Mercantile Bank Corporation — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. Mercantile is a Michigan community bank holding company operating primarily in western and central Michigan, with 49 banking offices and a new Troy, Michigan office opened in 2017. The bank’s lending is predominantly commercial.
Financial results and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total assets at year-end | $3.287 billion | $3.083 billion |
| Total loans at year-end | $2.559 billion | $2.379 billion |
| Total deposits at year-end | $2.522 billion | $2.375 billion |
| Net interest income | $109.7 million | $105.9 million |
| Net interest margin | 3.79% | 3.86% |
| Provision for loan losses | $3.0 million | $2.9 million |
| Noninterest income | $19.0 million | $21.0 million |
| Noninterest expense | $79.7 million | $77.1 million |
| Net income | $31.3 million | $31.9 million |
| Diluted earnings per share | $1.90 | $1.96 |
| Return on average assets | 1.00% | 1.07% |
| Return on average equity | 8.82% | 9.35% |
Net interest income increased 3.7%, as loan and earning-asset growth more than offset margin compression. Interest expense rose 25.5%, reflecting higher deposit and borrowing costs. Commercial loans grew $138 million, or 6.7%; total loans increased $180 million, or 7.6%. Residential mortgage loans rose $59.3 million, while other consumer loans declined $17.6 million.
For the fourth quarter, net income was $8.0 million and diluted EPS was $0.48, compared with $8.1 million and $0.49 in fourth-quarter 2016. Fourth-quarter 2017 income included the deferred-tax revaluation charge described below.
Operating cash flow was $38.7 million; investing cash flow was negative $191.5 million, primarily reflecting net loan funding; and financing cash flow was positive $169.3 million. Cash and cash equivalents increased $16.5 million to $200.1 million at year-end. Shareholders’ equity was $365.9 million.
Year-end funding included $2.522 billion of deposits, $220 million of Federal Home Loan Bank advances, $118.7 million of repurchase agreements, and $45.5 million of subordinated debentures. The FHLB borrowing line was $731 million, with $511 million available. Cash and securities available for sale totaled approximately $535.8 million. The bank’s total risk-based capital ratio was 12.6%; management reported the bank remained well capitalized.
Asset quality, changes and unusual items
- Nonperforming loans were $7.1 million, or 0.28% of loans, versus $5.9 million, or 0.25%, in 2016. Nonperforming assets were $9.4 million, or 0.3% of assets, versus $6.4 million, or 0.2%.
- Net charge-offs were $1.4 million, or 0.06% of average loans, compared with $0.6 million, or 0.03%, in 2016. The allowance for loan losses was $19.5 million, 0.88% of total loans.
- Commercial real estate represented about 57% of total loans; management identifies this concentration, particularly land development and non-owner-occupied lending, as sensitive to property values and local economic conditions.
- Reported net income declined by about 2.0%, but management’s adjusted diluted EPS, excluding identified one-time items, rose to $1.89 from $1.76. 2017 included a $1.4 million after-tax benefit from a bank-owned life insurance death claim and a $1.3 million tax expense from remeasuring deferred taxes after the Tax Cuts and Jobs Act. 2016 benefited from a $2.9 million pretax gain on repurchasing trust preferred securities and $1.4 million of accelerated bond discount accretion.
- Noninterest income fell 9.7%, in part because 2016 included the trust-preferred gain; management said its primary recurring fee streams increased 8.5% in 2017. Expenses rose 3.4%, mainly from salary growth and expansion-related costs.
Outlook, risks and contingencies
No specific full-year earnings or revenue guidance is provided. Management reported a strong commercial loan pipeline, including $154 million of unfunded construction and development availability expected largely to be drawn in 2018, and $185 million of additional loan commitments expected to be accepted and funded over the following 12–18 months. Management expected earning assets to remain about 93% of assets and anticipated selling 50%–55% of 2018 residential mortgage originations. It expected the consumer-loan portfolio to continue declining as repayments exceed originations.
Key risks include interest-rate and funding-cost sensitivity, intense competition, local economic and commercial-real-estate exposure, credit-loss and allowance estimation, regulatory change, cybersecurity and operational risks, and the transition away from LIBOR after 2021. The company’s model estimated that a 100-basis-point rate increase would raise next-12-month net interest income by 1.3%, while a 100-basis-point decrease would reduce it by 5.9%; larger modeled declines produced larger losses. These are simulations, not forecasts.
At year-end, unfunded loan commitments and standby letters of credit totaled approximately $1.012 billion, including $801 million of lines available to be drawn and $185 million of commitments generally expected to fund within 12–18 months. Management stated that commitments are monitored and that a contingency funding plan is in place. Troubled debt restructurings totaled $8.6 million. A $1.6 million bank-owned property transfer contributed to the increase in foreclosed assets; management expected the parcel to be sold within six months near book value. Management reported no material legal proceedings or known material loss contingencies.
The 2017 financial statements received an unqualified audit opinion from BDO USA, LLP, and the auditor also gave an unqualified opinion on internal control over financial reporting. The company adopted the new goodwill impairment guidance in 2017 without material impact. It planned to adopt the revenue recognition standard in 2018, which management expected would not materially affect results, and was evaluating the future CECL expected-credit-loss standard.
Most important facts for investors to verify
- Whether loan growth and pipeline conversion can sustain earnings while deposit and borrowing costs continue to rise and net interest margin remains under pressure.
- Trends in commercial real-estate concentrations, nonperforming assets, troubled restructurings, charge-offs and allowance adequacy.
- The stability and cost of funding, including growth in FHLB advances, brokered/out-of-area deposits and uninsured repurchase agreements.
- The recurring earnings impact of the insurance benefit, tax-law remeasurement and other one-time items, and the company’s post-tax-reform effective tax rate.
- The timing and eventual balance-sheet and earnings effects of unfunded commitments, mortgage growth, and CECL implementation.