective in the lack of buyers so it really is property specific on the commercial side, residential real estate is probably the biggest challenge in terms of deterioration of prices regarding that segment of the real estate portfolio.


Your next question comes from the line of Terry McEvoy – Oppenheimer

Terry McEvoy – Oppenheimer

Just wondering, does this rational lending practice that you’re seeing in the marketplace does that feel sustainable and then a lot of your larger competitors have received capital from the Treasury department and has there been a noticeable change at all in terms of how you’re competing against those larger banks and essentially are they out there lending money post this TARP capital from your perspective.

Michael Price

We believe the way the economy is now and we believe that 2009 at least the first three quarters are probably going to look an awful lot like 2008 and we also think its going to look like that on the lending front. I think banks at this point are having a hard time even if you want to deploy capital in the forms of loans its very difficult out there to get comfortable in finding a whole lot of industries right now that you want to go out and make a lot of loans to.

That being said there certainly are good customers out there and we continue to look at them and we continue to bring new customers into the bank when that is prudent to do so. As far as banks that have received TARP and have they acted any different then before they got TARP or now, I would say that its really too early to tell. We certainly haven’t seen anything specifically change and I think its for the same reasons.

I think its very difficult [flooding] out there right now and so we haven’t seen any change of behavior as to our competitor. And I think whether banks get TARP or whether banks don’t get TARP I think as bankers we’ve all learned that we just came through an unsustainable period of time when competition for bank credit for customers by lenders has just gotten too intense. We lost a lot of rationality in pricing and structure and we’ve been talking about this now for a couple of years.

Fortunately for us we’ve tried to hang onto our structure integrity as much as we could but we were the first to admit that we joined into the pack of wolves bidding loan prices down and quite honestly we’ve just said whether conditions get better or not, we’re not going back to those days because its unsustainable and we all I think as bankers learned that lesson.

But that at least from my chair that’s what I see.

Robert Kaminski

I think really what we want to focus in on is good customer relationships and customers that bring to the table their loan portfolio of credits as well as their deposit balances to build a relationship between the bank and the customer, some banks are after these transactional deals that are just loan for loan sake and we want to make sure we shy away from that to build the bank based on the full package and full menu of needs of the customer and what the bank has to offer to them.

I think right now banks are protecting their good customer bases, trying to take care of those good customers and make sure that their credit needs are taken care of and beyond that trying to go out and bring in new business. As Michael mentioned the credit quality is certainly a challenge right now and so we’re all just trying to make sure we take care of the good customers we have and service those customers and let the economic storm somewhat pass by.

Terry McEvoy – Oppenheimer

For awhile now MBWM has traded at a noticeable discount to its Michigan peers, so its nothing to do with simply being located in the state of Michigan, its got to be something within your operating strategy, balance sheet, etc. as you plan ahead and the dust settles do you expect to see any changes in that operating strategy and specifically with the percentage of your loans that you’re funding with FHLB advances and brokerage CDs, that number going up, do you think that ultimately is working against you so does it really come down to just raising traditional deposits in a very competitive market.

Michael Price

From the standpoint of the overall global strategy of the strategic planning group and the Board during the last year, year and a half, two years, and the first thing we wanted to do right and focus on intensely was asset quality issues as you might imagine, but we also wanted to get our margin up by making sure that loan pricing was rationalized.

We went through like most banks, and we started doing this before a lot of banks if you remember, we saw the storm coming in the first quarter or second quarter of last year 2008, we put a lot of money in loan loss provision, we downgraded a lot of credit well the problem with that is you downgrade a lot of credits you can’t immediately rationalize the pricing to the increased risk rating.

And we spent a lot of time during the last three quarters of 2008 doing just that, spending a lot of time on the floor issue which we talked about, rationalizing the pricing, changing loan policies and getting that squared away and those things are having tremendous impact right now in a very, very positive way. You followed our bank for a while and you know that typically in a time of extremely rapidly falling rates our asset yield usually goes way down.

We’ve actually been able to stabilize that in a way that we’ve never been able to do that before. That’s to give you a bit of a background. Now that being said we’re very frustrated with stock price as well because if you look at our peers and you look at what’s going on in the Midwest and Michigan and eventually going through the country, our non-performing asset level which isn’t acceptable to us is actually fairly reasonable for all things considered.

We think we’re getting very, very good things in place to get that reduced down. With that being said the issue that we really want to focus on this year and touched upon it earlier is reducing our dependence on the wholesale funding because that’s got to be in our opinion the reason we get discounted and it would be a reasonable assumption to make.

Unfortunately for us we had driven that wholesale funding reliance number down to below 60% prior to the [inaudible] on the crisis. But now with people going through this crisis a lot of our customers have less cash then they normally do. They’ve been having to use that cash. There’s been some customers while we’ve got new accounts because of FDIC insurance concern, we’ve lost customers for those same reasons.

So all those things being said it has worked against us to raise that level back up. But as part of some of our loan changes that we’ve made, we’re going to be much more diligent and vigilant to either putting minimum deposit balances with every loan requirement that we have out there, we’re going to spend a lot more time advertising structuring products and focusing on getting local deposits in the door.

That’s a frustrating and sometime counter intuitive thing for us to do because as we mentioned before our local deposit base, we have some banks that are I guess in need of liquidity in a very bad way because they’re bidding up local rates to rates far in excess of what we can fund nationally through wholesale funding. So there’s part of us that says, yes we need to do this because we need to make our bank look better I guess to the outside world, but it’s a very tough thing to do because at the same time it puts pressure on your income statement because you’re basically getting into the dog fight with some of these other banks with unreasonably high deposit rates.

But that’s for us to work out and that’s for us to challenge and to tackle and we’re going to do it and we’re going to make it happen.


Your next question comes from the line of Brad Vander Ploeg – Raymond James

Brad Vander Ploeg – Raymond James

Other then the Mercantile prime that you mentioned are there any other loan specific pricing initiatives that you put into place or is that the primary one.

Michael Price

That’s really one of an arsenal of many things we did. What we tried to do is look at loan grade and do a better job of making sure that we’re charging the appropriate interest rate and fees on loans that have been downgraded. Obviously like a lot of banks, we’ve had a lot of loans downgraded in the last year and a half and we’re just in some cases just now getting that opportunity to reprice them and in the last couple of quarters especially.

That’s been huge for us. The ultimate floor rates that we put in all new loans that we’ve booked over the last six months, that’s helped us. We have instituted pricing models that our people here have done a really great job of getting that up and running. And that’s helped us as well because it really gives us some ROE targets to shoot for and there’s been some other minor ones that I won’t go into.

But all those things together have had tremendous impact and has really started to lift our margin and as we are grinding through the repricing of our liabilities at much, much lower rates, we like the way the trend of our margin looks for 2009.

Brad Vander Ploeg – Raymond James

How much do you worry about the possibility that maybe people are accepting this now just because credit is a bit tighter but as things get better towards the end of the year hopefully that there might be some animosity towards that type of policy or does it really seem like true acceptance at this point.

Michael Price

The honest answer is that I don’t think any of us will know until things start to look a little bit better as you allude to and I’d love to be challenged with that next quarter but I think the real key here is communication and working closely with our customers. We have some very loyal customers. We have some very long-term employees who work with those customers and they understand.

Now if prime was 10 and a year ago it was eight and we decided when it started to come down that we weren’t coming down, that’s a different situation. But I think most businesses now realize that lending in the 3.5, 4, 4.25% range, that’s a pretty good deal and if Mercantile doesn’t go all the way down to a prime of 3.25, that’s not as big a deal to them as you might think because they feel that it’s a very fair rate to have.

They understand that community banks make most of their money by margin and it doesn’t take a real long explanation to say if prime is at 3.25 and they open the Sunday paper, which they can here in Grand Rapids, Michigan, to see money market rates at 3 and CD rates at 3.25 to 4, I’m the first one to tell them I’m not that smart as to how to make money at that kind of negative arbitrage.

So I think customers understand it pretty well. But that being said we’re not patting ourselves on the back and saying that the battle is over and we’re going to sleep well at night thinking that this is something that’s going to forever be the case because its our plan not to be, its unusual times and we’re going to watch it very, very closely as things start to get better.

Brad Vander Ploeg – Raymond James

On the non-performing loans and the charge-offs, I was curious you’ve got a number here in the press release of $4 million for a number of things and I was wondering if that’s for all of those things combined which are loan paydowns, sales of foreclosed real estate or if that’s just, I’m trying to get at the amount of non-performing loans and OREO that you sold during the period.

Robert Kaminski

As I mentioned the figure was $4 million and that accomplished through a combination of things, there were a couple of credits that were upgraded because of improved performance, but the majority of that $4 million was through the sale of distressed assets and also some loans that were non-performing that paid off.

Brad Vander Ploeg – Raymond James

So it’s a combination of loan and OREO sales then.

Robert Kaminski


Brad Vander Ploeg – Raymond James

What was the current run rate for FDIC insurance expense.

Charles Christmas

I don’t have that handy but I can get that to you later.

Brad Vander Ploeg – Raymond James

Fine, because it went up during the year right, so that $1.2 million increase is not necessarily a full year impact.

Charles Christmas

Yes that’s correct, its definitely changing and of course you’re starting with the first quarter this year, obviously its gone up yet again.

Brad Vander Ploeg – Raymond James

If you could just talk through a bit the decision not to participate in TARP and did you have any conversations with Treasury or is that just something you weren’t interested in from the get-go.

Michael Price

We really haven’t released any information regarding TARP or really any other capital management strategies at this point and its one of those issues that we’re constantly and I’m talking about our capital management strategy, talking about looking at and updating and we’re in one of those good situations where we don’t need to take TARP. We have some flexibility there and at this point we’re just going to continue to keep the public discussion of it down to a minimum until we’re ready to share what our capital management strategy is going to be going forward.


Your next question comes from the line of Eileen Rooney – KBW

Eileen Rooney – KBW

On the margin, what was the impact from interest reversals on non-accruals on the margin this quarter versus last quarter?

Charles Christmas

I think the reversals have been pretty consistent at least from the third and fourth quarter. To put a dollar amount to it, its probably right around $.25 million per quarter, $250,000 per quarter.


Your next question comes from the line of Daniel Cardenas - Howe Barnes Investments

Daniel Cardenas - Howe Barnes Investments

On watch list trend, it sounds like your 30, 90-day bucket has decreased a little bit, but what’s the internal watch list trend look like.

Robert Kaminski

It’s a pretty fluid number. As you see credit is coming in, going on a watch list, moving to non-performing. Ones that go the wrong direction. The ones that go the right direction we maintain a close tally on the loans that are just pre watch list as well. You look at the credits that exhibit some signs of stress and ones that aren’t quite on the watch list yet and we continue to see some good trends there so in terms of the feeder and the watch list, I think we’re encouraged by what we’re seeing there and then perhaps as you get into the latter half of 2009 that that whole segment of loans that are exhibiting signs of deterioration will continue to reduce.

Michael Price

Its kind of a good news/bad news, the good news is we’ve identified fewer new members of the watch list which is always a really good thing. The bad news is obviously the continued stress on the economy out there has made some of the watch list credits a little sicker if you will so that we continue to increase some provisions for some of those credits and then we expect the first quarter to be a lot like the fourth quarter and so its nice to have fewer to quarantine but those that we have quarantined are seeing some real stress out there.

The good news overall though for our organization is that we believe it’s a very manageable number and with the margin now going in the right way at a very significant level that we’ll be in much better shape to withstand some of those battles as well.

Daniel Cardenas - Howe Barnes Investments

Are there any certain industries that are causing you concern right now?

Michael Price

As you might imagine we’ve done a really good job internally of identifying anything and everything that we would have concerns about. One of them would be obviously the automotive industry. We’re not huge into the automotive industry but if you start looking at one-off and two-off levels and you start thinking about even transportation companies that have the automotive as customers you start to have some concerns about them.

But we’ve already done some proactive research on our portfolio and put some things in place and obviously at this point you see retail sales, the numbers that came out today were not good, not that anybody expected them to be so I think we really are paying attention to automotive.

I don’t think there’s an industry or an area right now that any bank has that they aren’t concerned about just because the general economy has just taken such a tough hit out there.

Charles Christmas

Our lending staff, our credit staff, loan review staff have done a really good job of being nimble. They have to generate some data on the portfolio to slice and dice it to look at various segments and industries that we see on the horizon that may be some problem warning signs for the future so I think we continue to do a good job of being proactive and looking at the portfolio every week, every month, to make sure that we have our arms around it and are looking to see where the trends are headed and to be able to provide the information to the Board as to the trends as we continue on in 2009.

Daniel Cardenas - Howe Barnes Investments

Geographically are you seeing problems increase in your Eastern part of the franchise?

Michael Price

We saw out of our [Washinaw] office probably about a year and a half ago, we saw an increase in some watch credits over in that area and they had to do primarily with residential real estate development and those have been quarantined and worked on and some cases worked off or charged off. But I would say we don’t see anything that we would say was region-specific where we’re saying, gee we don’t have any problems in this regions, or we have an inordinate number in anything.

Clearly the Southeastern side of the state is being challenged even more then the Western side. Fortunately for us we don’t have a big exposure over there. We probably have in both our [Washinaw] and Oakland offices probably around $80 million in loans and while that’s not zero, they’re generally in pretty good shape other then the aforementioned ones that I talked about in residential real estate.

And as you can imagine its hard for whether you’re in the Eastern side of the state or the Western side to find a lot of good new customers to lend money to right now so we’re not seeing a lot of growth on that end either.


Your next question comes from the line of Stephen Geyen – Stifel Nicholaus

Stephen Geyen – Stifel Nicholaus

Since the big jump in non-performing loans occurred late in 2007, early 2008 at least on a percentage basis, are many of these properties now moving into resolution considering the long foreclosure time in Michigan and just wondering what that might mean for non-performing loans, non-performing assets, and where you are going forward.

Michael Price

As you know in Michigan there is a redemption time that you have to work through, and that’s exactly what’s happening now. The fourth quarter was really the first quarter that we saw a significant number of properties both residential and commercial that came out of foreclosure and redemption that we’re able to get onto the market. Some of those pieces have moved fairly easily and in some cases surprisingly easily at reasonable prices as opposed to appraisal etc.

Others have been more challenging and a lot of it again just depends on location and the dynamics of the property but I think the good news I guess for us is that there was a lot of stuff that we were unable to bring to the market so to speak for the first half of 2008 that we’ll be able to bring to the market in the first half of 2009.

We’re looking forward to that.

Stephen Geyen – Stifel Nicholaus

You talked a bit about the desire to increase local deposits, just wondering what ideas are you floating to increase local deposits and what are you seeing today that maybe you didn’t see 12 months ago.

Michael Price

I guess we’re looking at products, we’re looking at structures of those products, enhancing the existing products, maybe adding new products. We’re looking at our rate scenarios across the board, really there isn’t anything that we haven’t considered or we aren’t thinking about doing. We haven’t been traditionally an organization that has done a lot of advertising and promoting of our local deposit rates and that’s going to have to change and we want it to change and we’re going to make the commitment to do that.

Internally more cross selling and profiling, all sorts of things that we need to do. There’s no magic bullet to raising local deposits, just like there’s no magic bullet to increasing our loan yield in a drastically reducing environment but when you put the focus on things with the group of people that we have and we sit down and put a strategy in place I’m pretty confident that we can do some real good work here.

And clearly the market is going to have a lot to do with it as well. There isn’t a lot of extra money floating around both from our retail and our commercial market here in Grand Rapids and we’re going to have to be competitive on rate, we know that, and structure and that type of thing but I think all those things put together we’ll be rolling out some real opportunities to raise that.

Charles Christmas

One of the things we’re going to have to deal with more from an outside standpoint and really what I think kind of shocked the system and we started seeing some significant dollars leave the bank was with regards to not only Mercantile’s financial condition but even that of the entire banking industry.

Obviously we had a tough first two quarters last year, lost money, and we really didn’t see a significant outflow of funds as a result of that. We certainly had a lot of discussions, a lot of luncheons, a lot of conference calls, and we’re all happy to do that as we try and obviously talking about our larger depositors now, and I think what really shocked the system was the failure of [Indimac] Bank and the other banks that followed.

I think that really grabbed the attention especially of the municipal treasurers and some of our larger depositors as well. And I think, I won’t call it panic although some people it was a panic, but that was a huge ripple effect I think of the people’s confidence not just in Mercantile, talking to other bankers, of the entire banking system and just a dramatic risk diversification is taking place with regard to larger depositors.

So I think part of being able to increase our local deposits and its not the only thing but it is an issue, is our overall health but also the overall health of the entire industry. We’ve got to get people back having confidence of having dollars in banks over the insurance limit.

Most of the people, the significant dollars that we lost, we didn’t lose the entire relationship, a lot of times they just reduced their exposure. Many times down to the 250 insurance limit but we even had customers that maybe had $2 or $3 million worth, they still have over $1 million with us but obviously we did lose some deposits just as they felt it prudent given the times to go ahead and diversify.

There still are good customers at the bank and hopefully at least as we improve, because we think we will, but hopefully the rest of the industry comes along with us to get their confidence back.


There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Michael Price

We continue to work closely with our customers who have been severely impacted by these tough economic times and we know that there are more challenges ahead. We feel very comfortable and confident to tell you that we’re continuing to make improvements in our organization in many, many areas.

We thank you for joining us today and we appreciate your interest in our company.

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