Mercantile Bank Corp. (NASDAQ:MBWM)
Q1 2013 Earnings Call
April 17, 2013 10:00 AM ET
Karen Keller - IR, Lambert Edwards
Michael Price - President and CEO
Chuck Christmas - SVP and CFO
Robert Kaminski - EVP, President and COO
John Barber - KBW
Daniel Hernandez - Raymond James
John Rodis - FIG Partners
Good morning and welcome to the Mercantile Bank Corporation First Quarter 2013 Earnings Results Conference Call. All participants will be in a listen-only mode. (Operator Instructions). After today’s presentation there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded.
I would now like to turn the conference call over to Ms. Karen Keller. Please go ahead.
Thank you, Yusuf. 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 2013. I’m Karen Keller with Lambert Edwards, Mercantile’s Investor Relations firm and joining me are members of their management team including Michael Price, Chairman, President and Chief Executive Officer; Robert Kaminski, Executive Vice President and Chief Operating Officer; and Chuck Christmas, Senior Vice President and Chief Financial Officer.
We will begin the call with management’s prepared remarks and then open the call up to questions. However, before we begin today’s call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings, and capital structure, as well as statements on the plans and objectives of the Company’s business.
The Company’s actual results could differ materially from any forward-looking statements made to date 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’d like to turn the call over to Mercantile’s CEO, Michael Price.
Thank you, Karen, and good morning, everyone, and thank you for joining us to discuss our first quarter 2013 results and other recent developments for Mercantile Bank Corporation. On the call today our Chief Financial Officer, Chuck Christmas, will provide details on our financial results followed by Chief Operating Officer, Bob Kaminski, and his comments regarding asset quality and other operational successes for the quarter.
Hopefully, you have all had chance to review our quarterly results which were highlighted by improved net income, a further decline in nonperforming assets and a stronger balance sheet. We made additional strive in our efforts to improve asset quality, and as a result Mercantile recorded a negative $1.5 provision for provision for loan losses during the first quarter.
This quarter was no different from past recent quarters in that our efforts remain focused on reducing nonperforming assets, protecting our net interest margin and maintaining our strong capital position. Earlier today, we also announced another increase to our quarterly cash dividend from $0.10 to $0.11 per share.
Our bank continues to grow stronger each quarter and we are proud of many accomplishments. We are convinced our relationship based approach is essential to our success in gaining market share or remaining respective partners to our customers by adding long true value for them and our shareholders. The success of these relationship building efforts was evident in our origination of approximately $50 million in loans to existing and new borrowers during the quarter.
As we look ahead, the Michigan economy continues to gain strength and is being recognized both locally and nationally, not only for the rate of its recovery but also for the future prospects in several key industries.
Mercantile remains well positioned to continue our success as a leader in our markets and our strong capital position creates many opportunities for us to fully participate in these trends as they play out in 2013. We will do this while remaining focused on building our franchise and helping our communities prosper.
At this time I'll turn it over to Chuck.
Thanks Mike, good morning everybody. This morning we announced net income attributable to common shares of $4.4 million for the first quarter of 2013, reflecting a 72% increase over net income attributable to common shares of $2.6 million we recorded during the first quarter of 2012.
On a diluted earnings per share basis we earned $0.50 per share during the first quarter of this year, an increase of over 78% from the $0.28 per share we earned during the first quarter of 2012. We have now recorded a net profit for nine consecutive quarters. The quality of our loan portfolio continues to improve, allowing for negative provision expense and further reductions in problem asset administration cost. The level of nonperforming assets has declined by almost $100 million or about 84% over the past three years and is currently at its lowest dollar volume since March 31, 2007.
Our improved earnings performance and financial condition also reflect the many positive steps we have taken over the past five years to not only mitigate the impact of asset quality related costs in the near term, but to establish an improved foundation for our longer term performance as well.
We have increased our net interest margin to well above historical levels, strengthened our regulatory capital ratios and further enhanced our liquidity position to dramatically less reliance on wholesale funding. In addition our improved financial condition and operating results led to the resumption of a quarterly cash dividend in our common shares during the fourth quarter of 2012 which, we have since increased from $0.09 per share to the current $0.11 per share.
Despite economic and regulatory headwinds that continue to face our industry and the economy, we continue to believe we are well positioned to succeed as a strong community bank and to take advantage of lending and market opportunities. Highlights from the first quarter of this year include a steady net interest margin that remains well above our historical levels and that has helped to mitigate the negative impact of the smaller loan portfolio.
Net interest income during the first quarter of 2013 was 3% lower than the first quarter of 2012. Average loans declined by $33 million or 3% during the first quarter of this year when compared to the first quarter of last year.
Our net interest margin during the first quarter of this year was 3.68% or five basis points lower than the comparable period in 2012. However, it should be noted that out first quarter 2012 net interest margin was our highest ever quarterly net interest margin.
During the past five quarters, our net interest margin has averaged 3.67% and has been within a range of only 11 basis points. The steady net interest margin reflects a lower cost of funds that has offset a lower yield on assets. The lower cost of funds primarily results from maturing of higher costing certificates of deposits and borrowed funds, as well as lower rates paid on local deposits.
The lower yield on assets primarily results from a lower loan yield, reflecting a low interest rate environment, improved borrower financial performance and increased competition, as well as a lower securities yield reflecting U.S. agency call and reinvestment activity, as well as principle pay downs in higher yielding mortgage-backed securities. The declining level of non-accrual loans has helped to offset the impact of lower yields on our loan portfolio.
We remain dedicated to maintaining a strong and steady net interest margin. For example, to the extent possible we are match funding fixed rate commercial loans and we have entered into certain derivative interest rate contracts.
While these and other strategies generally have a negative impact on shorter-term net interest income, we have been able to maintain a relatively steady net interest margin, one that is well above our historical average. This was completed in conjunction with strengthening our interest rate risk position, especially if interest rates are to increase in the future.
The continued improvement in the quality of our loan portfolios and recoveries of prior period loan charge-offs, which have provided for a positive impact on our loan loss reserve migration calculations, allowed us to make a negative provision of $1.5 million through loan loss reserve during the first quarter of this year.
Of the $2.4 million in gross loan charge-offs during the quarter, $2 million or about 83% is from charge-off of specific reserve on non-accrual loans that were established in prior periods. Recoveries of prior period loan losses totaled $1.3 million during the first quarter.
Our loan loss reserve was $26 million as of March 31 or 2.55% of total loans. Despite the significant improved condition of our loan portfolio and a 20 basis point reduction in our reserve coverage ratio during the first quarter of 2013, our loan loss reserve coverage ratio remained substantially higher than historical averages.
Local deposit and sweep accounts were down slightly during the first quarter of 2013 but are up almost $365 million since the end of 2008. As is typical during the first quarter each year, we experience some withdrawals relating to the payment of taxes and bonuses; however, deposits from new depositors and increased deposit balances from existing depositors substantially offset the withdrawals.
Local deposit growth and a reduction total loans have enabled us to reduce our level of wholesale funds by over $1.1 billion since the end of 2008. As a percent of total funds, wholesale funds have declined from 71% at the end of ’08 to 22% at the end of the first quarter of this year.
Non-performing asset administration and resolution cost totaled only $0.1 million during the first quarter of 2013. This expense line item was positively impacted by $0.7 million in gains on the sale of foreclosed properties in part reflecting our conservative valuation approach. In addition, further foreclosed property valuation write-downs totaled only $0.2 million during the quarter.
While gross expenses remain elevated over historical levels, we continue to experience significant expense reductions and we expect further declines in non-performing asset administration resolution costs in future period as the level of non-performing assets continues to go down.
We remain a well-capitalized banking organization. As of March 31, 2013 our bank’s total risk-based capital ratio is 15.4% and in dollars was over $62 million higher than the 10% minimum required to be well capitalized.
Those are my prepared remarks. I will now turn the call over to Bob.
Thank you, Chuck and good morning everyone. My comments this morning will focus on client acquisition, credit quality in the general operations of the bank. The net reduction of total loans for the first quarter does not tell the complete story of the successful new client acquisition and relationship building activities of our staff.
When we showed a reduction of loans on a net basis for the quarter, Mercantile lenders funded $37 million in loans to new customers and another $13 million amongst existing customers. The success of the new loan funding was maxed by some unexpected loan payoffs. These instances were primarily in commercial real estate loans where the borrower sold the asset because of the payoff of the underlying loan.
Additionally, some new loans scheduled to fund late in the first quarter were delayed however this creates a very strong pipeline of projected new loans to be funded in second quarter. It’s very encouraging that each of these new loan opportunities has been created by Mercantile’s staff through persistent relationship building with a continued demonstration of value added benefits for the prospective clients.
Our lenders are getting good opportunities with prospects, who are attracted to the Mercantile community banking philosophy. We continue to have success in identifying lending opportunities in commercial, industrial, owner occupied commercial real estate and non-owner occupied commercial real estate loans.
We are confident that by providing our sales officers with the ongoing training and coaching, our relationship building strategies and techniques, we are focusing on the key to success. The first core successes has served to further encourage the staff that the approach Mercantile takes to our client acquisition is the best strategy for obtaining long term mutual beneficial relationships.
Regarding community relations in marketing, in the first quarter, Mercantile introduced its 2013 Giving Together Program, which provides a $5000 gift to a different local non-profit organization each quarter. The program is focused on donations to non-profits that serve education, community and economic development, arts and culture, and health human services. The winner of each $5000 gift is chosen by the public, the voting taking place via social media.
The 3 Mile Project which is the local community organization supporting area using Grand Rapids was the recipient for the first quarter. With great response, we are now taking nominations for the second quarter.
Also during the first quarter, Mercantile commenced its 2013 marketing plan with the production of four new television commercials featuring Mercantile customers, accompanied by their bank relationship officers. These commercials have started to air in our markets and will continue throughout the year.
On asset quality, once again this quarter, we generated a huge improvement in reducing non-performing assets. Since December 31st, NPAs declined over $7 million or 27.1%. Year-over-year NPAs have dropped $33.3 million or 63.8%.
With the excellent work of our loan officers and our risk asset group, we have continued our momentum in reaching successful resolution on many troubled assets. Almost every category of problem assets saw significant reduction from December with the largest drop in non-owner occupied commercial real estate at $4.5 million.
During the first quarter, there were only 692,000 in new NPAs. Those charge-offs of $2.4 million were mitigated by low recoveries of $1.3 million for net losses of $1.1 million. Of the first quarter charge-offs, 83% were losses previously identified and reserved in prior quarters. Loans identified on the Bank's wash list continued to decline in the first quarter representing at March 31st the lowest dollar total in over five years.
Our loan loss reserve remains very strong at 2.55% of total loans and we continue to perform very well in terms of loan delinquencies. The total loans past due 30 to 89 days remains low at 224,000 while 90 day past due loans were zero at March 31st.
In conclusion, we remain very optimistic about our performance metrics for new business opportunities and continued improvement in asset quality for the rest of 2013. This concludes my remarks. I'll now turn it back over to Mike.
Thanks Bob, and thank you Chuck as well. Operator at this time, we would like to open the lines for any questions.
Thank you. (Operator Instructions). Our first question comes from John Barber with KBW. Please go ahead.
I was just wondering, could you talk about the $50 million of origination this quarter. I think that compares to $64 million last quarter. How much you are impacted by seasonality?
There is some seasonality, we saw in the first quarter some reduction of line balances which is more than we typically see during the first quarter and that certainly hurt our net loan totals for the quarter. As I mentioned in my comments, some loans that were supposed to fund in the first quarter were pushed into second quarter. That obviously didn't help us as well, but we’re very pleased with the activities that we saw new in loan fundings and again what remains in the pipeline is very optimistic for us.
And the timing of streamlined originations, what is it more backend loaded or is it pretty even throughout the quarter?
It was more backend loaded.
Okay. Okay. And then how about the spreads on the new origination, how does that compare to your current loan yields?
The spreads, we track those obviously very closely and while the new loans that we are funding are obviously are very good quality loans, the margins, while competitive I think are very much within the range of margins that we look at in terms of the overall margin maintenance program that we are looking at.
Yes, John this is Chuck. If I could just echo Bob's comments, we certainly have a pretty comprehensive loan pricing model that we generally adhere to depending on primarily the risk of the credit but certainly the terms and some other things as well and we trace every single loan origination that we do and report it up to the channels, and we’re very, very pleased with the results that we were able to get.
If you just kind of look at it from a more global prospective and something I kind of track on an ongoing basis, if you look at our average loan rate at the beginning of the year, and you look at our average loan rate at the end of first quarter, we were down three basis points. So, able to hold it on our spreads pretty well but certainly some compression there.
Do you by any chance have the accruing TER number? I had, I believe around $38 million last quarter and maybe you could just talk more broadly about the performance of those credits?
I believe that number was around $39 million at the end of the first quarter. I think it reflects our conservative philosophy in looking at loans that are showing some signs of stress and with that, the current treatment is reflected there and the specific reserves are established, and obviously working with the borrower, they try to make sure that we provide them with the resources and opportunities necessary to help their business or the real estate project and continue to work with them and provide support as best we can. But it really reflects our conservative nature in terms of identifying those loans and establishing the proper accounting trigger with the FAS 114 reserve.
And just last one I had, Chuck I think you said you booked $700,000 of gains on OREO property sold. Was that related to just one or two properties or a large number?
Yes, there was a couple of larger ones in there but we definitely, and from a trend basis, when you look at the properties that we sold during the first quarter; not only the first quarter but last few quarters, we are seeing more gains and certainly losses. I think a large part of our conservative nature to value these things as conservatively, as we are allowed to do per the accounting guidance, it also I think reflects some improvement in real estate markets for certain types of properties.
But if you look at the overall number, there were a couple of larger gains in there, but I think, and like I said, few losses on the sale of our OREO during the quarter. And the pipeline that we have for the second quarter looks pretty strong as well.
(Operator Instructions). Our next question comes from Russ Avermen with Avermen Management Corporation (ph). Please go ahead.
You talked about your strong pipeline. Could you break that down for us by just general categories commercial and other and in and around the state where you’ve seen sort of the best pockets of general loan demand growth or demand, I should say.
I don’t have the exact numbers in front of me as far as the breakdown but I think from memory it’s a fairly balanced group of loans that are in the pipeline for funding in terms of the carriers we discussed, commercial, industrial, owner occupied commercial real estate as well as non-owner occupied commercial real estate.
In terms of the pockets, really within the markets that we bake, the West Michigan County region, there is a healthy pipeline there as well as Essential Michigan in and around the Lansing area where office is located, some good loan opportunities there as well contributing to overall pipeline. So we’re very pleased with what we’re seeing in the variety of loans to keep a balance portfolio which is our intention and we’re seeing that in terms of the looks that’s we’re seeing within our markets.
And just one question, how in different parts of the country I’m hearing very aggressive pricing on say for argument, say a 10 year adjustable commercial rate loan. For argument’s sake where are you pricing that type of loan today?
On the 10 year, we do very, very little, I’m not even sure, we did any of that in any recent time. Occasionally, we’ve look at a seven year term but that’s also pretty rare as well per our policy and obviously our experience, if it’s a fixed rate, we attempt to balloon it in five years. I do know as the lenders call from time to time, asked me what the cost or funds for seven and 10, that definitely is out there but that’s something that we generally stay away from.
So what kind of real estate commercial loans are the typical terms?
They are going to be floating rate primarily based on Wall Street Journal.
Okay so everything is locked in for one of the first five or seven years and then let it flow?
Yes that’s possible.
Our next question comes from Daniel Hernandez with Raymond James. Please go ahead.
Daniel Hernandez - Raymond James
Just couple of quick questions here on the lending side. Can you may be talk about plans for increasing your lending staff or are you pretty good with the folks that you have right now and then maybe geographically where do you see most of the new growth coming from.
Hi Dan, this is Mike. We've got a real strong staff that we've been able to maintain for the last few years. Even we downsized the bank a little bit for capital reasons. But that being said we are constantly looking out in the marketplace to add people who might have specific expertise, especially in the CNI area, but as you might imagine that there's a lot of banks looking for that type of expertise right now.
But we'll continue to look at that. We've got also very strong credit department that we have some people that are ready to take the next step up, so I think some of that is already happening and it will continue to happen.
Geographically we continue to look to take advantage of the success we've seen in Central Michigan, especially through our Lansing office. I think Bob or Chuck or maybe both will have mentioned that, that also has been a very strong reason for us for a very long time now and we do continue to see some opportunity there. West Michigan is picking up steam finally after a long period of time but the biggest question continues to be and the previous caller had the question, the loan pricing continues to be very aggressive.
We clearly could have grown the loan portfolio even more in the last couple of quarters, which have been kind of break even, if we wanted to really see our margin take a hit and we've been really dedicated to maintaining that discipline and as you can see and Chuck mentioned we've seen very, very high, for us anyway, historical margins, and we just, we really want to continue to keep that strong and so we’ve walked away from some deals, specially some of the larger money centered banks have come in with really in our view ridiculous pricing. So we continue to work hard to express the Mercantile value proposition which is really a relationship based and not just a price based proposition and we are seeing some good success with that.
Daniel Hernandez - Raymond James
Good, good. And then just kind of given the intense competition that you're seeing right now, what levers exist that you can pull that can help you maintain your net interest margin as we go forward.
Well the levers that we continue to pull are ones that we've been pulling for a while. Some of them have less juices come out of them, we continue to see some pricing, re-pricing opportunities on the liability side although that clearly is not the benefit that we had for the last few years but there are still some opportunities with some blocked pricing that is coming up within our portfolio of this year.
The other real chance to keep the margin up there is to maintain the discipline that we have with our pricing on the loan side to make sure that we just stay with it and continue to express to the customer and prospect base, the value that they get out of Mercantile.
Daniel Hernandez - Raymond James
Okay. Excellent. And then on the capital front, you guys have done a good job, you have retired your TARP, you brought back the dividend, you have increased it the last couple of quarters. What other uses of capital do you, are out there for you with loan growth picking up a little bit but still being challenging?
Alright that’s a great question and we continually, within our Board room and executive management team is they look how to best deploy the capital and as we said now for a couple of years and we continue to stay the course I mean our, we would love continue seeing some organic loan growth and we are seeing, fits and starts as you can see by the last few quarters, but we have got a real good backlog going into this quarter and less and less of the bad stuff that we want to get of the Bank.
I mean we are down a 1.3 now NPA. So we don’t have a lot of stuff compared to a year or two, three years ago where we were really trying to force out the door. So we’d like to continue and we will continue to focus on organic loan growth. We continue to say that if the right situation came up that we would look at acquiring a bank, but again the organic loan growth is our first pick.
And we also continue to look at other opportunities to increase shareholder value which is, you have mentioned one of them increasing the dividend, and if we had to we would look at further on down the line look at stock buyback programs or those types of I guess financial maneuvering if you want to call them that.
But all things are on the table but I think rank order we would love to see the organic loan growth be where we are seeing some increase to that. But either way I think the Board and the management team hopefully have demonstrated to the investment community that through good times that we had the first 10 years of this organization, some really challenging times for the last few years there and now back to good times again, we do the very best we can to protect our shareholders and give them a good return.
(Operator Instructions). Our next question comes from John Rodis with FIG Partners. Please go ahead.
John Rodis - FIG Partners
Most of my questions were asked but I guess just one additional question would be the -- I guess with the recent closing of the FirstMerit Citizens Republic transaction, can you talk about is there any opportunities in your markets may be for new business or for new hires anything like that?
That’s a great question, we get asked that a lot because when you look at the size John, that’s fairly sizable transaction in terms of Michigan banking. But there was really not a lot of customer overlap or most of the transaction that you’re talking about there was on the east side of the state, very little impact for us here in the central or the western side.
As far as talented people, that remains to be seen. We’re always on the lookout for talented bankers. So there may be some fallout there as the closing really starts to take place and who’s going to stay and who’s going to go starts to shake out. But, we don’t see any real major, I’m sure there’ll be some opportunity but this is a deal like it was 10 years ago when Old Kent was sold at a third (ph) or something along those lines.
(Operator Instructions). I’m showing no further questions. This concludes our question and answer session. I would now like to turn the conference back over to Michael Price for any closing remarks.
Thank you Seth. Mercantile momentum is increasing and our team motivated and dedicated to build on our success. As I stated earlier, our longstanding relationships, proven excellence at commodity banking are serving us well, we continue on the path of achieving an efficient and profitable growth.
Thank you to all of you for joining us this morning and for your interest in our company. We look forward to talking with you again. This now ends the call.
This conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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