Mercantile Bank Corporation — Q1 2019 Form 10-Q
Business context and period. Mercantile Bank Corporation is a Michigan bank holding company. This unaudited filing covers the three months ended March 31, 2019; balance-sheet comparisons are with December 31, 2018, and operating results are compared with Q1 2018. The company cautions that quarterly results are not necessarily indicative of full-year performance.
Financial performance and condition
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior date |
|---|---|---|
| Net interest income | $30.6 million | $30.2 million in Q1 2018 |
| Net income; diluted EPS | $11.8 million; $0.72 | $10.9 million; $0.66 in Q1 2018 |
| Net interest margin | 3.88% | 4.06% in Q1 2018; 3.78% excluding prior-year purchased-loan accounting income |
| Total assets | $3.55 billion | $3.36 billion at December 31, 2018 |
| Total loans, gross | $2.80 billion | $2.75 billion at December 31, 2018 |
| Total deposits | $2.61 billion | $2.46 billion at December 31, 2018 |
| Shareholders’ equity | $383.7 million | $375.2 million at December 31, 2018 |
| Cash and cash equivalents | $214.9 million | $75.4 million at December 31, 2018 |
- Revenue and earnings: Interest income rose 10.5% to $38.6 million, reflecting growth and higher yields on earning assets. Interest expense rose 67.1% to $8.0 million as funding costs increased. Net interest income increased 1.5%. Noninterest income was $6.6 million versus $4.4 million, while noninterest expense increased 3.2% to $21.8 million. The effective tax rate was 19.0% in both periods.
- Reported versus underlying results: Q1 2019 included a $1.3 million bank-owned life insurance death-benefit claim and a $0.6 million gain from sale of a former branch; together these increased net income by about $1.8 million, or $0.11 per diluted share. Q1 2018 benefited by about $1.7 million, or $0.10 per diluted share, from collections on problem commercial loans. Excluding these items, diluted EPS increased about $0.05, or 8.9%, year over year.
- Credit and provision: The company recorded $0.9 million of loan-loss provision, versus none in Q1 2018, primarily reflecting loan growth. Net charge-offs were approximately $0.1 million, or 0.01% of average loans on an annualized basis. Nonperforming loans were $4.1 million, approximately 0.15% of loans; nonperforming assets were $4.5 million, or 0.1% of assets. Allowance coverage was reported at 559% of nonperforming loans.
- Cash flow: Operating cash flow was $2.4 million, down from $13.0 million in Q1 2018; investing cash use was $44.3 million, chiefly reflecting net loan growth. Financing provided $181.4 million, mainly from a $165.5 million increase in time deposits and $34.0 million net proceeds from FHLB advances, partly offset by other deposit outflows, dividends and repurchases. Cash and cash equivalents consequently increased $139.5 million during the quarter.
- Funding, debt and liquidity: Interest-bearing deposits grew $179 million, while noninterest-bearing deposits declined $32 million. FHLB advances totaled $384 million, repurchase-agreement borrowings $111 million, and subordinated debentures $46.4 million. FHLB borrowing capacity was about $827 million, with approximately $437 million remaining available. Wholesale funds were 18.3% of deposits and borrowings, up from 16.2% at year-end.
- Capital and distributions: The bank was classified as well capitalized. At March 31, its total risk-based capital ratio was 12.4%, Tier 1 ratio 11.7%, common equity Tier 1 ratio 11.7%, and Tier 1 leverage ratio 11.0%. The company paid a $0.26-per-share dividend and repurchased 119,120 shares for $3.6 million during Q1.
Material changes and management commentary
- Loans increased $46.6 million (1.7%) in the quarter; commercial loans were 85.7% of the portfolio. Management cited $125 million in new commercial term-loan originations and a strong pipeline, including about $147 million of construction/development commitments expected to be drawn over 12–18 months and approximately $127 million of additional commitments anticipated to close over that period.
- Management said competitive lending conditions have led some sound borrowers to refinance elsewhere, but it intends to maintain underwriting standards and concentration limits. Residential mortgage originations were $44.9 million, up nearly 10% year over year; management was optimistic about continued growth, while noting local housing inventory constraints.
- Funding costs increased materially: the weighted average cost of interest-bearing liabilities rose to 1.47% from 0.94%. The higher cost of time deposits, FHLB advances and other borrowings, plus a less favorable funding mix, more than offset improved earning-asset yields and compressed the reported net interest margin.
- Available-for-sale securities had $7.9 million of gross unrealized losses at quarter-end, primarily attributed by management to interest-rate changes; management stated it did not expect to sell the securities before recovery and did not consider the losses other-than-temporary. The portfolio’s net unrealized loss was approximately $6.0 million.
Outlook, risks and contingencies
- No formal earnings or EPS guidance is provided. Management expected the securities portfolio to remain around 11% of assets, interest-earning deposits around 2% of average earning assets, and anticipated continued loan opportunities. It expected consumer loans to decline as repayments exceed originations.
- Interest-rate simulation estimated next-12-month net interest income changes of -11.1% under a 200-basis-point rate decline, -5.4% under a 100-basis-point decline, +4.0% under a 100-basis-point increase, +8.1% under a 200-basis-point increase, and +16.0% under a 300-basis-point increase. These are model estimates subject to assumptions and uncertainty.
- Off-balance-sheet credit commitments totaled approximately $1.038 billion, including $126.6 million of commitments to make loans and $23.2 million of standby letters of credit. No reserve or liability was recorded for these instruments. The filing notes commitments may not be fully drawn and involve credit risk.
- Key disclosed risks include interest-rate and liquidity exposure, credit losses and collateral values, competition, economic conditions, customer repayment capacity, real-estate values, regulation and technology. Management said there were no material changes to previously disclosed risk factors and no material current legal proceedings.
- The company adopted lease accounting on January 1, 2019, recording approximately $1.3 million in right-of-use assets and lease liabilities. It was evaluating CECL, expected an initial model to be operational in Q2 2019, and planned parallel runs through the rest of 2019.
- Management concluded disclosure controls were effective at March 31, 2019, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether earnings growth persists after the $1.8 million of Q1 2019 unusual benefits and the prior-year loan-collection benefit; track underlying fee income, expenses and credit costs.
- Whether deposit and borrowing costs continue to rise, and the effects of time-deposit growth, wholesale funding, loan pricing and rate movements on net interest margin.
- Quality and funding of commercial real-estate and construction exposures, loan pipeline conversion, and trends in watch-list, nonperforming and restructured loans.
- Liquidity and funding concentration, including the growth in out-of-area deposits and FHLB advances, and the capacity to meet potential draws on $1.038 billion of commitments.
- Assumptions behind the interest-rate sensitivity model and the eventual impact and implementation of CECL.
- The filing reports 119,120 shares repurchased in Q1, while the issuer-purchase table lists zero shares as purchased under the publicly announced plan; verify the classification and remaining authorization.