Mercantile Bank Corporation — Q1 2020 Form 10-Q
Business context and period: Michigan-based bank holding company reporting unaudited consolidated results for the three months ended March 31, 2020; balance-sheet comparisons are with December 31, 2019. The quarter and subsequent weeks were affected by the COVID-19 pandemic and related economic restrictions.
Financial results and position
- Earnings: Net income was $10.7 million, or $0.65 per diluted share, versus $11.8 million, or $0.72, in Q1 2019. The prior-year quarter included $1.8 million of bank-owned life-insurance claim proceeds and a gain on sale of a former branch. Excluding those items, management said diluted EPS increased $0.04, or 6.6%.
- Income and margin: Interest income was $37.9 million, down 1.8%; net interest income was $30.3 million, down 1.1%. Net interest margin fell to 3.63% from 3.88%. Noninterest income was $6.6 million, roughly flat reported, but up 38.1% excluding the prior-year unusual items. Noninterest expense rose 5.1% to $22.9 million. Provision for loan losses was $0.75 million versus $0.85 million.
- Loans and credit: Loans were $2.90 billion, up $44.9 million, or 1.6%, from year-end. The allowance was $24.8 million, or 0.9% of loans. Nonperforming loans were $3.5 million, 0.12% of loans, compared with $2.3 million at year-end. Q1 recorded net recoveries of approximately $0.2 million.
- Assets and liquidity: Total assets were $3.66 billion, up $24.5 million from year-end. Cash and cash equivalents were $236.7 million. Deposits declined $45.0 million to $2.65 billion; repurchase-agreement balances rose $30.6 million to $133.3 million, and Federal Home Loan Bank advances rose $40.0 million to $394.0 million. Remaining FHLB borrowing availability was approximately $405 million.
- Debt and capital: In addition to FHLB advances and repurchase agreements, subordinated debentures were $47.1 million. Shareholders’ equity was $418.4 million. The bank was categorized as well capitalized; its total risk-based capital ratio was 12.9%, and its Tier 1 leverage ratio was 11.3%.
- Cash flow: Operating activities used $9.8 million, versus providing $2.4 million in Q1 2019. Investing activities used $2.3 million; financing activities provided $15.1 million. Cash and cash equivalents increased $3.0 million to $236.7 million.
Material changes and management commentary
- Lower commercial-loan yields, following Federal Reserve rate cuts, reduced earning-asset yield and net interest margin; lower funding costs partly offset the pressure. Accelerated discount accretion on called agency securities added 22 basis points to Q1 2020 margin.
- Mortgage banking income increased amid strong refinance activity. Mortgage originations were $133 million, and the mortgage pipeline was approximately $200 million at March 31.
- Management said the pandemic could pressure net interest income and loan quality, increase delinquencies, charge-offs and provisions, and reduce earnings. The company described itself as asset-sensitive. Its interest-rate simulation estimated a 0.6% decline in next-12-month net interest income for rates down 100 basis points and increases of 4.2%, 8.3% and 12.3% for rates up 100, 200 and 300 basis points, respectively; these are model estimates, not guidance.
- In early April, the bank introduced 90-day payment-relief programs. By April 30, it had processed commercial interest-only amendments covering $342 million in loan balances, commercial payment deferments covering $247 million, and retail deferments covering $34 million.
- As of April 30, the bank had originated more than 1,750 Paycheck Protection Program loans totaling $523 million and had $43.7 million of advances under the Federal Reserve’s PPP lending facility. Management expected PPP participation to significantly affect asset mix and net interest income for the rest of 2020.
- The company postponed CECL adoption as permitted under the CARES Act and continued using the incurred-loss method. Management noted uncertainty in economic forecasts and warned that future credit deterioration could require higher reserves. Its March 31 goodwill impairment assessment found no impairment.
- The company repurchased 222,385 shares for $6.3 million during Q1, then curtailed repurchases in late March to preserve capital. The board declared a $0.28-per-share dividend in April, payable in June. No formal earnings guidance was provided.
Important facts for investors to verify
- Subsequent-period performance of pandemic-affected borrowers, including the status and outcomes of loan modifications and PPP lending.
- Whether delinquencies, criticized commercial credits, charge-offs or required loan-loss provisions rise materially from Q1 levels.
- Net interest margin sensitivity as low rates persist, and the realized economics of PPP loans and related PPPLF funding.
- Deposit trends, reliance on wholesale funding, liquidity availability and the effect of customer concentration in repurchase agreements.
- Capital, dividends and any resumption of share repurchases as economic conditions evolve; the filing reports the bank was well capitalized at quarter-end.
- Comparability of reported credit reserves: the company deferred CECL adoption, and management cautioned that its allowance may not be directly comparable with institutions using CECL.