Good morning and welcome to the Mercantile Bank Corporation Fourth Quarter 2018 Earnings Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Mike Houston. 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 fourth quarter and full year 2018. I am Mike Houston with Lambert IR, Mercantile's investor relations firm. And joining me are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; Ray Reitsma, President of Mercantile Bank Michigan; and Bob Worthington, Senior Vice President, Chief Operating Officer, and General Counsel. We will begin the call with management's prepared remarks and then open up the call 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 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 today. 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’d like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski. Bob?

Thanks Mike and good morning everyone. Thank you all for joining us. As you saw this morning, Mercantile released its fourth quarter and full year 2018 financial results and announced an increase first quarter dividend as evidence of our confidence in the bank and commitment to enhancing total shareholder value. On the call today, we will provide an update on our overall performance, financial results, along with our key areas of strategic focus. We will also discuss loan development, growth initiatives and asset quality; afterwards we’ll open the call for question-and-answer session. As was outlined in the earnings release this morning, fourth quarter 2018 operating results represent a continuation of the strong performance demonstrated during the first nine months of the year, resulting from improved operating performance and balance sheet growth. This was evidenced in the healthy net interest margin, consistent loan funding which were produced from the ongoing strength of our commercial loan pipeline and another quarter of solid net loan growth and continuation of our improvement in an already sound asset quality. As a result, Mercantile reported a strong performance for fiscal 2018 with growth in total revenue and earnings per share. We are pleased with the increases in certain fee income categories and remain committed to controlling overhead cost, while at the same time investing in our people as we continue to prudently grow our business. Despite a reduced level of mortgage banking activity income in 2018 due to lack of inventory in our markets, and lower refinance activities, we are confident that the combined effects of our mortgage production strategies, consistently elevated level of pre-qualifications and focused efforts to sell a greater percentage of originated mortgage loans will lead to growth in our mortgage banking result. Ray and Chuck will provide more details on these areas…

Thanks Bob. During the fourth quarter, total loans grew by $55 million. Commercial term loans funded to new and current clients totaled a $136 million. We are very pleased with these results, as the level of new commercial term loan origination exceeded $500 million for the fourth consecutive year. Funding activities were consistent with the first nine months of 2018, contributing to a net loan growth rate of 7.6% during 2018. During the fourth quarter of the commercial loan portfolio over $54 million, included in this number is $10 million of loan growth funded by our Troy office, which opened in March of 2017. The office provided $40 million in incremental commercial and residential loans during 2018. Our commercial loan segments most notably the commercial and industrial loan portfolio grew during the year and our solid growth in commercial loans depicts our ongoing efforts to identify new lending opportunities and meet the credit needs of our existing customers. Note also that our pipelines continue to be solid. We entered 2019 with a pipeline that is consistent with the prior year and our current commitments to fund construction projects total a $170 million. We continue to build momentum in generating non-interest income with growth in credit and debit card fees, payroll processing revenue and treasury management income during the fourth quarter of 2018. As we look forward to growth in these areas and our business in our coming year, the strong results in the fourth quarter were more than offset by a decline in income from mortgage banking activity, although growth in these revenue streams during the full year of 2018 surpassed the decrease in mortgage banking activity income. While the increase in residential mortgage loans reflect the continuing success of our strategic initiatives that we are focused on expanding, our…

Thanks Ray and good morning everyone. This morning we announced net income of $11.6 million or $0.70 per diluted share for the fourth quarter of 2018. Comparatively during the fourth quarter of 2017, we earned $8 million or $0.48 per share. Net income for the full year of 2018 totaled $42 million or $2.53 per diluted share compared to $31.3 million or $1.90 per diluted share during the full year 2017. Net income during the fourth quarter and full year 2018 also benefitted from a reduction in the corporate federal income tax rate which was lowered from 35% to 21% effective January 1 of 2018, due to the enactment of the Tax Cuts and Jobs Act. Our year-to-date effective tax rate was approximately 19% during 2018 compared to about 32% during 2017. We remain pleased with our financial condition and earnings performance and believe we are very well positioned to continue to take advantage of lending and market opportunities, while delivering consistent results for our shareholders. Our net interest margin was 3.98% during the first quarter and 3.96% for all of 2018. Our net interest margin was 3.79% for all of 2017. Our net interest margin has benefited from the interest rate hike of the FOMC over the past couple of years, and was further supported from the recording of interest income that stem from periodic successful collection effort on purchased impaired and certain originated impaired commercial loans. Our yield on earnings assets increased 35 basis points during 2018, primarily reflecting a 31 basis points increase in our loan portfolio yield. Improved investment portfolio yield and a lower level of excess liquidity maintained at the Federal Reserve also positively impacted our yield on earnings assets. Our cost of funds as a percentage of average earning assets increased 9 basis points…

Thank you, Chuck. At this point in the call, we will now open it up to the questions-and-answer session.

[Operator Instructions] The first question is from Brendan Nosal of Sandler O'Neill & Partners. Please go ahead.

I just to start off here on the margin, so I believe you guys said 385 to 390 for full year 2019. If you look at where you ended the year, obviously a stronger number of 398 and even backing at the [PAAs], you’re kind of above that 390 mark. So, just curious as to your thoughts on – as to why it seems like the core margin could come down a little bit from here throughout 2019?

Yeah, Brendan, this is Chuck. Good question. I think there is really two primary reasons for that; one is the increase reliance on wholesale funds, certainly wholesale funding is more expensive than most local deposits, so there is some pressure there. And then second, as I noted, in my estimate and my range, we are not projecting any further interest rate increases which obviously have a very positive impact on our asset yield. So what we’re expecting is there is some lag in our cost of funds that we knew that once the interest rate environment did stop increasing from FOMC that there would be a lag effect on our cost of funds for a period of a few quarters, especially the first few quarters when we get in to that time period that we would see continued increases, albeit smaller than what we haven’t seen. But some increases in our cost of funds as we have some fixed rate CDs and the occasional FHLB advance that will mature, and will have to be refinanced at the higher rate environment. So I think it’s a combination of those two things that put us in to that 385 to 3.9% range.

Okay, that makes sense. And then if we were to see one or two rate hikes this year, I know it’s not expected why they currently, but if they were, do you still think the net interest margin would benefit from that?

Yeah, absolutely. We still have about 55% of our commercial loans are tied to floating rates as they have been. So we generally see under asset yield probably a 10 to 12 basis point increase every time the Federal Reserve increases the fed funds rate. So that will certainly continue. I was thinking if we do get those rate increases, we would see further increases in interest rates and deposits and FHLB advances and those types of things too. So there definitely would be an offset. But for the most part our asset yield would equal if not exceed I think those increases in the cost of funds as long as the fed keeps raising interest rates.

And last one from me before I step back, just looking at the average balance sheet this quarter, it looks like loans now make up about 88% of total earning assets. I’m just wondering how much more in mixing if any do you think could take place over the next couple of quarters or are you pretty much more or less tapped out remixing dynamics?

I think we’ll probably see that lower a little bit. One of the things that with our excess funds that we keep at the Federal Reserve, we do that at an average basis because there is quite a bit of volatility from day-to-day and week-to-week. And what we saw, what I saw going in to the fourth quarter is that our year-to-date average, we try to keep it around 40 million. I think our year-to-date average for the first nine months was still around 60 million to 65 million, because the first of last year we did have some excess liquidity that we no longer have, and so I let that $40 million average was much lower than that during the fourth quarter, as I just try to balance out that year-to-date average. Here in the first quarter and in to the second quarter we’ll build that back up closer to the $40 million mark. So, that 88% number that you talked about will likely be 86%, 87% for most of 2019, and that has some impact on the margin just questioning that earlier as well.

Your next question is from Kevin Reevey of D.A. Davidson & Company. Please go ahead.

First question is, I know when we talked last quarter, you had talked about three of your deposit gathering initiatives focused on a couple in London with deposit opportunities and then cross-selling your cash management product and the third leg of that was your leverage in your muni relationships. Can you give us an update as to where you stand on those three initiatives?

Yeah, I’ll touch on muni and then I’ll let Bob or Ray touch on the other ones in regards to the commercial lending efforts. On the municipal side, I think what we have been doing for the last year or two years, I think there’s kind of two groups here. We have some really strong and very much appreciated municipal relationships on the non-time deposits side. So from savings accounts and checking account and those we’ve definitely have kept strong relationships with. Sometimes those relations come with time deposits and we have been active and bidding on those time deposits as part of our entire relationship mantra with that. The public time deposits that we’ve been letting go over the last again year or two years are those that are those that are just time deposits customers only and those generally tend to municipalities that put their deposit opportunities out there for bid and so it could be anywhere from two to 10 banks are out there bidding, and those are the opportunities if you will that we’ve been kind of staying away from and shy off because of the very strong competitive market. But having said that, again if we go back to those relationships that we have that are strong banking relationships, we have their operating accounts, we have their savings account, we still have some very good time deposit relationships with those folks as we make sure that we make to continue to price those relationships on an overall basis and that will continue.

Kevin, this is Bob, our deposit issues remain. One of our most important areas of focus in 2019, I think what you saw in the fourth quarter was, we continue to maintain some very nice growth all year in non-interest bearing deposits especially on the commercial side. If you look at the fourth quarter, I think we were hampered a little bit by some spectacle seasonal patterns of deposit withdrawal that happened typically around year end. But be that as it may, the initiatives are something that Ray has reason to charge on and that is wrapped in to the focus that we have with prodding our treasury products and the ability to tie those together to get a complete customer wallet as far as deposit relationship which I think we do a very good job on. I think we’re also looking at some additional initiatives we expect to deposit only customers that are out there, and I think, like I have said from the standpoint of the focus of all of our calling officers, loan people, deposit people, everybody is focused with a great intent this year on gathering those local deposits.

And if I could just add, as we add commercial relationships we’ve done a very nice job of adding the full complemented treasury services, and our adoption rates by our clients has been very strong. So overtime that will certainly build a deposit base that accompanies those activities.

And then you had some pretty strong C&I loan growth in the quarter? What was your [long] utilization at the end of the fourth quarter, and can you remind us where that was at the end of the third quarter, and were there any particular industries or sectors that contributed to that growth?

Kevin, this is Chuck. I’ll talk on the line usages, its’ been staying pretty consistent right around 50%. So most of the vast majority of the C&I loan growth that you spoke off is really new relationships that have come to the bank not only during the quarter, but previous quarters that are now in a funding phase.

And I would add to that, that the nature of the relationships that we added, they came from consistent long term calling efforts and one of the more significant relationships that came in the bank was one that had been with its prior banks for decades, and consistent long term calling effort resulted the fruition of that relationship at our bank.

I think what we also see is the great diversity in our C&I pipeline that you look at the new customers that are coming on board. They are coming in from a variety of industries within our market and that’s encouraging because it shows the breadth of our client efforts, the breadth that our loan officers are engaging clients to develop relationships and as Ray said, when they do come to fruition, we’ll get some very nice victories there as we did with the customer that Ray mentioned.

[Operator Instructions] the next question comes from Damon DelMonte of KBW. Please go ahead.

Wonder if you could talk a little bit about loan growth and the outlook, and I think in your prepared comments you guys noted that the economy still seems to be holding up pretty good. How do you look at the state of the pipeline and do you think that could translate in to growth for 2019?

This is Ray, our pipelines are very consistent with what they’ve been in the past and for that matter economic environment is very consistent with what we’ve seen in the past as our customers, suppliers with ongoing results that certainly seems to be the case. So we really don’t expect the results that come out of the pipeline or the impact of the economy to be much different in the very near future than it has been in the past.

And the nice thing that we’re seeing is that despite the nice, consistent strong level of funding that we saw in the fourth quarter and resulted in net loan growth, the pipeline has been remaining amazingly consistent which shows that lenders are out there continuing to develop new relationships and replenishing the pipeline, keeping at the same level as it was despite some very nice loan funding during the quarter.

And if I can just add to pile on your answers here, I think you get from Ray and Bob’s comments that we feel pretty confident that our funding can be similar to what they’ve been over the last few years, and you know for commercial loans we’ve had over $500 million in new term funding over the last four years. We see the environment for our comments that that would be, it seems to us that it would be relatively consistent if the economy continues to hold throughout this year. As we always talk about the big unknown, the thing that’s the hardest to predict are the pay-offs and it was gratifying to see that the pay-offs some of which we want certainly, but the pay-offs in 2018 were actually a little bit lower that what we see saw than what we saw especially 2017. So our gross funding were actually a little bit lower in 2018, but our net loan growth was higher, because we didn’t have quite the level of loan pay-offs. But on overall basis, we’re budgeting, forecasting our net loan growth to be similar to what it was last year in that 7% to 8% range.

And then with respect to the margin this quarter, Chuck, were there any benefits from interest recoveries, I think you may have mentioned something like that in your remarks?

Yeah, there was a little bit. When we talk about interest recovery, I assume you’re talking about originated loans. I think we might have had about a basis point, but we certainly got some more purchase income as we talked about, I think it was 600,000 which is about 400,000 more than what our forecast were and that was primarily through one pay-off of purchased impaired loan that we got there in the fourth quarter. That was the one of those CRE loans. So we got a few basis points there.

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

Quick question, I think Chuck you mentioned that your wholesale funds were about 18%. Right now is that correct?

It’s 16% right now.

16%. Okay, so as you kind of look at that total, where is kind of the maximum that you guys want the wholesale funds to represent?

We really don’t want to get over 20%; we like to keep it around 15%. We’re projecting probably close to 16%, 17% for this year, just given some of the dynamics that happened especially the strong loan growth through the fourth quarter and the ongoing strong loan growth and the fact that we do need to get our excess liquidity back up to where we wanted overtime. So 16%, 17% is probably what we’re shooting for this year. That’s a level that we’re comfortable with. Again for my comments, not only on this call, but in previous comments in investor meetings and stuff is. If we have to go out there and get the wholesale funds which obviously we do have to from time to time given our strong loan growth. The good part of that is it does allow us to do some really good things we believe in managing our interest rate risk. And while we like the 55% of commercial loans that are floating rates, the other 45% are fixed rate primarily, especially on the real estate side, our five year fixed rate balloon. If we have to get the wholesale funding standpoint to fund loan growth, there is definitely an advantage to be able to go out there to the federal home loan bank systems and get those advances in those 3 to 7 year term that I mentioned and do what we believe is a prudent thing in managing our longer term interest rate risk.

And then maybe just kind of jumping over to the loan side, when you look at your growth expectations for 2019, can you give us a little bit of color as to geographically where most of that growth – I’m assuming most of that growth is coming from the western part of the state. But may be some update as to what the footings look like on the eastern part of the state and may be some thoughts on expectations for talent additions in ’19?

Dan, this is Bob. I think your assumption is correct that the majority of the growth will come from our activities here in west Michigan that is our largest and strongest market that we’ve had for a long time. We are expecting some nice growth in the markets in southeast Michigan based in Troy. Those folks are doing a very good job over there, and I think that’s an area that has tremendous potential and the size of the market alone will give us some very good opportunities. So we look forward to continuing to lever to opportunities as we go in to 2019 and beyond as well. That said, I think if you look all the rest of our markets including some of the smaller rural markets, we are some good activities in the pipelines from those areas. Certainly not to the size comparison that you get in the west Michigan and Detroit area, but there are some nice activities happening there and some nice opportunities that we’re leveraging as well in the company. So the regarding your question on talent acquisition, we are always looking to add new folks to the Mercantile team, but that’s been our culture, that’s the most important thing. Over the course of any year, we maintain conversations with people in our various markets and we know who the people are that we’d like, we think will be a good fit for the Mercantile team and we’d like to have them on board at some point, so we maintain conversations and at some point the time might be right to add that person on the team. And as we’ve said in the past, culture is extremely important to us and so we maintain a very flexible approach to having conversations with people as we gain a sense that they will fit our culture and redevelop plans and strategies to eventually have them join the team, if their situations changes down the road with their current employer.

And then last question, just on the buyback, given just kind of where the stock is right now, kind of at $34-ish level. I mean is that – quells your appetite for buying back stock or is this a price level that would still kind of peak your interest?

Dan, this is Chuck. I think the $34 is in our opinion and in discussions with our Board get a little bit lofty from what we are trying to accomplish from buying back our stock. So we’ve been very active certainly when it was in the upper 20s and even low 30s. Obviously we like what the stocks’ doing this morning, hopefully it holds, but word is right at this minute it’s starting to get above our target where we would be active.

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 Bob Kaminski for closing remarks.

Thank you for joining us on our call today. We certainly appreciate your interest in our company and we look forward to talking with you again after the end of first quarter. That concludes our call. Thanks again.

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