Interactive Q&A: Ted Awerkamp, President and CEO of Mercantile Bancorp

This is the latest in the Seeking Alpha series of interviews with leading companies of interest to our readers. These are interviews with a twist: the executive has agreed to answer questions and respond to comments not from a single interviewer, but rather from our community of readers and contributors.

This interactive Q&A is with Ted Awerkamp, President and CEO of Mercantile Bancorp, Inc. (AMEX: MBR), a multi-state bank holding company. This interview works like this:

• Ted briefly introduces himself and the issues he's focused on below.
• Readers and contributors can immediately start to post questions and remarks using the comment box below (Note: you need to sign up for free registration and be logged in to do so).
• Seeking Alpha editors will not filter or edit the questions and comments from readers, except to delete profane or hostile language.
• Ted will respond to the questions and remarks beginning Tuesday, November 6th. Readers can track his answers and respond to them during that period, with the resulting dialogue remaining on the site.

Readers from external sites may join the Q&A by following this link.

Over to Ted:

Welcome to the Mercantile Q&A session on Seeking Alpha. I would like to thank Seeking Alpha for providing an excellent platform for the discussion of our unique banking business, the general banking environment, Mercantile’s 2007 performance, and our strategy going forward.

I would like to highlight a few of our recent accomplishments:

• 2007 Third Quarter EPS Increased 14% to 57 Cents
• Deposits Up 30%
• Total Assets Exceed $1.6 Billion, Up 32%
• Bank Acquisition Completed
• Recorded $2.1 Million Gain on Investment

We have a dynamic strategy for earnings and asset growth, and we believe that our company is well positioned to generate continued earnings growth and enhanced shareholder value. In addition to building earnings through share-price growth, our company policy is to pay shareholders a meaningful cash dividend.

Mercantile employs a three-pronged growth and operational strategy designed to fuel long-term earnings growth. Our de novo bank (start up) investment strategy is very different than the growth methods used by most community banks.

The three prongs are:

1. Maximizing returns and earnings by efficiently managing a core group of community banks

2. Sparking earnings growth by acquiring well-run community banking operations in rapidly expanding markets that have promising long-term demographic and income profiles

3. Generating returns that exceed those available from core banking operations by making investments in startup banks located in fast-growing communities underserved by existing community banks. This is unique when comparing Mercantile to other community banks.

MBR maintains a community bank focus and service culture.

With that approach, our company can:

• Serve stable, quality markets

• Deliver a high level of customized personal service

• Build a high quality loan portfolio by attracting customers not comfortable with the impersonal service provided by larger banks

• Leverage operating efficiencies

• Offer fee-based services, including asset management and brokerage services

• Utilize local management expertise

Mercantile’s bank portfolio includes six banks that serve established communities that are expected to grow at the same rate as the overall economy. However, two additional banks serve areas with fast growing populations. The core banks in more mature areas provide sound returns and modest growth, but the growth rates of their served markets limit upside opportunities. To maximize returns from established banks in mature markets, MBR focuses on efficient operations, increasing noninterest income and modest market share growth.

We believe the keys to maximizing returns and building market share in modest growth markets are:

• Minimizing non-interest expenses with back-office operating efficiencies that a larger bank can incorporate

• Providing personal “community bank” style service to retain customers

• Keeping in step with “big bank” product offerings and providing efficient Web-based banking services

• Closely monitoring loan quality with the goal of zero bad debt

• Judiciously managing investment portfolios to maximize interest margin

• Minimizing interest rate risk exposure to both asset and liability portfolios, particularly in changing rate environments, like we have recently

That said, to drive a higher rate of earnings expansion, our management team is continually looking to acquire banks with significant growth opportunities. Mercantile identifies banks that will be an optimal fit with MBR’s corporate culture and operating philosophies. We look only at banks in markets that we understand, primarily institutions in communities which serve as near by hubs for an extended small quasi-metro area. MBR will not divert management energy or attention by trying to understand or analyze markets, such as large cities, with unfamiliar banking and economic dynamics.

To growing community banks, Mercantile is an attractive acquirer by providing access to lower-cost capital, “bigger bank” technology, operations and marketing, and skilled asset management services. Another reason MBR is an acquirer of choice is our philosophy that the management team and employees are an integral part of the value of an acquisition. We seek out institutions with compatible operating and service philosophies. Our goal is to retain the character, the management and the employees of the banks we acquire. Mercantile seeks out well-managed, growing banks that can benefit from access to its operational capabilities (cost savings) and that need more capital to reach their expansion potential.

This strategy is not constrained by geography: by focusing on banks with compatible operations, MBR has the freedom to acquire banks in any market. MBR doesn’t buy banks that need to be “fixed,” nor does it consider banks because management wants to make radical changes.

Lastly, I would like to touch on our de novo bank investment strategy. From 2000 through 2006, Mercantile invested approximately $15 million in eight de novo banks. We anticipate that de novo bank investments will comprise no more than 10% of our total capital. In two instances in 2006, banks in which MBR has invested were acquired by other institutions. These transactions resulted in aggregate pre-tax gains of $4.3 million from cash distributions and tax-exempt exchanges of shares from the acquiring institutions. In 2007, we had similar results from other bank investments. Because Mercantile’s investments in de novo banks usually take several years to mature, Mercantile’s return on equity is lower than it would otherwise be.

Now I would like to turn the session over to our readers. I will do my best to respond to all questions as quickly and appropriately as possible.

Thanks again for joining us.

Comments

[Mick Weinst...:]

Hello Ted, thanks for joining us on Seeking Alpha.

How does the turmoil surrounding subprime debt affect your business?

Many investors are wary of the financial sector across the board because of this matter - what should they know about the impact on community banks in particular?

2007 Nov 06 07:11 AM

[Ted Awerkamp:]

The direct issues associated with subprime debt will have no affect on the balance sheets of our banks or company as we do no subprime lending in any of our banks, nor are any of the mortgage backed securities or CMO bonds we own in our portfolios backed by such paper.

The only indirect effect we perceive at this time is that the subprime fallout is affecting the pricing of capital markets overall, and future borrowing could be more costly as a result thereof.

Though I can't speak for the community banking industry, my associations and feedback on the question nationally would lead me to believe most community banking companies would provide a similar assessment to ours.

2007 Nov 06 10:24 AM

[Jonathan Liss:]

Ted,

Thanks for taking the time to answer our questions.

What is Mercantile's plan to stay profitable and keep margins strong considering the rise of low-cost internet banking?

Best,
Jon

2007 Nov 06 09:33 AM

[Ted Awerkamp:]

Thank you for your interest Mr. Liss.

The delivery system of low-cost Internet banking has already proven not to be the end of community banks. Financial service consumers will always seek qualified advice and services from reputable companies and individuals they trust.

Our plan to maintain profitability on the margin side is to stay focused on interest rate risk and balance sheet management of our banks from a top down level. Interest rate markets have been difficult the last couple of years, and we have limitations to the tools available to manage the risk on our balance sheets, but it is a daily management focus to which we have become conditioned to, mistakes and all, and we learn from. It is the business we're in.

I too believe it is important to further develop dependable and quality non-margin income streams. It would be inappropriate to provide details of the strategy, but we are working to enhance across our bank platform services in trust and brokerage offerings to our customer base that we are experiencing success with already, and believe it can be a core benefit to the bottom line as well.

2007 Nov 06 12:20 PM

[Ezra Marbach:]

Ted:

I have read about your de novo bank investing strategy and that Mercantile wholly owns community banks in a variety of areas outside of your core market. Given the lending and interest rate environments, do you see any additional acquisition or investment opportunities for MBR? Do you think that the current climate has created a number of sellers in the community banking arena?

Thanks,
Ezra

2007 Nov 06 11:35 AM

[Ted Awerkamp:]

Ezra:

I am absolutely seeing additional opportunities for MBR, and I am seeing and hearing of the current climate bringing forth an unusual number of sellers or merging opportunities to the market.

That being said, the challenge to us as a small-cap banking company is to protect our capital and invest wisely in markets and bankers that best positions MBR for quality, profitable growth. I purposefully did not include the word rapid.

Thank you for your question.

Ted

2007 Nov 06 12:31 PM

[CrossProfit:]

Thank you for this opportunity.

My questions are a bit off color so if you prefer to skip them, I don't think the SA community will hold it against you.

MBR has a float of about 4M shares and averages about 1500 shares traded daily. The volume is so low, that some charts have not bothered to update since the 3 for 1 split in June 2006! In fact I just checked the Yahoo Finance board, and the last relevant comment was; what happened to the stock, why did it drop from 60 to 20? Naturally no one bothered to answer! I think you get my point.

1) Was the primary objective of the 06/06 split to increase trading volume?
2) Is the primary objective of this interview to increase awareness and perhaps inform us how you intend to increase trading volume in the future?
3) Do you feel that the investment community in general is unaware of regional small cap banks? If yes, on what do you base your impression?
4) Have you yourself invested in stocks with low liquidity (excluding MBR)? If yes, when and why (without numeric details)?
5) What do you consider are the advantages and disadvantages of a small cap/low liquidity issue?

Please note that I am not getting into the financial aspects of MBR, rather focusing on a single issue that I must say has prevented me and others I work with from investing in stocks similar to MBR. Please, take this opportunity to convert my disposition!

Saul Sterman
CEO
CrossProfit

2007 Nov 06 11:52 AM

[Ted Awerkamp:]

I don’t recognize your questions as off color Mr. Sterman, so I will do my best to provide you my perspective.

Though Yahoo is a large site and I find it unfortunate they choose to minimalize small cap opportunities, I do not monitor every site. One could have quickly drilled down that in fact a split occurred by visiting our Company site.

To your direct questions:

1) Yes, the stock was split as a first step toward improving the number of shares outstanding and we recognize there is more to do.
2) Yes, there is low liquidity. We have engaged an investor relations firm and initiated a program to improve the same, including this forum and meeting with investors in person. From our beginning as a public company in early 2005, the steps to date have proven returns. However, liquidity might stay on the low side until more people begin to invest in banks again. Too, as you are aware, with low liquidity the leverage can work in favor of an investor as well as against one. More trading will attract more investors, including institutional and we believe that would be a healthy addition to our mix. Some very good investors like limited float stocks.
3) I can’t speak for the awareness of the investment community in general toward regional small caps, but it would stand to reason there are undiscovered opportunities when comparing market valuations of some to others.
4) My personal stock investing would offer little insight to MBR.
5) Again, I doubt my perception of advantages or disadvantages of a small cap-low liquidity issue are relevant to anyone’s interest, but most large-caps start out as a small cap, so the single issue of not investing in stocks similar to MBR by you or others would seem a missed opportunity if the overall fundamentals of a stock met your risk tolerances otherwise.

Though I doubt I have changed it, I do fully respect your disposition, and your taking the time to inquire.

Ted

2007 Nov 06 01:17 PM

[User 47298:]

Hi Ted, thanks for putting yourself up to the scrutiny of the Seeking Alpha community.

There seems to be an ongoing trend within the community banking sector towards consolidation through the purchase of competing community banks. A case in point was Sovereign Bank's purchase of Independence Community Bank. As a former account holder at Independence, I've seen the negative impact that their buyout had on my service and I therefore migrated to another bank.

Have you seen account attrition in the banks you've been purchasing? With all the benefits of scale, do you find that your core clients are unhappy or happy with the results of your business strategy? How do you propose to keep the quality of service of a small community bank intact, while incorporating it into your growing organization?

Thank you in advance for your reply.

2007 Nov 06 12:59 PM

[Ted Awerkamp:]

User 47298:

We have not seen account attrition in banks we have purchased. In all fairness to the meaning of your question, I think appropriate to disclose we have not purchased a bank competing against one of our own in any market until our most recent, and the merger of those two banks is a year away. We expect none or minimal loss of business when that occurs.

As to our core clients being happy or unhappy with the results of our business strategy, I'll assume you mean from our bank clients versus our company owners. The general perception of our bank clients in the markets we serve is they are not aware that the bank is part of a company of banks. We have historically maintained the charter, the name, the local bank board and executive management. Decisions relative to their clients are theirs subject to standard policies. As we have executed a few charter collapses and merged some of our banks in the same regions over the last 18 months, we have seen no attrition from those steps as well. Responsive and quality service to the customer base is key.

To keep that quality intact in a growing organization is keeping in place the ability to listen to our customers and then communicate internally. Secondly, we are now developing consistent training across our collective banks. Lastly, we empower our employees to deal with our customers fairly and honestly on a common sense level. That approach generally diffuses any real problems.

When we lose business, and we of course do, it is generally due to pricing that is reflective of too many banks in a market, though I am sure most consumers would beg to differ to that thought.

Thank you for your inquiry.

Ted

2007 Nov 06 03:05 PM

[User 120917:]

Thank you Ted for taking the time to chat.

1. What goals do you have for MBR over the next 5-10 years? Follow up: How will you acheive these goals?

2. As investors continue to shift their focus overseas, does MBR have any intention to enter the international banking arena?

Thanks again for your time,

Zach

2007 Nov 07 03:41 PM

[Ted Awerkamp:]

Zach:

Our goal for MBR in any time frame is profitable growth in the business we know, community banking. That said, the business model for banks continues to morph and I'm reluctant to risk too far forward on what our model will look like that far out. Progressive community banks can compete and compete well with super regional and national brands, but it requires quality bankers and flexibility, so I'm prone to shorter term plans.

Providing a glimpse of specificity, as I indicated in an answer yesterday we are spending time enhancing trust and brokerage offerings from a community bank perspective to supplement the margin business and therefore total income stream. The level of demand for those services will increase with boomers and a community bank level approach to meeting those needs in a quality manner will be sought by consumers. We are and will compete well for that business.

As to your second question, and quite limited to my knowledge of other countries banking charter laws or allowance of foreign ownership, I would not perceive opportunities for a company such as ours to consider a foreign based entity. Too, I believe the US is very unique in its banking structure as to state vs. national charters, private vs. public companies and large vs. small banks.

Thank you for your interest.

Ted

2007 Nov 07 04:09 PM