Mercantile Bank Corporation (MBWM) Q1 2019 Earnings Report, Transcript and Summary

Good morning and welcome to the Mercantile Bank Corporation First Quarter 2019 Earnings Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mike Houston, Investor Relations. Please go ahead.

Thank you, Lisa. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the first quarter 2019. 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, SVP, Chief Operating Officer, and General Counsel. 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 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'd like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski. Bob?

Thank you, Mike, and good morning, everyone. Thank you all for joining us today. On the call, we'll provide an update on our overall performance and financial results along with our key areas of strategic focus. We will also discuss loan development, growth initiatives and asset quality. Afterwards, we will open the call for a Q&A session. We're very pleased with our start to 2019 with continued strength and core profitability and loan originations. The first quarter operating results represent a continuation of the robust performance delivered in 2018, which is supported by healthy loan pipelines, improved operating performance and balance sheet growth. This was evident in solid net revenue growth, a strong net interest margin, increased fee income, and controlled overhead costs. Our emphasis on building and cultivating value added relationships continues to successfully attract new customers, as well as retain existing clients. Relationship building is also important in the area of talent acquisition, and with that, we're pleased to add some experienced lenders to both the commercial and retail functions of the Bank. Based on our sound financial condition and healthier loan pipelines, we remain confident in our ability to take advantage of opportunities for growth within our markets and deliver solid operating results through the remainder of 2019. More specifically, our net interest margin remained solid during the first quarter of 2019, reflecting a continued focus on risk-based loan pricing and prudent underwriting. We're also encouraged that recent declines in residential mortgage loan rates are spurring increased refinance activity and should result in additional mortgage banking activity income. The enhancement of mortgage banking activity income through increased market share remains a priority for the Company. The success of our ongoing strategic initiatives has led to growth in certain fee income categories, while we have also demonstrated our ability to effectively manage overhead costs during the quarter. Ray and Chuck will provide more detail on all these areas momentarily. Turning to the Michigan economy, the directional trend remains positive. Employment in our primary markets continues to improve and real estate conditions remain healthy. Lastly, our cash dividend program and competitive dividend yield together with an active repurchase program demonstrate our commitment to enhancing the shareholder value. Mercantile repurchased approximately 119,000 shares for $3.6 million during the first quarter of 2019. In addition, we're pleased to have paid increased regular quarterly cash dividend as evidence of our confidence in the Bank's strong financial position and outlook. Mercantile's robust core profitability, solid capital position and healthy commercial and residential mortgage loan pipeline should provide us with a position of strength throughout the balance of the year as we remain confident in our ability to optimize future growth opportunities. That concludes my remarks and I'll turn it over to Ray.

Thanks Bob. During the first quarter of 2019, total loans grew by $47 million or nearly 7% on an annualized basis. Commercial term loans funded to new and current clients totaled approximately $125 million, reflecting ongoing sales and relationship building efforts. New commercial term loan originations during the quarter were in line with quarterly originations over the past few years as the commercial loan portfolio grew $40 million complemented by growth in the retail portfolio. Included in this number is $6 million in quarterly net loan growth achieved by our office in Southeast Michigan. This office, which opened in March of 2017, provided $40 million in incremental commercial and residential loans for 2018. Our residential mortgage portfolio grew for the 12th consecutive quarter, majority of which consisted of adjustable rate residential mortgage loans, which reflects the success of our strategic initiatives to increase our market penetration. Our current commercial loan and residential mortgage loan pipelines provide confidence that solid loan growth can be realized in future periods. Our net interest margin was 3.88% for the first quarter of 2019 and the yield on average earning assets equaled 4.89%, up from 4.7% during the prior year first quarter, primarily due to increased yield on commercial loans and a change in earning asset mix. We were positively impacted by higher interest rates and variable rate commercial loans stemming from actions of the Federal Open Market Committee, which raised the target federal funds rate by 25 basis points four times during 2018. On average, higher yielding loans represented 86.8% of earning assets during the first quarter of 2019, up from 84.4% during the prior year first quarter. While lower yielding interest earning deposits represented 2.1% of earning assets during the current year first quarter down from 4.1% during the corresponding 2018 periods. We delivered non-interest income during the first quarter of 2019 of $6.6 million compared to $4.4 million during the prior year first quarter. Non-interest income during the first quarter of 2019 included a Bank-owned life insurance claim of $1.3 million and a gain on the sale of a former branch facility of $0.6 million. Excluding these impacts, non-interest income still increased $0.4 million or 8.2% during the current year first quarter compared to the corresponding 2018 periods. The higher level of non-interest income primarily reflects increased mortgage banking activity and credit and debit card income as well as increases in service charges on accounts and payroll processing fees. Furthering mortgage banking income through increased market share remains a priority and we will continue to hire proven mortgage loan originators as we are able. We expect that these trends will continue along with increased refinancing activities due to declines in residential mortgage loan rates, creating opportunities to grow mortgage banking income. Our lending officers and Management continue attentive monitoring of our loan portfolio for potential signs of stress. Asset quality performance metrics for the first quarter reflected our strong portfolio with total non-performing assets of $4.5 million at March 31 or 0.13% of total assets. Total deposits at March 31, 2019 equaled $2.61 billion, an increase of $147 million since year end 2018. Local deposits and brokered deposits were up $75 million and $72.3 million respectively during the first three months of 2019. Growth in local deposits primarily resulted from a special time deposit campaign that was introduced mid first quarter along with an increase in business money market accounts. Wholesale funds were $570 million or approximately 18% of total funds as of March 31, 2019 compared to $474 million or approximately 16% of total funds at year-end 2018. A substantial portion of the growth in wholesale funds during the first quarter of 2019 occurred in January funding our strong loan growth recorded in late 2018 and early 2019 and offsetting typical and expected seasonal business deposit withdrawals used for bonus and tax payments as well as to maintain sufficient balance sheet liquidity. That concludes my comments. I will now turn the call over to Chuck.

Thanks Ray, and good morning to everybody. This morning, we announced net income of $11.8 million or $0.72 per diluted share for the first quarter of 2019. Comparatively, during the first quarter of 2018, we earned $10.9 million or $0.66 per diluted share. A Bank-owned life insurance claim and a gain on the sale of a former branch facility during the first quarter of 2019 increased net income by approximately $1.8 million or $0.11 per share, while the successful collection of certain purchase impaired commercial loan relationships during the prior year first quarter increased reported net income by approximately $1.7 million or $0.10 per diluted share. Excluding the impact of these specific transactions, diluted earnings per share increased $0.05 or nearly 9% during the current year first quarter compared to the prior year first quarter. 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 3.88% during the first quarter. Our net interest margin has benefited from the interest rate hikes by the FOMC over the past couple of years and has been further supported from the recording of interest income stemming from the periodic successful collection efforts on purchase impaired and certain originated impaired commercial loans. Our yield on earning assets increased 9 basis points during the first quarter compared to the linked quarter, in large part reflecting the increases in the prime and LIBOR rates in late 2018. Our cost of funds as a percent of average earning assets increased 19 basis points during the first quarter of 2019 compared to the fourth quarter of 2018, an accelerated level when compared to quarterly increases over the past couple of years. In large part reflecting the increase in interest rate environment, we've continued to see increased cost of funds from higher rates on certain money market deposit accounts, time deposits and borrowed funds. The additional increase during the first quarter primarily reflects a higher level of wholesale funds and a time deposit campaign. We increased our reliance on wholesale funds during the latter part of the fourth quarter and into the first month of the first quarter due to strong commercial loan fundings and seasonal business checking account withdrawals for tax and bonus payments. As expected, we are already seeing account withdraw - we are already seeing a replenishment of fund balances in business checking accounts, a process that typically takes us to the next two quarters. Based on our current liquidity position and funding projections, it appears that we will be able to reduce our wholesale funding reliance over the next couple of quarters and at least into the fourth quarter. As expected, we recorded $0.2 million in purchase loan accretion and payments received on CRE pool loans during the first quarter of 2019. Based on our most recent valuations and cash flow forecast on purchase loans, we expect to record additional quarterly interest income totaling about $0.2 million throughout the remainder of 2019. Also, we expect to receive in aggregate about $1.8 million in principal payments on purchase impaired CRE pool loans over the next several years, which will be courted as interest income upon receipt. We expect our net interest margin to be in a range of 3.70% to 3.75% during the second quarter and then in a range of 3.80% to 3.85% during the third and fourth quarters. The forecasted reduction during the second quarter reflects the elevated level of our balance sheet liquidity, which we expect to use to fund loan growth and wholesale funding maturities over the next two quarters. In addition, as just noted, we expect to see increases in business checking accounts over that same time period. The overall quality of our loan portfolio remains very strong with continued low levels of non-performing loans and loan charge-offs. Non-performing assets as a percent of total assets equaled only 13 basis points at the end of the first quarter. Loan charge-offs totaled just $0.2 million and net loan charge-offs equaled only $0.1 million during the first quarter. Provision expense for the first quarter totaled $0.9 million in large part reflecting commercial loan growth. We expect to record quarterly provision expense in the range of $0.5 million to $1.0 million throughout the remainder of 2019, assuming a steady economic environment. Our loan loss totaled $23.1 million at the end of the first quarter or 0.89% of total originated loans. This coverage ratio has remained steady for many quarters and no significant changes are expected during remainder of 2019. With regards to CECL, we have completed the quantitative framework and are working to complete the qualitative and economic modeling segments over the next few weeks. We expect to have the full CECL model up and running by the midpoint of second quarter and we will run the CECL model in parallel to our existing model through the end of 2019. We recorded non-interest income of $6.6 million during the first quarter of 2019, which includes the Bank-owned life insurance claim of $1.3 million and a gain on the sale of a former branch facility of $0.6 million. Excluding the impacts of these transactions, non-interest income increased by 8% when compared to the first quarter of 2018. We recorded increase in most fee income categories including treasury management fees, payroll processing revenue, mortgage banking activity income as well as credit and debit card fee income. We expect quarterly non-interest income to be in the range of $4.7 million to $5.0 million during the remainder of 2019. We recorded non-interest expense of $21.8 million during the first quarter of 2019, up about 3% when compared to the first quarter of 2018. The higher level of expense primarily resulted from increased salary cost, mainly reflecting one-time pay increases for all hourly employees that went into effect on April 1 of last year and annual employee merit pay increases. Currently, we expect quarterly non-interest expense to total in a range of $22.3 million to $22.8 million through remainder of 2019, with our effective tax rate remaining near 19%. Total deposits increased $147 million during the first quarter of 2019, split about equally between net growth and local deposits and net growth and broker deposits. Although, we experienced typical seasonal reductions of business checking account balances as noted earlier, we did record growth in time deposits and money market deposit accounts during the first quarter. For the remainder of 2019, we expect to see strong growth in business checking accounts stemming from the replenishment subsequent to first quarter tax and bonus payments along with new account growth associated with new C&I lending relationships. We discontinued our recent time deposit special in early April and plan to maintain our traditional time deposit pricing strategies for at least the near term. As of the end of the first quarter, wholesale funds comprised about 18% of total funds, up from 16% as of year-end 2018. The increase reflects the influx of broker deposits and FHLB advances to fund strong commercial loan growth and the seasonal business checking account withdrawals. Currently, we expect to reduce the level of wholesale funds throughout the second and third quarters and to at least the beginning of the fourth quarter ending 2019 at about 16%. We remain a well capitalized banking organization. As of March 31, 2019, our Bank's total risk-based capital ratio was 12.4% and in dollars was approximately $77 million higher than the 10% minimum required to be categorized as well capitalized. We were active in buying back our stock during the month of January, buying about 119,000 shares for approximately $3.6 million at an average price per share of $30.23. We currently have approximately $6 million available in our current buyback plan. Those are my prepared remarks. I'll now turn the call back over to Bob. Thank you.

Thanks Chuck. At this time, we'll now open the call to the question-and-answer session.

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

Just want to start off here with a few on the NIM outlook. So just want to make sure I understand correctly. So the 3.70% to 3.75% for the second quarter, that's a function of increased liquidity, which it looks like we saw on the period end balance sheet with the jump in cash equivalents, correct?

That's correct, Brendan.

Okay. So I guess, that sizable increase in liquidity didn't happen until later in the first quarter, hence not much margin impact in the 1Q?

Correct.

Okay, great. And then looking out beyond the 2Q, just kind of walk us through the puts and takes that took the margin outlook from the 3.85% to 3.90% previously to five basis points lower. I mean, I guess, it makes a whole lot of sense to me just given the shape of the curve, but just curious to hear your thoughts.

Yes, I think there's two things, one is the shape of the curve certainly had an impact and the other is just the overall increased level of wholesale funds. Moreover, I expect the average to probably between 16% and 17% for all of 2019. I think it was closer to 12% or 13% for most of 2018 and that's where we were for a majority of that year. So the shape of the yield curve obviously competitive pricing pressures remain not only on loans but certainly deposit accounts as well, but also just the overall level of wholesale funds and we continue to extend the duration of our wholesale funds, again it's a flat yield curve, but we haven't gone away from the idea that when we do bring in wholesale funds that we're going to primarily buy advances and even the broker deposits say in a three to seven year category to make sure that we're doing an appropriate interest rate risk management program with our fixed rate commercial loans.

And then one more from me before I step back just on mortgage banking. I mean, obviously, it was a strong start to the year that kind of bucked the typical seasonal decline that we normally see in the first quarter, and this is clearly a priority for you guys. Just kind of help us understand what the opportunities are in that business and that line item throughout the year?

Well, this is Bob. As we talked about the last couple of years now, this has been indeed a priority for us. And over the course of that time and continuing in the first quarter, we've been very pleased that we've been able to add new commissions, mortgage lenders that are very experienced and have good followings in their respective markets from which they reside. And with that, that has allowed us to continue to grow our mortgage banking activity as we said for the 12th consecutive quarter. With the rate situation being what it is now, there is even the possibility of getting into a little bit heavier refinance activity. But even if it doesn't, we're very optimistic and pleased with the fact of being able to generate a good volume with the new purchase activity that will be loans sold on secondary market and also loans retained in the portfolio based on the existing staff and the new lenders that have come on-board. So again, this has been a big focus for us and the management there continues to be on top of their game, looking to continue to make processes even more efficient to add quality individuals to the staff and to keep our processes going, so that the customer experience is excellent.

Our next question comes from Kevin Reevey of D.A. Davidson. Please go ahead.

So question is given competition and then we recently saw the Chemical TCF merger, are you seeing any opportunities to bring more new talent as a result of that recently announced transaction? And then if you could kind of talk about the competition for talent both on the commercial as well as residential lending side?

Yes. Kevin, this is Bob. As we talked about in past quarters, we continue to maintain ongoing dialogue with the people that we'd like to add to the Mercantile staff. Culture is very, very important to us. It's one of the most important things that we do and that we focus on. And then there are bankers out there, who we know would be a good fit for us, although timing may not be right at particular time. We continue to have ongoing dialogue and at some point in time there may be an opportunity or that person is ready to make a change. We also have been very successful of growing homegrown talent and continuing to train and mentor and grow the staff through Mercantile system and to have a good balance between folks, that we've grown internally and folks that we bring in from the outside. There are always opportunities out there with folks that are becoming unhappy with maybe their current situation, whether it be because of a recent merger or acquisition or other reasons. But we go back to the culture and it's a very - it's a very special situation and we want to make sure ,we maintain in our organization and bring only the best on board. That would be a good fit for the way we do business.

And then you mentioned earlier in your remarks, you hired some mortgage lenders, how many did you bring on and what market were they have…

This is Ray, we brought in three new mortgage lenders, all of them happened to be in the Grand Rapids market during this quarter.

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

First question is just want to talk little about loan growth, I mean it sounds like you guys remain pretty optimistic that favorable trends are going to continue. Bob can you kind of help frame, what you're expecting for a full year level of growth. Are you comfortable with the high single digit range, given a strong start in the first quarter?

Yes I'll start off and Ray can add and amplify. But I think as we talked about for several quarters now, our pipelines continue to be very strong, despite the fact that we have had some nice fundings, we've been able to replenish that pipeline, each quarter that goes along with new business and increased opportunities with existing clients.

Yes I would echo that and say that just emphasize the consistency of our efforts and results they've yielded from a funding standpoint. We expect that to continue. The unknown is how many of our assets - or how many of our customers will choose to sell assets or their businesses and thereby provide the counterpoints to the funding that we bring to our balance sheet, but, based on the events that we know, right now, that and the activity that we have to build and replenish our pipeline, we feel very good about what's coming up in the next quarters.

As we talked about for the last four years now, we've had each year over $500 million in new loan fundings. And depending on the payoffs as Ray alluded to, is how much that goes to the bottom line growth. But we've been very pleased with the fact that we're able to do that on a very consistent basis, in new and existing markets, and even overcome quarters when there are heavier loan payoffs to make sure we still have good growth on an annualized basis.

And you know along the way, your credit quality continues to be really strong. Are there any areas that you're seeing a little bit of stress across your footprint and maybe segments that you are not actively pursuing deals in?

We manage our portfolio for concentrations and monitor the activity within each of the segments. There are some that you know show a little bit more risk than others but none that are flashing warning signs at this point. We continue to follow certain industries and see cycles and seasonality through them. But by and large, the economy and the help of our client base continues to be as good as it has been in recent months and quarters and years.

And then just lastly on capital management, you guys noted, you are little bit active this quarter and buying back stock. I think you said there's about $6 million left in the current authorization. What are your thoughts on continuing to repurchase stock and potentially reopening the authorization?

Damon, this is Chuck, I think we're pleased with where our capital levels are at right now. If they were - we saw our Tier 1 leverage or our leverage capital down a little bit, we'd be okay with that, as obviously that benefits the ROE but we also going to be mindful of where we are in the cycle and making sure that we do, keep a little bit of powder in our capital base especially in relation as well to the potential loan growth that we see coming down the road. But we certainly want to be opportunistic, when it comes to buying back our shares. You know, like I said we were active in the first quarter with the average price little over $30. It's likely that the stock would have to drop down back to that level, before it would become active again. But obviously it is one of the tools that we have in our toolkit that we can go ahead and avail ourselves to. And when we look at our loan growth, which we think we'll be right around 7%, 8%, as we talked about and as we achieved in the first quarter, with our expected earnings performance and our cash dividend staying around 40%, that creates the capital ratios that are very, very steady for us. So we do have the opportunity to lower those capital ratio little bit through other means. But again, stress if we want to make sure that we do maintain some dry powder in there for events that may take place in future quarters. In regards to our current plan, we are working with our boards and with the Federal Reserve as required by their proclamations and putting a new plan together. So stay tuned on that.

This concludes our question-and-answer session. I would like to turn the conference back over to Bob Kaminski for any closing remarks.

Thank you very much. That concludes our conference call today. We appreciate your interest in our company, and we look forward to speaking with you again in July. The call has ended.

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