Mercantile Bank Corporation — 2018 Form 10-K
Business context and reporting period. Mercantile Bank Corporation is a Michigan-based bank holding company serving businesses and individuals primarily in Western, Central and Southeastern Michigan through 46 banking offices. This filing covers the fiscal year ended December 31, 2018; the comparative period is 2017 unless noted. Amounts below are in U.S. dollars.
Key financial results and position
| Metric | 2018 | 2017 | Change / context |
|---|---|---|---|
| Interest income | $142.0 million | $125.5 million | Up 13.1% |
| Net interest income | $120.1 million | $109.7 million | Up 9.4%; net interest margin rose to 3.96% from 3.79% |
| Provision for loan losses | $1.1 million | $3.0 million | Lower provision; 2018 included net loan recoveries |
| Noninterest income | $19.0 million | $19.0 million | Essentially flat as reported |
| Noninterest expense | $86.2 million | $79.7 million | Up 8.1%, principally compensation-related |
| Net income | $42.0 million | $31.3 million | Up 34.4% |
| Diluted earnings per share | $2.53 | $1.90 | Up 33.2% |
| Return on average assets / equity | 1.28% / 11.33% | 1.00% / 8.82% | Both improved |
| Total assets | $3.36 billion | $3.29 billion | Up $77.2 million |
| Total loans | $2.75 billion | $2.56 billion | Up $194.5 million, or 7.6% |
| Total deposits | $2.46 billion | $2.52 billion | Down $58.7 million |
| Cash and cash equivalents | $75.4 million | $200.1 million | Down $124.7 million |
| Shareholders’ equity | $375.2 million | $365.9 million | Up $9.4 million |
Fourth-quarter detail: 2018 net income was $11.6 million and diluted EPS was $0.70, compared with $8.0 million and $0.48 in fourth-quarter 2017.
Cash flow: Net cash from operating activities was $61.7 million; investing activities used $210.5 million, largely reflecting net loan growth; financing activities provided $24.0 million. Cash and cash equivalents fell by $124.7 million during the year.
Margins and funding costs: Average earning-asset yield increased to 4.68% from 4.33%, while the average cost of interest-bearing liabilities rose to 1.08% from 0.80%. The higher asset yield more than offset funding-cost pressure and improved the net interest margin.
Credit quality and capital: Nonperforming loans were $4.1 million, or 0.15% of loans, versus $7.1 million, or 0.28%, a year earlier. Net loan recoveries were $1.8 million in 2018. The allowance for loan losses was $22.4 million. The bank’s total risk-based capital ratio was 12.3%; the bank remained “well capitalized” under regulatory standards. Securities available for sale totaled $337.4 million and included $10.4 million of net unrealized losses before tax.
Material changes versus 2017
- Net income increased substantially, reflecting higher net interest income, lower loan-loss provision expense and a lower effective tax rate. The effective tax rate fell to 18.9% from 32.1%, following the reduction in the federal corporate tax rate to 21% in 2018.
- Loan growth was strong, led by commercial and industrial, commercial real estate and residential mortgage lending. Commercial loans were 85.7% of total loans at year-end.
- Deposit funding declined while FHLB advances increased by $130 million to $350 million. Wholesale funds, including brokered deposits and FHLB advances, were 15.9% of deposits and borrowed funds, compared with 11.3% in 2017.
- Noninterest expense rose $6.5 million, driven mainly by salaries and benefits. The company cited annual merit increases, higher stock-based compensation and a one-time increase for hourly employees.
- Reported noninterest income was nearly unchanged. Excluding a $0.9 million one-time mortgage-banking accounting adjustment in 2018 and a $1.4 million bank-owned life insurance death benefit in 2017, management said noninterest income increased $0.5 million, or 2.9%.
Outlook, risks and unusual items
- Management reported a strong commercial loan pipeline and expected most of $170 million in construction and development availability to be drawn during 2019. It also cited $102 million of additional loan commitments expected largely to close over the next 12 to 18 months.
- Management expected residential mortgage originations to increase, with 45% to 50% of 2019 originations expected to be sold; loans retained were expected to be primarily adjustable-rate. The consumer loan portfolio was expected to decline as repayments exceed originations.
- Loan commitments and standby letters of credit totaled approximately $1.04 billion at year-end, including $784.9 million of unused commercial lines. These are contingent exposures, not necessarily expected cash outflows.
- Interest-rate risk is material: the company’s model estimated that a 100-basis-point increase in rates would raise next-12-month net interest income by 3.5%, while a 100-basis-point decrease would reduce it by 4.4%. These are model estimates dependent on assumptions and balance-sheet behavior.
- Risks include the concentration of lending in Michigan and commercial real estate, competitive pressure on loan pricing and deposit costs, economic and interest-rate changes, and dependence on wholesale funding. Management noted that approximately 65% of commercial loans—about 56% of total loans—related to commercial real estate.
- Many commercial loans and subordinated debentures reference LIBOR. The filing warned that LIBOR may be discontinued after 2021 and that transition to another benchmark could affect loan income, funding costs and contract values.
- The company paid a $0.75-per-share special dividend in December 2018, in addition to a $0.25 regular dividend that quarter. Total 2018 dividends declared were $1.68 per share. It also repurchased 199,905 shares for $5.9 million.
- The company planned to implement the current expected credit loss (CECL) model, expected its initial model to be operational by March 31, 2019, and planned parallel testing through the remainder of 2019. The filing did not quantify the expected adoption impact.
- Management reported no material legal proceedings, and the independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth and the reported pipeline convert into funded, appropriately priced loans, and how the commercial real estate concentration evolves.
- Whether the improved 2018 earnings persist after separating the effects of lower taxes, net loan recoveries and the one-time mortgage-banking adjustment.
- How funding costs, deposits and reliance on FHLB advances change as rates and competition shift; verify available borrowing capacity and maturity schedules.
- Whether asset quality remains strong and the $22.4 million allowance remains adequate, particularly as CECL is implemented and troubled debt restructurings are monitored.
- How the LIBOR transition affects floating-rate assets and subordinated debentures, and whether contract fallback provisions adequately address the change.
- Whether the special dividend, ongoing dividends and share repurchases remain supportable within bank capital, regulatory and liquidity constraints.