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Mercantile Bank (NASDAQ:MBWM)

Q1 2011 Earnings Call

April 19, 2011 10:00 am ET

Executives

Robert Kaminski - Chief Operating Officer, Executive Vice President, Secretary, President of Mercantile Bank of Michigan, Chief Operating Officer Mercantile Bank of Michigan and Secretary of Mercantile Bank of West Michigan

Charles Christmas - Chief Financial Officer, Principal Accounting Officer, Senior Vice President, Treasurer, Chief Financial Officer of the Bank, Senior Vice President of Bank and Treasurer of Bank

Michael Price - Chairman, Chief Executive Officer, President, Chairman of Mercantile Bank of Michigan and Chief Executive Officer of Mercantile Bank of Michigan

Analysts

Stephen Covington

Daniel Cardenas - Raymond James & Associates, Inc.

Stephen Geyen - Stifel, Nicolaus & Co., Inc.

John Barber - Keefe, Bruyette, & Woods, Inc.

Terence McEvoy - Oppenheimer & Co. Inc.

Operator

Good day, ladies and gentlemen, and welcome to the Mercantile Bank Corporation First Quarter 2011 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. And now, I'll turn the call over to Michael Price, Chairman and CEO. Please begin, sir.

Michael Price

Thank you, Tyrone. Good morning, everyone, and welcome. We are very happy to report Mercantile Bank's return to profitability. While there is still much work to do to bring asset quality back to our desired levels, much has been accomplished during the past four quarters. The hard work of our team, the improving economy and the success of our strategic initiatives melded together to produce our first profitable quarter in some time. Looking forward, we see a very bright future for the bank, and we're very grateful that we survived this deep recession with a strong capital position and great team of bankers ready to provide West and Central Michigan with superior service and products. As usual, Chuck Christmas will cover the financials and then we will have Bob Kaminski cover the dynamics of our loan portfolio. We will remain available for questions at the end of the presentation.

At this time, I'll turn it over to Chuck.

Charles Christmas

Thanks, Mike, and good morning, everybody. This morning we announced that we recorded net income of $1.1 million during the first quarter of 2011, compared to a net loss of $3 million during the first quarter of last year. This $4.1 million improvement, which expands to $5.2 million if we excluded federal income tax benefit and one-time investment and loan sales gains recorded during the first quarter of last year, results from improvement in many key areas of our financial condition and operating performance, but especially reflects a significantly lower provision expense and a record high net interest margin.

We are, of course, pleased to be able to report net profit to the first quarter of 2011. Our first profitable quarter after two years of quarterly losses, reflecting improved economic conditions combined with a positive impact of numerous strategies developed and implemented over the past several years. Declining nonperforming asset levels, a pruned loan portfolio along with honed credit underwriting and administration practices, a record high net interest margin, lower controllable overhead costs and improved liquidity position through substantial local deposit growth and dramatically reduced reliance on wholesale funding and strong and improving regulatory capital ratios provide us with cautious optimism as we look to our future earnings performance and overall financial condition. Yes, much more work lies ahead and many headwinds continue to face Mercantile, the banking industry and the economy at all levels. However, we believe we are well positioned to succeed as a strong community bank and continue to play a pivotal role within the markets that we serve.

During the first quarter of 2011, we saw the continuation of the very positive trends we reported during all of 2010 and throughout most of 2009 as well and I'd like to touch on some of them with you this morning.

An improved net interest margin has provided substantial support to net interest income that has been negatively impacted by the decline in earning assets. Net interest income during the first quarter of this year was $13.4 million or about 6% lower than the first quarter of last year. Average total earning assets declined by about $305 million between the first quarter of this year and the first quarter of last year. However, our net interest margin increased from 3.25% to 3.64% or about 12% during the same time period. The improvement is primarily due to a decline in our cost of funds, but also reflects a relatively stable yield on assets resulting from the many strategic initiatives we have successfully implemented within the commercial loan function.

Provisions for the reserve totaled $2.2 million during the first quarter of 2011, a substantial decline from the $8.4 million we expensed during the first quarter of last year and well below the average quarterly provision amount during the past three years. Our loan loss reserve was $42.1 million at the end of the first quarter or almost 3.5% of total loans. A year ago, total loss reserve equaled 3.35% of total loans.

Local deposit and sweep accounts were up $55 million during the past 12 months and are up almost $275 million since the end of 2008. Combined with the reduction in our loan portfolio, we have been able to reduce our level of wholesale funds by about $840 million since the end of 2008. As a percent of total funds, wholesale funds have declined from 71% at the end of 2008 to 40% at the end of the first quarter. Overhead cost reduction strategies have been realized. Salaries and benefits, occupancy and furniture and equipment costs declined $0.5 million or about 8% during the first quarter of 2011 compared with the first quarter of last year, and are down $1.6 million or almost 23% when compared to the first quarter of 2009.

Nonperforming asset administration and resolution costs remain elevated. These costs totaled $3.1 million in the first quarter of this year, similar to that of the third and fourth quarters of last year, but $600,000 higher than the first quarter of 2010. As with provision expense, we do expect a reduction in nonperforming asset administration and resolution costs in the future period if the level of nonperforming assets continue to decline. We remain a well-capitalized banking organization. As of March 31, our bank's total risk-based capital ratio was 13% and in dollars was about $41 million higher than the 10% minimum required to be categorized as well capitalized. A year ago, our bank's total risk-based capital ratio was 11.2% and the surplus was about $20 million. Those are my prepared remarks.

I will now turn the call over to Bob.

Robert Kaminski

Thank you, Chuck. As usual, my comments this morning will focus on the details of the company's asset quality. The favorable trend of declining nonperforming assets totals that started in the second quarter of 2010 continued in the first quarter of 2011. Nonperforming assets at March 31 were $76.1 million, consisting of $60.2 million in nonperforming loans and $15.9 million in ORE and repossessed assets. This compares favorably to NPA totals of $86.1 million at December 31, 2010 and $117.6 million at March 31, 2010.

This is the lowest that the NPAs have been since the first quarter of 2009 when the level was $83.7 million and the reserve was at $31.9 million. The breakdown of March 31 NPA is as follows: $14.3 million, residential land development; $2.3 million, residential construction; $8.9 million residential owner-occupied and rental; $2.4 million commercial land development; $13.4 million, commercial owner-occupied; $30.1 million in commercial non-owner occupied; $4.7 million in commercial non-real estate and a small portion of consumer non-real estate. Reconciliation of nonperforming assets for the first quarter shows that we had $5.5 million in payments, $2.2 million in sales proceeds, $4.8 million in charge-offs, $600,000 in valuation write-downs and $700,000 in loans returning to performing status, which offset $3.8 million in new additions to nonperforming status.

The net result of this above activity was $10 million reductions in NPAs during the first quarter. Net charge-offs for the quarter totaled $5.5 million. Of these losses, 59.6% was previously allocated in the allowance for loan losses prior to the first quarter. The allowance was $42.1 million or 3.49% of total loans compared to 3.59% at December 31 and 3.35% a year ago. Charge-offs from the first quarter were allocated as follows: $2.8 million was commercial non-real estate; $1.4 million was commercial owner-occupied real estate; $1.2 million residential owner-occupied and rental: $126,000 consumer non-real estate, plus some small net recoveries in the commercial real estate non-owner occupied and commercial land development and residential construction buckets.

Provision expense for the first quarter was $2.2 million. Although this provision is significant, it represents a sizable reduction in the quarterly provision compared to recent quarters. The provision total is closely related to the relatively low amount and number of new nonperforming loans added in the first quarter, as well as a demonstration of some portfolio stabilization as determined by the various asset quality metrics and the banks a triple O [ph] methodology. The majority of the first quarter provision was taken to adjust for some updated valuations of collateral and existing impaired loans.

Loans delinquent of 30 to 89 days were $59,000 as of March 31, down from $1.1 million at December 31 and $1.3 million at September 30, $12.8 million at March 31, 2010. So you can see there's been a sizable reduction on that loan delinquency category as well.

Mercantile continues to make good progress in the reduction of higher risk commercial real estate loans in the portfolio. Productions of over $30 million in loan totals from these categories were demonstrated during the first quarter. Those are my prepared remarks.

And I'll now turn it back over to Mike.

Michael Price

Thanks, Bob, and also thank you, Chuck, for your presentation as well. We would like to open the lines now for any questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Stephen Geyen of Stifel, Nicolaus.

Stephen Geyen - Stifel, Nicolaus & Co., Inc.

Nice to see the improvement in credit. Couple of questions, the OREO expense of $3.1 million, could you give us a breakdown of the various categories?

Charles Christmas

This is Chuck. I don't have the specific breakdowns in front of me, Steven. But it was pretty much a combination of property taxes, some write-downs and legal bills and those types of things. There was nothing abnormal in there. I can give you that breakdown later if you want.

Stephen Geyen - Stifel, Nicolaus & Co., Inc.

Great. Okay, and other income was down from fourth quarter if you know the OREO -- or OREO income, excuse me, were there significant sales or shifts in the type of OREO?

Charles Christmas

Yes. It was down quite a bit because if you remember during the fourth quarter, we saw a pretty sizable reduction in our net ORE balances and a lot of the stuff that we sold which happened towards the end of that quarter was some of those properties that had some pretty good rental income with them, albeit that's why we're able to sell like we did. So it's pretty much a reflection of lower balances and therefore having less rental income off those properties, Steve.

Stephen Geyen - Stifel, Nicolaus & Co., Inc.

So there wasn't anything else driving that really, it was mostly OREO?

Charles Christmas

Pretty much it, yes.

Stephen Geyen - Stifel, Nicolaus & Co., Inc.

Question on the net interest margin, just curious what -- you talked a bit about what drove the increase in the fourth quarter. If you give us a little bit more color. Was it broker deposits, FHLB [Federal Home Loan Bank] advances?

Charles Christmas

It was a combination of things. I'll walk you through a little bit. The first thing and the biggest thing was if you remember in the fourth quarter, we had a lot of Fed Funds sold. And that, really at 25 basis points, that really dampened the asset yield, specifically just for that quarter alone. And the reason why the Fed Funds was so high is we got quite a bit of local deposit growth throughout the quarter. And if you remember, we did prepay some FHLB advances to try to get that balance down a little bit. So now in the first quarter, we got the Fed Funds down to where we want it to be, close to the $50 million mark, and so that had a positive impact on the margin quarter-over-quarter. We also did -- as I mentioned, the FHLB advances, the ones that we did prepay in the fourth quarter, obviously we didn't have any of those interest costs in the first quarter and certainly going forward. And then we also did revisit during the fourth quarter a little bit in our first quarter revisited our deposit rates here locally. Really what we saw was throughout 2010, we didn't do a lot of changes to our local deposit rates and we were doing the competitive shops to those in our marketplace, we found that they had actually been periodically but systematically reducing their rates pretty much throughout 2010. So we elected to reduce our rates. We're still in the top three with virtually every deposit we've got but we definitely, as part of that rate shop, were able to see that we were quite a bit higher than the market and so we did reduce those rates towards the end of the first quarter, a little bit in the first quarter. Again, we're still incredibly competitive, but that lowering certainly had a positive impact on our cost of funds. On the broker side, yes, there's a little bit of improvement as some of those products mature and we replace some of those. But one thing that we do with that portfolio is we are starting to push out the maturity date on those little bit. So the rate that's coming on to the books isn't significantly lower than what's yield in the books because we're pushing out those maturities. So as far as going forward, we don't really see any major change to our margin, up or down, especially as long as the primary stays unchanged.

Stephen Geyen - Stifel, Nicolaus & Co., Inc.

Okay, that's helpful. Thank you. And I guess just last question, just curious if you had a target for the commercial real estate loans as a percent of total loans.

Charles Christmas

I don't really determine necessarily a target percent saying that's where we want to be. I think we're looking more at individual loan risk types and saying there's outfitters. Obviously, there's a lot of bad commercial real estate that has been very challenging in our portfolio and the whole market, but there's also some good commercial real estate. I think we're trying to reposition the portfolio so that we're centered around -- C&I, obviously, is a big thrust but also there is some good commercial real estate out there that will be part of our portfolio now and in the future as well. So trying to just restrike that balance between what we see as acceptable risks as opposed to saying we need to be at a certain percentage in the portfolio.

Operator

Our next question is from Terry McEvoy of Oppenheimer & Co.

Terence McEvoy - Oppenheimer & Co. Inc.

Maybe just a question for each of you. I'll start with Bob. The NPA additions, $3.8 million, was that considerably below what you had modeled? I mean, that number showed a nice decline and then as you look at the 30 to 89 days past due loans that in the release somewhere, I think you said it was pretty close to 0. So would you expect that number to continue to drip lower as we move forward through the year?

Robert Kaminski

Well, as you mentioned, the NPA additions for the quarter was very, very low and compared to recent quarters, we're glad to see that. I think that we've seen the preview of those metrics, the lowering additions to the NPA portfolio back even late last year and that while they were a lot higher in the fourth quarter than they were now, I think the additions that we had in the fourth quarter were just a couple of loan transactions that took that amount higher than what we ultimately would like it to have been. I think in the first quarter, we had some real good traction that the additions were smaller type transactions and the volume was very, very low. And as we look at the problem loan list in its entirety, there's been definitely a downward trend as you went through the course of 2010 that has continued into 2011 as well. So I think we're kind of saying it's about time in terms of that $3.8 million additions, that's where we want to see the numbers trending to. Still a lot of challenges out there certainly, but I think the overall dynamics of the portfolio and looking at the customers that are on the watch list, there seems to be a feel that we continue our very hard look at the portfolio to make sure we flush out any problem loans, and we've been very diligent in doing that the last couple of years, but I think now we're seeing that diligence is paying off and the loans that we're seeing pop up, and boy, this has been a struggle and they need to go on the watch list, that's really dropped and we're not seeing that nearly as much as we had in the last couple of years.

Michael Price

Terry, this is Mike. Before you ask your next question, I need to insert something here and that is the Safe Harbor statement that we neglected to do at the beginning, but all listeners should understand that this conference call may include the forward-looking statements. These statements may include projections, plans, objectives, assumptions and other information are intended to be covered by the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from the forward-looking statements. Some of the factors that could cause the actual results to differ are included in our most recent annual report to the SEC on Form 10-K, including the Risk Factors section. We assume no obligation to update any forward-looking statement. Thank you for letting me insert that and keep on going with your questions.

Terence McEvoy - Oppenheimer & Co. Inc.

Chuck, what might have been overlooked over the last couple of years is the change in your funding profile and the increase in local deposits. Can you just go through 2, 3 years ago what the funding profile look like compared to today? And then talk about your interest rate sensitivity as we look out into next to first quarter of next year, potentially a rising rate environment?

Charles Christmas

Sure. I'm happy to do that for you, Terry. I think historically this company, and I would say probably for its first 8 or 9 years, we started out using wholesale funds and during that first 8 or 9 years, our wholesale funds, as a percent of our total funds, was about -- stayed right within 60% to 70%. Sometimes closer to 60%, sometimes closer to 70% but very, very consistent in regards to that percentage. Yet the company was growing quite rapidly and so therefore, the wholesale funding program was growing as well. But from a percentage standpoint, our balance sheet stayed very, very consistent, which as I always tried to stress whenever anybody would listen to me, is that it did show that our local deposits, while not gaining traction as far as becoming a bigger part of our funding mix, actually was keeping up with our very strong asset growth throughout that period. I think that over the last 3 years, as the regulators like to say, the world has changed in how they view wholesale funding, especially broker deposits has changed and whether we agree with that or not, or parts of it or not, it is what it is and obviously that's a framework that we need to be part of and to work with. And so a little over 2 years ago, we really made a strong push to even increase our local deposits. Not only get more local deposit growth, but actually drive down that wholesale funding reliance. We did that with a lot of new products. We did that with a lot more marketing. And we really hadn't quite frankly done a lot of marketing in the past, especially in regards to more retail deposits, but you know we did billboards and a lot more television advertising. We actually started doing TV advertising and some of those types of things, and especially with some of the new products, a high earning interest-bearing checking account, which we call the executive banking account, caught out some significant traction. So as I mentioned in my prepared remarks, we've seen a lot of local deposit growth because of the new products because of the increased marketing. We were always aggressive, relatively aggressive with our pricing. I think it's just a matter of making sure that Mercantile was out there and that people were made aware of us. We also, within the commercial loan function, we put a lot more emphasis than we had in making sure that we had not only deposits for the companies, but also the personal deposits of the officers and other people associated with those businesses. So again, we've had strong local deposit growth because of that. At the same time, as we do start loan portfolio, we pretty much have effectively used those funds coming in on the loan payouts and loan reductions and used those funds to basically pay out broker deposits and FHLB advances as they have matured just doing enough of that wholesale funding activity just to keep the balance sheet where we need it to be. Our peak was at the end of 2008, it got up to 71%. Again, pretty much aligned with that 60%, 70% I mentioned before. But over the last 2 plus years, we've been able to drive that down to about 40%. A lot of that quite frankly -- certainly part of that was the local deposit growth, a lot of that was reduction to the loan portfolio. So where do we go from here? We would like to continue to reduce that number to get it below 40%. There is no magic number out there. We don't have a specific number we're shooting for. The regulators haven't asked us for it to get down to a specific level. They just want to see continued reduction in the reliance on wholesale funding. One thing that we're starting to see I think has already been mentioned is we're starting to see less of reduction on the loan portfolio and certainly we want to get to a point where we feel comfortable with the economy and everything else, so we can start to get a little more aggressive on making additional loans. So if we're not getting that high volume of loan reductions, obviously that's going to impact the ability for us to really, really drive that wholesale funding number down. We think we can still get that down from where it is now, we went from 71% to 40% in over 2 years, I don't think we're going to go from 40% to 10% or something like that in the next 2 years. So maybe more of a slow but steady decline in that number, at least in the near term.

Terence McEvoy - Oppenheimer & Co. Inc.

And a question for Mike and I'll let you take a breath, not only after reading the Safe Harbor statement, but also what you guys have done over the last years. I know it's been a lot of work. And just to your commentary at the end of the press release, which was kind of looking ahead or looking forward on the changing landscape within Western and Central Michigan. Are you beginning to move people away from the credit side to the loan production side? And just specifically what do you foresee happening as you hopefully make that shift from the defense back to offense again?

Michael Price

That's a good question and that's exactly what we've been for some time now within our strategic planning group is talking about strategies, plans, training whatever it's going to take to shift the focus back to, as you call it, offense. For the last three years, obviously, we did what we had to do to get through this thing in a very strong position. There wasn't a lot of loan demand out there anyway. We're very gratified to see that loan demand is starting to pick up. It's certainly not where it was before the recession, but it's going in the right direction. So we are spending a lot of time with -- whether it's specific job descriptions, plans, that type of thing to get people pointed towards adding loan volume, again in a very conservative way, and we expect to see those results start to really take effect later this year.

Terence McEvoy - Oppenheimer & Co. Inc.

Appreciate it. Thanks a lot.

Operator

Our next question is from Daniel Cardenas of Raymond James.

Daniel Cardenas - Raymond James & Associates, Inc.

Just a quick question on capital. We did see your TCE ratio improve due to a combination of profits as well as some contraction on the balance sheet. Can you give us some comments as to how comfortable you are with the current ratio?

Charles Christmas

Yes, Dan, this is Chuck. We're certainly comfortable where the ratio is at currently. We spent, obviously, a lot of time and effort and certainly made some strategic decisions along the way to make sure that we were good shepherds of our capital position not only maintaining, at least at a steady level, as we were going through the significant provision expense and other costs, which is having obviously a very significant impact on our bottom line. Not only, again, keeping it steady, but also making sure that we were increasing it. Obviously, we've been able to do that. Obviously, a very rapid increase in Tier 1 leverage ratio during the first quarter. It kind of goes back to my margin discussion before when we were able to reduce our average assets, which that ratio's based on, in the first quarter compared to the fourth quarter. So it's a pretty core number where it is now. It's approaching 10%. Again, we're comfortable with it, especially in regards to where it was and where it is now. But also you're certainly looking at the asset quality and looking at the earnings performance. Obviously, there's some big improvements there and we would expect improvements to continue. So overall, we're pretty comfortable with where the ratio is at. I think our expectation is that we'll likely see that ratio continue to improve. I think you'll see some reduction in the balance sheet, especially loan portfolio as we go forward over the next, probably at least couple of quarters. Again, that's hard to judge, but we're certainly hopeful and optimistic that we'll continue to be profitable as we go forward, which obviously has a positive impact on net ratio as well.

Daniel Cardenas - Raymond James & Associates, Inc.

Ratio strong enough to support any balance sheet growth that could come later in the year?

Michael Price

Yes. This is Mike, Dan. Depending on what level of the balance sheet growth we're talking about but to kind of add on to Chuck's comments, we feel very positive about the profitability of the organization going forward, and we also don't see a tremendous increase in the balance sheet for 2011. What we're really focusing on is starting to slow the contraction, which is already happening and slowing that down to maybe a neutral position. And by the end of the year or first part of next year, we'll start to see some balance sheet growth and even that isn't going to be like the old days we did when we had tremendous quarters of growth, we just don't see it in the demand out there. Now if that should change, then I think we've shown in the last three years that we know how to manage our capital position through some very interesting times. But if that should change, we'll change our approach. But right now to answer your question, we feel very comfortable with the capital management of this bank.

Daniel Cardenas - Raymond James & Associates, Inc.

If you can just give me your thoughts on TARP [Troubled Asset Relief Program] repayment?

Michael Price

Well, we've stated numerous times that our first goal is obviously using the CPP [Capital Purchase Program] program of TARP to make sure that we had a very strong balance sheet and that has done its job, and we will work very closely with all constituencies involved and with our board. Our plan is to pay the TARP back as soon as it makes sense to do so. And that's really kind of adding on to your question before and that is looking out the window to see when is the good time, what if we brought the level of profitability up and it's sustainable, the profits up, that we feel like we can pay it back either in little bits or in one big chunk.

Operator

[Operator Instructions] Our next question is from John Barber of KBW.

John Barber - Keefe, Bruyette, & Woods, Inc.

So we talked a little bit about the NPA improvement and the improvement of 30 to 89 days past due. But what other leading indicators do you look at that may be indicative of future credit performance?

Michael Price

As I mentioned, the viable loans that are being downgraded has greatly improved. If you look at the report each month and each quarter of upgrade and downgrade, the upgrades have certainly outweighed the downgrades for some time going back into late last year. That's a very good trend. We're starting to see some customers that have been downgraded to watch list have shown and demonstrated some good sustained improvement. So they're being upgraded off the watch list and that's a very positive thing. And through all levels of the loan rating metrics, there has been improvement in more highly rated credits as well as some of the credits that have struggled, you're starting to see some turnaround there. And don't get me wrong, there still -- $76 million is still way too high for levels for NPAs, but we like the trends. We like the metrics of what we've seen in terms of downgrades and additional NPAs all going the right direction and now our job is to keep driving that down.

John Barber - Keefe, Bruyette, & Woods, Inc.

Is the plan to continue to work down nonperformers organically or would you guys entertain an accelerated strategy? Maybe bulk sale or something like that?

Michael Price

Well we've consistently, since the beginning of this crisis, have always kept our ears and eyes open to other potential ways of reducing NPAs other than organically. However, the bulk sale happening, as you suggested, for example, has been such a discount and such a haircut that it just didn't make sense for us to go too much further down that line. We've been able to do it much better organically. Now that being said, if that market is in continual flux, we'll continue to look at those types of strategies. What I have to tell you, I've been very, very satisfied watching the last few quarters, especially the success of our internal efforts to take it down. I don't know where we were a year ago, $120-some million in NPAs, get it down to $76 million. That's pretty significant and it's been very consistent and it continues to be consistent. So I'm a great person at extrapolating. If we can keep extrapolating that type of reduction, we'll be in really, really good shape.

John Barber - Keefe, Bruyette, & Woods, Inc.

Okay, and my last question was, I think at the end of the year, your valuation allowance coming from DTA was about $30 million. Can you just walk me through the process recapturing that asset and what events need to occur and any conversation you've had with your auditors about that?

Charles Christmas

That's kind of the big unknown right now, not only for us, but I think the entire industry. Certainly, the most important aspect of getting rid of that valuation allowance or having some adjustment to it right now, it's a full valuation, is the profitability of the company. And so now we have 1 quarter of profitability. As everyone tells me, 1 quarter is not a trend. So we certainly need to demonstrate that we got the profitability not just for 1 quarter but consistently, and consistently show improvement and certainly that's going to be driven by the loan portfolio and the quality and how that impacts provision expense, bad debt costs and certainly making sure that we can keep our margins upward is and control everything else. So I think it will likely be a year-end type discussion that we'll have with our auditors. We've already having some discussions with them. But as they tell me and into our talks, when they're talking to themselves, when they're talking to other CPA firms, there's not really a lot of guidance, whether it's specific accounting literature or maybe some guidance by folks such as the SEC, as to how to sort of unwind valuation allowance. There is certainly a tremendous amount of information on how to put one out there, to put a valuation allowance on the books, but not really how to unwind that. So we'll continue to have discussions and figure this all out. Certainly, a big part of getting rid of the valuation allowance or reducing it is going to be predicated on future profitability. So everybody needs to get comfortable with future projections and what those mean and have those discussions again, primarily, probably at the end of the year and assuming the profitability stays within our income statement.

Operator

Our next question is from Steve Covington of Stieven Capital.

Stephen Covington

Apologize if I missed this, but could you just touch on the nonperforming asset costs and what that $3.1 million in the first quarter. I mean, assuming that we get back to a more normalized environment at some point. Is that number more normally a couple of hundred thousand or $300,000 a quarter?

Charles Christmas

Yes, Steve. This is Chuck. We did touch on it a little bit, but that's fine. As far as what it was in the quarter, again, it is mostly property taxes, legal bills, some write-downs, some ROEs, those types of things. I think we would look at that number trending the same way that our nonperforming assets would trend. Again, given the makeup of those costs, that's a really hard number to try to project in addition to provision expense. But certainly as nonperforming assets continue to improve and obviously as you heard from our comments this morning, we think that there's going to be continued improvement. We would expect that number to decline in future quarters. As far as what is a normalized level, I think it's been so long since we've been in this current environment as to what is normalized when things get back to normal. I guess I'll just leave it at we would expect that ratio to -- or excuse me, that number to decline in future periods and I guess it's just going to be what it is. Obviously, we need to continue to use legal firms to help us out work out of the situations and continue to monitor what we've got. Collateral valuations are starting to solidify. So hopefully, we won't see a lot more write-downs. There will be some. There's no doubt about that as we continue to unwind some of the ORE that we've got on our balance sheet and certainly if we own it, we're going to have to pay the property taxes on the property. So I think a gradual, but hopefully significant decline as we go forward. And I think that would be somewhat similar to what we see in the overall nonperforming assets number.

Operator

I'm showing no further questions or comments in the queue. I'd like to turn the call over to Mr. Price for any closing remarks.

Michael Price

Thank you, and thanks again to all of you for your interest in our company. Again, we're very gratified to get -- return to profitability and look forward to a really strong future going forward for the rest of 2011. At this time, we'll end the call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect and have a wonderful day.

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Source: Mercantile Bank's CEO Discusses Q1 2011 Results - Earnings Call Transcript

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