Mercantile Bank Corporation (NASDAQ:MBWM)
Q2 2010 Earnings Call
July 20, 2010 10:00 a.m. ET
Mike Price - Chairman, President, and Chief Executive Officer
Bob Kaminski - Executive Vice President, and Chief Operating Officer
Chuck Christmas - Senior Vice President and Chief Financial Officer
Greg Dodgson - Royal Securities
Stephen Geyen - Stifel Nicholaus
Terry McEvoy – Oppenheimer
Eileen Rooney - Keefe, Bruyette & Woods.
Welcome to the Mercantile Bank Corporation Second Quarter Earnings Conference Call. There will be a question and answer period at the end of the presentation. (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 statement made today due to important factors described in the company’s latest Security 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 website, www.merbcank.com
On the conference today from Mercantile Bank Corporation we have Mike Price, Chairman, President, and Chief Executive Officer, Bob 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 to questions. At this point, I would like to turn over the call to Mr. Price.
Thank you, and good morning everyone and welcome. Our strategic initiatives continue to provide steady improvement to our results. Asset quality and margin improvement led the way and we almost swung back to profitable status for the quarter. Bob Kaminski will detail the entire dynamic of our loan portfolio and the provision for loan losses during his comments.
While we did suffer a small loss for the quarter, significant improvement in our pass-through loans and our nonperforming assets suggest that we may have finally turned a corner in our relentless efforts to counteract the effects of the steep economic downturn. Even if we have turned the corner, we know that upcoming quarters will still be difficult as commercial real estate values remain challenging and the cost of disposing of our remaining ORE portfolio will also be challenging. It is, however, very heartening to see some very tangible signs of improvement in so many areas.
Chuck Christmas and Bob will detail these actions in their comments as well. I want to thank our customers for their loyalty and support, our board for its wisdom and vision and our hardworking employees for their dedication and sacrifice. At this time I'm going to turn it over to Chuck Christmas.
Thank you Mike. Good morning everybody. This morning we announced that we recorded a net loss of $0.7 million during the second quarter of 2010 compared to a net loss of $6.4 million during the second quarter of 2009 and a net loss of $3.6 million during the first 6 months of 2010 compared to a net loss of $10.9 million during the first 6 months of 2009.
On a pre-tax basis, which we believe provides a more accurate comparison of our operating results given the change in our tax position, our net loss during the second quarter of 2010 was $1.2 million compared to a net loss of $9.6 million during the second quarter of 2009. And our net loss during the first 6 months of 2010 was $4.3 million compared to a net loss of $16.9 million during the first 6 months of 2009.
While we are of course disappointed any time we have to report a net loss, we are encouraged with the significant improvement in our operating results as well as the continued improvement in may key areas of our financial condition and performance.
Our financial performance during 2010, like that throughout 2009 and 2008, has been impacted by a significant provision expense. Unfortunately, continued state, regional, and national economic struggles have negatively impacted some of our borrowers' cash flows and underlying collateral values, leading to increased nonperforming assets, higher loan charge offs, and increased overall credit risk within our loan portfolio when compared to historical norms.
From the time we sensed economic weakness over 2 years ago, we have been working with our borrowers to develop constructive dialog, which has strengthened our relationships and enhanced our ability to resolve complex issues. With the environment for the banking industry likely to remain stressed until economic conditions improve, credit quality will continue to be our major concern. We will remain relentlessly vigilant in the identification and administration of problem assets.
Unfortunately, provision expense as well as nonperforming asset administration and resolution costs will likely remain higher than historical levels, dampening future earnings performance. But during the second quarter of 2010, we saw the continuation of very positive trends we reported for the first quarter of 2010, and throughout 2009 as well, and I'd like to touch on some of them.
Despite a reduction in our total earning assets, an improved net interest margin has provided for increased net interest income. Net interest income during the second quarter of 2010 was $2 million higher, an increase of 16% over the second quarter of 2009. Our net interest margins during the second quarter of 2010 was 3.31%, compared to 2.50% during the second quarter of 2009, an improvement of 81 basis points, or over 32%.
The improvement is primarily due to a significant decline in our cost of funds. While we expect further reductions in our cost of funds during the remainder of 2010, it will likely be at a much slower pace than during the past several quarters. For the remainder of 2010, we have about $280 million in wholesale funds maturing at an average rate of 1.80%. For perspective, our average rate on new wholesale funds was about 1% during the second quarter. Also contributing to our improved net interest margin has been a very stable yield on assets.
The loan pricing initiatives we have undertaken within the commercial loan function have almost completely mitigated the negative impact of the increase in non-accrual loans. Overhead cost reduction strategies are becoming realized. Salaries and benefits, occupancy, and furniture and equipment costs declined $0.9 million or 14% during the second quarter of 2010 compared to the second quarter of 2009.
Nonperforming asset administration and resolution costs totaled $2.5 million during the second quarter of 2010, almost unchanged from the first quarter of 2010, but up from the $1.1 million expensed during the second quarter of 2009. During the second quarter of 2010, valuation writedowns on foreclosed properties totaled $0.7 million while property tax payments and legal expenses both totaled $0.6 million.
We remain a well-capitalized banking organization and our regulatory ratios have increased throughout 2010. As of June 30, our banks' total risk-based capital ratio was 11.9% and in dollars was over $29 million higher than the 10% minimum required to be categorized as well-capitalized. At the beginning of the year our banks' total risk-based capital ratio was $11.1 million, and the surplus about $18.5 million. Local deposit sweep accounts were up $13 million during the first 6 months of this year and are up $224 million since the beginning of 2009.
Combined with the reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by $580 million since the beginning of 2009. As a percent of total funds, wholesale funds have declined from 71% at the beginning of 2009 to 51% at the end of the second quarter.
Our loan loss reserve was $47.7 at the end of the second quarter, almost unchanged from the balance at the beginning of the year. However, with the reduction in total loans throughout this year, the reserve as percent of total loans has increased from 3.11% at the beginning of the year, to 3.38% at the end of the second quarter.
Those are my prepared remarks, and I'll now turn the call over to Bob.
Thank you Chuck. My comments today will address asset quality performance during the second quarter. As usual, our press release has much information in tabular form, aligning the key statistics for the quarter, so my comments will amplify, and in some cases add color to that information.
Mercantile continued to see some signs of stabilization in the key metrics in the marketplace and in the loan portfolio. As we noted in the first quarter, there has been an uptick in the inquiries and movement of real estate, including some troubled asset real estate, although low values are still a significant challenge. Additionally, some commercial industrial customers are experiencing increased backlogs for the rest of 2010 and into 2011.
Nonperforming assets at June 30 showed a $7 million net decrease from the totals at March 31. That net decrease was reflected and led by a reduction of over $2.2 million in non-real estate commercial loan types, plus over $1 million in net reductions, each in nonperforming assets in the residential land development, residential construction, and commercial owner-occupied asset categories.
Offsetting $13 million in new nonperforming loans in the second quarter were $7.3 million in principal payments, $2.4 million in sales proceeds, $1.4 million in loans returning to performing status, and $8.2 million in chargeoffs. Also included in nonperforming asset totals are $5.9 million in restructured but accruing loans where the bank is working with the distressed borrowers to provide relief with some loan modifications. Total net chargeoffs during the quarter totaled $8.6 million compared to $6.2 million in the first quarter. It should be noted that the second quarter number is net of $1.3 million in loan recoveries. These were loans that were previously charged off and the recoveries were possible by diligent and persistent collection activities.
$2.5 million of the second quarter chargeoff was attributable to non-owner-occupied commercial real estate. $1.9 million was attributable to residential real estate development and construction loans, and $1.6 million was attributable to commercial and industrial loans. Provision expense totaled $6.2 million during the quarter.
The major allocations of that provision among the various loan types show $3.9 million for non-owner-occupied commercial real estate and owner-occupied commercial real estate, $2.5 million for residential real estate development and construction, $1 million for residential real estate first liens including rentals, and finally a benefit of $2.2 million was derived from those $1.3 million in recoveries plus portfolio reductions.
Loans delinquent 30-89 days totaled $370,000 at June 30. This compares favorably to $12.8 million as of March 31, $982,000 at December 31, 2009, $8.3 million at September 30, 2009, $8.0 million at June 30, 2009, $2.6 at year end 2008, and $1.4 million 2 full years ago at June 30, 2008.
Mercantile continues to make good progress in its goal of reducing the level of commercial real estate in the portfolio. For the year to date 2010 the various categories of commercial real estate have been reduced by a total of $82 million in outstandings and commitments.
As I mentioned, much more information is included in the press release, and I'll be happy to answer any questions in Q&A. And now I'll turn it back over to Mike.
Thanks Bob, and thank you Chuck for your comments. At this point we would like to open it up for Q&A.
(Operator instructions) Our first question comes from Steven Geyen with Stifel Nicholaus.
Stephen Geyen - Stifel Nicholaus
I was wondering, I guess Bob you had mentioned backlogs. A little bit of color on that. But, wondering if you'd also provide some color on what you're hearing from customers as far as the strength of recovery and thoughts on the second half.
Yeah Stephen, this is Mike. I think it depends a lot on the industry you're in from our customer's point of view. Some of them are seeing pretty modest recovery but anybody that has anything to do with real estate or especially commercial real estate, retail, it's been slow and steady progress but no one is saying that this is a V-shaped recovery, that's for sure. The positive side, it is definitely better than it was a year ago, it's better than it was 6 months ago, and I think that as they look towards the second half of the year there's a cautious optimism. But as I said in my opening remarks I don't think any of us believe that it's going to turn on a dime and things are going to get hugely better in the next quarter but we definitely are seeing slow and steady progress.
Stephen Geyen - Stifel Nicholaus
Okay. And Chuck, if you could provide some thoughts on what we can expect for taxes?
Yeah, the taxes. Generally speaking because we set up a valuation allowance for our deferred tax assets they're basically zero. But in a busy kind of month, it quirks because of our budgeted numbers as well as the changes in FAS 115, we get a little bit of a tax benefit going forward. But all of that is related to unrealized securities gains on our investment portfolio, so going forward a large part of that is going to depend on what happens with that unrealized gain on that investment portfolio. So it shouldn't be material especially if interest rates stay steady, which we think they will.
Stephen Geyen - Stifel Nicholaus
And I might have missed this in the report, the release that you put out, but do you have the C&I and consumer end of period loans for the quarter?
We don't have those in front of us, Stephen, but the consumer loans is a little bit under $6 million, and I think that most of the difference is going to be the C&I.
Our next question comes from Terry McEvoy from Oppenheimer.
Terry McEvoy – Oppenheimer
I was hoping you could provide a little bit more color on the sales activity. I think it was mentioned there was sales proceeds of $2.4 million, maybe what assets were you selling? Who were the buyers and if you could provide some color on the pricing of those assets.
As you mentioned, while the pricing and the values remain challenged, I think what we're seeing is that the values were pretty consistent with recent valuations that we have placed on particular real estate asset properties. I think in terms of activity we've seen some activity in a variety of different areas. Some residential real estate has been moved, some commercial properties have been moved and that's something that we really hadn't seen. Residential real estate had picked up a little bit earlier this year and we hadn't seen as much activity on the commercial real estate side and that has started to occur as well during the second quarter. So that was certainly a pleasant thing for us to see.
The other thing, Terry too, just to add to that, as Bob said, the velocity has picked up but this quarter it was heartening to see that some of the sales that took place, took place at levels that were either at where we had them pegged and written down to, or in some cases we even got some recoveries, and boy it's been a long time since we've been able to say that on a consistent basis. It was about four or five quarters in a row there where anything we didn't move we had to continue to take further hits as we sold. I think that's, again, another sign that things are stabilizing out there for us somewhat.
Terry McEvoy – Oppenheimer
And is this more than just the seasonality or what you'd typically see in the second quarter? Is it more sustainable and just feels different than a typical Q2?
I don't think it's so much seasonality, because if you look at the cycle last year it didn't matter what season we were in, there wasn't a whole lot of activity any quarter. So I think what we're seeing now is that people are getting back into the market that had been on the sidelines previously, and it just so happens to coincide with this offspring summer seasons. But no, I don't believe what we're seeing, or what we saw, is anything to do with seasonality.
It definitely does feel different than a year ago, that's for sure. But like Bob said, prior to this economic crisis, as you know, we had some very very very strong credit qualities. So the last 8 quarters just felt unusual anyway, and "unseasonal" if you will, and difficult, but it definitely feels like there's momentum. And you know our group here, we typically try not to be overoptimistic unless we feel like there's something to be optimistic about. And at this point we are cautiously optimistic that we are seeing good tangible progress all across the board.
Terry McEvoy – Oppenheimer
And just a last question, unfortunately I can't bring up the file, but if I remember correctly a few weeks ago did you put out an 8-K talking about the TARP dividend, preferred stock dividends? Comment a little bit into what was behind that decision, who was behind that decision and when you think you'd be able to get back to paying those dividends?
I'll try to answer first and then Chuck can add any color or anything I might miss, but as we talked about, really since we saw this thing start to go sideways 2 years ago, our number one goal to our company and to our shareholders was to make sure that we remain a well-capitalized institution and we had all sorts of tricks in our bag that we were employing, all sorts of strategies, all sorts of ways to do that, and you're aware of a lot of them. One of them obviously is to spend the dividends or the interest payments as we are allowed to do within those agreements. And as to when we will pay them or resume paying them again, I can tell you that it is our goal to do that as soon as we can, but certainly not going to make that prediction until we know that we have a profitable and solid footing to go forward. As you know we kept those payments going as long as we could, but we in looking at everything, we want to make sure that those capital ratios stay very very strong.
Our next question comes from Greg Dodgson at Royal Securities.
Greg Dodgson - Royal Securities
I was wondering if management had a plan to repay TARP. Is there a plan that you guys have?
The plan is to repay it as soon as possible but there is nothing on the table that would suggest that's going to happen in the next quarter because, going back to my last comment to the question made, is that we want to make sure we're beyond this economic crisis. We're starting to see signs that we are and we want to make sure when TARP gets repaid that we are still well-capitalized and expect to be well-capitalized for the future.
Our next question comes from Eileen Rooney at Keefe, Bruyette & Woods.
Eileen Rooney – KBW
Just had one question. Sorry if I missed it on the call, but the outlook for provisioning going forward, we saw that the chargeoffs were a little bit higher than the provisions this quarter and reserves came down. Wondering how you're thinking about that going forward now that nonperformers seem to be leveling off?
That's a good question and I'll try to answer it. As you know, we don't really particularly pay a lot of attention to does the chargeoff number and the provision number match up. That, in our point of view, has nothing to do with anything. Although I know some people are really concerned about that, what's more important is what is the provision as to where things are looking at in your portfolio, and as you might imagine some very positive things happened in the second quarter because the provision did come down a little bit.
But if you look back at the first quarter and the fourth quarter, we hit some real strong provision numbers in those quarters, especially the fourth quarter, because we weren't sure of a couple of major things. One of them was we provided for a couple of loans that had some strong personal guarantees on them, but we were not sure of how those guarantees were going to be collected. And fortunately during the last two quarters we collected a lot of that money that we had provided for in case we weren't able to collect on those unsecured personal guarantees.
So that in effect gave us a little wiggle room if you will, as to not having to provide for that in the first or second quarters. And finally, the overlay is is that you're exactly right, your view that nonperformers have seemed to cop out a little bit. Our watch list numbers have started to trend down, which is the first time in probably a long long time we've been able to say that.
So all those things considered, we're very comfortable where the level of provision was. Now, to your question as to where it goes forward? We would suspect that if we continue to see nonperformers level out, or even fall, like they did last quarter, and if we expect to see our watch list basically continue on the downward trend, we would expect that provision would fall along those same lines.
I am showing no further questions. I'd like to turn the call over back to Mr. Price.
Thanks again for your interest in our company. If you do have any follow up questions please feel free to give Chuck or Bob or myself a call, and we will talk to you again next time.
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