Mercantile Bank Corporation — Q3 2016 Form 10-Q
Business context and reporting period
Unaudited consolidated results cover the three and nine months ended September 30, 2016; balance-sheet comparisons are against December 31, 2015. Mercantile is a Michigan-based bank holding company. Results include Mercantile Bank of Michigan and its subsidiaries. Management cautions that interim results are not necessarily indicative of full-year performance.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $26.45 million | $25.63 million | $79.43 million | $75.52 million |
| Provision for loan losses | $0.60 million | $(0.50) million | $2.30 million | $(1.50) million |
| Noninterest income | $5.28 million | $4.28 million | $16.43 million | $11.99 million |
| Noninterest expense | $19.66 million | $19.69 million | $58.73 million | $59.28 million |
| Net income | $7.85 million | $7.34 million | $23.83 million | $20.54 million |
| Diluted EPS | $0.48 | $0.45 | $1.46 | $1.23 |
- Management reports net interest margin of 3.76% for Q3 versus 3.87% a year earlier, and 3.89% for the first nine months versus 3.84%. Q3 margin was pressured by lower loan yields and higher funding costs. MD&A also presents tax-equivalent net interest income of $26.65 million for Q3 and $25.77 million for Q3 2015; the income statement reports GAAP net interest income shown above.
- At September 30, assets were $3.06 billion, up $160 million from year-end 2015. Loans were $2.41 billion, up $129 million (5.6%); deposits were $2.33 billion, up $54.1 million (2.4%). Commercial loans were 86.8% of total loans, including $741 million in non-owner-occupied commercial real estate and $750 million in commercial and industrial loans.
- Cash and cash equivalents were $141.7 million, compared with $89.9 million at year-end. Shareholders’ equity was $349.5 million, versus $333.8 million. The allowance for loan losses was $17.5 million; management reported allowance coverage of nonperforming loans at 375%.
- For the first nine months, operating cash flow was $22.2 million, investing cash use was $108.5 million, and financing cash provided was $138.2 million. Cash and cash equivalents increased $51.8 million.
- Borrowings included $178 million of FHLB advances, $146.8 million of repurchase agreements, and $44.7 million of subordinated debentures. FHLB advances increased $110 million from year-end. The bank reported $367 million of available borrowing capacity under its FHLB line. Wholesale funds were 10.1% of deposits and borrowed funds, versus 7.6% at year-end.
- The bank was categorized as well capitalized. Its total risk-based capital ratio was 13.1%, Tier 1 risk-based ratio 12.5%, common equity Tier 1 ratio 12.5%, and Tier 1 leverage ratio 11.3% at September 30.
Material changes versus comparable periods
- Net income increased about 7% in Q3 and 16% year to date; diluted EPS rose 7% and 19%, respectively. Higher net interest and noninterest income more than offset increased loan-loss provisions.
- Year-to-date noninterest income benefited from a $3.0 million pretax gain on the January repurchase of trust preferred securities for 73% of par. The after-tax gain was about $1.8 million, or $0.11 per diluted share. The transaction reduced regulatory capital ratios by about 35 basis points, while the company remained well capitalized.
- Loan growth was led by commercial lending, particularly non-owner-occupied commercial real estate. Acquired loans declined 19.4% from year-end as originated loans grew 15.9%.
- Nonperforming loans decreased to $4.7 million from $5.4 million at year-end; nonperforming assets were $5.5 million, or 0.2% of assets, versus $6.7 million. Net charge-offs were $0.5 million year to date, compared with $2.4 million in the 2015 period. Provision expense shifted from negative provisions in 2015 to $2.3 million in 2016, reflecting loan growth and higher qualitative economic and concentration reserves.
- Year-to-date noninterest expense decreased 0.9%. Savings from a cost-efficiency program announced in 2015 were fully realized beginning in Q2 2016; lower problem-asset and FDIC costs helped offset higher salaries and data-processing expense.
Outlook, risks, and unusual items
- Management described the commercial loan pipeline as strong: approximately $119 million of new lending commitments, most expected to be accepted and funded over 12–18 months, plus $113 million available on construction and development loans expected to be drawn largely over the next year. Management expects future loan growth to be funded primarily by deposits and borrowings, after completing its securities-to-loans asset reallocation strategy.
- Management cited intense competition, loan payoffs and refinancing, persistent low rates and pressure on loan yields. The filing’s modeled 12-month net interest income sensitivity ranges from a 14.5% decline under a 400-basis-point rate decrease to a 9.7% increase under a 400-basis-point increase; these are estimates subject to uncertain assumptions.
- Unfunded loan commitments totaled $742 million, including $623 million in available credit lines, and standby letters of credit totaled $24.9 million. The filing states there was no reserve or liability for these commitments at quarter-end. The FHLB advances are secured by a blanket lien on bank assets; repurchase agreements are generally overnight and secured by pledged securities.
- After quarter-end, the board declared a regular $0.17-per-share dividend and a special $0.50-per-share dividend, both payable December 21, 2016. Management estimated the special dividend would reduce regulatory capital ratios by 25–30 basis points. The filing also notes share repurchases of $3.7 million during the first nine months; none occurred in Q3.
- Management identified no material changes in previously disclosed risk factors and no material current legal proceedings. It stated disclosure controls were effective and there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether loan growth and the stated pipeline convert to funded, appropriately priced loans, particularly given commercial real-estate concentration and competition.
- Whether margin pressure persists as loan yields, deposit costs, and the mix and cost of FHLB funding evolve.
- Credit quality trends, allowance adequacy, and any changes in watch-list, impaired, or restructured loans; acquired impaired loans are accounted for separately from reported nonperforming loans.
- The effects of the special dividend and future repurchases on capital, liquidity, and funding needs.
- How much 2016 earnings depended on nonrecurring or timing-sensitive items, including the trust-preferred repurchase gain, accelerated securities discount accretion, and the Q3 medical-insurance reimbursement.