Mercantile Bank Corporation — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Unaudited consolidated results include Mercantile Bank of Michigan and its subsidiaries. Comparisons below are with Q2 or first-half 2018 unless otherwise stated.
Financial performance
| Metric | Q2 2019 | Six months 2019 | Comparison |
|---|---|---|---|
| Interest income | $39.8 million | $78.5 million | Up 16.0% and 13.2% |
| Net interest income | $31.1 million | $61.8 million | Up 6.5% and 3.9% |
| Net interest margin | 3.79% | 3.83% | Down from 3.92% and 3.99% |
| Provision for loan losses | $0.9 million | $1.8 million | Prior-year periods: $0.7 million in each |
| Noninterest income | $6.3 million | $13.0 million | Up from $4.6 million and $8.9 million |
| Noninterest expense | $22.1 million | $43.9 million | Up 3.1% and 3.2% |
| Net income | $11.7 million | $23.5 million | Up from $9.4 million and $20.3 million |
| Diluted EPS | $0.71 | $1.43 | Up from $0.57 and $1.22 |
Higher earning-asset balances and loan yields supported interest income, while funding costs rose faster: Q2 interest expense increased 70.8% to $8.7 million, and first-half expense increased 69.1% to $16.7 million. Management reported that costlier time deposits, borrowings, and a shift in funding mix contributed to margin compression. Salaries and benefits were the main driver of higher operating expenses.
Reported earnings included unusual items. A bank-owned life insurance (BOLI) claim added about $1.3 million, or $0.08 per diluted share, in Q2. For the first half, BOLI claims and a $0.6 million gain on sale of a former branch increased net income by about $3.1 million, or $0.19 per diluted share. Excluding specified unusual items, management said diluted EPS grew approximately 11% year over year in both periods.
Financial position, liquidity, and capital
- Balance sheet at June 30: Assets were $3.58 billion, up $212 million from year-end 2018. Loans were $2.88 billion, up $128 million (4.7%); deposits were $2.62 billion, up $156 million (6.3%).
- Funding and debt: FHLB advances were $374 million, repurchase-agreement borrowings $119.7 million, and subordinated debentures $46.5 million. Wholesale funding was $543 million, or 17.5% of deposits plus borrowings. Out-of-area deposits rose to 6.5% of total deposits from 4.6% at year-end.
- Liquidity: Cash and cash equivalents were $150.4 million, versus $75.4 million at year-end. The bank reported approximately $363 million of remaining FHLB borrowing availability and access to additional correspondent-bank and Federal Reserve borrowing lines. Sweep/repo balances are secured borrowings, not federally insured deposits, and can fluctuate.
- Cash flow, first half: Operating activities provided $13.9 million (versus $21.4 million); investing activities used $122.9 million, mainly reflecting loan growth; financing activities provided $184.0 million, led by time-deposit growth and FHLB funding. Cash and cash equivalents increased $75.1 million.
- Equity and capital: Shareholders’ equity was $400.1 million, up from $375.2 million at year-end, including an $11.1 million after-tax securities valuation gain. The bank was categorized as well capitalized; its total risk-based capital ratio was 12.4% and common equity Tier 1 ratio 11.6%.
Credit quality and material changes
The portfolio remained predominantly commercial: commercial loans were $2.46 billion, or 85.5% of total loans. Commercial and industrial loans increased 7.1% from year-end, while residential mortgages grew 9.1%; acquired loans declined 9.6%. Nonperforming loans were $3.5 million, or 0.12% of loans, down from $4.1 million at year-end. Nonperforming assets totaled $4.0 million, compared with $5.0 million at year-end. The allowance for loan losses was $24.1 million, and management reported coverage of nonperforming loans of 686%.
Troubled debt restructurings totaled $29.0 million at quarter-end, including $28.1 million performing and $0.9 million nonperforming. First-half loan-loss provision increased primarily with loan growth. Management cited a strong commercial pipeline, including $129 million of unfunded construction and development availability and about $91 million of new lending commitments expected largely to close over the next 12–18 months. It also noted intense competition and instances of performing borrowers refinancing elsewhere, while stating it would maintain prudent underwriting standards.
Outlook, risks, and other notable items
- No specific full-year earnings or financial guidance is provided. Management expressed optimism about commercial lending opportunities and residential mortgage origination growth, while expecting consumer loans to decline as repayments exceed new originations.
- Management’s interest-rate simulation estimated next-12-month net interest income changes of -11.4% under a 200-basis-point rate decline, -5.4% under a 100-basis-point decline, +3.9% under a 100-basis-point increase, +7.8% under a 200-basis-point increase, and +11.6% under a 300-basis-point increase. These are model estimates, not forecasts, and depend on uncertain assumptions.
- Key stated risks include interest-rate and funding changes, competition, borrower repayment capacity, local real estate and economic conditions, regulation, technology, and LIBOR replacement. Management cautioned that actual results may differ materially from forward-looking statements.
- Off-balance-sheet commitments and standby letters of credit totaled approximately $1.02 billion; amounts drawn may differ, and many commitments may expire unused. The filing reported no related liability at quarter-end.
- The expected-credit-loss standard (CECL) was scheduled to take effect for the company in 2020. Management was refining assumptions, processes, controls, and disclosures and planned enhanced parallel runs during the rest of 2019.
- The board authorized a new $20 million share-repurchase program in May, replacing the prior authorization. The company repurchased no shares in Q2; first-half purchases totaled 119,120 shares for $3.6 million. A $0.27 dividend was declared in July for payment in September.
- The filing reported no material change in risk factors, no material pending legal proceedings, and effective disclosure controls as of June 30, 2019.
Important facts for investors to verify
- Whether deposit and borrowing costs continue to rise faster than earning-asset yields, and the resulting effect on net interest margin.
- Credit performance in the commercial and commercial-real-estate-heavy portfolio, including migration of watch-list credits, TDRs, and construction commitments.
- The sustainability of earnings after excluding the BOLI claims and former-branch sale gain, and the trend in recurring fee income and expenses.
- Funding concentration and stability, particularly growth in time and out-of-area deposits, wholesale funding, and uninsured sweep balances.
- CECL implementation assumptions and any resulting allowance or retained-earnings impact when adopted.
- Actual outcomes versus the interest-rate sensitivity model and the company’s stated loan-growth pipeline.