Q1 2020 Earnings Call

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Good morning, and welcome to the Mercantile Bank Corporation. First quarter 2020 earnings results conference call. All participants will be in listen-only mode. Should you need assistance placing all-conference specialist wage pressing the star key followed by zero after today's presentation. There will be an opportunity to ask questions. Ask a question. You may press * then 1 on your touchtone phone to withdraw your question, please press * then two, 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.

Grant's 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 4th or for the first quarter 8:20. I might usin with Lambert IR mercantile's investor relations firm and joining me today are members of their management team including Bob kominski president and chief executive officer Chuck Christmas Executive Vice President and Chief Financial Officer and Ray reitsma president of Mercantile Bank of Michigan. We will begin to call with Management's prepared remarks and presentation view the quarter's results 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 directions 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 first quarter 2020, press release and presentation deck 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 kominski, Bob.

Thanks, Mike and good morning everyone at the conclusion of our call in January. When we told you that we look forward to speaking with you in April. None of us could have imagined our world was going to change in a few short cons on the call this morning. We will provide details of our performance for the first quarter as usual. But we also spend a significant amount of time in our comments discussing the package which we believe will be of interest to you awake up and covid-19 pandemic.

Covid-19 has obviously created a life-threatening crisis around the globe as February ended it became more and more apparent that the virus was rapidly spreading in the United States committed States and action had to be taken first and foremost Mercantile work expeditiously to ensure the health and safety of our employees and customers and our detailed response is noted on slide three of the presentation.

S concerns over the pandemic in the US and Michigan start to grow Mercantile worked to limit face-to-face contact with our customers beginning on March 18tj will eventually lead up to the full closure of our lobbies beginning of our lobbies with Governor would burst at home order on March 25th.

Customers are able to continue fulfilling their banking needs with our drive-thru facilities and he'll banking machines and electronic banking.

Since the beginning of the crisis, for example, our daily retail online banking logins have almost doubled.

regarding our staff as mentioned on slide three since March 23rd, and any day we generally have over 75% of all employees working remotely from home and some of the gracious feedback from our customers can be seen as live for

as we have discussed in recent years mercantile's worked continuously since the end of the Great Recession the place ourselves in a position of strength. The goal was to leverage the opportunities of a solid black on me to also provide our company with strong financial metrics allow us to be successful during week or Economic Times.

All the pandemic certainly creates new challenges for everyone and the financial services industry our foundation remains extremely solid as we work with our clients to help them weather the storm caused by this crisis.

During this call. We will be providing you with details on our loan portfolio including metrics on some areas of focus as we work through the issues presented to our industry. They'll talk about our historical credit quality leads us to the crisis low concentrations including breakdown by loan type as well as non-owner-occupied real estate vs. Owner-occupied Thursday and our C&I portfolio by industry classification.

We'll also discuss activity with our clients relative to our payment relief program for existing loans during the pandemic. We also talked about our efforts to provide funds to our clients to the SB office with the payment paycheck protection plan.

We'll discuss our key metrics including liquidity and capital positions as well as the position of taking regarding the new rules that allow the postponement of the adoption of Cecil.

We'll discuss the impact on our net interest. Margin by the actions taken by the fomc at the start of the crisis to boost the economy.

With cuts and interest rates are Mortgage Banking business has been able to generate record pipeline biomes comprised primarily of refinances.

To stay at home and is making the new purchase activity quite challenging at the current time. But real estate agents and consumers are trying to be creative with real estate movement while maintaining compliance with the executive orders.

Michigan has unfortunately been a hot spot for a coolant cases Southeast Michigan including the city of Detroit is a large metropolitan area that has been hit very hard with confirm cases and deaths skyrocketing in early April.

The areas of the state where work on Tower remains maintains the vast majority of its Market presence including Kent County in West Michigan along with the central part of the state has seen its critical statistics increasing but at levels allowing the Healthcare Systems to keep Pace with the spread. It's also distancing and conduction with the state mandate wage citizens to remain at home with the exception of those working in essential critical Industries many local businesses have engaged Federal stimulus relief help you Thursday. It's paid as our state waits for the virus cases to subside. So the economy can be safely reopen.

for this crisis the Michigan economy economy was

Generally steady throughout 2019 some areas of manufacturing had a down year, but unemployment was low real estate prices continue to increase in the tourism industry continue to exhibit strength.

It certainly everyone's hope that is infections from the virus of side and plans for lifting the restrictions on movement movement in our communities are implemented at the economy is driving force wage the consumer returns with animal energy to jump start businesses that have been placed in hibernation.

We'll continue to monitor the situation closely and be prepared to take additional measures if those needs arise as always we remain confident in our positioning in use too strongly serve our customers as we navigate through and eventually out of this ever-changing environment.

Those are my introductory comments. I'll now I'll turn it over to Ray. Thanks, bud our loan portfolio increased $45 million dollars in the first quarter of 2020 with each of our markets contributing authors. Gross our pipeline remains solid as well with seventy seven million dollars of commitments and commercial construction and development loans, which we expect to fund over the next twelve to eighteen months off the semblance of normal construction activity resume during that time frame our asset quality remains strong as non-performing assets, totaled three point seven million dollars or one tenth of 1% of total assets and March Thirty One. We recorded nine interest income during the fourth quarter of six point five million dollars about 1.8 million dollars or 38% from the prior-year first quarter, excluding 1.9 million dollars in non-recurring items related to that quarter. This improved level of non-interest income was largely driven by increased mortgage bap.

Reflecting the success of ongoing strategic initiatives designed to increase market share and a higher level of refinance activities stemming from a recent decrease in rates wage continuing to enhance Mortgage Banking income through increased marketshare including an increase share in the purchase Market remains a priority and we will continue to hire Movement Mortgage Loan Originators when a table we also recorded continued growth in the quarter in other fee income categories, including credit and debit card income service charges on accounts and payroll processing credit and debit card income has trended downward as stay-at-home workers or implemented in March and are scheduled to remain in effect through April Thirty.

Exercising discipline related to overhead costs as we focus on efficient delivering Delivery Systems and all of our lines of business remains of priority.

Dance lot of the covid-19 virus provided an opportunity to demonstrate the value of Community Bank combining high-touch service with strong capabilities is Bob mentioned our Electronic Banking ability allowed us to close our lobbies and March twenty five and contributed to an ability to have three quarters of our employees work from home door from that day forward.

Any banks labored under the SBA paycheck Protection Program work until funded over fifteen hundred applications representing over five hundred million dollars in loans supporting thousands of workers in our communities and contributing to the maintenance of asset quality as a crisis plays out. Our communities have been consistent and providing us with supportive feedback praising our commitment professionalism throughout the process some of this gracious feedback from our customers can be found on slide floor of the presentation as Bob mentioned.

In addition to the federally funded programs as you can see on Slide Five work until created payment deferral programs allowing interest-only programs and total payment deferral programs for entities directly impacted by the covid-19 prices. Next N Slide six while consumer lending is a small proportion of our portfolio at approximately 30 million dollars over 3,500 hardship inquiries have been logged by our customer service team.

And less than fifty cases and in less than fifty cases have our customers requested implementation.

For past-due list on slide seven has maintained the proportions the pre-crisis world as of March Thirty One and to date in April as well. The risk weighing process is seen on T just slides reflects a portfolio is strong characteristics reflecting the strength of the pre-crisis economy, maintaining accurate risk ratings will remain a key focus in the upcoming Quarters off will be paying particular attention to the financial condition of performance of credits in the filing segments Automotive dealerships hotels and lodging Assisted Living restaurants construction movie theaters and Retail none of these individual segments account for more than 5% of the commercial loans.

Turning to slide 11:00. We will go over some of the details of the recent programs implemented by the cares Act and the Federal Reserve paycheck Protection Program provides for more forgivable loans off eligible small businesses to maintain employment during this pandemic belongs carry a 1% interest rate and deferred payments for the first six months and monthly payments for the following 18 months money belongs may be forgiven if the funds are used by the borrower for payroll rent and utilities in the specified proportions.

The SBA also provides iteration and origination fee of between 1% and 5% which is paid within five days of closing. The Deferred income is a created to interest income over life alone with accelerated accretion if the loan is paid off or forgiven,

These result in an effective yield enhancement of two and half percent from these loans. The Federal Reserve is providing term advances, which you can see on slide twelve these advances allows us to get dollar-for-dollar on the PPP loans with fixed rate of thirty five basis points. The advances are required to be repaid as forgiveness and payments are received be a far as the borrower.

repaid the loan over the

Before month term that concludes my remarks will not turn the call over to Chuck. Thanks, Frankie, Bernie and everybody. I started at 9:13 this morning. We announced net income of $10,000 or $0.65 per diluted share for the first quarter of 2020 compared with that income of 11.8 million dollars or $0.72 per diluted share for the first quarter of 2019 proceeds from a bank own life insurance claim and a gain on the sale of a former Brandt facility increased that income in the prior-year. By one point eight million dollars or $0.11 per diluted share excluding the impact of these transactions diluted earnings per share increased $0.04 or approximately 7% during the current year first quarter compared with prior-year first quarter movie that's like fourteen interesting, on loans declined due to the fomc rate Cuts aggregating 225 basis points suck.

Beginning of the third quarter in 2019 with a hundred fifty basis points of those cuts occurring in the first quarter of 2020.

Interesting, Securities benefited from a 1.8 million dollars in accelerated discount accretion from US government agency bonds during the first quarter of 2020 Chef interesting comes down zero point seven million dollars during the first quarter of 2020 compared to the first quarter of 2019 or down 2.5 million if the accelerated discount across is excluded interest expense decline in all categories during the first quarter of 2022 compared to the first quarter of 2019 reflecting a declining interest rate environment.

That interesting, decline 0.3 million dollars during the first quarter of 2020 compared to the first quarter of 2019 or two point 1 million dollars at The Accelerated discount accretion is excluded.

Provision expense total $750,000 or the first quarter of 2020 relatively similar to the $850,000 would be expense during the first quarter 2019. We elected to postpone the adoption of see so as permitted by the cares at as you know, an economic forecast is a key component of the Cecil methodology. We are embarking in Georgia unprecedented economic environment, whereby a sizable portion of the economy has been significantly impacted by shelter-in-place declarations and similar reactions by businesses and individuals substantial government stimulus has been provided to businesses individuals and state and local governments financial institutions have offered businesses and individuals payment options.

Economic forecasts are regularly updated and there is no economic forecast consensus, even the high degree of uncertainty surrounding economic forecasting. We have you'd like to bring it in you to utilize our incurred loan loss Reserve model for the time being updating lost migration calculations and modifying as necessary the nine environmental factors at Each corner rent.

first quarter

2020 provision expenses reflects a combination of lung growth and economic environment allocation change and a reduction of specific allocations and certainly uncertain fully collected landing page.

Moving on the slide fifteen total fee incomes are in the first quarter of 2020 was similar to the income recorded during the first quarter 2018.

However, if the aforementioned bully claim and former Branch facilities sales being on sale are excluded being come during the first quarter increased by one point eight million dollars or 38% off Mortgage Banking income expanded by about 150% reflecting increased refinance activity during the latter part of the quarter and the successful implementation of several strategic initiatives, including the ongoing hiring of additional mortgage lenders. We also recorded 13% growth a service charge income a large part reflecting higher treasury management wage and 14% growth in payroll processing income due to an expanded client base.

On page sixteen overhead cost increase one point 1 million dollars during the first quarter of 2020 compared to the first quarter of 2019 salary and benefit costs rep point five million reflecting Merit pay increases and higher mortgage lender commissions occupancy furniture and Equipment costs were up a combined zero point four million dollars in large pack reflecting the fall of 2018 completion of our main office expansion.

And 517 reflects that our net interest margin was 3.63% during the first quarter of 2020 unchanged from the fourth quarter of twenty thousand two thousand nineteen and twenty five basis points compared to the first quarter of 2019.

Previously mentioned accelerated discount increased on you called US government agency bonds and a 22 basis-point positive impact on our yield on earning assets and net interest margin during the fourth quarter of this year.

You'll download was 32 basis points during the first quarter of 2020 compared to the fourth quarter of 2019 and down 52 basis points. When compared to the first quarter of 2019 off in large part reflecting the aforementioned fomc's aggregate 225 basis point reduction in the targeted federal funds rate. The cost of funds has also been on a declining Trend wage primarily reflecting the falling interest rate environment, but in terms of magnitude and scale not to the degree experience and our yield on loans

Excluding the impacts of the PPP loan and P PP l m programs. We forecast a lower net interest margin during the second quarter of 2020 has the experience of Life impact of the aggregate hundred fifty basis point rate reduction in early March and then it relatively stable and that interest margin for 24 remains 2020s.

Friday 18 our mortgage loan origination totaled almost a hundred thirty-three million dollars or in the first quarter of twenty-twenty in eighty eight million dollar or 195% increase compared to the first quarter 2019 about 65% of the mortgage volume during the first quarter of 2020 consisted of refinance applications compared to only 33% off the first quarter of last year approximately 72% of the mortgage loan origination during the first quarter of 2027 or will be sold on the secondary Market that's up about 48% from a year ago. The net gain on the sale of mortgage loans was lowered during the first quarter of this year relative to our level of activity reflecting the one-time impact of our decision to our host loans closer to the commitment expiration. They'd rather than soon after the closing date of the mortgage loan.

The Accelerated refinance activity did result in a higher level of mortgage servicing right amortization. However, as we use a lower of cost or Market methodology no valuation down was recorded the estimated value of our mortgage servicing right rights remains well above the carrying value at March Thirty One.

Moving on a slight nineteen. We remained a strong and well-capitalized. We remain in a strong and well-capitalized rabbits. For example position the banks Tier 1 leverage Capital ratio. Would you love a point three-per-cent and the total risk-based Capital ratio was 12.9% as of March Thirty One hundred twenty the total risk-based Capital ratio was over $94 million dollars above the minimum thresholds being categorized as well capitalized share repurchase activity during the first quarter of 2020 total of 222000 shares at a total cost of six point three million dollars or $28.25 average per share price in late March. We elected to suspend share pre-purchase activities due to the fact certainty surrounding the covid-19 environment. You currently have about ten million dollars available in our current repurchase plan.

Sorry that it's like 20 on semantics qualities numbers the overall quality of the loan portfolio remains, very strong with continued low levels of non-performing loans and Loan charge-offs non-performing loans as a percent of average loans equals only 12 basis points at the end of the quarter.

Balance of other real estate on was less than $300,000 at quarter-end.

Roselawn charge total less than a hundred thousand dollars or in the first quarter of 2020 while recoveries of Prior. Loan charge-offs total over 200,000.

Resulting that loan recovery of about 200,000 equated to three basis points of average total loans annualized.

A slight 21 additions and non-performing assets total 1.3 million dollars during the first quarter of 2020 in large part reflecting purchased in. Residential Mortgage Loans off due to materiality considerations loan purchase. Accounting was a large part discontinued effective January 12020 there for at least specific stress Residential Mortgage Loans are now reported as originated.

Even despite 22 due to the high degree of uncertainty that currently exists. We will not be providing earnings performance guidance as we have done on past conference calls. However long it will do offer a key considerations. It should be factored into any earnings forecast of our company included in regards to that interesting, the 30-day LIBOR rate 56 floating-rate commercial loans or 25% of total commercial loans are tied to this index. We repriced 30-day live or loans based loans off the first business day of each month equal to the closing rate of the previous month end and then hold that rate constant for the entire month while historically the 30-day LIBOR rate is approximated. The targeted federal funds rate in credit risk premium has resulted in elevated 30-day LIBOR rate.

The 30-day LIBOR rate was 99 basis points at March $31, 20 compared to the federal federal funds rate of twenty five basis points. Interesting. Come of commercial loans will be impacted two degrees of 30-day LIBOR rate fluctuates in future periods.

PPP loan and PPP volume Upp loan findings are in excess of $500 SBA loan origination fees total in excess of $40,000 direct loan origination cost aggregate about 1 million dollars.

It is likely that PPP program will be used to find a majority of the resulting deposit outflows over the next six to ten weeks net deferred SBA loan origination fees and direct loan origination costs would be included into interesting come out loans over the life of the loans and a level yield method Home Loans are under written for a 24 month. The degree to which PPP loans are forgiven and the loans are effectively paid off by the SBA net deferred loan fee application will be accelerated.

Accelerated discount accretion and probable US government agency bonds total 1.8 million dollars during the first quarter of 2020 Honda created discount aggregated 1.5 million dollars, as of March Thirty One the degree to which discounted agency bonds are called discount accretion will be accelerated.

And finally the an asset quality in margin the degree to which an increase in non-accrual loans experience loan interest income may be negatively impacted.

For provision expense loan growth require some level of Reserve bills be a provision expense the degree to which loans are downgraded in accordance with our loan grading Paradigm Reserve building be a provision expense may be necessary the degree to which loans become impaired due to being placed in non-accrual or TDR status Reserve building via phone. Not an expense may be necessary.

Denying qualitative environmental Reserve allocation factors are formally reviewed and each quarter in any changes may have an impact on the required Reserve calculation which may impact could impact the provision expense.

Or seeing come Michigan shelter at home declarations have had a substantial impact on the home purchase Market the degree to which changes in covid-19 measures are made by Michigan Governor are difficult to predict on our mortgage banking operations, Michigan shelter at home decorations have also had a substantial impact on debit and credit card interchange fees as a child uses drop the degree to which changes in covid-19 measures are made by the Michigan's Governor are difficult to predict on our debit and credit card operations.

And last name for ever had cost as you can shelter home decorations have had a substantial impact on various overhead costs such as employee meal and mileage reimbursement as well as foreign ATM fee reimbursements the degree to which changes in covid-19 measures are made by Michigan's Governor are difficult to project on various overhead costs.

Any increase in problem own relationships could result in an increase in collection costs.

And closing while there are many uncertainties that may impact mercantile's Financial condition and Earnest performance in future. We note that we enter the stress environment with strong asset quality and cam position. Those are my prepared remarks not turned to call back over to stop. Thank You Chuck and thank you Ray. Then. I'll concludes Management's prepared remarks will models in the call of the question and answer session.

We will now begin the question-and-answer session ask a question, and they press * then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset before pressing the keys will draw your question, please press * then two at this time. We will pause momentarily to assemble our roster.

Our first question comes from Brenda no soul with Piper Sandler, please. Go ahead.

Hey, good morning, guys. How are you?

First off. Just wanted to thank you for the level of disclosure you guys offered in the spot definitely very helpful. So I'm questions to just starting off on the level of the reserve. You know, I get that em, pretty stable charge also really benign and you guys got some to delay Cecil implementation, but I guess even so just kind of looking at the level of unemployment things coming out of Michigan. It seems like it's one of the harder it states. So just help me square up kind of relatively stable Reserve level, you know versus the the stress that we're seeing in the Michigan economy right now.

Can't read any as as we mentioned is is we all know there's so many moving parts to a reserve calculation. And of course now we have the incurred model as well as the Cecil model and for my comments by preparing marks. We we thought of best just trying to manage the process and given the massive uncertainty when it comes to the economic forecasting process, which we all know is a significant impact on the calculations with in Cecil. We thought a very appropriate to continue to use the incurred model. I think it's service quite well since we've performed back in nineteen, ninety seven, and yeah, it is an incurred model and it definitely starts with migration but like everybody else to use the model. We do have the nine Reserve Reserve environmental allocation factors that we're certainly going to consider and we did consider at the end of March and we did make some adjustments. So we yep.

You obviously be relying very heavily on those and then quite frankly. We need to see how this is going this environment going to impact our borrowers over the next especially the next couple of quarters off and true of Michigan has definitely been hard hit but that was already stated by Bob. But we also note that when you look at Michigan's primary presents those areas have not been as hit hard cuz most of the cases being in southeast Michigan. So there's somewhat of a of a separation there, but obviously it does affect the economy for the entire state but one of the interesting things was see so is that upon adoption are de one calculation actually showed a reduction of our reserve of seven hundred thousand dollars. So by not adopting so at least out of the gates on a day one calculation, we actually increased our Reserve so to speak by $700,000. So so going forward, you know, we're going to we understand. Yep.

That there's going that we are entering in our in the midst now of a very stressed environment in per my comments. We're definitely going to be working with our borrowers understanding the impact of this is having on them and obviously, you know doing any down drains that are necessary executive management will continue to look at the environmental factors and adjust those as needed given the changes in circumstances involving those allocation factors. We've already downgraded the economic factor to its lowest level possible within our current rating Paradigm. So I think you know, I think one last thing as we saw and we're that $700,000 reduction the reserve came from is that you know over 55% of our loan portfolio our commercial loans it was so we don't have much of a exposure to the consumer retail area and that that we do have is primarily mortgage lending Club.

when you look at

So it's a duration base model and with our commercial lending footprint. Our average duration is barely over two years that drives by Looking Down by itself that drives a lower level of Reserve. So while while I say the $700,000 reduction would have been taken on day one that's actually a net reduction. If you actually look at the walk-ins are reserved allocations for commercial loans would have fallen much more than that, but we did see an increase from our mortgage loans allocation calculations, which result of that $700,000 that quite frankly to this management team doesn't make a lot of sense. But unfortunately, it's just part of the rules of Cecil where we cannot assume renewals and wage commercial loans. We have great relationships with with many of our commercial borrowers that we expect to have in in many future periods. Notwithstanding any maturity that they may have. Yep.

Up in the next few quarters or a couple of years and then I think lastly and I think really what drove us did not using Cecil was the economic forecast aspect to it off. We saw the third party that we're going to rely on a primarily for our Cecil modeling changes forecast quite regularly and there were some very dramatic changes Thursday that we were going through. So just trying to pick which one of the forecast we should use was being questioned one of the other controls that we have as we were building our back tomorrow was that why we were selecting one third-party provider. We wanted to make sure that that provider was in the range of the consensus that was out there since as we know there's many books out there providing economic forecasts. We know that there is absolutely no consensus whatsoever. So one of those key controls that we have in our own model I make sure that our economic forecast that we yep.

Is in is within or very close to consensus. It's not because there is no consensus. So we were very troubled to have to start using a brand new model that we believes some serious shortfalls in the midst of a very dire crisis that we're in so long waited answer to your question, but I want to make sure that everybody understands why we took it we obviously we certainly did not take it to lower our provisioning expense. We know the banks had a reported so far reported very significant increases in provision expense. That's fine. We also note that most of those banks have very large consumer loan retail loan exposures that we saw at least in our own models that we saw the impact that that could have moved on on calculations and again being a Commercial Bank Kevin this rating Paradigm that we've always had added a night of environmental factors.

Those are the ones that were going to continue to rely on and if we see, you know.

Significant stress within our portfolio or we specific credits. I should say we're going to downgrade them accordingly and we'll do our Reserve calculations. But you know, it's very very difficult to understand exactly what the impact is going to be on asset quality as we move forward just because of the amount of stimulus that has been put in we we have over 1,500 of our clients and more waiting to get PPP loans, which obviously is providing them up and two months of cash flow for some of the biggest expenses that they have. We're also offering our mortgage borrowers payment options that will help protect their cash flows and even for other commercial borrowers. We are also offering them payment deferral options as well. So we see significant stress off on our entire economy throughout our Market places, but we also see a tremendous amount of stress of stimulus and other variety of programs that are going to lessen. Yep.

Three that the stress has on our borrowers in on our consumers and Commercial borrowers. So, you know, the big question is going to be what is the duration of the of the impact of our our governor has been very aggressive on her measures reflecting the significant impact that has had especially in southeast, Michigan. No one's arguing that point that those should have been done but to the fact that we're going to start seeing those lifted if at all over the next few months is going to have by far the biggest impact on our asset quality and during that time we're going to continue to measure our portfolio page of the quality of our loan portfolio and make provision expense entries as required.

All right. Thank you so much for all of your thoughts there. I certainly appreciate all the the problems of adopting Cecil especially in light of you know, an unprecedented environment just a follow-up for those comments. You know, if we are on the old and curd lost methodology and kind of credit migration. It's such a big component of what provision expense and the open very very reserved should be I mean to be sure that you guys have taken at other banks have taken, um, whether it's forbearance or deferrals. Does that slow down the trajectory of migration such that you know Reserve building is took it out even further. Um, as those credits are, you know under a deferral?

Yeah, I think one of the things I want I should have stressed in my long-winded answer to your first question. Was that our migration, you know our bank and many banks, but our bank has had very minimal loss really over the last five six seven years and recognizing that and if you go through our mind, if you go to our migration calculations, there's a lot of our loan categories where I'm a grade four or five rate alone would have zero or a very very small allocation to it. But we did a long time ago was we actually adopted minimum or de minimis reserve a loaner from factors for are five primary categories of commercial loan or primary segments along with each grade that was quite a significant increase in amount of cost. If you will remodel Reserve, we were required to carry as part of our migration to our migration numbers were very very small, but we we put in place these de minimis. Yep.

Quite frankly. That was one of the big differences between are encouraged model and our Cecil model.

Was that the system model did not allow for these de minimis or these minimum Reserve allocation factors. And if you look at the decline that I mentioned reserve allocations for commercial loans incurred and the Cecil. It was really the elimination of those de minimis numbers. So obviously we did not feel comfortable with that because we thought it was very appropriate to include some de minimis phone numbers in our Reserve calculations given the very very clean level of our asset quality of our loan portfolio over the last five and seven years, which obviously was driving a lot of our own Nation.

In regards to your second question here, you know, we're going to continue to work with our buyers. Our lenders are talking to our borrowers on a regular basis based on those discussions. If it's determined that we need to downgrade credits were certainly going to do that, but it's just going to take a while for this to you know to shake out of it. So and every customer is going to be impacted in a very different way. It's very difficult to a carte blanche. This is this is what's going to impact everyone and everyone's going to be treated equally or impacted equally that's just not the case, especially with commercial lending. I think maybe that can have a little bit better of an impact if you're looking at a retail lending base, but in commercial lending every single borrowing relationship we have is different and it needs to be looked at on its own merits. That's why we have a game system. That's why we rely on our grading system to really Drive our Reserve balance. This is Bob. I'll handle it Chuck said and and just re-emphasize what he said earlier. Is that off.

Our loss Reserve methodology is served as a very well over the years during good Economic Times and under channels Economic Times and we'll see how it all plays out with Cecil the next couple of years back to the adoption and the eventual adoption of that by all all banks, but we feel really good about our methodology. We feel really good that our customers are very solid going into this choices. They were across the board portfolio and great strength customers and Performing very, well. I think that will serve them at us very well as we work through this crisis and took whatever comes down the road as a result of the shutdown of our economy. So that's very unfortunate that we had that strength point in the truck said we'll continue to analyze each customer that life situation understanding where the revenues are coming from and the economy eventually gets reopened here in Michigan and I think the governor and legislators are working on that to make sure that yep.

Don't go overboard with the restrictions, but make sure that we continue to flatten the curve and I think the results are showing that that's happening and I think a ones that proves to be a sustained pattern. Then you start to see some of the non-essential businesses allowed to be reopen back up and that will bring some certain relief to our customers and non-customers in our communities that have been shut down and as a result the unemployment numbers are very hot. There's no question about that. But he drives through town parking lots are empty. So you're going to have unemployment but I think the measures will serve as well the the state will emerge from the crisis and the county will be reopened and businesses back to work and employees back to work.

All right, perfect. Thanks for the comments. And then last one for me before I step back. So on the T program, you know five hundred million of loans approved so far looks like the average fees about 2.8% seem to make sure I have it right here. That's roughly fourteen billion of origination fees that you expect to accrete into ni over whatever life of the loans ends up being. Is that correct? That's correct.

And then we have about a million. And then we have about just to add to that we have about a million dollars and direct origination cost that will defer and you know net that with those game is over the life of loans as well.

Got it. Thank you.

Our next question will come from John roditis with Jamie, please go ahead.

Good morning, guys. Actually my question was just asked and answered on the average fee on the PPP loans, but I'm obviously guys a lot of uncertainty and stuff but Chuck just curious and I I get all the moving parts and stuff. But when you stress the loan portfolio any thoughts on sort of cumulative losses over the over the next few years.

No, that's we've actually run several different models. If you will John we we had our back in the early 2017. We went through a formal name of Ender to do a formal stress test of our loan portfolio using the stressed environment that the FED had set out for the defense and seek are testing that years and you know, we felt pretty good. It didn't surprise us the results in surprises when they come back given if the loan portfolio hasn't changed much in its makeup and its characteristics we can I use those same inputs if you will and we apply it to our current portfolio. We think that that's a sufficient proxy without having to go through the process and the cost of money doing that. And again, we we we think that's a good proxy because of the ongoing similar characteristics of our portfolio and that was standing the growth and as you might expect we definitely see in both the you know the wage

Scenario is the base case the one and two. Obviously we would see an increase in provision expense certainly well and above and beyond an annual ization of what we expect during the first quarter, you know.

Brian I'm president of time so it's so hard to to put a scenario out there of saying this is what's going to happen. You know, it's you know, hopefully this is going to be Thursday the the depths of it of the environment going to be relatively short-lived per batch comments. I won't repeat that. I think he's spot-on to how long this crisis is going to impact and again it goes back trying to repeat myself to answer another question. But we're a Commercial Bank and it's going to impact all of our commercial borrowers in a different way and quite frankly a couple of our borrowers are having great quarterback because they happen to produce products that are very essential during this time quite interestingly two of our larger watchlist credit are some of our best performing credits. We have a great now just because of the line of business that they're in so we can throw numbers at it all day long and I could give you numbers all day long and this is one of the reasons why we didn't want to go with

We'll see you still methodologies because we wanted to be as as quantity.

Toyota of and logical as we possibly could given up the make up of our loan portfolio. There's no doubt that it's a stress environment companies and individuals are going to suffer going to see an increase in past dues in non-accrual and likely some charge-offs but the degree of which is just anybody's gas and we can sit around and and do scenarios all day long, but it's not going to matter. We're not going to be able to tell today unlike what Cecil told us. It was going too fast. We told us was it was going to predict future losses. This environment is just too Dynamic took precedent. It's really have any understanding on April 21st of what the impact is going to be on our bank or any other bank.

No, you're right. It's hard to tell what the The New Normal is going forward. So just just Switching gears Chuck. You said that the margin without specific guidance? I think you said I just want to confirm you said you expected it to be down in the second quarter and then sort of stable in the second half of the year. And then I just to confirm though. When you say down in the second quarter is the right way to think about it down from backing out the discount accretion. So the sort of the core margin in the first quarter was roughly 342, I think so down from that level in second-quarter.

Yeah, I think yeah, you're exactly right. That's what my comments would be laying was that we had a core of around three hundred forty-three forty-two and that we would expect further reduction in the second quarter given the fact that the fomc rate Cuts happened in early March. So we we get a full quarter of that not having said that and again we can go into lots of different scenarios a lot of our Prime based loans, which is half of our floating rate loans hit their floors at the beginning of March. So not every loan went down by the hundred and some-odd basis points off a hundred fifty basis points that the FED reduced by and then of course my comments on the 30-day Libor, you know, that was 99 basis points. We already see that Libor down this month, which I would have expected with some solidification of the markets that are out there. But again, lots of moving Parts there. So I yep.

Really want to give specific guidance there just because of all the moving Parts. But yeah, I would say there was death. There's definitely going to be a reduction of our core. Margin that was standing the PPP program second quarter compared to our first but then I would expect it again on a court basis to be relatively steady for the rest of the year. Once we get out of any major changes in any of the indices that support our own.

Okay makes sense. Okay guys. Thank you and be safe. Thank you.

Our next question will come from Damon Delmont with KBW, please go ahead. Hey, good morning, guys. How's it going today? So quick question on the the longer you saw this quarter and and see Ni how much of that was attributable to increase line utilization. And what was mine utilization rates last quarter to this quarter off your name is this is Chuck, you know, all of our loan girls just to kind of back it up a little bit about half of it was Residential Mortgage Loans basically held for sale portfolio. Then the other half was net loan growth on the commercial. I just want to make sure that we we got that math, right? We saw some increases in line balances towards the end of March but it wasn't anything out of the ordinary. I don't I mean the level of change wasn't anything out of ordinary, you know, we're a Commercial Bank and we got lots of lines of credit. So we do see our line balances, you know, fluctuating, you know, five ten fifteen million birth.

and the day on

Ridge and I would say that while we saw some gradual increases towards the end of the first quarter, it wasn't anything out of the ordinary to what we typically see in the daily basis and I thought overall basis our line utilization continues to be around 50%

and I would also just stress the fact that our line balances are supported by borrowing formulas and so customers, you know may have the need to come in and bar authors credit and we're more than happy to do so so long as we've is there within our borrowing formula and certainly any slowdown that they may be seeing in their business because of the correct. It may have a negative impact on the on the maximum amount that they can borrow under existing line. So again, sorry say it again, but lots of moving Parts there but have not on an overall basis. We have not seen any major spike in line utilization, of course five hundred billion dollars in loan fundings through PPP has certainly helped their Cashflow situation.

Got it. Okay, and then just the kind of circle back on the PPP may have said this but the the $14 and fees, you know, obviously you said a million dollars in expenses associated with that. Does that all come in on when the loan is originated or is that spread out over the life of the loan? I may have missed that, We are suppose the emphasis. I am suppose to get to get the fee within five days of money. Although for us. We were I thought you know, we got to give so much credit to our team and what they've done over the last three weeks. It's a basically work with over 1,500 borrowers and putting the applications through and now we're funding these loans. I think our funding Center this morning or last night. We're up to $485,000. So we're almost through the initial wave that we've gotten we are certainly hopeful that Congress refunds that or puts more money into that program cuz we have more customers wage.

That five hundred million dollars. I think we're definitely through the largest amount but there are other borrowers out there that that would like the assistance and we would like to get it to them what we're finding as we find what we could get it in the PPP program or finding getting in the the federal reserve's liquidity program. And now we're finding trying to get our fees is that everyone's trying to figure this out on the fly. So this is not a criticism one. This is all brand new and everyone's trying to figure it out one step at a time. And so we got through the origination process now, we're actually with banks working with the treasury and getting these days and what type of reporting that we have to provide to them because they don't know the degree that we funded them. They definitely know what we've what we've asked for what are brows have asked for what they have approved wage because the fees are based on when we fund they don't know that so now we're finding that there's a reporting mechanism that we need to provide to them that will then initiate them paying us the fees. Yep.

Supposed to pay within five days of funding but that assumes that we're providing them that information on that day and there's definitely some ketchup.

Coming with that having said all that I would think that we're going to be caught up within the next week or so on that and getting those funds in house. This is Bob. I want to just pause for a for a second and then it follows with something Chuck said I wanted to give our team here at Mercantile everyone in our team strong faith use and congratulations for being able to work through this p p p p p p process continuing to work through it all hands on deck against people from all different areas of the bank regardless of what they did in the regular day job helping with the process to make sure that we got these applications in processed entered into the system and approved by this be a month and we wanted to include some of the comments that are exact just reflect some of the feedback we've heard from customers that expressed appreciation of some of the things that they heard that were going on at other Financial Staffing.

The processes hadn't gone this smoothly and and the trucks set. This is the new process. We're all trying to work through it. But I give tremendous props to the Mercantile team for the work that they did make it as smooth off of a process as we could for our clients with some very challenging times for everyone and I want to just take a couple seconds of saying that because they really deserve it and I can't think them all in the bath.

Great. Well, there's another data point is the white Community Banks are so important to the success of our banking system. So congrats to your team. Just one quick one more quick follow-up question on that. So Chuck when we think about these fees like have have much of them hid in the first quarter or do we kind of model in the majority of the Fourteen million dollars coming in here in the second quarter month?

Yeah, I mean that's going to be the $100,000 question Damon is we expect obviously don't know we never been through this again. We expect a majority of our borrowers to ask for forgiveness soon after you know going through their their borrowings to pay their salary mortgage payments rent payments and utilities. So when happens we would suspect that would be towards the end of May and into June when they would actually get to that standpoint to that Milestone if you will so working through the Forgiveness you believe a lot of it will really be a third quarter event, but we definitely would expect that some of that will tail off through the rest of the year. It is 1% financing and I think some of our borrowers will learn that and ask for forgiveness later on down the road. We just don't know how they're going to react we look at ourselves and think okay. I'm going to Jordy are going to ask for forgiveness. Yep.

Gotten through the two months of cash flows, but it's it's hard to know but my opinion and doing my internal analysis is that we expect a majority of that the funds through in the third quarter month and a little you know, most of the rest in the fourth quarter.

Got it.

Okay, that's all that I had. Thank you and stay safe out there.

If you'd like to ask a question and his * then 1 against our then one to ask a question.

Our next question will come from Brandon with Piper, please go ahead.

Hey guys, just one follow-up from me on slide 10 you lay out, you know, all of the The covid-19 Package Industries, and obviously he has up to a decent chunk of em, kind of total commercial loan balances, which of these are seeing the most stressed today and and which of these sectors kind of have you guys most concerned as this pinned and like, oh, yeah play that over the next few months.

This is Ray. I would say that the movie theaters are one key area that we're focused on their completely closed and practically have no Revenue. So that will be an area of focus and restaurants are reduced to drive-thru only in some cases the complete clone know another's so that'll be another and hotels motels lodging are significantly impacted by the inability to move around and travel for business and Leisure, so

I'd say those three are three key areas.

Well, I want to stress the Brendan that you said earlier over the years as part of our risk mitigation concentration processes life partner with what we feel a very strong borrowers. And as we the comment early going into this crisis, most of our borrowers were very solid Financial condition and they have that ability to certainly one of the storm probably more so than many other attempts to clients. You could Bank in our communities that said Ray makes some very good points all about businesses are tough right now and that's why I think people in our state are working very hard to strike a good balance between blending the curb and reducing the virus but also making sure that we're not exceedingly harming the economy more than we have to to accomplish that so it's a balancing act but but those are all the we're looking at our entire portfolio because there there are some are dead.

And that probably the the longer this thing goes on. We'll have some some some surprises and some things that will have some some unintended consequences from an economic and Commercial standpoint. But with him.

March of the whole part follows. We wanted to put this out there for the wrists industries that we see are the the biggest immediate impact industries of of the closures so far.

Yeah, that that all makes sense. And it's it's definitely helpful detail last one for me. Just looking at retail payment assistance inquiries, you know looks like wage inquiries Keith around the end of March early April then came down is that just kind of timing due to when you know, what payments were due is that why that came down and would you expect inquiries wage increase again as we get to the end of April?

You know, I think the way over to answer that would answer breaded is that a lot of people are that are either laid off or partially laid off or some talent in college situation. They want to keep making their payments early and they will as long as they can and I think the increase in at the start, where's the hey, what are my options in case I need to to go on a payment relief program. So I think the longer this goes on certainly the more customers you have partaking in those opportunities. So again, as we said there are a lot of moving Parts a lot of it depends upon the depth of this crisis and the duration of the crisis and so will be very pleased with the performance of our clients so far, but certainly the longer goes on the more they'll be challenged and certainly part came in these relief programs.

Yeah, got it. All right. Thanks guys. Stay healthy. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Bob kominski president and CEO for any closing remarks. Thank you grant. I thank you all very much for your interest in our company and participate in the call today. We hope you and your families stay healthy and safe. This concludes the call.

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