Mercantile Bank Corporation (MBWM) Q4 2015 Earnings Report, Transcript and Summary

Good morning, and welcome to the Mercantile Bank Corporation Fourth Quarter 2015 Earnings Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Robert Burton from Lambert, Edwards, Investor Relations. Please go ahead sir.

Thank you, Laura. 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 fourth quarter and full year of 2015. 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 Web site, 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 fourth quarter and full year 2015 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'll agree with me that 2015 was a very successful year for Mercantile. We've completed our first full year following the 2014 merger with Firstbank and on metric-after-metric our results have been outstanding. While full year-over-year comparisons are affected by the fact that the merger was completed in mid-2014, whether you examine progress from a quarter-to-quarter or compare second half of both years, the Mercantile team has delivered on key performance metrics like net interest margin, fee income, loan origination, asset quality and asset quality to name several among many. This was a strong performance that lays the basis for continued success that upon review we're very pleased with the effectiveness of the merger integration, the strength of our Bank, the dedication of our team and market opportunities we see ahead. In particular, let me point out several accomplishments and areas of strategic focus that underline our optimism for 2016. New loan generation totaled $532 million for 2015 and reached $167 million in the fourth quarter. Bob Kaminski will detail the health of our markets and the strength of our customer base in his comments in a moment. Mercantile has been consistently successful in realizing the projected benefits of the Firstbank merger. 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 slow interest rate environment. This rebalancing is a competitive advantage that can enhance the spreads at which we do business in the year to come. Non-interest income performed above expectations for 2015, as we've worked hard to develop stronger fee income both on card services and in our mortgage banking area. Asset quality continues to improve as non-performing assets and loans in the 30 to 89 day delinquent category declined again from the third quarter. On an annual basis non-performing assets have declined by 79% from 31.4 million to 6.7 million. As evidence of our strong capital position and demonstrating our commitment to shareholder return, we earlier today announced a quarterly cash dividend of $0.16 per share payable for the first quarter 2016, providing an annual yield of about 2.9% based on our current share price. Looking forward to 2016, we see further opportunity to participate in the economic strength of our markets as Michigan's premier community Bank. The area's economic indicators remain positive suggesting growth will continue through the coming months. At this time, I'd like to turn our call over to Chuck.

Thanks, Mike, and good morning everybody. This morning we announced net income of $6.5 million for the fourth quarter of last year, and net income of $27 million for all of 2015. On a dilutive earnings per share basis, we earned $0.40 during the fourth quarter and $1.62 for all of 2015. As mike mentioned, given that the merger with Firstbank was effective on June 01, 2014, comparisons between 2015 and 2014 can be difficult to make. However, we are pleased to report that our 2015 results reflect a successful integration of the two banking organizations and the leveraging of the strengths that each organization provided to the new company. We are very pleased with our financial position and earnings performance for the fourth quarter in all of 2015. We believe we are very well positioned to take advantage of lending and market opportunities to enhance our strong position as Michigan's community Bank, while delivering consistent results for our shareholders. Our net interest margin was 3.81% during the fourth quarter continuing a relatively stable trend during 2015, in which the margin range from 3.81% to 3.87%. The stability of our net interest margin primarily reflects our ongoing strategy to fund a large portion of our net loan growth with moneys from the lower yielding securities portfolio. Average loans represented 84% of average earning assets during the fourth quarter of 2015, compared to 79% during the fourth quarter of 2014. In large part 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 earnings assets has remained in the tight range of just 7 basis points. We reported loan discount accretion totaling $1.1 million during the fourth quarter, lower than the prior fourth quarters but in line with our expectation. Based on our most recent evaluations, we currently expect to record further quoted loan discount accretion totaling $1.0 million to $1.2 million during 2016. As a reminder, 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 cost of funds during the fourth quarter of 2015 was relatively unchanged from the third quarter. Our cost of funds had increased 3 basis points during the third quarter compared to the second quarter, in large part reflecting the completion of purchase accounting fair value adjustments relating to Firstbank's time deposit portfolio at the end of July. We have been recording a quarterly reduction and interest expense of almost $0.6 million, which declined to about $0.2 million during the third quarter again when it ended. We expect our net interest margin to be in a range of 3.75% to 3.85% throughout 2016. This assumes no further rate changes from the Fed. While the ongoing very low interest rate environment continues to observe compression pressure on our net interest margin, the recent Fed rate increase provided some relief and we expect to continue to use cash flows for monthly downs 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 a portion of our expected loan growth during the first half of 2016. 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, had produced a positive impact on our loan loss reserve calculation and allowed us to make no or negative provisions in 11 consecutive quarters and in 14 out of the last 15 quarters through September 30th. We did record a positive provision expense of $0.5 million during the fourth quarter, in large part reflecting net loan growth, but did record a negative provision expense of $1.0 million during all of 2015. We expect to record quarterly provision expense of $0.5 million to $1.0 million during 2016. Gross loan charge-offs totaled $1.3 million during the fourth quarter, and totaled $6.3 million for all of 2015. Recoveries of prior period loan charge-offs equaled $0.3 million during the fourth quarter and totaled $2.9 million for the whole year. Resulting annualized net loan charge-offs as a percent of average total loans were 0.17% during the fourth quarter and 0.15% during the full year. A vast majority of the gross loan charge-offs in 2015 was associated with a large commercial credit that was resolved during the second quarter. Our loan loss reserve totaled $15.7 million at the end of the 2015. The reserve for originated loans at $15.2 million equaled 0.94% of total originated loans at year-end. We recorded non-interest income of $4 million during the fourth quarter of 2015 reflecting a $0.7 million increase compared to the fourth quarter of 2014. The improvement was led by higher credit and debit card usage fees and mortgage banking income, as well as recoveries on legacy Firstbank loans that have been charged-off prior to the date of our merger. With caution that mortgage banking income and recoveries and a certain acquired charge-off loans can be difficult to forecast, we expect quarterly non-interest income during 2016 to be in a range of $3.7 million to $4 million. We recorded non-interest expense of $20.1 million during the fourth quarter of 2015, an increase of $0.5 million from the fourth quarter of the prior year and just slightly ahead of the high-end of our guidance provided during the third quarter earnings conference call. During the quarter, we expensed about $0.8 million associated with the efficiency program we announced in late October, in large part reflecting accruals for severance payments. Expenses related to the efficiency program are expected to be less than $0.1 million during the first quarter of this year. And as we indicated in the efficiency program press release, annual cost savings are expected to total $2.7 million pretax beginning on January 1st. We expect quarterly non-interest expense to total between $19.0 million and $19.5 million during 2016 with our effective tax rate at around 31%. We remain a well capitalized banking organization. As of year-end, our Bank’s total risk-based capital ratio was 13.5% and in dollars it was approximately $90 million higher than the 10% minimum required to be categorized as well capitalized. As part of a $20 million common stock repurchase program that we announced in January of 2015, we repurchased approximately 789,000 shares at an average price of about $20 per share or approximately $15.8 million during 2015. Funding for the stock repurchase program has generally been provided via cash dividends from our Bank and any further stock purchases would 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. Mercantile finished 2015 in strong fashion, especially with regard to client acquisition and loan growth. For the quarter, net loan growth was $60 million, reflecting new loans funded to new and existing customers of $167 million. For all of 2015, total loans grew $188 million through funding of $532 million. Management is pleased with the new client activity in 2015 as our sales team has many successes with the promotion of our mutually beneficial relationship banking approach. Competition is very intense, both in terms of pricing and structure. The banker organizations have been very aggressive. Our ongoing philosophy is to remain vigilant to the principles of sound credit underwriting and structure loan based on risk profile of the borrower. Pricing is also based on the risk inherent in the loan request and determined based on our internal pricing models. This consistent approach to loan underwriting continues to resonate with our customers and existing customers and prospective clients and has created some great new loan opportunities for Mercantile. The growth in 2015 demonstrates the gains from that approach and loan funding and prospect pipeline remains solid for 2016. In October, we announced some efficiency initiatives that included the closing of five underperforming branch locations in West and Central Michigan. The initiatives are consistent with our strategic plan, which focuses on appropriate allocation of resources to the markets we serve which present the greatest potential for our client acquisitions and growth. The closures of the five branches will be completed in early March. Much care has been taken to ensure minimal disruption for any customers as a result of the efficiency initiatives. Asset quality continues to perform at a strong level. For the fourth quarter, non-performing assets were $6.7 million, down from 10.5 million at September 30 and 31.4 million at December 31 2014. Regarding the general economic activity in Michigan, while the state is not without its share of challenges, Michigan continues to benefit from strong job growth in the automotive and parts manufacturing subsectors. The state’s unemployment rate dropped to 5.1% as of the state’s fiscal year ending September 30th. Additionally, residential real estate market continued to improve, particularly in West Michigan. Home prices increased 5.9% in the third quarter ahead of the national pace of 5.7%. Despite the positive performance metrics for the state’s economy, we remain watchful for signs of overexpansion and saturation in various subsectors and the possible for shadowing of the timing of a more widespread economic slowdown and the impact of those factors that they may have on some of our customers. Those are my prepared remarks on the fourth quarter. I’ll now turn it back over to Mike.

Thank you, Bob. And thank you Chuck for your comments as well. At this time, we would like to open the call up to questions Laura.

I guess my first question is on -- I know you guys mentioned that you're going to continue to shift the mix in the earning assets, Chuck how comfortable or how low should we expect the securities to become as a percentage of earning assets?

Yes we look at it -- I don't have that specific number but I look at it as 11% of total assets.

Okay.

So I think we are about a 1% or 2% away from that at year-end.

Okay.

I think the price is expected to get there sometime during the second quarter.

Okay, great. And from an interest rate sensitivity perspective, what percentage of the loan portfolio is variable and how quickly does that begin to re-price once rates eventually do rise?

Yes, our portfolio has stayed relatively steady over the last quite a few years now and even combining with Firstbank, so there is -- we didn't see a lot of change, but half of our loan portfolio is floating rate and if I remember the numbers correctly, when the Fed raised rates last month we had about half of that re-priced maybe 60% of that re-priced and then with that rate increase over the whole slew of loans that were at floors, that are no longer at floors. So I think and I mean I can verify this data later but I think about three fourths of our floating rate loans will price on the next increase Fed increase, assuming there is one and then when we get another two or three on top of that, virtually all of our loans will actually float.

Okay, great. And then the tax rate this quarter, I think it was a little bit lower than what we're looking for, is there anything do you need for this quarter or this is an year-end true ups?

Yes, exactly it was year-end true ups, obviously we're using estimates throughout the year and then when we put our year-end financial figure, we actually go through all of our calculations on a actual basis and true it up, so like I said, I'd expect our rates to be right around that 31% level for 2016.

Okay. And then just my last question then I'll hop out, probably more directed to Mike, with regards to M&A, can you just give us a little update on, your thoughts on M&A and would you characterize recent discussion activity to be increasing and if so what are your prospects for potentially doing a deal on 2016?

Yes Damon, the fourth quarter is typically pretty quiet for M&A just because everybody is generally tied up with the holidays and more importantly year-ends and that type of things. So I would portrait it at about the same level it was at the end of the third quarter and that is, there is a lot of activity, there is a lot of talking, but there is still some headway as far as what sellers in the State of Michigan are thinking that their franchises are worth and what we're willing to pay and that's a healthy discussion that goes back and forth. I mean sure that we protect our shareholders’ interest in the right way, but we always say the same thing and then it would be true for 2016, we continue to look out there for any deals that might make some sense, but organic growth is always our main focus, but if we find something like Firstbank which was a great deal for both franchises to put together we'll certainly pursue it.

And along those lines would you be open to doing something similar to Firstbank as far as size-wise where it's potentially a Bank of a similar asset size or are you guys think your better opportunity is something that's smaller that, is a much smaller percentage of your total assets that could just be folded into Mercantile?

Yes well at the time we did Firstbank, obviously as you know it was a merger of equals and to do a merger of equals today would be substantially bigger than that one. So to frame the question there, framing the answer right, could be do another one that was a same size as the Firstbank and 1.5 billion, yes, I think we've shown that we could do that extremely well, while are there other deals that might make some sense at a smaller size yes, so certainly there is some opportunities out there as well.

The next question will come from Matthew Forgotson of Sandler O'Neill.

In terms of loan growth, I guess we had a 9% increase year-on-year in 2015. Can you give us a sense of what we should expect in 2016?

This is Bob. I think if you look at some metrics of our pipeline and what we're doing in each of our markets, I think you can get a look for a year that will be very similar to 2015 in terms of the loan growth potential that's out there, obviously we still have some good boost coming in from construction draws and projects that we've committed to and closed during 2015 and that will certainly help. We also have some very nice opportunities that we're seeing in all of our markets and most significantly here in Grand Rapids down in Kalamazoo, in West Michigan on the commercial industrial side, as well as some high performing commercial real-estate types of projects as well. So, we're seeing opportunities in all segments of the portfolio there in the commercial side and if had to frame 2016 as we see it, here today it would be a similar potential year that we had from the looks of 2015.

Yes. And just staying there for a second, can you give me a sense of the marginal spread on the new production, the yield on a blended basis, less the incremental funding costs? Trying to get a sense of how that relates to your core margin and the dynamics there.

Yes. Now that's a loaded question, this is Chuck. And obviously we have a pretty -- we have a formalized loan pricing model for our commercial loans. That as you might expect take a lot of items into account, obviously the cost of funds, incremental cost of funds certainly the credit quality of the loan played a significant role, additional services and products that they may use, certainly their deposit relationship comes into play as well. We haven't really, we haven't changed the pricing model obviously the cost of funds adjust and we make some tweaks here and there, but the pricing model we came up with several years ago now has served us very-very well. So, putting all that into a perspective, we saw that during 2015 our loan yield was going down, about 1 basis point or 2 per month and I don’t think it will go down that aggressive just the Fed increase has helped us quite a bit there, but the loan yields on an overall basis was to go down 2 or 3 basis points per quarter at the rates that we're at right now and the environment that we're operating in, on a competitive basis I wouldn't be surprised, and that's kind of what we budgeted for 2016. So, I think there'll be somewhat of a decline on our loan yield, but not to the degree that it was last year.

Okay. And then just shifting over to expenses, just at a high level, if you take the 19.3 million of core OpEx in the fourth quarter of ’15 and then you strip out the 675,000 or so of expense savings from the efficiency initiative, back of the envelope suggests expense run rate could dip down towards 18.6 million or so per quarter. How do you reconcile that 18.6 million with the 19 million to 19.5 million guidance that you are projecting per quarter across ’16?

A lot of that interest can be merit increases, obviously all of our officers get pay raises coming January 1st, they will be -- we run that through, obviously our budget went into, obviously played a role in putting together our guidance. And there's -- the other inflations out there, so we looked at some of our major contracts, professional services that we use and try to make sure that we accounted for those things. So, while there's definitely savings every year you do have some areas that have increases in them as well.

Okay. And then just lastly, and then I'll hop out, in terms of the charge-off provisioning dynamic, is it fair to say that 4Q ’15 is normalized, and that we should expect you to continue to provide for growth here on out?

Yes, I gave you my guidance of $0.5 million to $1 million per quarter and a vast majority of that is reflective of booking the new net loans and the reserve that would come off of that which when we do our number calculation keeps that reserve to originated loans pretty consistent at just under 1%.

And our next question is from John Rodis of FIG Partners.

Actually I guess, Chuck a question for you a quick on I guess operating expenses your guidance of 19 million to 19.5 million that includes the cost savings of 2.7 million annually, is that correct?

That's correct.

And then I guess Chuck maybe another question for you just on the share buybacks, so I guess you'd leave around 200,000 shares. Can you talk about maybe your appetite given where the stock is trading today around 23, you guys weren't as active in the fourth quarter and I assume that's just because of a function of the stock price and so forth?

Yes. We've been very-very consistent with how we've operated our stock buyback program throughout 2015 and don't plan to make any changes here in 2016 when our expectations is we'll fully utilize that we got about 4.2 million less than that plan. We don't want to be the driver of the market, we want to be more opportunistic and that's what we have been and you're right on with the nice run that we had in our stock price throughout most of the fourth quarter. We did a little bit of buying towards the beginning of it, but pretty much stayed on the sidelines thereafter obviously looking at it each and every day. Certainly there's been a fall off in our stock price and well as covered from today it is certainly, it's quite a bit below where we saw our stock trading for a good portion of the fourth quarter. So, it seems to us that we've got some opportunity here coming out of our Blackout period starting on Friday. There could be some opportunities to buy some additional shares and continue to utilize that plan that's out there.

Okay. Bob maybe just a quick question for you on the loan growth obviously you guys continue to put up good growth numbers. As far as the growth this quarter, was it fairly granular, were there any bigger credits, can you just talk about that a little bit?

It's -- we had a couple of larger credits that funded this quarter, we had some pay downs and when that results felled into the numbers you saw I think the growth that we saw from this quarter came from our West Michigan area and was really commercial industrial related and in terms of the type of loan, but as I mentioned earlier would, we still have some good opportunities that we will see from funding of construction projects that continue to go into the spring month of 2016 and that will provide some boost for us as well.

And when you say, a couple of larger credits can you sort of talk about what sort of size?

The growth in the West Michigan market was primarily Grand Rapids and Kalamazoo, I think if you look at a larger credit with some more in the range of $40 million or $50 million on the loan credit and then there was some other significant fundings that made it the rest to the amount.

Okay. So one credit at $40 million to $50 million?

Right.

Okay. And can you provide what industry or what category?

Yes, it was commercial industrial in nature.

Okay. And that was in the West Michigan?

Right.

And the next question will come from Eric Grubelich, Bank Investor.

Just wanted to get a follow-up on two things, one, on the margin guidance I think you can correct me Chuck if you were basically saying that your guidance did not include any further increase in rates part to Fed?

That's correct.

Okay. So obviously if there is a further rate increase something like curve doesn’t do something crazy that would be positive?

That's correct as well.

Okay. And then just for Mike maybe, just going back to the M&A comment, regardless of size of what you might look at how about geography, is there any chance that you might move out of Michigan?

Yes, there is always a chance I mean we prefer to look at stuff that's within the state, but we have taken some cursory looks that have things in some neighboring state. So again if you look at a purchase price, the dynamics of the company, the mission of the companies’ performance and how it melts with our strategic initiatives if it's something that fit we certainly would be willing to look at something most likely in a continuous state.

Yes, the reason why I asked is there are a couple of -- as you know, there are a couple of deals in Wisconsin recently a small one and a relatively larger deal. So that's why I was curious. Okay thanks very much.

[Operator Instructions] Our next question will come from Daniel Cardenas of Raymond James.

Just quickly if you could remind me what's your quarterly cash flows from your security portfolio?

That varies quite a bit depending on the call activity. We get about between 2 million to 2.5 million a month Dan in mortgage-backed pay downs, then it's just the matter of we got at least the maturity is pretty much a ladder when it comes to the government of agency and the municipal bond portfolio, but obviously and we got one this morning occasionally we will get calls that are coming in. So we probably have kind of put it -- wrap it up for you, we probably have about $15 million in excess right now and I would expect to burn through that by the time we get to the mid of the second quarter.

Okay, great. And then maybe some color on deposit competition right now. Are you seeing anybody starting to get a little bit nervous, and priced a little bit more competitively on the deposit side?

I think we started -- on the non-CD side no, really haven’t seen much deposit rate pressures there, everybody was for the most part pretty much hands off with the Fed increase of last month, so haven’t seen any changes there, I haven’t seen any pickup and competition with those types of products. I think it is probably a little bit early for that given where rates are still obviously historically very-very low. CD rates we actually started seeing some competition pop-up in the second half of last year, and it continues, and is as typical it is driven by just a couple of different banks that are out there that generally have at least one that I see have some pretty big mortgage operation, so I think they are using especially the jumbo end-market and the public unit market to help fund their warehousing. The credit unions are always tough when it comes to the deposit rates and certainly the CDs kind of lead that, so I think from a banking perspective the other community banks out there, our other and larger competitors really haven’t seen much on the deposit side at all from a competitive standpoint.

Okay, good. And then just one quick question, in your press release you reference some recent hires on the commercial lending side, were these fourth quarter hires or where these of previous quarters?

Spread out a little bit in the second half of the year, fourth quarter and prior to that.

And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Price for any closing remarks.

Thank you, Laura. And thank you all for your interest in our Company today. We look forward to talking with you again after our first quarter results.

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