Mercantile Bank Corporation — Q2 2011 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2011; balance-sheet comparisons are with December 31, 2010. Mercantile is a Michigan-based bank holding company whose business is primarily commercial banking, with a loan portfolio concentrated in commercial lending and real estate. The interim financial statements are unaudited.
Key financial results
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Interest income | $18.5 million | $22.7 million | $37.6 million | $45.9 million |
| Net interest income | $13.2 million | $14.4 million | $26.6 million | $28.7 million |
| Provision for loan losses | $1.7 million | $6.2 million | $3.9 million | $14.6 million |
| Noninterest income | $1.7 million | $2.0 million | $3.5 million | $4.7 million |
| Noninterest expense | $10.4 million | $11.4 million | $22.0 million | $23.1 million |
| Net income (loss) | $2.7 million | $(0.4) million | $4.1 million | $(3.0) million |
| Net income (loss) available to common shareholders | $2.4 million | $(0.7) million | $3.5 million | $(3.6) million |
| Diluted earnings (loss) per share | $0.27 | $(0.08) | $0.39 | $(0.43) |
- Margins: Net interest margin was 3.61% in Q2, versus 3.31% a year earlier; for the first six months it was 3.62%, versus 3.28%. Net interest income nevertheless declined as the smaller earning-asset base outweighed margin improvement.
- Balance sheet at June 30: Total assets were $1.54 billion, down $94.5 million from year-end 2010. Loans were $1.123 billion, down 11.1%; deposits were $1.248 billion, down 2.0%. Shareholders’ equity was $130.9 million, up from $125.9 million.
- Credit quality: Nonperforming assets were $61.9 million, or 4.0% of assets, versus $86.1 million, or 5.3%, at year-end. Nonperforming loans were $43.4 million versus $69.4 million. The allowance was $38.7 million, or 3.45% of loans, compared with 3.59% at year-end. Six-month net charge-offs were $10.5 million, an annualized 1.76% of average loans.
- Cash flow and liquidity: Six-month operating cash flow was $15.0 million, investing cash flow was $149.5 million, and financing cash flow was negative $101.7 million. Cash and cash equivalents increased $62.8 million to $127.0 million. The bank also reported approximately $88 million available under its FHLB borrowing line.
- Debt and funding: At June 30, repurchase agreements were $71.2 million, FHLB advances $45.0 million, and subordinated debentures $33.0 million. Wholesale funds were $522.9 million, or 38.3% of deposits and borrowed funds. The bank was categorized as well capitalized; its total risk-based capital ratio was 14.0% and Tier 1 risk-based ratio 12.7%.
Material changes versus comparable periods
- The company returned to profitability: Q2 2011 was its second consecutive profitable quarter after two years of quarterly losses, and first-half common earnings improved from a $3.6 million loss to $3.5 million of income.
- The principal earnings improvement was the lower loan-loss provision, reflecting fewer downgrades and nonperforming loans and more upgrades. Net interest margin also improved, while funding costs and operating expenses declined.
- Lower interest income reflected a substantially smaller average loan and earning-asset base. Average earning assets in Q2 fell $287 million year over year; average loans declined $286 million.
- Loans declined $139.6 million during the first half, including a $67.4 million reduction in non-owner-occupied commercial real estate loans. Deposits fell $25.9 million, while cash increased and repurchase agreements and FHLB advances declined.
- Nonperforming assets fell $24.2 million from year-end, but foreclosed and repossessed assets rose $1.8 million to $18.5 million during the first half.
Outlook, risks and unusual items
- Management gave no specific earnings or revenue guidance. It said credit quality remained its major concern and expected problem-asset costs and net charge-offs to remain elevated for at least the near term. It was cautiously optimistic that improving asset-quality trends could continue.
- Commercial real estate exposure, borrower cash flows, collateral values, the Michigan and broader economy, and interest-rate movements are key risks. Management expects to retain elevated liquid-fund balances, approximately 2.5%–3.5% of average earning assets, until conditions normalize.
- The full net deferred tax asset remained subject to a valuation allowance; management cited continued uncertainty about future taxable income despite improved results.
- Interest payments on subordinated debentures have been deferred since July 2010, and preferred dividends since August 2010. Preferred-dividend arrears were approximately $1.1 million as of filing. Common dividends remain suspended, and the deferrals and accrued preferred dividends restrict dividend payments.
- In June 2011, the company entered into a $100 million purchased and $100 million sold interest-rate cap corridor. It does not qualify for hedge accounting; the net fair-value change increased Q2 commercial-loan interest income by $52,000.
- Off-balance-sheet commitments and standby letters of credit totaled $255.6 million. Management reported no material current legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether the decline in nonperforming assets and loan-loss provisions is sustained, and whether charge-offs or foreclosed assets increase again.
- The effect of continued loan runoff on net interest income, margin, and future earnings.
- Funding mix and liquidity, particularly the level and stability of out-of-area deposits and wholesale funding.
- Capital adequacy and the duration and cumulative cost of subordinated-interest and preferred-dividend deferrals.
- Management’s allowance estimates, collateral valuations, and full valuation allowance against the net deferred tax asset.