Mercantile Bank Corporation (MBWM) Q4 2014 Earnings Report, Transcript and Summary

Good morning. And welcome to the Mercantile Bank Corporation Fourth Quarter 2014 Earnings Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After towards presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is also being recorded. I would now like to turn the conference over to Robert Burton with Lambert, Edwards. Please go ahead.

Thank you, Andrew. Good morning, everyone. And thank you for joining Mercantile Bank Corporation conference call and webcast to discuss the company’s financial results for the fourth quarter and full year 2014. I’m 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, Senior Vice President and Chief Financial Officer. We will begin the call with management’s prepared remarks and then open the call up to questions. However, before we begin today’s call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure, as well as statements on the plans and objectives of the company’s business. The company’s actual results could differ materially from any forward-looking statements made 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. And thank you for joining us to discuss our fourth quarter and full year 2014 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 growth initiatives, merger integration and asset quality. Hopefully, you’ve all had a chance to review the quarterly performance, which was highlighted by a return to solid loan growth, as well as further progress on our successful integration of the Firstbank operations. The fourth quarter results completed a truly transformational year for our company. As part of our strong capital position and our commitment to shareholder return, we earlier today announced the quarterly cash dividend of $0.14 per share, which was a $0.02 per share or 17% increase from last quarter’s dividend. Looking forward to 2015, we see opportunity to participate in a continuing economic recovery of Michigan as Michigan’s premier community bank. Our business activity levels reflect the overall continue gains and employment and business expansion that are being reported for Western Michigan and particularly, the Grand Rapids market. The third quarter study of the regional economy found that employment in West Michigan grew by 0.3%, a gain of nearly 2,500 jobs, on increases in goods producing and government employment. The area of economic indicators were positive suggesting job growth will continue through the [time] [ph] of the coming months. Having noted that the trends are positive, I would also point out that they are only modestly solved. Mercantile’s loan growth in the fourth quarter improved from the third quarter, but remains below the gains we saw earlier in the year. We remained very competitive in the market on a rational and discipline basis, as our emphasis on relationship banking provides us with a competitive advantage and allows us to gain market share. Our expanded market area as a result of the merger also provides us with new opportunities over the coming year. We look for a continuous loan growth in the mid-to-upper single digits over the coming year. The overall interest rate environment and continue pressure on the yield curve will continue to affect us in several ways. Pressure on net interest margin is a factor for all banks and we are no exception. Our outlook is for a steady margin over the coming year. Mercantile is fortunate that our cost of funds to earning assets is reflecting the expected benefit of the merger with Firstbank. This ratio stabilize at 0.44% for both the third and fourth quarters of 2014, significantly below Mercantile’s 0.84% in 2013 and as a consequence we are getting the full accretion to earnings that we expected and this competitive advantage enhances the spread at which we can do more business in the future. Likewise, reflecting continued pressure on yields, mortgage banking income rebounded in the fourth quarter of 2014, improving more than 20%, but continues to run at a rate below what Firstbank and Mercantile combined achieved a year earlier. Our markets continue to be extremely competitive, but we are encouraged that our pipeline for loans remained strong, as Bob will discuss in a moment. We have a great team in place and look forward to new activity as the year progresses. 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 $6.3 million for the fourth quarter of 2014 and net income of $17.3 million for all of 2014. On a diluted earnings per share basis we earned $0.37 per share in the first quarter and a $1.28 per share during all of last year. Our fourth quarter and year-to-date earnings results have been significantly affected by the merger with Firstbank Corporation, which was consummated effective June 1st. In addition to our earnings results reflecting seven months of operation as a combined organization, we recorded relatively large merger related costs during 2014. Merger related costs totaled $0.4 million during the fourth quarter and $5.4 million during all of 2014. On an after-tax basis that equates to $0.2 million or $0.01 per average diluted share during the fourth quarter and about $3.8 million or $0.28 per average diluted share for all of 2014. We do not expect any further significant merger-related costs in further periods. We are pleased with our financial condition and earnings performance and believe we are very well-positioned to take advantage of lending and market opportunities and deliver success as a strong community bank for our shareholders. Our net interest margin continues to reflect the benefit of the Firstbank merger. We recorded a net interest margin of 3.79% during the fourth quarter of 2014 at an average of 3.87% during the third and fourth quarters. This compares to the first and second quarter of 2014 average net interest margin of 3.52%. A majority of the improvement reflects Firstbank’s lower cost of funds and purchase accounting entries relating to fair value adjustments associated with the merger. Our net interest margin during the fourth quarter of 2014 declined when compared to the third quarter of 2014, primarily reflecting a higher volume of low-yielding overnight investments. In addition, our third quarter net interest margin was positively affected by the collection of higher commercial loan prepayment fees and the receipt of interest on a non-accrual loan that fully paid off during the quarter. We recorded loan discount accretion, totaling $1.5 million during the fourth quarter and $3.2 million since June 1. Based on our most recent valuations, we currently expect to record further loan discount accretion, totaling about $1.2 million per quarter during 2015. Actual accretion amounts recorded in future periods may differ from our forecast due to a variety of reasons, including periodic reestimations and the payment performance of the acquired loan portfolio. We recorded time and FHLB advance amortizations, totaling $0.6 million during the fourth quarter of 2014 and $1.4 million since June 1. We expect to record further amortizations, totaling $0.6 million during the first and second quarters of 2015 and $0.2 million during the third quarter of 2015. As we noted in prior merger-related SEC filings, these particular fair value adjustments will be completed at the end of July this year. We have also recorded trust preferred security amortization since the merger was consummated, totaling $0.2 million during the fourth quarter and about $0.4 million since June 1. Unless recall all or part of our trust preferred securities which currently we have no plans to do, we expect to record further amortizations totaling $0.2 million per quarter into the year 2036. We expect our net interest margin to be in the range of 3.80% to 3.85% during the first and second quarters of 2015 and then decline slightly to a range of 3.75% to 3.80% during the third and fourth quarter of 2015. The primary reason for the anticipated decline is due to the elimination of the time deposit and FHLB advance amortizations in July/ While the ongoing very low interest environment continues to exert compression pressure on our net interest margin, we expect to use low yielding, excess overnight investments and cash flows from 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 throughout 2015. Reflecting the market’s current 2015 interest rate forecast, which includes a 25 basis point increase in the federal funds and prime rate during the third and fourth quarter, we have modeled such increases as part of our 2015 budget process. Per our net interest income simulations disclosed in prior Form 10-Qs and 10-Ks and as confirmed in our budget process, the forecasted increases in short-term interest rates are expected to have only a nominal impact on our net interest margin. The overall quality of our loan portfolio combined with recoveries of prior period loan charge-offs and the eliminations of and reductions in many specific reserves have produced a positive impact on our loan loss reserve calculation and allowed us to make no or negative provisions in eight consecutive quarters and in 10 out of last 11 quarters. We recorded no provision expense during the fourth quarter of 2014 and negative provisions totaling $3.0 million during all of 2014. Gross loan charge-offs totaled $0.5 million during the fourth quarter and $1.5 million during all of 2014. Recoveries of prior period loan charge-offs totaled $0.1 million and $1.7 million during the same time periods respectively. And for all of 2014, we recorded a net recovery of $0.2 million. Our loan loss reserve was $20 million at the end of the fourth quarter or 1.54% of total originated loans and remained higher than our historical averages. We recorded non-interest income of $3.3 million during the fourth quarter of 2014, a 15% improvement over the third quarter. We recorded improvement in virtually every fee income category, with a 21% improvement in mortgage banking income leading the way. Knowing that mortgage banking income can be difficult to forecast, we currently expect non-interest income to come in around $3.0 million to $3.3 million per quarter in 2015. Non-interest expenses during 2014 were significantly impacted by merger-related cost totaling $0.4 million during the fourth quarter and $5.4 million for the whole year. As noted earlier, we expect no further significant merger-related cost in future periods. As originally projected, we expect to realize savings of approximately $5.5 million annually. We realized the portion of the cost savings during the third quarter and we realized the vast majority of them by the end of the fourth quarter. We expect to realize 100% of the estimate for all of 2015. We are currently projecting quarterly non-interest expenses to total in a range of $18.7 million to $19.0 million during 2015. Our effective tax rate for 2015 is expected to be around 31% to 32%. We remain a well-capitalized banking organization. As of December 31st, our bank’s total risk-based capital ratio was 14.4% and in dollars was approximately $101 million higher than the 10% minimum required to be categorized as well capitalized. Those are my prepared remarks. And I'll turn the call over to Bob.

Thank you Chuck, and good morning everyone. In the fourth quarter, Mercantile returned to the net growth position in its loan portfolio, the funding of over $90 million of loans to new and existing customers. The relationship development approach employed by our calling officers continues to resonate positively with clients and potential clients. We remain steadfastly committed to the mutually beneficial value-added style of banking as opposed to focusing mainly on price has been the primary tactic of many of our competition. With our knowledgeable staff of bankers, we are able to generate comprehensive banking packages with cash management products including our payroll processing to service all of the client’s financial needs. Fourth quarter funding was generated in the fairly balanced fashion of very wide range of loan types including non-owner occupied real estate, owner occupied real estate and commercial and industrial lending. Mercantile should benefit with a good tailwind for construction funding over the course of 2015 as we presently held about $115 million in commitments where the building construction has begun and the advances have started to fund. The loan pipeline remains strong as we enter 2015 and we’re projecting net loan growth in the range of $180 million to $200 million for the year. While we expect loan growth in all of our markets, we anticipate the most significant opportunities will be available in Grand Rapids, Kalamazoo, Lansing with a meaningful growth also in Mount Pleasant and Cadillac. While competition remains quite intense in these and all of our markets, we continue to be encouraged and our client staff was energized by the response to our client outreach efforts. With a significant part of the merger integration and transition complete, we are now embarking on some major revenue enhancement and expense mitigation and efficiency initiatives. One tremendous opportunity we are seizing with the merger is the introduction of our full suite of treasury products into our new markets. Our staff is already identifying clients and potential clients who would benefit from these products and its outreach has been well received. Another project focuses on leveraging retail mortgage opportunities especially in our largest market in Grand Rapids. We are also looking at potential sources of new non-interest income involving fee structure and frequency with its special focus on relationship-based pricing on various products. Additionally, we have an initiative that focuses on gained efficiencies in all areas of our organization including revisiting processes and procedures, vendor relationships and supply procurement as well as facility maintenance issues. Finally, we are exploring new customer sales opportunities resulting from customer dislocation as some of our competitor bank have been recently acquired in our markets. Those are my prepared comments. I’ll be happy to answer questions during the Q&A and turn it back over to Mike now.

Thank you, Bob, and also thank you, Chuck, for your comments. Andrew, at this point, we’d like to open up conference for questions.

[Operator Instructions] The first question comes from Damon DelMonte of KBW. Please go ahead.

Hey good morning guys. How are you?

Very good.

I just -- would you just start off with one of the last things that was being discussed regarding like looking at facilities and things like that. Is that more of a broad-based expense initiative you're looking to employ in 2015?

We are looking at it as how we manage our facilities on a global basis because in parts of the merger, our facilities were held in different manners throughout the organization. Looking to centralize everything, so it’s done consistently in a manner that’s consistent throughout the company and we’ll take some of those responsibilities away from the people that are on the line because they are all willing to do more positive things such as selling to customers. So taking some of those backroom functions and centralizing them for gaining efficiencies.

Okay. And will that include, I think the actual physical locations of branches throughout the footprint? Do you have any intention of doing some sort of branch optimization?

We are looking at a wide range of opportunities within how we do business in our branches and making sure that it’s consistent. So customer has a consistent experience as they go into any of our locations and so initially it’s pretty broad based and we look at a wide variety of potential opportunities for efficiencies.

Damon, this is Mike. And right now it’s really focused on the operational program then looking at branch by branch profitability. However, that clearly is always on our radar from time to time to review. But the real focus as Bob said of this particular initiative is the general overall operating efficiency of the bank.

Got it. Okay. That's helpful. Thank you. And then a question on the margin, probably for Chuck. If I look at the yield on loans quarter-over-quarter, they went from 503 down to 490. I know you had mentioned there was some prepayment income in last quarter's results. How much of that 13 basis point decline was related to the excess commercial income from loan preps?

The reason why you see that decline, Damon, was, as you mentioned, the prepayment penalties that we collected during the third quarter and then we also had a non-accrual loan that paid off in full that had a pretty sizeable accrued interest balance that obviously we weren’t accruing for but the customer owed us. And that accounts for virtually all of it -- a vast -- I shouldn’t say virtually -- a vast majority of it. The other reason would just be, as we talk about and I’m sure all the banks are talking about is, it’s a low rate environment and when we are putting loans on, they are typically at a rate that’s lower than what our average rate is. And certainly I think Mike perhaps touched on it briefly. It’s very competitive out there and why we are obviously trying to stick to our policies and our guidelines. It does put pressures on the loan rates that we give and we are putting new deals on the books.

Damon, there is one other contributor to that and that is we did put a large loan on non-accrual, I believe in the fourth quarter.

Yes. That was going to be my next question. Could you give a little bit more color around that relationship? I think it was around $22 million.

That will be correct. It’s obviously one of the larger credits that we have in the bank. It had been struggling yet sometimes things have stabilized a little bit. But obviously we don’t expect that type of event to happen again this quarter. We don’t have anything on our horizon that looks sizeable at all going into the non-accrual buckets. But it is in an active workout situation and it’s a very cooperative situation between the customer and ourselves and we hope to have a fairly positive resolution to it, but it may take sometime as credits of this size do.

And, Damon, this is Chuck. Just from a numbers perspective, those are about 2 basis points of our margin for the fourth quarter. Compared to the third, we did put that a non-accrual at the end of November or early December.

Okay. Was that disclosed as a TDR in the Q, by chance?

Yeah. That was a -- but we disclosed that as a performing TDR, as of September 30th and it was during the third quarter that we put that into TDR status but it was still on accrual. So the change in the fourth quarter was to actually put it on non-accrual.

Got you. All right. So it's the same credit? It's not an additional.

Right.

Right. You are correct perhaps.

Okay. Good to know. Okay. That's all I had for now. Thank you.

Thanks Damon.

The next question comes from Matthew Forgotson of Sandler O'Neill and Partners. Please go ahead.

Hi. Good morning, everybody.

Hi, Matt.

Just to follow up on the non-performer, can you give us a sense -- is this loan paying as agreed right now and have you charged any of it off to date? And is there a specific reserve attached? Just trying to get a sense of overall exposure.

Sure. To answer your questions, when we put the loan on non-accrual, it was current with payments. As we go forward, we may change the payment structure to give the company some relief in some of its cash flow issues. But that would be a positive thing because that means that we are still working with them and we think we’d see light at the end of its tunnel. So, yeah, it was current when we put it on non-accruals, just being very, very conservative in the treatment. Have we charged anything off? No, we haven’t. Like all loans, there is a reserve against it. But as you could imagine, being a non-accrual loan that reserve is larger than the general population of loans. Do we have an estimate of loss at this time? It’s real difficult to see from the standpoint of -- this company had some options available to it. It’s a distribution company in the agricultural business and there is quite a bit of interest in people purchasing either the company as a whole, or purchasing the assets, or the company returning to profitability. We made some significant changes in our operating structure that could make this return to an operating loan. So it’s kind of right now really in the early stages of a rather significant workout situation but we like the way it’s headed.

Okay. So, I'm not going to press, but it doesn't sound like you want to volunteer a dollar amount for the specific reserve held against this loan.

Well, I’m not sure it would be accurate or helpful to do so. I mean, I could -- I’m going to tell you we are not going to lose $22 million. So anybody that thinks that this is, boy, you know that big of an exposure but it’s really hard. It is probably a week to week change in dynamic depending on what, how the company is being managed and how its relationship is with us. But I would characterize it as I’m less concerned about it today than I was a month ago. But it’s still an active workout situation.

Okay. And then just how many of those loans do you have in the portfolio, just call it north of $20 million? And I know that they are all performing, but any granularity there would be helpful.

Sure. We probably have a handful of loans that are north of $20 million. One of the things that we spend a lot of time doing and we went back and did recently for our Board is we discussed. As you can imagine, so as we put the merger together, our legal lending limit is massive and we don’t go anywhere near where that number is. But one of the things we did is we went back to the Great Recession and analyzed the portfolio and looked at our largest 20 credits and how they perform vis-à-vis the rest of the portfolio and while they have the same uptick in percentage delinquency and loss, as a whole of those larger loans performed significantly better than the portfolio as a whole. Again, that should be that way because those loans tend to have better quality cash flows, better quality management, stronger guarantees and stronger collateral but we keep an eye on that fairly closely.

And I think from the standpoint of the largest credits of the bank that there is some very good, very good diversity in terms of the types of credits, the types of loans that are comprising the biggest credits in that bucket.

Okay. And then lastly and then I will hop out. Just trying to get a sense here of earning asset balances as we trend across 2015. It sounds to me like you are going to continue to redeploy cash flows from securities and cash into loans. Does that mean that earning asset growth will be relatively muted across 2015?

Yeah. This is Chuck. We’re looking for growth in earning assets of probably around 1%, 1.5% net.

Okay.

So, yeah, as I’ve mentioned and as you’ve kind of alluded to, the vast majority of the net loan growth we do get is expected to come from a reallocation of earning assets.

Thank you very much.

And that certainly supports a stabilized margin.

Thank you.

Thanks, Matt.

The next question comes from John Rodis of FIG Partners. Please go ahead.

Good morning, guys.

Hi, Jeff.

This might be a question for you, Bob. Just -- could you just talk about the level of paydowns you saw during the fourth quarter relative to prior quarters, I guess?

The level of paydowns probably picked up in the fourth quarter and muted some of the growth that we would have seen otherwise. And payouts for a variety of reasons, there weren’t any payouts that left the bank because they were dissatisfied with the bank. It all was -- customer sold the asset to payoff the loan. Company or entity took the financing to secondary market, financing with insurance or HUD or something like that, so a variety of reasons and we try to get our arms around them. Sometimes they pop up in unexpected situations. But I think we could continue to manage that process and continue to be encouraged by the growth that we did see on net basis and what still we have in the pipeline right now, while I’m sure we will have some payoffs in 2015. There is nothing on the horizon right now that looks like it’s a huge detractor on the growth, but said sometimes those things are little bit unexpected.

Okay. And Bob, could you just maybe talk a little bit more about the new lenders in the Grand Rapids and Lansing market and were they from bigger banks or smaller banks or?

Yeah. It’s a, probably, come from variety of different situations. You’ll see some that come over from bigger banks, competitor banks. Some others that may have come from smaller banks, but they maybe have spend sometime with larger banks in the course of their career. But really what we’re looking for when we bring commercial lenders onboard or any type of lender or employee, is a good well scaled person that we can teach how we do business in Mercantile Bank and so we’ve got some nice additions with these folks and have a nice contact list through the years of banking in our various markets and are encourage by what the potential for them holds for 2015 and beyond.

Okay. And Mike, maybe just one quick question for you, just your thoughts on the M&A environment, obviously, there continues to be some deals in your Michigan markets? And then where do you think Mercantile stands today as the ability to do deals going forward?

That’s good question, John. They’re clearly is a lot and I know you’ve noted as many people have, a lot of M&A activity going on in Michigan at some fairly healthy prices, which is one of the reasons why we, along with obviously, I want to make sure we digest this Firstbank merger very well which we have. The new thing about us is when you look at our capital position, the success we had in integrating the merger we closed and where we stand as an ever-dwindling number of Michigan domicile banks. We can choose to participate in M&A activity or not and -- or we can choose to focus on organic growth which is always our favorite way of growing or do a little bit of both. So where we are right now, John, is we -- listen, we are active participant in seeing what’s going on out there, but we try to be just like we build our organic portfolio very disciplined and making sure that we protect our shareholders and any delusion that we may expose them to has a proper earn back and a proper the result in the company is properly strong enough to justify doing it. So we are in the listening mode and sometime the talking mode and but if we didn’t do a deal, as I said in 16, 17 years doing this job at Mercantile, if we didn’t do a deal on the next couple of years, it wouldn’t surprise me, but if we did one that wouldn’t surprise me either. That’s really -- hopefully you don’t think it’s too evasive but actually that’s where we are at.

I hear what you are saying and maybe just one final question for you, Chuck, jut a follow-up on the one large credit that you moved to non-performing? You said that’s still paying as agreed under the, I guess, as you restructured it or?

Hey. I think, as Mike noted, it was paying as agreed when we put it on non-accrual and it continues to pay as agreed, I think what we are trying to say is that, as we work with the borrower, we made from time-to-time restructure, what they do have to pay from -- to us and trying to help them write the shift if you will. But they continue to make all the interest payment they continue to make. So it still coming in but again we’ve taken the conservative approach, we put it on non-accrual and any payments we do get from a book standpoint, we are putting 100% to the principle balance.

Okay. Fair enough. Thanks guys.

You bet. Thank you.

The next question comes from Daniel Cardenas of Raymond James. Please go ahead.

Good morning, guys.

Hi, Dan.

Just a quick credit quality question, maybe you could just more for house cleaning purposes, give me your balance of your TDRs at the end of the quarter?

Yeah. I got that, hey, Dan, performing TDRs were $22.1 million and our non-performing TDRS were $24.9 million.

Okay. Great. And then in terms of loan growth that you saw, could you maybe give us a little bit of color as to what’s line utilizations look like this quarter and how that compared to Q3?

Yeah. I think we continue to look at the lines of credit, we are not seeing any major changes to the percentage if you will that our borrowers are using their lines. Overall, our lines of credit are growing, because we are growing the loan portfolio in a nice percentage of that growth is with some C&I businesses. But, overall, we don’t see any major changes in to the degree that companies are using their lines.

Okay. Great. And then just one last question here, maybe if you could talk about competitive pressures and if there’s been any shift in terms of where those pressures are coming from, are they coming more from the larger banks or is it just kind of across the board?

Generally, you see it come from across the board but obviously some of the credits that we are working with tend to attract the larger competitors and so you’ve seen that a lot of cases from them. But in some cases, you see some competition from smaller banks, some credit unions that come in and work hard to obtain some of those smaller loan transactions. But as I said in my comments, our style of banking is one that based on relationships and we’ll offer a fair competitive price to the customer. It got to be a mutual beneficial relationship and we find time and time again that customers that want to work with us and because we’re able to provide a lot of intangible type of benefits that they see that they can obtain by banking with Mercantile. And while at the same time receiving a competitive package for their loans and all their financial services. They feel it’s an attractive opportunity for them to work with the bank that they can have a partnership with for a long time.

Okay. Great. Thanks guys.

Thank you, Dan.

[Operator Instructions] The next question comes from Stephen Geyen of D.A. Davidson. Please go ahead.

Hey, good morning.

Good morning.

You gave some interesting color about -- or commentary about kind of the outlook for loan growth and the loans that you -- the new loans generated in the fourth quarter, I guess roughly around $90 million. Looking out in 2015, do you expect the pull-through that kind of pick up in 2015 and paydowns to decline? I think you had commented earlier about responding to one question that paydowns may not be as high in 2015 on an ongoing basis as they were later half of 2014. So do you expect -- or you feel fairly comfortable that the pull-through in new loans is likely to pick up in 2015?

Frankly, as we look at our budgeting process for 2015 working with our head loan people and line lenders trying to get a sense as to which credits -- which loan situations might be at risk for payout for a variety of reasons that we talked about for 2014. We try to factor that into the numbers that we’re putting forth as far as what we see for potential net loan growth for 2015. And it is obviously just an estimate and sometimes the estimate might come up higher, it might come out low because it is such an uncertain situation. I think we’ve done a good job at this point of trying to identify the ones that maybe at risk for paying off and obviously you have a continued intense effort to drive down watch credits and that risk credits in the bank and so that will factor in it as well as some of the reason why credits left in 2014. So what we’re seeing is that we have a strong pipeline and while it will be somewhat muted by loan payouts, of course we’re projecting some good traction and what we’re seeing drop to the bottom line in terms of net portfolio growth, I think.

Okay. Very good. And then a last question, just curious about -- and I know that you commented a tough number to give, and it varies across whatever kind of comes into the bank. But as far as an average reserve that you are establishing for new loans, can you kind of give us what that has been in the last, say, quarter or two?

Yeah. It’s an interesting question, Stephen. And it’s up from that, as we go through our migration and we see less and less charge-offs. It’s obviously -- its good problem to have, I should back up and say that. It’s good problem to have. But as our charge-offs continue to be very nominal and we continue to get lot of recoveries actually, that does, from a migration standpoint, push down our allocation factors that we utilizes specially for commercial own program that’s divided in the five segments. And we get allocation factors by grade. It’s been to the point that some of the -- it’s even good enough to grade fours and even fives. Now some of the segment show a zero allocation, and then obviously adding some environmentals to that. But those cases just to ensure everybody, we did put in some de minimis amounts. So it’s a long answer to your short question. But we’re probably somewhere in the 40 to 70 basis points, if I had to venture, I guess, for the average credits that we’re booking.

Okay, great. Thanks again.

Okay.

The next question comes from Matthew Forgotson, a follow-up from Sandler O'Neill and Partners. Please go ahead.

Hi, gentlemen. Just one last question, just -- of the 13 FTEs, you added this quarter, I know some were lenders. But can you just give a complexion, say frontline versus back office, revenue producing versus non-revenue producing, of those 13 FTEs?

Yes. Matt, this is Chuck. A vast majority of those increases in FTEs pretty much reflect the fact that we had some openings at the end of September that were filled during the course of the fourth quarter. So most of them would be staff positions, backroom, as you called it, positions, they are not new positions, they were just vacancies that we had at the end of the third quarter that have been filled.

Okay. So do you expect to add -- continue to add to the back-office in 2015 or -- and for headcount to tick up as well?

No, the only thing that we continue to do is just fill in the vacancies that we have. Having gone through the merger and over the last several months and obviously a lot planning before that, have the right people in the right job. Obviously, like any company, any business, enterprise continues on ongoing basis you look who you have got doing and how they are doing it. And you obviously want to try to find some efficiencies. Bob already spoke to that. But overall, we don’t expect to hire any new staff, again just replace any vacancies that may come above.

And now that we have been -- Matt, this is Mike again, and now that we have been merged for a while, a better picture emerges as to the proper allocation of FTEs. And as Bob talked about earlier, that’s one of the key parts of the profitability initiatives that we’re taking a look at is, do we have the right people in the right places? Are we doing things the way that are most efficient? And I’m sure we’ll find some opportunities here, but we really are getting into that now because, as you might imagine, when you put an MOE together in the middle of the year, the first thing you got to protect is your customer base and your operational integrity and we have done a real good job of that, got a great staff that’s worked hard to do that. And now we are getting in some more. Okay, how do we do X? How do we do Y? Are there opportunities there? And if there are, how do we best do it? But our analysis is that we really won’t be adding the staff other than, as Chuck said, just replace folks that do leave or retire or whatever. And we may not replace them one for one. We may be able to find some efficiencies along those lines. So that’s kind of where we’re at.

A lot of what the process involves is going back and looking at the some of the assumptions that we made and preparing for the merger, and now that the merger has occurred and the dust is settling, to look back and see how are the estimates that we made. Are there some scope adjustments that we can make to gain more efficiency? Are there some opportunities to shift some job responsibilities around to make sure the people’s skills are matched with the job that they’re doing? And we all believe that there are some opportunities there that’s why we are excited about that potential there to continue to tune the machine and make sure the efficiencies are such that there is a good match of skills and jobs and that is going in a way that doesn’t grow the operational expenses.

Thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Michael Price, President and CEO for any closing remarks.

Thank you, Andrew. And thank you to all of you for your interest in our company. We look forward to talking again with you next quarter. At this time, we will end the call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.