Mercantile Bank Corporation — Q3 2019 Form 10-Q
Business context and reporting period. Unaudited consolidated results for the quarter and nine months ended September 30, 2019, compared with the corresponding 2018 periods; balance-sheet comparisons are to December 31, 2018. The company is a Michigan-based bank holding company. Results are not necessarily indicative of a full year.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Interest income | $40.3 million | $35.5 million | $118.8 million | $104.8 million |
| Net interest income | $31.6 million | $29.8 million | $93.4 million | $89.3 million |
| Net interest margin | 3.71% | 3.87% | 3.79% | 3.95% |
| Noninterest income | $6.7 million | $4.7 million | $19.6 million | $13.6 million |
| Provision for loan losses | $0.7 million | $0.4 million | $2.5 million | $1.1 million |
| Noninterest expense | $22.0 million | $21.7 million | $65.9 million | $64.2 million |
| Net income | $12.6 million | $10.1 million | $36.1 million | $30.5 million |
| Diluted earnings per share | $0.77 | $0.61 | $2.20 | $1.83 |
For Q3, reported net income increased about 24%; for the first nine months, it increased about 19%. Management says nine-month diluted EPS growth was 17.4% excluding the identified special items and purchased-loan accounting effects. The effective tax rate was 19.0% in both years.
Financial condition, cash flow and liquidity
- At September 30, 2019, total assets were $3.71 billion, up $346 million from year-end 2018. Loans were $2.93 billion, up 6.5%; deposits were $2.77 billion, up 12.3%; and shareholders’ equity was $407.2 million, versus $375.2 million.
- Commercial loans were $2.51 billion, or 85.5% of total loans. Residential mortgage loans were $346.1 million. The allowance for loan losses was $24.4 million; reported nonperforming loans were $2.6 million, or approximately 0.09% of loans. Allowance coverage of nonperforming loans was 923%.
- Cash and cash equivalents ended the period at $228.5 million, up $153.2 million from year-end. For the nine months, operating cash flow was $20.1 million, investing cash flow was negative $165.5 million, and financing cash flow was positive $298.6 million.
- Funding included $364 million of Federal Home Loan Bank advances, $104.0 million of repurchase agreements and $46.7 million of subordinated debentures. The bank reported $407 million of remaining FHLB borrowing availability. Wholesale funds were 16.0% of deposits and borrowed funds combined.
- The bank was classified as well capitalized. At September 30, bank capital ratios were 12.5% total risk-based, 11.8% Tier 1 risk-based, 11.8% common equity Tier 1 and 11.0% Tier 1 leverage.
Material changes versus comparable periods
- Net interest income rose with growth in average earning assets, but margin compressed: Q3 NIM declined 16 basis points year over year and the nine-month margin declined 16 basis points. Funding costs rose as deposit and borrowing costs increased and funding mix shifted toward time deposits and wholesale funding.
- Noninterest income growth reflected stronger mortgage banking activity. Nine-month residential mortgage originations were $258 million, up about 52%; a higher proportion was sold than in 2018.
- Loan growth was driven principally by commercial and industrial and non-owner-occupied commercial real estate lending. Total deposits grew $303 million, including a notable increase in time deposits.
- Nonperforming assets declined to $2.9 million, or 0.1% of assets, from $5.0 million, or 0.2%, at December 31, 2018. Net charge-offs were an annualized 0.05% of average loans in Q3 and 0.02% for the first nine months.
- Shareholders’ equity benefited by $12.5 million from the after-tax change in unrealized gains on available-for-sale securities. The company repurchased approximately 231,000 shares for $7.1 million during the first nine months and paid $0.79 per share in dividends.
Outlook, commentary and risks
- Management described the commercial loan pipeline as strong: $165 million in new lending commitments were expected largely to be accepted and funded over the following 12–18 months; $91 million of existing construction and development commitments were also expected to draw over that period. These are expectations, not formal earnings guidance.
- Management remained optimistic about mortgage banking volumes, while expecting consumer loans to decline as repayments exceed new originations. It emphasized prudent underwriting amid intense competition and said some performing commercial borrowers refinanced elsewhere on terms the bank considered aggressive.
- Interest-rate risk is material: the company’s simulation estimated next-12-month net interest income would fall 8.2% under a 200-basis-point rate decrease and rise 11.2% under a 300-basis-point increase. The model is assumption-dependent and actual results may differ.
- Off-balance-sheet commitments totaled $1.06 billion, including $735.9 million of commercial unused lines, $164.6 million of commitments to make loans and $22.1 million of standby letters of credit. The filing notes that commitments may be drawn and create funding or credit risk.
- Management was preparing for CECL, effective for the company in 2020, with model assumptions, controls and parallel runs still being refined. Other stated risks include economic and real-estate conditions, borrower repayment capacity, competition, regulation, interest rates and reference-rate transition.
- Unusual nine-month items included $2.6 million of bank-owned life insurance claims and a $0.6 million gain on sale of a former branch facility. Together, these increased net income by $3.1 million, or $0.19 per diluted share. Purchased-loan accounting added $0.9 million to nine-month net income in 2019, versus $2.7 million in 2018.
- The company reported no material ongoing legal proceedings and no material changes to previously disclosed risk factors. It declared a $0.27-per-share dividend payable December 18, 2019.
Important facts for investors to verify
- Whether deposit and borrowing costs continue to outpace asset yields, pressuring net interest margin.
- Commercial real-estate and commercial-loan concentration, loan pipeline conversion, and the quality of new originations.
- Allowance adequacy and trends in criticized, impaired, restructured and nonperforming loans, including charge-offs and recoveries.
- Deposit composition and retention, reliance on time and wholesale funding, and available liquidity as loan commitments fund.
- How much earnings growth is recurring after excluding BOLI claims, the branch-sale gain and acquired-loan accounting accretion.
- CECL implementation assumptions and its eventual effect on the allowance and retained earnings; the filing does not provide a clear quantified CECL impact.