Good morning, and welcome to the Mercantile Bank Corporation Third Quarter 2019 Earnings Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mike Houston of Investor Relations. Please go ahead.

Thank you, Eileen. 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 third quarter 2019. I'm Mike Houston with Lambert IR, Mercantile's Investor Relations firm. And joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, President of Mercantile Bank, Michigan. We'll 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?

Thanks, 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. At the conclusion of our comments, we'll open the call for a question-and-answer session. We are pleased again to deliver solid operating results for the third quarter, continuing our year-to-date strength. The bank's strong financial condition, accelerating commercial and residential mortgage loan originations and solid loan pipelines give us confidence that the healthy results achieved during the first nine months of the year will provide the foundation for continued strong performance through the rest of 2019 and in future periods. The third quarter operating performance includes growth in net interest income resulting primarily from a higher level of earning assets. Interest margin remains solid despite rate reductions by the FOMC, reflecting our ongoing emphasis on loan pricing discipline and sound underwriting. Chuck will discuss the margin in more detail later. Our team's emphasis on building and cultivating value-added relationships continues to successfully attract new customers as well as retain existing clients. Increased non-interest income also led to improved earnings for the quarter. The increase in mortgage banking activity fees was primarily driven by the ongoing success of strategic initiatives that were put in place several quarters ago. Mortgage banking results were also boosted by increase in mortgage refinance activity and a higher percentage of our loan production being sold. Growth in mortgage banking income for expanded market share remains a priority for our company. Our strong team of mortgage bankers, coupled with our wide range of products and services, allows us to continue to build deep and meaningful client relationships throughout our market. Regarding non-interest expense, we remain pleased with our work of -- with…

Thanks, Bob. We are pleased to report loan growth during the third quarter, which represents a 7% annualized growth rate. New commercial term loan originations remained strong during the quarter, representing the highest quarterly level since the second quarter of 2016. Approximately $153 million and $412 million in commercial term loans to new and existing borrowers were originated during the third quarter and the first nine months of 2019 respectively as our lending team continues its focus on identifying new customer relationships and meeting the needs of our existing customer base. Our pipeline remains solid as well with $91 million for commitments in commercial construction and development loans, which we expect to fund over the next 12 to 18 months. Our asset quality is sterling as non-performing assets declined to $2.9 million or less than one-tenth of 1% total assets at September 3rd. Recorded non-interest income during the third quarter was $6.7 million, up $2 million or nearly 42% from the prior year third quarter. This improved level of non-interest income was largely driven by increased mortgage banking, reflecting the success of ongoing strategic initiatives designed to increase market share, a higher level of refinance activity stemming from a recent decrease in rates and an increased percentage of loans sold, continuing to enhance mortgage banking income through increased market share, including an increased share in the purchase market, remains a priority and we will continue to hire proven mortgage loan originators as we are able. We also recorded continued growth during the quarter in other fee income categories, including credit and debit card income, service charges on accounts and payroll processing fees. We exercised discipline related to overhead costs as we focus on efficient delivery systems and all of our lines of business remains a priority. That concludes my comments. I will now turn the call over to Chuck.

Thank you, Ray. Good morning, everybody. This morning, we announced net income of $12.6 million or $0.77 per diluted share for the third quarter of 2019 compared to third quarter of 2018 net income of $10.1 million or $0.61 per diluted share. Net income for the first nine months of 2019 totaled $36.1 million or $2.20 per diluted share compared to net income of $30.5 million or $1.83 per diluted share during the first nine months of 2018. Bank-owned life insurance claims and a gain on the sale of a former branch facility increased net income during the first nine months of 2018 by approximately $3.1 million or $0.19 per diluted share. Interest income related to purchased loan accounting entries increased net income during the first nine months of 2019 by $0.9 million or $0.05 per diluted share and net income during the first nine months of 2018 by $2.7 million or $0.16 per diluted share. Excluding the impacts of these transactions, diluted earnings per share increased $0.29, or over 17%, during the first nine months of 2019 compared to the respective 2018 period. 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 3.71% during the third quarter compared to 3.79% during the second quarter of 2019. The decline in large part reflects the FOMC's decision to lower the federal funds rate by 25 basis points on July 31st, along with another 25 basis points in mid-September. About 53% of our commercial loans or approximately 36% of our total assets are tied to either The Wall Street Journal Prime Rate or the 30-day LIBOR rate. As a result, our yield…

Thank you, Chuck. That concludes management's prepared remarks. I'll open the call up to a Q&A.

[Operator Instructions] The first question comes from Kevin Reevey with D.A. Davidson.

Good morning.

Hi, good morning.

How are you?

Pretty good.

So, first question is related to your commercial loan book -- what percentage of the variable rate portion of your commercial loan book contains floors. And if you can kind of talk about the amount of floors you're putting on new loans if at all and where those rates are?

Yes, Kevin. This is Chuck. It's not a high percentage of loans that have floors, We do have some, we have been over the last few years trying to negotiate some floors into our into our loan relationships and we've been successful. Those that we do, I would say, I still have a few more potential rate cuts before they come into play. But I can assure you that as the Fed has started to talk about lowing rates and it actually started talking about lower rates. But we've been much more active in negotiating floors into our relationships.

And as far as -- what are those strategies, I know you talked about some of your brokered deposits coming, what are the strategies do you have in place to mitigate NIM pressure as far as lengthening the duration of your securities portfolio or hedges?

Yes. I mean, we're always looking at our balance sheet to help manage interest rate risk. We don't have -- currently we don't have any derivative instruments that we're involved in. Obviously first and foremost, we look at the rates that we are offering on our deposit accounts. Like most banks out there, we didn't do much, if anything, on savings and interest checking accounts while rates were going up. So there's not a lot of opportunity there. it's lower rates. As I mentioned in my comments, so we have been relatively aggressive in lowering rates on our money market accounts as we were relatively aggressive increase in those rates. As we -- as we saw our competition, doing the same thing over the last few years. We've also been relatively aggressive similar to money market rates on lowering our CD rates. Obviously there is a lag there, but we do have obviously every month, every day CDs that are maturing with the vast majority of those will be repricing downwards. It's more of a timing issue as say what the wholesale funds. One of the things that we were very big proponents and kept to our standards. while rates were going up was to -- when we were engaged in wholesale funds, first to go relatively long generally four to seven years as we were matching our fixed rate commercial loans. And certainly looking back now, we would have been in a better shape with our margin. I have we gotten shorter and had those rates, not only be lower when we got the advances, but obviously available for refinancing at a much quicker pace, but hindsight being 20 regardless. We still believe that that was the right thing to do. We were managing our interest rate risk for…

Thanks for the color. And then, I have one last question and I'll let someone jump in. The GM strike has been going on for better month. Can you talk about what you're seeing as far as the impact of that to your customers in your market.

I think Kevin overseeing is that there are some softness that has manifested itself because of what's going on with the order situation with the GM strike. I think there has been some pockets of it, nothing that's systemic. But I think the longer it goes on, certainly the deeper -- the refresh it might be some impact of that, but nothing I think widespread or significant at this point in time, just some pockets of weakness.

Great. Thank you very much.

Our next question comes from Damon DelMonte with KBW.

Good morning, guys. How are you doing today?

Good, Damon. How are you?

Great, thanks. Just to kind of follow up on Kevin's last question about the impact from the GM strike, how has that -- has that at all kind of impacted your outlook for loan growth as we finish off 2019 and go into 2020?

I think, if you look at what we're seeing, Damon is, as we often talk about every year, we have fundings on the loan side of -- in excess of $0.5 billion. And I think what you're going to see is that continuing for 2019 as well. I think there -- as there is challenges and aspects of the portfolio. That's always the case, there is something going on somewhere in the portfolio. But there is enough strength on a widespread basis in all segments of the portfolio that I think is not going to dampen our loan growth. I think, the dampening of the growth may be, as we talked about from time to time as they have some payoffs. We've been very fortunate thus far to 2019, we haven't had those path, but anticipate certainly them being more prevalent in the fourth quarter. But as we said on the funding side, we're always going to be consistent having sustained fundings of over $0.5 billion, and we see that for this year as well.

Okay, that's helpful. And then, probably a question for Chuck here going back to the margin. So just to confirm, you said that you thought the margin would be in the 3.50% to 3.55% range, and that reflects one additional in the latter half of this year. Is that correct?

Yes. I think the 3.50% reflects the cut later this month. If we don't get that cut that comes in December, probably on the higher side of that range.

Okay. Are you guys internally forecasting any cuts in 2020?

We're not quite there yet. We are just -- as we get here through the end of the third quarter, we'll start working wholeheartedly on our budget. We do see that the market has priced one in for March. And so, that is something that we'll take a look at to determine if we want to put that one in there. But at least right now, it doesn't appear that we'll get -- hopefully it does not get too many more in 2020, maybe just that one. But it seems like right now and looking at the market expectations is, most of the decline will come here in the second half of 2019. And then we'll just build our margin back up to more of a core level throughout next year.

Got it, okay. And then, just lastly, your thoughts on the buyback, have a little bit of activity this quarter. Do you think that will be a tool you guys will continue to use?

Yes. I mean -- like I said , we're just now starting to use our new plan that we put in place in the spring that replaced our existing plan that was getting low on share availability. We went buying back in general recently anything under $32, I think will continue to be active if our price drops below that level. Again, perhaps a little bit higher. Obviously we're looking at that in conjunction with our cash dividend program. We're looking at in conjunction with our capital levels. And as we look at the various ratios that we use to take into account risk-based capital such as CRE concentrations, and so it's a blend of all that, but we definitely recognize the fact that our stock is trading very low on a have multiple basis compared to where we've historically been, not just us, but the entire banking sector. We've got a very strong balance sheet, good earnings performance. There's always going to be some level of headwinds we want some level of excess capital to make sure we're prepared for that. But we do see an opportunity as our price does drop low to take advantage of that price, and we definitely will.

Got it. Okay, that's all that I had for now. Thank you.

Thanks, Damon.

Our next question comes from John Rodis with Janney.

Good morning, guys. Chuck, just not to beat this to death, but back to the margin. So, you're talking about roughly around 3%-3.5% with another 25 basis points later this year and then some improvement next year if nothing else happens. But hypothetically if the Fed were to cut 25 later this month and then another one to two times later this year, early next year, do you think -- do you think you could hold the 3.5% level instead of the modest improvement.

That would be a difficult situation if they get -- they continue to be very aggressive. Certainly as they continue to be very aggressive, we will see all the other yields fall as well, rates fall. And so, those money that we have maturing both in local time deposits as well as brokered deposits, and even some FHLB advances, then reprice at a greater level, so I can't put a number to it. To speak of that -- but I would think that the more aggressive the Fed is, in future periods, the more difficult and it's going to be or at the timing standpoint of us recovering to more of a core margin. So, I think it'll be one of more timing, but certainly you might impact the first and second quarter differently than what -- just one more [indiscernible], perhaps one in March, yes.

Yes, it made scene. Just looking at -- just looking at the mortgage banking results and obviously they were strong. Looking beyond the fourth quarter, what do you sort of think as a more, I guess, normalized level of mortgage revenues if refi activity slows some? I mean, the second quarter was around $2.9 million in revenues. Second quarter -- I'm sorry, third quarter was close to $2.9 million, second quarter was like $1.3 million. What do you think sort of a more normalized quarter is for mortgage, given your build-out of the team?

Yes, John, that's going to be a really difficult one to predict. Certainly on an overall trend basis as we've built that out and added additional lenders, then we will continue to embark on doing more of that in future periods. There's just so much outside environmental factors that come into play. It's very difficult to put precise numbers on it, especially on a quarterly basis. Obviously interest rates play a very significant role, especially in regards to refinance activity. It does help purchase activity, although I would say that maybe purchase activity is more based on the overall economic picture that may be interest rates are, and we have seen some nice increases just on the refis, but we've also seen some nice increases on the purchases. So that gives me optimism for future periods as far as permanent growth, if you will, with that program. We've also, and Ray mentioned, we've been able to sell a higher percentage of the loans that we've been making than in the past. I think on a year-to-date basis, we sold almost 70% of our originations where historically it's been closer to 45%. So that comes into play. Of course, here in Michigan, especially we have seasonality with the first quarter -- during the winter months. So, there's just so much that goes into it. It's really hard to put numbers to it. But I think I would -- I'm pretty sure that I'm accurate in saying that we will continue to see overall growth. It's just a matter of what takes place with the rate environment and those other things that I mentioned. I also mentioned when we get to that number that you quoted, that does include the amortization of mortgage servicing rights. And certainly with the lower rates and the refinancing activity we've seen, we have had to increase the amortization of our mortgage servicing rights. So, if we did see a slowdown in mortgage activity, it's likely that the amortization would also lessen as well. So, obviously there is a natural hedge in there to some degree. So, I don't want to be evasive of your answer, but it's really hard to put numbers exactly as to how the mortgage operation is going to do, given the amount of environmental factors that we have to contend with.

This is Bob, and I would add to that. We've been very intentional about the lenders that we've added to our mortgage area. These are lenders that are some veterans in our markets that have demonstrated the ability despite the environmental conditions and the things that naturally occur in the economy to develop loyal followings where they've been able to have some strong production regardless of the economic conditions. Will it be as strong as it is at a time such as right now? No, probably not. But I think overall in terms of the ability of them to generate volume to come in to the bank and new markets, new clients, new opportunities because of the fact that they've joined our organization gives us some encouragement and provides some good comfort that the mortgage banking activity will continue to be a growth area for us. The ones that we'll continue to look to add commission mortgage lenders as the department continues to grow and gain in reputation with our clients and among the mortgage community.

Okay. Hey Chuck, just the MSR, what was the write-down this quarter?

We wanted to give you that offline, John. I don't have that off the top of my head.

Okay, thanks guys.

Thank you.

[Operator Instructions] Our next question comes from Daniel Cardenas with Raymond James.

Good morning. Just -- most of my questions have been asked and answered. Just a couple of quick questions here. In terms of your operating expenses, I mean, you guys have done a really great job of controlling those throughout '19. As we look at '20, I mean, is it safe to assume that maybe a low single-digit growth rate is reasonable?

Yes. Like I said -- Dan, this is Chuck. We're kind of just starting to get in the midst of our budget preparations for 2020. But I would say, probably a 2% increase, probably off the second quarter is probably a good -- second quarter of this year is probably a good base if you look at and maybe somewhere around 2% increase is what I would project it to be in it, most of that being in the salary area with the merit increases and those types of things.

Okay, great. And then, any color you can give us on day one impact on -- from CECL?

Yes. As I mentioned, we're not at a point we want to give out specific numbers. We're still working through our framework with our auditor friends and making sure that we're comfortable with this brand-new model, and it's a whole different world of assumptions and economic environments, and those types of things. I don't want to go too far off the edge here. I think as we look at it, in relation to what we're doing now, there is not a significant amount of base change, if you will. We're still using our grading systems, we're still looking at environmental adjustments, still looking at the same strong loan portfolio as we switch from one day to the other. So it doesn't seem to us at the end of the day, switching from CECL is going to have a significant effect on our overall loss level -- loan loss reserve level, but I'll say that. But then I'll also say, we continue to work through. We have our framework develops, and we just got to work through the assumptions in regards to that framework and things like environmental stuff, but it doesn't look like it's going to be significant at this point.

Okay, great. All right. Thanks, guys. Good quarter.

Thanks, Dan.

Our next question is a follow-up from Kevin Reevey with D.A. Davidson.

Yes. So, I was just curious about, you've got a nice currency to do deals. So, I was just curious about your appetite for acquisitions and criteria and geographies and what you're hearing from sellers and what their appetites are, given where we are in the cycle.

Yes. I would answer that, Kevin, the same way we have on our recent quarters that our appetite hasn't changed. We remain interested certainly in opportunities that come along, and we have, from time to time, seen some opportunities across our desk. But as we often talk about, culture is very, very important to us, and those types of things weigh very -- very significantly on our assessment of M&A opportunities. So, it probably shrinks the universe when compared to what it might be for other organizations. So, I think there's certainly lots of talk out there, lots of conversations. But I think from our standpoint, we're staying the course. We're looking at opportunities that come down the pike, and we're being very selective and opportunistic as any of those opportunities may continue down the road in future dates.

Great, thanks. That was helpful.

Thanks, Kevin.

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

Yes, thank you very much for your interest in our company. We look forward to speaking with you again in January. This call has now been completed. Thank you.

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