Mercantile Bank Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; balance-sheet comparisons are against December 31, 2016. The filing covers the consolidated company, including Mercantile Bank of Michigan and its subsidiaries. Financial statements are unaudited.
Financial performance and condition
- Q3 earnings: Net income was $8.34 million, or $0.51 per diluted share, versus $7.85 million, or $0.48, in Q3 2016.
- Nine-month earnings: Net income was $23.30 million, or $1.41 per diluted share, versus $23.83 million, or $1.46, in 2016. Management’s adjusted diluted EPS, excluding specified noncore items, was $1.34 versus $1.27.
- Interest income and margin: Q3 interest income rose 11.2% to $33.03 million; reported net interest income rose 8.3% to $28.64 million. Net interest margin was 3.83%, up from 3.76%. For nine months, interest income rose 4.4% to $92.64 million and net interest income rose 2.4% to $81.35 million, while margin declined to 3.80% from 3.89%.
- Other income and expenses: Noninterest income was $4.61 million in Q3, down from $5.28 million, and $14.50 million for nine months, down from $16.43 million. Noninterest expense increased 2.8% to $20.21 million in Q3 and 1.9% to $59.87 million for nine months. Nine-month effective tax rate was 30.7%, versus 31.6%.
- Loans and credit: Loans increased 7.4% from year-end to $2.55 billion; commercial loans were 86.7% of the portfolio. The allowance for loan losses was $19.19 million. Nonperforming assets were $10.6 million, or 0.3% of assets, versus $6.4 million, or 0.2%, at year-end. Net charge-offs were $1.1 million for nine months; annualized net charge-offs were 0.06% of average loans.
- Assets, funding and debt: Total assets were $3.25 billion, up $172 million from year-end. Deposits rose 4.8% to $2.49 billion. FHLB advances increased to $220 million; repurchase agreements were $122.3 million and subordinated debentures $45.3 million. Cash and cash equivalents totaled $177.1 million.
- Cash flow: Nine-month operating cash flow was $24.8 million, investing cash flow was negative $173.7 million, and financing cash flow was positive $142.4 million. Cash and cash equivalents decreased $6.5 million from the start of the period.
- Capital: Shareholders’ equity was $362.5 million. The bank was categorized as well capitalized; its total risk-based capital ratio was 12.5%, common equity Tier 1 ratio 11.8%, and Tier 1 leverage ratio 11.0%.
Changes versus comparable periods
- Q3 net income and diluted EPS increased year over year, supported by loan growth, higher earning-asset yields and a higher net interest margin.
- Nine-month reported net income and EPS declined year over year. Results in both years included noncore items: 2017 included a bank-owned life insurance death benefit; 2016 included a trust-preferred securities repurchase gain and accelerated securities discount accretion, among other items. On management’s adjusted basis, nine-month diluted EPS increased.
- Funding costs rose: Q3 interest expense increased 34.8%, and the nine-month weighted average cost of interest-bearing liabilities rose to 0.77% from 0.65%. Higher deposit and FHLB borrowing costs partly offset asset growth and improved loan yields.
- Loan growth was led by commercial lending and one-to-four-family mortgages. Total deposits grew, with money-market balances increasing and large local time deposits decreasing; management attributed part of that movement to one depositor shifting funds into a money-market account.
- Nonperforming assets increased, in part because a $1.6 million bank-owned facility was reclassified to other real estate owned. Management expected to sell it within six months near carrying value.
Outlook, risks and unusual items
- Outlook: Management described the commercial loan pipeline as strong. It cited $163 million of unfunded commitments on construction and development projects in the construction phase and about $130 million of new lending commitments, most expected to be accepted and funded over the next 12–18 months. No specific earnings guidance was provided.
- Credit and commitments: Total off-balance-sheet commitments were $958.2 million, including $931.2 million in loan commitments and $27.0 million in standby letters of credit. No reserve or liability was recorded for these instruments. Management noted that actual drawdowns may differ from contractual totals.
- Interest-rate sensitivity: The company’s model estimated next-12-month net interest income would decline 5.4% under a 100-basis-point rate decrease and increase 1.8% under a 100-basis-point increase; a 400-basis-point decrease was estimated to reduce income 16.5%. Management cautioned that results depend on uncertain model assumptions and market conditions.
- Liquidity and competition: The company reported approximately $430 million of remaining FHLB borrowing availability and a $50 million unsecured federal funds line. Management cited competitive pressure and aggressive lending terms in its markets, while stating it remained committed to prudent underwriting.
- Other items: The company said securities’ unrealized losses reflected interest-rate changes and were not considered other-than-temporary. It reported no material change in risk factors and no material pending legal proceedings. Management said disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth and the pipeline convert into funded loans at yields sufficient to offset rising deposit and borrowing costs.
- Whether the increase in nonperforming assets, past-due loans and troubled debt restructurings remains contained, and whether the allowance is adequate as the portfolio grows.
- Whether the $1.6 million former bank facility is sold near carrying value within management’s expected timeframe.
- How much of the $958.2 million in off-balance-sheet commitments is drawn, and the resulting effects on liquidity and credit exposure.
- Whether reported earnings comparisons remain affected by unusual items and how management’s adjusted EPS reconciles to GAAP results.
- Whether capital ratios and available borrowing capacity remain adequate as risk-weighted assets and loan balances expand.