Business context and reporting period
Mercantile Bank Corporation’s unaudited Form 10-Q covers the three months ended March 31, 2018, with balance-sheet comparisons to December 31, 2017 and income and cash-flow comparisons to the first quarter of 2017. The company operates through Mercantile Bank of Michigan and subsidiaries. Unless noted, amounts are in U.S. dollars.
Financial results and position
| Metric | Q1 2018 / March 31, 2018 | Comparable period / prior year-end |
|---|---|---|
| Net income; diluted EPS | $10.9 million; $0.66 | Q1 2017: $7.6 million; $0.46 |
| Interest income; interest expense | $35.0 million; $4.8 million | Q1 2017: $28.7 million; $3.2 million |
| Net interest income; net interest margin | $30.2 million; 4.06% | Q1 2017: $25.5 million; 3.73% |
| Provision for loan losses | $0 | Q1 2017: $0.6 million |
| Noninterest income; noninterest expense | $4.4 million; $21.1 million | Q1 2017: $5.9 million; $19.8 million |
| Operating cash flow | $13.0 million | Q1 2017: $8.0 million |
| Cash and cash equivalents | $211.2 million | December 31, 2017: $200.1 million |
| Total assets; total loans | $3.294 billion; $2.551 billion | December 31, 2017: $3.287 billion; $2.559 billion |
| Total deposits; shareholders’ equity | $2.540 billion; $368.3 million | December 31, 2017: $2.522 billion; $365.9 million |
| Borrowings | $104.9 million repurchase agreements; $220 million FHLB advances; $45.7 million subordinated debentures | FHLB advances were unchanged from year-end; repurchase agreements were $118.7 million and subordinated debentures $45.5 million |
- Net income rose 42.8% year over year. Management said successful collection of certain problem commercial loans added about $1.7 million, or $0.10 per diluted share, in Q1 2018. A bank-owned life insurance death-benefit claim had added about $1.1 million, or $0.06 per diluted share, in Q1 2017; excluding these items, diluted EPS increased about 40%.
- Q1 2018 effective federal tax rate was 19.0%, versus 30.7% in Q1 2017, reflecting the reduction in the federal corporate tax rate from 35% to 21% effective January 1, 2018.
- Higher loan yields and average earning assets supported interest income and margin. The company reported average earning assets of $3.02 billion, up 8.4%; interest-bearing liability cost rose to 0.94% from 0.68%.
- Net loan recoveries were about $0.5 million: $0.6 million in gross charge-offs offset by $1.1 million in recoveries. The allowance for loan losses was $20.0 million, including $19.1 million for originated loans and $0.9 million for acquired loans.
- Nonperforming loans totaled $5.7 million, or 0.23% of total loans, down from $7.1 million at year-end. Nonperforming assets totaled $8.1 million, about 0.3% of assets. Loans were 86% commercial, with commercial real estate non-owner occupied the largest category.
- Available-for-sale securities were $337.0 million. Rising market rates contributed to a $5.6 million after-tax reduction in their value recorded in other comprehensive income; comprehensive income was $5.2 million, versus $8.3 million in Q1 2017.
- Q1 cash flow from investing was negative $2.5 million and financing cash flow was positive $0.5 million; cash and cash equivalents increased $11.1 million. The prior-year quarter had a $130.6 million decrease in cash and cash equivalents.
- The bank was categorized as well capitalized. Its total risk-based capital ratio was 12.9%, common equity Tier 1 was 12.3%, and Tier 1 leverage was 11.3%. The company paid a $0.22 per-share dividend and declared another $0.22 dividend for payment in June 2018.
Material changes, outlook and risks
- Total loans declined 0.3% from year-end despite $111 million in new commercial term loan originations; management cited elevated commercial payoffs, including approximately $21 million from watch-list borrowers and $21 million from borrowers selling collateral or businesses. Residential mortgage loans grew, while consumer loans declined.
- Deposits increased 0.7%. Noninterest-bearing deposits and sweep balances fell, while interest-bearing deposits—particularly money-market accounts—increased. Wholesale funding was $322 million, or 11.3% of deposits and borrowed funds. The company reported approximately $519 million of remaining FHLB borrowing availability.
- Management described the commercial loan pipeline as strong: approximately $238 million in new lending commitments were expected to be accepted and funded largely over the next 12 to 18 months, and more than $133 million of construction and development commitments were available to draw. Management also said residential mortgage pre-qualifications were near a record level. These are expectations, not guarantees.
- Management expects a rising-rate environment to benefit net interest margin, based on its interest-rate-risk model. The model estimated net interest income increasing 1.5% under a 100-basis-point rate increase and 7.3% under a 400-basis-point increase, but decreasing 5.3% and 16.6% under corresponding rate declines. Management cautioned that model assumptions and actual outcomes may differ.
- Key risks include interest-rate and liquidity exposure, competition and deposit pricing, commercial real estate and borrower credit quality, local economic and property-value changes, and the potential for unexpected funding needs. Unfunded credit commitments and standby letters of credit totaled approximately $1.06 billion; the filing states these amounts do not necessarily represent future cash requirements. No reserve or liability was recorded for these commitments.
- Adoption of the new revenue-recognition standard and ASU 2016-01 had no material financial-statement impact. The company was evaluating CECL, effective for it after December 15, 2019, and had selected a software vendor. Management expected the new lease standard to have no material impact.
- The filing reports no material legal proceedings, no material changes to previously disclosed risk factors, and no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much of earnings growth came from recurring net interest income and lower taxes versus the $1.7 million commercial-loan collection benefit, and whether those drivers persist.
- Whether deposit costs continue rising and how rate changes affect net interest margin, given the bank’s sensitivity to both rising and falling rates.
- Whether loan production and the stated pipeline offset commercial payoffs, and how commercial real estate concentrations and borrower credit quality evolve.
- Whether loan recoveries, nonperforming assets, troubled debt restructurings, and allowance coverage remain consistent with management’s credit-quality assessment.
- How unrealized securities losses and future interest-rate movements affect accumulated other comprehensive income, equity, and liquidity.
- Whether available liquidity and capital remain adequate as unfunded commitments are drawn and FHLB advances mature.