Q3 2019 Earnings Call
Good morning, and welcome to the Mercantile Bank Corporation third quarter 2019 earnings results Conference call. All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the Starkey followed by zero.
After today's presentation, there will be an opportunity to ask a question to ask a question you May Press Star then one on your telephone keypad to withdraw your question. Please press Star then too. Please note. This event is being recorded I would now like turn the conference over to Mike Houston of Investor Relations. Please go ahead.
Thank you I always good morning, everyone.
Thanks for joining Mercantile Bank Corporation conference call and webcast.
That's the Companys financial results for the third quarter 2019.
Like Houston.
Mercantiles Investor Relations for.
Joining me today are members of their management team, Bob Kaminski, President and Chief Executive Officer, Chuck Christmas Executive Vice President and Chief Financial Officer right right.
Mercantile Bank, Michigan.
To begin the call with management's prepared remarks, and then open the call into question.
However, before we begin todays call. It is my responsibility to inform you that called May involve certain forward looking statements such as projections of revenue earnings and capital structure as well its statements on the planet objected to the company's business.
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 pilots.
Company assumes no obligation to update any forward looking statements made during the call.
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 Dot work bank Dot com.
At this time I'd like to turn the call over to Mercantiles, President and Chief Executive Officer, Bob Kaminski.
Thanks, Mike and good morning, everyone. Thank you all for joining us today.
On the call we will provide an update on our overall performance on financial results.
With our key areas of strategic focus at the conclusion of our comments.
Open the call for question and answer session.
We're pleased to get to deliver solid operating results for the third quarter, continuing our year to date strength.
Based on financial condition, decelerating commercial <unk> residential mortgage loan originations.
Bob Dole pipelines give us confidence that they helped the results achieved during the first nine months of here.
Provide the foundation for continued strong performance through the rest of 2019 and in future periods.
The third quarter operating performance includes gross and 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 how long pricing discipline.
That's all the underwriting.
I will discuss the margin in more detail later.
Our teams emphasis on building a cultivating and value added relationships continues to successfully attract new customers as well as retain existing clients.
Increased noninterest income.
Also led to improved earnings for the quarter.
The increase in mortgage banking activity fees was primarily driven by the on what success.
It seems like initiatives that were put in place several quarters ago.
Mortgage banking results were also boosted by increase the mortgage refinance activity in a higher percentage of our loan production being sold.
We're also 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 the work of our senior leadership the entire team to diligently monitoring control overhead costs.
Our objective is to be in officially operating company well at the same time, making the appropriate investments to ensure we are meeting our customers' needs and exceeding their expectations and building I highly sustainable organization or the ears to call.
Turning to the Michigan economy trends remain steady as employment and our primary markets continued to be strong and real estate conditions remain healthy.
They'll continue to monitor these indicators closely for any possible shifts in these trends.
Yeah, I was on cash dividend program, including the announcement our fourth.
Our fourth quarter regular dividends today exhibits our commitment to enhancing total shareholder return.
During the quarter, we also presumes share repurchases under our program.
We're going to tell repurchased approximately 112000 shares for for $3.5 billion per weighted average all in cost per share of $31.36. During the third quarter 2019.
Well I can tell is well positioned to take advantage of future growth opportunities, reflecting the excellent work other mercantile team and all of our markets.
Our steady core profitability.
Strong capital position and healthy loan pipelines will service well for the balance of the year and beyond.
Although we operate potentially volatile interest rate environment as always we will continue to monitor both micro and macro economic activity and our focus remains on creating leveraging opportunities whatever the economic climate.
We have started we are excited about or ability to expand in our markets continually improve and both the near term and long term.
That concludes my repair a prepared remarks, I'll turn it over to right.
Thanks, Bob we're 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 levels since the second quarter of 2016.
Approximately $153 million and 412 million towers, and 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 hard.
Listing customer base.
Our pipeline remains solid as well with $91 million commitments in commercial construction and development loans, which we expect to fund or the next 12 18 months.
Our asset quality is sterling as nonperforming assets declined $2.9 million for less than 110th of 1% total assets at September Thirtyth.
[laughter] recorded non interest income during the third quarter of $6.7 million up $2 million or nearly 42% in the prior year third quarter.
This improved level of noninterest income was largely driven by increased mortgage banking.
Reflecting the success of ongoing strategic initiatives designed to increase market share.
Higher level of refinance activity stemming from our recent decreasing rates and an increase percentage of loan so.
Continuing to enhance mortgage banking income increased market share, including an increase year in the purchase market remains a priority and we will continue to higher proven mortgage loan originators as we were able.
Also recorded continued growth during the quarter and other fee on matter categories, including credit and debit card income service charges on accounts and payroll processing.
The exercise discipline related to overhead costs as we focus on efficient delivery systems in all of our lines of business remains a priority.
That concludes my comments I will turn the call over to John Thank you and good morning, everybody. This morning, we announced net income at $12.6 million for 77 cents per diluted share the third quarter of 2019.
Compared to third quarter of 2018 net income.
$10.1 million or 61 cents per diluted share.
[noise] net income for the first nine months in 2019 totaled $36.1 million or $2. Some 20 cents per diluted share compared to net income of $30.5 million or $1.83 cents per diluted share during the first time lots of 2018.
I think on life insurance claims and a gain on the sale of a former branch facility increased net income during the first nine months of 2019, I approximately $3.1 million or 19 cents per diluted share.
Interest income related to purchase loan accounting entries increase net income during the first nine months of 2019 by zero point $9 million or five cents per diluted share and net income during the first nine months of 2018 by $2.7 million or 16 cents per diluted share.
Putting the impacts of these transactions diluted earnings per share increased 29 cents over 40 over 17% during the first time up to 2019 compared to the respective 2018 period.
We remain pleased with our financial condition earnings performance and believe we are very well positioned there continue to take advantage of funding at 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 2019.
The decline in large part we flex the other one sees decision to lower the fed funds rate by 25 basis point 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 on loans declined 12 basis points, one can train up there and second quarters.
Our cost of funds as a percent of average earning assets declined four basis point through the third quarter was a fair to the second quarter in large part, reflecting a reduction in our money market deposit account great offerings in association with the F. One sees right decisions. We have also lowered rates on time deposit accounts. However, the impact on those.
Rate cuts will be leg as those deposits were not reprice until maturity date.
For the fourth quarter of 2019, we expect our net interest margin to be in a range of 3.50% the 3.55% with lower end of the range, reflecting the assumption of an additional 25 basis point rate cut.
Currently widely expected by the markets on October Thirtyth.
Assuming no further FOMC rate reductions, we do not expect our net interest margin through Oh, we do expect government net interest margins to improve throughout 2020 as fixed rate time deposits and FHLB advances mature and can be reprice, our place at lower rates [noise].
For example, we had $80 million and broker time deposits that mature between December and July which we currently expect experienced a rate reduction of about 100 basis points as these bonds mature and every place.
The reduction of excess liquidity consisting of funds on the positive to the Federal Reserve English I go over the next summer months will provide further support to our net interest margin.
We recorded zero point $3 million and purchase loan accretion payments received in CRD four loans during the third quarter 2019.
Based on our most recent valuations in cash flow forecast on purchase loans, we expect to record additional interest income told in zero point $2 million.
The fourth quarter.
Also we expect to receive in aggregate about $1.5 million in principle payments I'm purchase prepared for loans over the next several years, which will be recorded interest income upon receipt.
The overall quality of our loan portfolio remains very strong with continued low levels.
Assets at no charge offs.
Performing assets as a percent of total assets equaled only eight basis points that then the third quarter.
Charge offs totaled zero point $5 million during the third quarter and totaled less than zero point $8 million for the first nine months of 2019.
Reported net loan charge offs to zero point $3 million during the third quarter and zero point $4 billion. During the first nine months of 2019, equating to only five and two basis points of average total loans respectively.
Provision expense for the third quarter total zero point $7 billion in large part reflecting commercial loan growth.
We expect to record provision expense in a range of 0.5 million to $1.0 million during the fourth quarter.
Our loan loss reserve totaled $24.4 million <unk> third quarter or 0.8% of total originated loans. This coverage ratio has remained steady for many quarters and no significant changes are expected during the remainder of 2019.
Regards to see so we have completed our national framework and we'll continue to be working to fine tune the framework in the assumptions during the remainder of 2019.
[noise] right previously provided color on our fee income performance for the third quarter first nine months in 2019, I will add that we expect non interest income to be in a range of $5.6 million to $6.0 million during the fourth quarter.
We recorded non interest expense of $22.0 million for another quarter of 2019.
Zero point $4 million, when compared to third quarter of 2018.
We recorded a higher level of salary and benefits expense, mainly reflecting employee merit pay increases.
Mortgage lender commissions and higher stock based compensation expense.
However, our FDIC insurance expense was down zero point $5 million, reflecting.
Deposit insurance credits currently we expect non interest expense to total in a range of $22.0 million to $22.5 million during the fourth quarter.
Our effective tax rate remaining your 19%.
Total deposits increased $303 million during the first nine months of 2019 comprised of 263 million dollar growth in local deposits and a $40 million increase in broker deposits.
Increase in local deposits, primarily reflects growth and this is checking account balances associated with new cnine lending relationships any time deposit campaign earlier in the year.
In addition, during the third quarter, we experienced seasonal deposit growth for many of our municipal deposit customers.
So the ended the third quarter wholesale funds comprised 16% of total funds unchanged for the level as of yearend 2000.
We remain well capitalized speaking organization as of September Thirtyth 2019, our biggest total risk based capital ratio was 12.5% ended dollars was approximately $84 million higher under 10% minimum required to be categorized as well capitalized.
As Bob mentioned, we were active in buying back our stock during the third quarter.
All of 2019, we have repurchased about 231000 shares at a weighted average cost of $30.76 per share or total cost of $7.1 million. We currently have approximately $16.5 million available in our current buyback plan.
Those are my prepared remarks, I'll now turn the call back over to Bob. Thank you.
Thank you Chuck that concludes managements prepared remarks on all of them a call up to a QNX.
We will now begin that question answer session to ask a question you May Press Star then one on your Touchtone phone. If you are using speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then.
At this time, we'll pause momentarily to assemble our roster.
The first question comes from Kevin Reevey with D.A. Davidson.
Good morning.
Why would you.
Pretty good.
So first question was related to our Youre a commercial loan book what percentage of the very boring portion of your commercial loan book.
Oh it contains floors and if you can kinda talk about.
But the amount of floors, you're putting one new loans, if at all and where those rigs are.
Yes, Kevin this is Chuck inside a high percentage of loans that have floors. We do have some oh, we have been over the last few years trying to negotiate.
So floors into our into our loan relationships that we've been successful those that we do I would say is I still have a few more potential rate cuts before they come into play.
But I can assure you that as a pad has started to talk about lowering rates is actually started talking about our rates that we've had much more active in negotiating fours into our relationships.
[laughter].
And.
As far as though what other strategies I know you talked about some of your broker deposits deposits coming do what are the strategies do you have in place to mitigate NIM pressure as far as.
Blend pending the duration of your securities portfolio will weigh hedges.
Yeah I mean.
Always looking at our balance sheet to help manage interest rate risk and we don't have currently we don't have any derivative instruments that were involved in.
Actually the 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.
Savings in interest checking accounts, a while rates were going up so there's not a lot of opportunities. There that's a lower rates a as I mentioned in my comments. So we have been relatively aggressive and lowering rates on our money market accounts as we were relatively aggressive increasing 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 Lorraine, our CD rates.
Obviously, there's a lag there, but we do have obviously every month every day Cds that are measuring what the vast majority of those will be repricing downwards.
It's more of a timing issue that same with the wholesale funds.
One other things that we were very big proponents and and kept to our standards.
Why rates were going up was too when we were engaged in wholesale funds.
To go relatively long generally four to seven years as we were matching our our fixed rate commercial loans and certainly looking back out like Wow that you know we would've been in better shape with our margin I have you gone shorter and had those rates not only beach lower when we got the advances but.
But the 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 or long term and.
Putting that wholesale funding program into managing the interest rate risk associated with five year fixed rate loans. We think was the right thing even today as we sit here and look at a net interest margin that over the next few quarters is going to get banged up a little bit from the rapid reduction or that the federal reserve has put out all banks.
Obviously, including ours. So it's more of a timing issue than anything else well things that we've been saying all along is that mercantile, but its composition of it Oh. That's mail. She does not meet has not really bad and a core basis, a 3.83, 0.9% margin bank.
We've always said that we're closer to a 3.63, 0.7% bank. We were just taken advantage over the last several couple of years of taking advantage of the increasing interest rate environment. So given that back a little bit over the next few quarters as I mentioned, probably around a 3.5% margin, but we do.
Expected started getting that back once that that is done inc. lorien rights.
I think overtime, perhaps by the end of next year, we'll be back to their core level.
So it's more a timing issue than anything else.
But like all of our decisions yet mercantile bank, we are enough for long haul and we're going to continue to manage our balance sheet not only for short term gains or short term increases in our net interest margin, but they maintain and due to maintain that margin at least had a car level over a long term.
[laughter]. Thanks for the color and then to know up one last question at all on what someone jump in the G.M. strike and then I'm going on for about a month can you talk about what your I'm seeing as far as we impacted that to your customers in your markets.
I think that kind of overseeing is that there are some softness that does manifested itself because of what's going on what the auto situation with the GM strike I think there's been some pockets of it nothing that systemic but I think longer goes on the certainly a deeper a that they the reflection might be some.
The impact of that but but nothing nothing widespread or or significant at this point in time, just some pockets of weakness.
Weakness.
Great. Thank you very much.
No.
Our next question comes from Damon Delmonte with KBW.
Hey, good morning, guys I was going today.
Good day Marianne great. Thanks, just to kind of follow up on a Kevin's last question about the impact from the GM strike how is that or is it has added all kind of impacted your outlook for loan growth as we finish off 2019 and go into 2020.
No I think you can look at what we're seeing a de minimis.
As we often talk about.
Every year, we have funding some alongside of an excess of half a billion dollars I think what you're going to see is that continuing our 2019 as well I think there's as there are challenges and that aspects of the portfolio. That's always the case, there's something going on somewhere in the portfolio in.
But there is enough strength on a widespread basis in all segments of the portfolio that I think is not going to.
The dampened our longer all the I think they the dampening the growth may be as we've talked about from time to time as they have some payoffs.
We've been very fortunate thus far far 2019, we haven't had those payouts, but dissipate certainly them being more prevalent in the fourth quarter, but but as we set out in the funding side, we're always going to be consistent having a sustained fundings of over half a billion dollars Missy that for this year as well.
Okay.
It's helpful and then.
Hi question for Chuck had gone back to the margin. So just to confirm you'd said that you thought the margin would be in the 350 to 355 range and that reflects one additional caught in the latter half of of this year is that correct.
Yes, it's a 350 reflects the cut later this month.
If we don't get that quarter. It comes into summer probably on the higher side of that range. Okay are you guys, hi internally forecasting any cuts in 2020.
Well, 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 and for March and it's all that is something that will take a look at to determine what we want to.
I went in there, but at least right now it doesn't appear that will get hopefully it's not get too many more in 2020, maybe just that one but it seems like a right now and looking at the market expectation is no. Most of the declines will come here in the second half 2019, and then we'll just build our margin.
Back up tomorrow or level throughout next year.
Got it okay.
And then just lastly, you know thoughts on and on the buyback it how little bit of activity this quarter.
Do you think that to be a tool you guys will continue to use.
Yes, I guess that we're just now starting to use our new plan that we put in place in the spring that replaced our existing playing it was getting low on share availability.
Excuse me, we've been buying back it in Genoese recently and anything under $32, Oh, I think we'll continue to be active.
If our if our price drops below that level again, or perhaps a little bit higher obviously, we're looking at in conjunction.
Whether a cash dividend program, we're looking at in conjunction with our capital levels and as we look at the various ratios that we use that take into account risk risk based capital assets, such as CRT concentrations. So something it's a blend of all that but we definitely recognize the fact that our stock as to.
Rating <unk> very low.
Multiple basins compared to where we started event not just that's what the entire banking sector.
We've got a very strong balance sheet that earnings performance.
There's always going to be some level of headwinds we bought some level of excess capital to make sure we're prepared for that.
But we do see the opportunity for price does drop a low and take advantage of that pricing and we definitely.
Got it okay. That's all that I had for now thank you.
Thanks.
Our next question comes from John Rodis with Janney.
Good morning, guys.
Our job.
Hey, Chuck just not to beat this to death, but back to the margin or you know [laughter].
So.
You know you're talking about roughly around three 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 you know 25 later this month and then another one to two times you. You know later this year early next year do you think do you think you could hold.
That 3.5% level instead of the modest improvement.
That would be a difficult situation if they get it they continue to be very aggressive.
Certainly as they continue to be very aggressive we would see all the other yields fall as well rates fall and so those monies that we have mature in Boston locals time deposits as follows broker deposits and even some FHLB advances.
Maybe even reprice had a greater level.
So I can't put a number two it to speak of that but I would think that the more aggressive the fat is in future periods, the more difficult, it's going to be or the timing standpoint, well bust recovery into more of a car margins. So I think it'd be more one or more timing, but certainly might impact the first and second quarter differently than what.
Just one more cost or perhaps one in March.
Yes.
Yeah, you saw in essence.
Just looking at I'm, just looking at the mortgage banking results and obviously they were strong.
Looking beyond the fourth quarter, what do you what do you sort of think is a more I guess normalized level of mortgage revenues.
Refi activity slows you know I mean, the second quarter was around 2.9 million in revenues.
Second Corp.'s I'm, sorry, third quarter was close to 2.9 billion second quarters, like 1.3 million, where do you think sort of more normalized.
There is for mortgage given your build out.
Of the team.
Yeah, you know John that's going to be really difficult one to predict.
Certainly our overall trend basis, as we felt that out an added additional lenders.
We will continue to embark on and doing more of that in future periods. There's just so much outside environmental factors that come into play. It's it's a it's very difficult to support 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. There's more based on the overall economic picture than maybe interest rates are and we have seen some nice increases decide on the refinance was also seeing some nice increases on the purchases. So [noise] that gives me optimism.
Optimism for future periods as far as permanent growth if you will put that program.
We've also and Ray mentioned, we've been able to sell a higher percentage of the laws that we've been making the past I think on a year to date basis, we sold almost 70% of our originations were historically as Pat [noise].
Closer to 45% [noise] excuse me.
So that comes into play.
Course here in Michigan, especially we have seasonality.
The first quarter ended during the winter months. So there's just so much that goes into it as really hard to what numbers to it but I think I would I I'm pretty sure that an accurate in saying that we'll continue to see overall growth.
Just a matter of what it takes place at the rate environment, a lot of things that I mentioned.
I'd also mention yeah, when we get to that number that you quoted that does include the amortization of mortgage servicing rights and certainly with a lower rates in 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 income mortgage activity, it's likely that amortization would also a lesson as well. So obviously, there's a natural hedge in there.
Some degree so I don't want to be a based on your answer but.
It's really hard to put numbers exactly as to how the mortgage operations Gonna do given the amount of environmental factors that we have to contend with the there's no Bob and I would add I would add and that they the we've been very intentional about the lenders that we've added to our mortgage area due to lenders that are some veterans and our market.
That have demonstrated the ability.
Despite the environmental conditions in the things that naturally occur in the economy to develop loyal following its where they've been able to have some strong production regardless of economic conditions will it be as strong as it is at a time said is right now no probably not but I think overall in terms of the ability of them to generate bias.
Coming to the bank and new markets, new client new opportunities because of the fact that they joined our organization gives us some encouragement and provides.
I'm good comfort that the mortgage banking activity will continue to be a growth area for us the ones that will continue to look to add commission mortgage lenders as the department continues to grow and gain and reputation with our clients and among the mortgage community.
Okay, Hey, Chuck just the MSR what was the write down this quarter.
We want to give that offline I don't have that Oh, probably had okay. Thanks guys.
[noise] again, if you have a question. Please press Star then one.
Our next question comes from Daniel Cardenas with Raymond James.
Hey, guys good morning.
Right.
Just the most my questions have been asked and answered just a couple of quick questions here and in terms of your operating expenses. I mean, you guys have done a really great job controlling those [laughter] throughout 19.
As we look at 20, I mean is it safe to assume that maybe a low single digit growth rate is reasonable.
Yeah like I said the Dan This is Chuck.
I was just starting 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 a second quarter. This year is probably a good base.
To look at and maybe somewhere around 2% increases what I would projected to be yet most of that being in the salary area with the merit increases and those types of thanks.
Okay great.
And then.
And any color you can give us on on day, one impact on from Cecil.
[laughter] 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 auditors are friends and making sure that we're comfortable with this brand new model and that's a whole different world of assumptions and economic environments and those types of things I don't want to go to.
As far out at your I think as we look at it in relation to what we're doing now there's not a significant amount of based change if you will.
Still use integrating systems were still looking at environmental adjustments.
So looking at the same strong loan portfolio as we switched from one day to the other.
So it doesn't seem to us that as I know that day switching to diesel is going to have a significant effect on our overall off level loan loss reserve level, but I'll say that but then I'll say, we continue to work through a we got our framework develops yeah. We just got to work through the assumptions in regards to that framework.
Eric and things like environmental and stuff, but.
It doesn't look like it's gonna be significant at this point.
Okay, Great Alright, thanks, guys good quarter banner.
Our next question is a follow up from Kevin Reevey with D.A. Davidson.
Yeah, Kevin here [laughter]. So I would just I was just curious about your you've got a nice currency to do deals. So I just curious about your appetite for acquisitions in or criterion, geography, and what you're hearing from from sellers and what's their appetite.
Given where we are in the cycle.
Yeah.
Kevin the same way, we have a on a recent quarters at our appetite hasn't changed liver remain interested certainly it 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 hard to us and those types of things away very very soon.
Typically 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.
I think there's certainly lots of talk out there lots of Bob.
Conversations, but I think out from our standpoint are staying the course or our looking at opportunities that come down the pike and we're being very selective an opportunistic as a as a any of those opportunities may continue down the road or a in future date.
[noise] repairing star was helpful.
Thanks, Kevin.
This concludes our question answer session I'd 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'll look forward to speaking with you again in January and this call. His outcome been completed thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.