Mercantile Bank Corporation (NASDAQ:MBWM)
Q1 2016 Earnings Conference Call
April 19, 2016, 10:00 AM ET
Robert Burton - Investor Relations, Lambert, Edwards & Associates
Michael Price - Chairman of the Board, President and Chief Executive Officer
Robert Kaminski - Executive Vice President, Chief Operating Officer and Secretary
Charles Christmas - Executive Vice President, Chief Financial Officer and Treasurer
Damon DelMonte - KBW
Daniel Cardenas - Raymond James
Matthew Forgotson - Sandler O'Neill
Good morning, and welcome to the Mercantile Bank first quarter 2016 earnings release conference call. [Operator Instructions] I would now like to turn the conference over to Bob Burton. Please go ahead.
Thank you, Kate. 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 of 2016.
I am Bob Burton with Lambert Edwards, Mercantile's investor relations firm. And joining me are members of their management team, including Michael Price, President and Chief Executive Officer; Robert Kaminski, Executive Vice President and Chief Operating Officer; and Chuck Christmas, Executive 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 today, 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, www.mercbank.com.
At this time, I would like to turn the call over to Mercantile's President and Chief Executive Officer, Mike Price. Mike?
Thank you, Bob, and good morning, everyone. Thank you for joining us to discuss our first quarter 2016 results for Mercantile Bank Corporation. On the call today our CFO, Chuck Christmas, will provide details on our financial results; followed by COO, Bob Kaminski, with his comments regarding loan development, growth initiatives and asset quality.
I hope you will agree with me that Mercantile is off to a great start in 2016. Our financial results are strong, our markets continue to be robust and our company continues to build momentum across the board. We are encouraged by these first quarter results and our market position and look forward to continued strong performance in 2016.
Comparisons of first quarter results are affected by a non-recurring gain taken in the quarter, resulting from the repurchase of $11 million in trust preferred securities, which increased reported net income by approximately $1.8 million or $0.11 per diluted share. Nonetheless, our performance around key metrics, like net interest margin, non-interest income and new loan generation were solid in the quarter.
In particular, let me highlight several accomplishments in areas of strategic focus that underline our optimism for the rest of the year. New commercial loan growth was $105 million for the quarter. While lower than the very strong fourth quarter of 2015, we are pleased with this result, and our committed loan pipeline should provide solid growth during the balance of the year. Bob Kaminski will detail the health of our markets and the strength of our customer base in his comments in a moment.
We are pleased with the stability and level of our net interest margin, reflecting the ongoing reallocation of earning assets initiative, strong asset quality and loan pricing discipline. We continue to shift our mix of interest earning assets out of low yielding securities and into higher yielding loans, resulting in a relatively stable yield on total earning assets, despite the low interest rate environment and competitive pressures.
Although, the reallocation strategy is expected to conclude during the second quarter of this year, the impact of this will be somewhat tempered by the FOMC's December 2015 rate increase and our continued focus on loan pricing discipline.
As evidence of our strong capital position and demonstrating our continuing commitment to shareholder return, we earlier today announced a quarterly cash dividend of $0.16 per share for the second quarter, providing an annual yield of about 2.9% based on our current share price. We also expanded our share buyback program by $15 million, allowing from future repurchases of approximately $16 million.
Looking forward, we see additional opportunity to participate in the economic strength of our business area as Michigan's premier community bank. Our business activity levels indicate that the overall continued healthy employment and economic expansion that is being reported for central and western Michigan will continue, particularly within our largest markets. The areas economic indicators remain positive, suggesting growth will continue through the coming months.
At this time, I'd like to turn the call over to Chuck.
Thanks, Mike, and good morning, everybody. This morning we announced net income of $8.5 million for the first quarter of 2016 or $0.52 per diluted share compared to $6.6 million or $0.39 per diluted share for the first quarter of last year. The repurchase of $11 million in trust preferred securities at a 27% discount during the first quarter of this year increased reported net income by approximately $1.8 million or $0.11 per diluted share.
Provision expense totaled $0.6 million during the first three months of 2016 compared to a negative provision expense of $0.4 million during the first three months of 2015. We are very pleased with our financial condition and earnings performance for the first quarter, and believe we remain very well-positioned to take advantage of lending and market opportunities, while delivering consistent results for our shareholders.
Our net interest margin was 3.92% during the first quarter, continuing a relatively stable trend during the past seven quarters, in which the margin has ranged from a lower 3.79% to a higher 3.95%. The stability of our net interest margin primarily reflects our strategy to grow the loan portfolio as a percentage of average earning assets in large part by funding a large portion of our net loan growth with monies from the lower yielding securities portfolio.
Average loans represented about 85% of average earning assets during the first quarter of 2016 compared to 80% during the first quarter of 2015. Primarily reflecting the ongoing very low interest rate environment and competitive pressures, our yield on total loans has generally been on a declining trend. However, our yield on total earning assets has remained in a tight range, which when combined with the steady cost of funds, provides for a stable net interest margin.
We recorded loan discount accretion totaling $1.3 million during the first quarter of 2016, a little higher than the guidance provided in January, due to certain payoffs and ongoing solid performance of the acquired loan portfolio. Based on our most recent valuations, we currently expect to record further quoted loan discount accretion totaling $1.1 million to $1.3 million during the remainder of 2016. Actual accretion amounts recorded in future periods may differ from our forecast due to a variety of reasons, including periodic re-estimations and the payment performance of the acquired loan portfolio.
Our yield on securities portfolio during the first quarter of 2016 was about 35 basis points higher than expected, resulting from the call of certain U.S. Government agency bonds that have been purchased at a discounted price. The immediate accretion on these called bonds total about $250,000 during the first quarter.
We expect our net interest margin to be in a range of 3.75% to 3.85% throughout the reminder of this year. While the ongoing very low interest rate environment continues to exert compression pressure on our net interest margin, as Mike mentioned, the December FOMC rate increase did provide some relief.
Our strategy to use cash flows for monthly paydowns on lower yielding mortgage-backed securities and periodic maturities and calls on lower yielding U.S. Government agency and municipal bonds to fund a large portion of our expected loan growth is expected to end during the second quarter, as the securities portfolio measured as a percent of total assets nears the desired level.
The overall quality of our loan portfolio remains very strong. Non-performing assets as a percent of total assets equaled only 22 basis points as of March 31. Gross loan charge-offs equaled $0.5 million during the first quarter of 2016 with recoveries of prior period loan charge-offs also equaling $0.5 million.
We did record a provision expense of $0.6 million during the first quarter of 2016, primarily due to loan growth. The provision expense in the first quarter was similar to the $0.5 million we had expensed during the fourth quarter of last year and in line with our expectations. We continue to expect to record quarterly provision expense of $0.5 million to $1.0 million during the remainder of 2016.
Our loan loss reserve totaled $16.3 million as of March 31, 2016. The reserve for originated loans equaled 94 basis points of total originated loans at quarter end, unchanged from yearend 2015. We recorded non-interest income of $7.1 million during the first quarter of 2016, reflecting a $3.4 million increase compared to the first quarter of 2015.
About 85% of that improvement was due to the one-time gain associated with repurchasing $11 million in trust preferred securities at a discount. We recorded a $200,000 increase in service charges on deposit accounts compared to a year ago, in large part reflecting an ongoing project to ensure that all depositors are in a product that best meets their needs and is priced appropriately.
With caution that mortgage banking income as well as recoveries on certain acquired charge-off loans can be difficult to forecast, we expect quarterly non-interest income during the remainder of 2016 to be in a range of $3.7 million to $4.0 million. We recorded non-interest expense of $19.9 million during the first quarter of 2016, an increase of $0.6 million from the first quarter of 2015 and ahead of the high-end of our guidance provided during the fourth quarter earnings conference call in January.
During the first quarter of this year, we expensed $0.6 million associated with our bonus programs compared to no bonus accrual during the first quarter of last year. The expected $2.7 million in annual pre-tax cost savings, associated with our efficiency program announced in late 2015, started to be realized during the first quarter and will be in full force, starting during the second quarter. We currently expect quarterly non-interest expense to total between $19.2 million and $19.7 million through remainder of 2016 with our effective tax rate around 31%.
We remain a well-capitalized banking organization. As of March 31, 2016, our bank's total risk based capital ratio was 13.1% and in dollars it was approximately $81 million higher than the 10% minimum required to be categorized as well-capitalized.
As part of $20 million of common stock repurchase program that we announced in January of last year, we repurchased approximately 148,000 shares at an average price of $22.07 per share or $3.3 million in total during the first quarter of 2016. Since the repurchase plans inception, we have repurchased about 936,000 shares or nearly 6% of the total shares outstanding at yearend 2014 for $19 million at an average cost of $20.32 per share.
We announced this morning that our Board has authorized a $15 million expansion of the common stock repurchase program, allowing for future share repurchases of about $16 million. Funding for the stock repurchase program has generally been provided via cash dividends from our bank and any further stock purchases will likely be funded in a similar manner.
Those are my prepared remarks. I'll now turn the call over to Bob.
Thank you, Chuck, and good morning. The first quarter 2016 produced a solid performance in terms of client acquisition and operational improvement. Commercial term loan funding to new and existing clients was approximately $105 million for the quarter, which translated to a net loan growth of $18 million.
While this funding level was somewhat lower than our very strong fourth quarter, we are very pleased with the ongoing client acquisition activities. The pace of funding fluctuates from month-to-month and quarter-to-quarter and the timing of commercial loan closings, once the borrower has accepted a commitment, is often hard to forecast, creating uneven patterns of loan growth.
While competition remains fierce for new business, our focus on relationship banking as a trusted client advisor continues to provide a great potential for new client acquisition. The loan commitment pipeline is strong at over $200 million and we are experiencing a good distribution of new loan opportunities in all of our markets, including Grand Rapids, Kalamazoo, Lansing, Cadillac and Mount Pleasant.
We remain pleased with our approach, as we are continually engaging numerous perspective clients in commercial and industrial and commercial real estate projects in all of our markets. We will, however, steadfastly hold to our principles of sound credit underwriting and loan pricing.
We realize that not every loan prospect will be an appropriate fit for Mercantile. We continue to seek and engage potential clients, who value mutual and beneficial relationships with their financial institution. We believe that businesses in the markets we serve, place high importance on these characteristics, and this is reflected in our loan pipeline and ongoing client negotiations.
From an internal standpoint, Mercantile is also engaging its commercial lenders with a commercial sales training program throughout our markets. In this program, lenders are provided best practices to develop methods of serving customers needs by selling solutions.
On the retail side of the bank, we continue to build our residential mortgage unit to leverage opportunities in our larger urban markets of Grand Rapids, Holland, Kalamazoo and Lansing. We are constructing this process for a long-term vision with the objective of significantly increasing mortgage volumes through more commissioned lenders and an effective allocation of support staff. We want to build a residential mortgage machine capable of producing robust mortgage volumes that are sustainable during a variety of economic cycles.
In the first quarter, we have added calling officers in our treasury management area to work in tandem with our commercial lenders, our new client acquisition, in addition to mining the existing portfolio for treasury opportunities with current clients in the areas of payroll services, electronic banking and card services. Asset quality remains very good at $6.3 million. Non-performing assets declined about $0.4 million from December 31 and over $21 million from the level of the year ago.
Regarding the Michigan economy, the unemployment rate of 5.1% is near the national rate and continues to decline. Jobs continue to be added in all sectors of the economy. Manufacturing jobs lead the way boosted by strong performance in the automotive industry. Job increases have also been experienced in other sectors as well, including gains in professional and businesses sector and educational and health services sectors. Home prices have continued to increase in most markets in Michigan at a higher pace than the national rate. All these factors are encouraging for our outlook for the remainder of 2016.
Those are my prepared remarks from the first quarter. I'll now turn it back over to Mike.
Thank you, Bob. And also thanks, Chuck. Kate, at this time, we would like to open the call up for questions.
[Operator Instructions] The first question comes from Damon DelMonte of KBW.
My first question deals with expenses, so probably directed towards Chuck. Could you just talk a little bit about your outlook in the upcoming quarters? This quarter's results were a little bit higher than what we were looking for. And I didn't know if it was a timing issue on some of the expense initiatives that you have ongoing, or maybe there was some seasonality for some uptick on items in early part of the calendar year?
Yes, Damon, good question. Like I had said, it came a little bit higher than the high end of our guidance that we had provided. There was about $200,000 or $300,000 in a variety of, what I would call, one-time items, nothing by itself very, very large. But I don't expect that those will continue. In fact, those are one-time type things.
And as I mentioned, that our guidance would be somewhere between $19.2 million and $19.7 million; part of that variance being potentially what we put into the bonus programs. So I have upped the guidance a little bit, but I think we'll be down a little bit from what we did in the first quarter.
Does that guidance take into account some of the plans you have for expanding the mortgage banking operations?
Yes. We think that those numbers will incorporate that and then obviously we hope that will get some additional fee revenues as we get later into the year and put those into work.
Then with regard to the security yields, I think you commented that you had some higher than expected income related to calls on some government securities. How do we think about the overall yield on the portfolio next quarter? Do we kind of back out that 35 basis points, and that's kind of a decent run rate?
I would actually probably keep that money in there. The calls are coming in pretty aggressively. And most of them are closer to par, but we have gotten some calls already this month with some discounts in there. And if the trends continue, I think that will continue to get some additional one of those. Obviously, it's only finite as to how much this kind of stuff people would guide in there, but we do have a fair amount that should help the securities portfolio in the second quarter. For that $0.25 million that we did, I would definitely keep that in for the second quarter.
And then these securities that are being called, are these like Ginnie Mae's or something?
No. These were primarily Federal Home Bank and Federal Farm Credit Bank bond deals, and while back when rates had gone up we found some discounted ones that were available. That's something that I've always tried to put in the portfolio. For times like this that when rates do go down, they do get called and we get that immediate bump that helps offset some of the repricing that obviously has taken place. Hate to lose the overall yield. These are probably yielding on average of 3.5%, 3.75% and you have to put that back to work 7500 basis points lower as we go forward.
And you said your range for the margin for the remainder of the year is 3.75% to 3.85% range?
Yes. I think, we'll be closer to 3.85% in the second quarter with that discount coming through. But without that, I think 3.75% to 3.80% is probably more likely.
And then just my final question, with regards to the outlook for loan growth for the year. Average loans were strong on a quarter-over-quarter basis, period end were down a little bit. How do we think about the remainder of the year? Do you think that the high single-digit, maybe possibly low double-digit range, is attainable for the full year?
I think we're getting a lot of opportunities. And if we wanted to grow the bank a lot faster, we could take advantage of some of the fierce competition and match their rates, but as we said, we're not doing that. Despite that, though, we're seeing some great opportunities and customers are accepting proposals.
And so I think for us to be on track for the rest of the year, the levels we've forecasted is still very likely the remainder of the year, because our pipeline is strong and we've continued to get new customer opportunities every week. And there's some very good opportunities. All of our markets are showing that the people are really appreciating the kind of approach we're taking on client acquisition side.
The next question comes from Daniel Cardenas of Raymond James.
Nice quarter. Maybe if you could give a little bit of a discussion here on your deposit strategy, given your loan growth outlook, your current loan to deposit ratio, which is about 101%. I mean, what's the focus on the deposit side? And are you factoring in any growth in the margin assumptions or guidance that you gave?
It's a great question, Dan, and I know you and I have talked before that this is going to take a lot of our attention as we go through 2016 and beyond, because obviously if we want to grow our balance sheet forward, we're going to have to start getting some additional deposit growth. And so we've had a team together probably for three months now going through different scenarios and different products, most primarily looking to enhance existing products.
We think that we can get some deposit growth with that. We're obviously talking to our branch folks, our retail folks, certainly are treasury management folks about making sure that they are out there on ongoing basis and doing what they need to do to get some deposit growth out there.
Lot of the growth that we are getting is coming from the commercial loan area. And obviously we expect that, as Bob just talked bout, we expect some good commercial loan growth, especially on the C&I side to continue. And we have seen some very, very strong deposit growth resulting from that, so we would expect that to continue as well.
One thing on the loan-to-deposit ratio, as I always tell everybody, that those sweep accounts or those repo accounts on our balance sheet are really check-in accounts, so we always kind of throw that into the loan-to-deposit mix, because in fact they really are deposits. So we're around 94% to 95%, but that's certainly on the high end of where we would expect to be. So again, we need to grow those deposits.
I would also mention that we've been very, I want to say, uncompetitive, I don't know if that's a word. We have not been very aggressive when it comes to public unit money. We do have a decent portfolio of that, but over the last, I would say, five to six quarters, that portfolio has been declining, primarily because we haven't needed to use that money when we're using the securities portfolio, but obviously we're going to be looking to the public unit sector again to grow that portfolio to some degree to help us fund our future loan growth.
Again, we haven't needed to use the money and there are a couple of competitors out there that tend to be relatively aggressive with the pricing of that, so it didn't make sense to be competitive then, but again, that's part of what we'll be looking at. So from growing the deposits, there is not any magical silver bullet out there. We're looking at existing products. We're looking at existing customer relationships. Looking to get back again into the public unit realm. That change in mix where we have to go and grow the deposit is factored into our margin guidance that we provided.
I would add to that as well. With our focus on treasury, we're taking opportunities to look for clients on the commercial side that maybe don't have as much borrowing needs at the current time, but have a lot of cash-on-hand and have the need for the electronic banking and card products that we can offer and that's also added to the mix of the things that Chuck talked about.
Then maybe a quick update on the M&A front. What's the environment like right now? Are you guys seeing more opportunities or is it fairly quiet out there?
As you know, there has been a couple of mergers in the state that have made some pretty big waves, if you will. So we're seeing, from a business standpoint, some good opportunities from that. As far as our participation directly in the M&A market, it hasn't changed a lot. I think there is still a lot of conversations going on, but I think for us, as we've always said, it takes exactly the right partner and culture, and obviously, the financial metrics for us to get really interested.
And we haven't obviously seen anything that make sense for us, so we continue to focus really hard on good strong organic growth, but keep our eyes and ears open for any opportunities that are out there. We think there are going to continue to be opportunities just because of the increasing costs of risk management, regulatory pressures. But we don't wake up everyday just salivating to do a deal. They really need to make a lot of sense for us to get them done.
The next question comes from Matthew Forgotson of Sandler O'Neill.
Just approaching the margin question a little bit differently, if I strip out the elevated accretion income and the calls, I'm placing your core margin closer to 3.86%. That's still above the top end of your range. Can you walk through, Chuck, the puts and takes within the margin that would lead you to set the lower bound at 3.75%? Is that just deposit gathering, as we move through the back half of the year?
Yes. Some of that's deposit gathering, but more of that is related to loan portfolio, Matt. Our loan portfolio goes down given where current rates are at, somewhere between 4 basis points to 6 basis points a quarter. And I don't really see much lowering of the cost of funds. In fact, I've got that going up a little bit, because of the things that we already talked about. So I think the lower end of that range really reflects the continued pressures that we got in the loan portfolio that is no different than any other bank that's out there.
We remain in a really low rate environment, and that from a mathematical standpoint reflects the overall yield and the impact that it has. Certainly the competitive pressures that I know Bob touched on already certainly don't help as well. So that's where that's mostly coming from, and knowing that added to that, that we're pretty much done with this earnings remix from the securities portfolio to loan portfolio.
And then just on expenses, I mean just looking at the first quarter run rate. You did $19.9 million. If you back out the $300,000 of what you're calling one-timer or non-run rate expenses, that puts us to $19.6 million. And then you shave off the benefits, the efficiency initiative, it sets the core expense run rate on a stabilized basis closer to $19 million. It sounds like based on your guidance it's too optimistic to set it at that level. But I guess, the question for you is what are the puts and takes that take it off of that level into your guidance range?
Yes, I think that's being relatively aggressive. The range I gave was $19.2 million to $19.7 million. And I think when we look at all the different moving parts and what we think that we're going to be able to accomplish from a bonus accrual standpoint that that's an appropriate guidance to give.
And lastly, just a technical point. What drove the increase in other income quarter-to-quarter?
Well, there were obviously two things there. One, obviously, is the trust preferred repurchase discount; and then we also had a $300,000 gain related to an investment that we had in a local company here that we sold that entire -- a relatively small equity position, but we're able to realize a really nice gain off of that. But that was one-time. We're totally out of that position now.
There are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Price for closing remarks.
End of Q&A
Thank you, Kate. And thank you everyone for your interest in our company today. We look forward to talking with you again after the second quarter.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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