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Edited Transcript of MBWM earnings conference call or presentation 16-Jul-19 2:00pm GMT

Q2 2019 Mercantile Bank Corp Earnings Call

Grand Rapids Jul 18, 2019 (Thomson StreetEvents) -- Edited Transcript of Mercantile Bank Corp earnings conference call or presentation Tuesday, July 16, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Charles E. Christmas

Mercantile Bank Corporation - Executive VP, CFO & Treasurer

* Raymond E. Reitsma

Mercantile Bank of Michigan - President & Director

* Robert B. Kaminski

Mercantile Bank Corporation - President, CEO & Director

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Conference Call Participants

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* Brendan Jeffrey Nosal

Sandler O'Neill + Partners, L.P., Research Division - Director

* Damon Paul DelMonte

Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director

* Daniel Edward Cardenas

Raymond James & Associates, Inc., Research Division - Research Analyst

* John Lawrence Rodis

Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts

* Kevin Kennedy Reevey

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Mike Houston

Lambert, Edwards & Associates, Inc. - Senior Director

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Presentation

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Operator [1]

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Good day and welcome to the Mercantile Bank Corporation Second Quarter 2019 Conference Call and Webcast. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Mike Houston, Investor Relations, Lambert, Edwards & Associates. Please go ahead.

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Mike Houston, Lambert, Edwards & Associates, Inc. - Senior Director [2]

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Thank you, Ben. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the second quarter 2019. I'm Mike Houston with Lambert IR, Mercantile's Investor Relations firm. And joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; Ray Reitsma, President of Mercantile Bank Corporation -- or Mercantile Bank, Michigan; and Bob Worthington, SVP, Chief Operating Officer and General Counsel. We'll begin the call with management's prepared remarks and then open up the call to questions. However, before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to the factors described in the company's latest Securities and Exchange Commission filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the press release issued by Mercantile today, you can access it at the company's website, www.mercbank.com. At this time, I'd like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski. Bob?

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Robert B. Kaminski, Mercantile Bank Corporation - President, CEO & Director [3]

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Thank you, Mike, and good morning, everyone. Thank you, all, for joining us today. On the call, we will provide an update on our overall performance and financial results, along with our key areas of strategic focus. At the conclusion of our comments, we open the call for question and answer session.

We are very pleased to deliver strong operating results for the second quarter, and first half of 2019. Our sound financial condition, sustained strength in commercial and residential mortgage loan originations and loan pipelines give us confidence that the strong results achieved during the first 6 months of the year will provide the foundation for solid performance throughout the balance of 2019.

The second quarter operating performance includes growth in net interest income, resulting from a higher level of earning assets. Our net interest margin remained strong, reflecting our ongoing emphasis on loan pricing discipline and sound underwriting. Increased noninterest income and well-managed overhead costs were also strengths for the quarter's results. Our team's emphasis on building and cultivating value-added relationships continues to successfully attract new customers as well as retain existing clients.

We remain pleased with the growth in fee income. The increase in mortgage banking activity income reflects the success of continuing strategic initiatives, designed to increase market penetration along with the jump in refinance activities, spurred by the recent decline in residential mortgage loan interest rates. Growth of mortgage banking activity and income through expanded market share remains a priority for the company. Our strong team of mortgage bankers coupled with our wide range of products and services allow us to continue to build deep client relationships. Ray and Chuck will provide more detail on all of these areas momentarily.

Turning to the Michigan economy, trends remain steady as employment in our primary markets continues to improve and real estate conditions remain healthy. We will continue to watch these indicators closely for any longer-term slowing or inflection point.

The ongoing cash dividend program, including the announcement of an increased third quarter regular dividend earlier today exhibits our commitment to enhancing total shareholder return. We remain confident in our ability to optimize future growth opportunities. Mercantile's robust core profitability, strong capital position and healthy commercial and residential mortgage loan pipelines position us well for a solid performance for the balance of the year despite the potentially volatile interest rate environment in which we currently operate. As always, we continue to monitor both micro and macroeconomic activity, and our focus remains on creating and leveraging opportunities whatever the economic climate. We are excited about our ability to expand on our markets and continually improve results in both the near and long term. That concludes my remarks. I'll now turn it over to Ray.

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Raymond E. Reitsma, Mercantile Bank of Michigan - President & Director [4]

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Thank you, Bob. We are pleased with loan growth during the first half and particularly in the second quarter growing at an annualized rate of 9.2%. Approximately $134 million and $259 million in commercial term loans to new and existing borrowers were originated during the second quarter and in the first 6 months of 2019, respectively, as our lending teams focused on identifying new customer relationships and meeting the needs of our existing customer base. Our pipeline remains strong and steady as well with $129 million of commitments on commercial construction and development loans to be funded over the next 12 to 18 months. We continue to expand and establish the Mercantile culture within our Southeast Michigan operations and are pleased with the results.

In the second quarter, our Southeast Michigan office grew total loans by $23 million. Our asset quality continues to improve, as nonperforming assets declined to $4 million or 0.11% of total assets at June 30.

We delivered noninterest income during the second quarter of 2019 of $6.3 million compared to $4.6 million during the prior year second quarter. Noninterest income during the second quarter of 2019 included a bank-owned life insurance claim of $1.3 million. Excluding this item, noninterest income still increased $0.5 million or 10.9% compared to the corresponding 2018 period. The higher level of noninterest income primarily reflects increased mortgage banking activity and credit and debit card income.

Residential mortgage originations jumped 29% from the prior year quarter, which reflects the success of our strategic initiatives to increase our market share. Continuing to enhance mortgage banking income through increased market share remains a priority, and we will continue to hire proven mortgage loan originators as we are able. We expect that the positive trends we experienced in the first half of the year will continue through the balance of the year, as declines in residential mortgage loan rates increase refinancing activities and create opportunities to expand our mortgage banking portfolio. That concludes my comments. I will now turn the call over to Chuck.

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [5]

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Thanks, Ray. Good morning, everybody. This morning, we announced net income of $11.7 million or $0.71 per diluted share for the second quarter of 2019 compared to a second quarter of 2018 net income of $9.4 million or $0.57 per diluted share. Net income during the first 6 months of 2019 totaled $23.5 million or $1.43 per diluted share compared to net income of $20.3 million or $1.22 per diluted share during the first 6 months of 2018.

A bank-owned life insurance claim during the second quarter of 2019 increased net income by $1.3 million or $0.08 per diluted share. Excluding the impact of this transaction, diluted earnings per share increased $0.06 or almost 11% during the second quarter of 2019 compared to the second quarter of 2018.

Bank-owned life insurance claims and a gain on the sale of a former branch facility during the first 6 months of 2019 increased reported net income by $3.1 million or $0.19 per diluted share while the successful collection of certain nonperforming commercial loan relationships during the respective period in 2018 increased reported net income by $1.7 million or $0.10 per diluted share. Excluding the impact of these specific transactions, diluted earnings per share increased $0.12 or nearly 11% during the first 6 months of 2019 compared to the first 6 months of 2018.

We remain pleased with our financial condition and earnings performance and believe we are very well positioned to continue to take advantage of lending and market opportunities, while delivering consistent results for our shareholders.

Our net interest margin was 3.79% during the second quarter, higher than the range of 3.70% to 3.75% we provided in April, in large part reflecting strong loans fundings in the beginning of the quarter that resulted in a lower level of excess liquidity as well as higher-than-expected purchase-accounting related interest income.

Our cost of funds as a percent of average earning assets increased 5 basis points during the second quarter of 2019 compared to the 19 basis points increase during the first quarter of 2019. The increase in our cost of funds during the first 3 months of 2019 primarily reflected a higher level of wholesale funds in a time deposit campaign, while the cost of funds increased during the second quarter primarily reflects a full quarter impact of that time deposit campaign that ended in early April.

We had increased our reliance on wholesale funds during the latter part of the fourth quarter and into the first 6 months -- into the first month of the first quarter due to strong commercial loan fundings and seasonal business checking account withdrawals for tax and bonus payments. As expected, we continued to see a replenishment of fund balances in business checking accounts.

Based on our current liquidity position and funding projections, it appears that we'll be able to slightly reduce our wholesale funding reliance during the remainder of 2019. We recorded $0.6 million in purchase loan accretion and payments received on CRE pool loans during the second quarter of 2019. Based on our most recent valuations and cash flow forecasts on purchased loans, we expect to record additional quarterly interest income totaling $0.2 million throughout the remainder of 2019. Also we expect to receive, in aggregate, about $1.6 million in principal payments on purchase-impaired CRE pool loans over the next several yield, which will be recorded as interest income upon receipt.

Assuming the FOMC reduces the federal funds rate by 25 basis points on July 31st, as is widely expected by market participants, we expect our net interest margin to be in a range of 3.70% to 3.75% during the remainder of 2019.

The overall quality of our loan portfolio remains very strong with continued low levels of nonperforming loans and loan charge-offs. Nonperforming assets as a percent of total assets equaled only 11 basis points at the end of the second quarter. Loan charge-offs totaled less than $0.1 million during the second quarter and totaled less than $0.3 million during the first 6 months of 2019. We recorded a small net recovery during the second quarter with year-to-date net loan charge-offs equaling less than $0.1 million.

Provision expense for the second quarter totaled $0.9 million, in large part reflecting commercial loan growth. We expect to record quarterly provision expense in a range of $0.5 million to $1.0 million throughout the remainder of 2019, assuming a steady economic environment.

Our loan loss reserves totaled $24.1 million at the end of the second quarter or 0.0 -- 0.89% of total originated loans. This coverage ratio has remained steady for many quarters and no significant changes are expected during the remainder of 2019.

With regards to CECL, we have now completed our initial framework, and we will be working to fine-tune that framework and assumptions during the remainder of 2019. Based on initial results, we believe the impact of adopting CECL at the beginning of 2020 will not have a material impact on the balance of our loan loss reserve or our operating results.

We previously provided color on our fee income performance for the second quarter and first 6 months of 2019, I will add that we expect quarterly noninterest income to be in the range of $4.8 million to $5.2 million during the remainder of 2019. We recorded noninterest expense of $22.1 million during the second quarter of 2019, up about 3% when compared to the second quarter of 2018. The higher level of expense primarily resulted from increased salary costs, mainly reflecting employee merit pay increases and higher stock-based compensation expense. Currently, we expect quarterly noninterest expense to total in a range of $22.7 million to $23.2 million for the remainder of 2019 with our effective tax rate remaining near 19%.

Total deposits increased to $156 million during the first 6 months of 2019, comprised of $99 million growth in local deposits and a $56 million increase in brokered deposits. We experienced typical seasonal reductions in business checking account balances primarily in January for taxes and bonuses, while we are seeing replenishment as expected as well as with account growth associated with new C&I lending relationships. We discontinued our time deposit special in early April and plan to maintain our traditional time deposit pricing strategies for at least the near term.

At the end of the second quarter, wholesale funds comprised 17% of total funds, up from 16% at year-end 2018. The increase reflects an influx of broker deposits and Federal Home Loan Bank advances to fund strong commercial loan growth and the seasonal business checking account withdrawals. Currently, we expect to reduce the level of wholesale funds throughout the remainder of the year, ending 2019 around 16%.

We remain a well-capitalized banking organization. As of June 30, 2019, our bank's total risk-based capital ratio was 12.4%, and in dollars, was approximately $78 million higher than the 10% minimum required to be categorized as well-capitalized. We were not active in buying back our stock during the second quarter, but do have $20 million available in our current buyback plan. Those are my prepared remarks. I'll now turn the call back over to Bob. Thank you.

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Robert B. Kaminski, Mercantile Bank Corporation - President, CEO & Director [6]

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Thank you, Chuck. That now concludes management's prepared comments, and we'll now open the call for the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Brendan Nosal of Sandler O'Neill Partners.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [2]

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Just wanted to start off on the margin here. Definitely, appreciate the clarity on kind of what the first said rate cut would mean for the NIM. I mean as we look out past July, it looks like there is the potential for a couple of more rate cuts going forward. I mean is it fair to assume that kind of the mid-10 basis point reduction in the margin outlook for the rest of this year for one rate cut would kind of mean the same thing for each incremental rate cut? Or is the first one a little more painful than the later ones?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [3]

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Yes. This is Chuck. It's obviously a pretty difficult answer -- question to answer only because of the timing and what we can do with deposit rates. But with 50% of our commercial loans are floating, and looking at the structure of our deposit base, I would say that a reduction of 7 to 9 basis points in general would make sense each time the Fed lowers rate 25 basis points at least in the near term. As we go out further, we certainly have CDs and some Federal Home Loan Bank advances that were taken out over the years that would reprice to a lower level. So timing is everything, but I would say a 7 to 9 basis point reduction at least in the front end would be logical.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [4]

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Okay. Great. And then moving on to I guess just the general health of the economy, it feels like every article I read and everybody I talk to I feel that everyone is on a recession watch, but every bank that I speak with just they don't really see anything in their markets that indicates a turn in the economy. I mean -- and based on your prepared remarks, it seems that you guys kind of feel the same way. I mean, is there anything you're seeing that indicates a slowdown at large?

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Robert B. Kaminski, Mercantile Bank Corporation - President, CEO & Director [5]

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As we look across our client base and the economy in general, I think we are seeing generally the strength that we have seen over last several quarters. From time-to-time, there are pockets of slowness on a one-off basis from a client or 2, nothing that appears to be systematic or anything on a long-term basis. And -- but as you indicated, we are all on recession watch, making sure that we on the early end of any signs that represents a red flag, but we just aren't seeing those right now.

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Brendan Jeffrey Nosal, Sandler O'Neill + Partners, L.P., Research Division - Director [6]

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Okay. great. And then last one from me. Just help us understand the fine-tuning of the expense guidance. Is this a function of adding more mortgage lenders than you would have expected previously? Or is there anything else going on in the expense base?

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Robert B. Kaminski, Mercantile Bank Corporation - President, CEO & Director [7]

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No, I think that's most of it. As we have added lenders, and vast majority of our lenders, mortgage lenders are on commission. So as we see the increased activity, we do have to increase the commissions surrounding that. But overall it's pretty steady.

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Operator [8]

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Our next question is from Kevin Reevey, D.A. Davidson.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [9]

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So Ray or Chuck, I was wondering if you could give us some color as far as what kind of yields are you getting on the new commercial loans that you're booking versus kind of what's on portfolio? And if you can kind of talk -- give us some color when you talked about loan pricing disappointments in this environment. If we could get some color on it that would be great.

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Raymond E. Reitsma, Mercantile Bank of Michigan - President & Director [10]

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Sure. This is Ray. I'd say that in general, the new debt that we put on reflects pretty closely what is already on the books, and it's a competitive world out there and we do from time to time increase or have to face increased pressures as we price loans. But we take a lot of care to make sure that in each relationship that we enter into that the total package is mutually beneficial to the client and the bank. And we look at the whole relationship and make sure that when you take that mix of deposits and fee income and spreads that the whole package makes since relative to return on capital, and as a result we end up with a fairly consistent yield between the new business that we put on and the existing business that continues to be there.

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [11]

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As you go from client to client, as Ray said, there are some pressures from time to time from a competitive standpoint. But customers understand from our standpoint what we're looking for. And if they are particularly rate sensitive then we see as an opportunity to look and see if there are more deposit that can be brought over from the relationship or other services that we could engage them in to generate some additional fee income and other ways to keep our overall customer profitability where it needs to be, but still remain competitive from a pure rate standpoint on the credit.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [12]

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And then you had some pretty strong growth on the nonowner-occupied loan category. Can you talk about what type of nonowner-occupied loans you're booking and kind of the structures there?

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Raymond E. Reitsma, Mercantile Bank of Michigan - President & Director [13]

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Well, the portfolio has -- is generally kept the same proportions that it had in the past and owner-occupied, nonowner-occupied, the terms remain consistent with what we've done in the past. Our commercial borrowers are trying to be as -- our commercial industrial borrowers are trying to be as efficient as possible with their space and when they expand it's because they really need to and -- so the efficiency and use of the spaces is really excellent and as a result it's a pretty strong portfolio. We have pretty strong clients that are expanding.

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Operator [14]

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Our next question is from Daniel Cardenas with Raymond James.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [15]

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Maybe if you could talk a little bit about your loan growth outlook for the second half of the year. Just kind of given strong growth in this quarter, do you think that temper is down a little bit? And then, in conjunction with that, looking at loan-to-deposit ratio about 110%, does that factor in to your loan growth outlook in terms of maybe slowing it down a bit?

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Raymond E. Reitsma, Mercantile Bank of Michigan - President & Director [16]

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Our loan growth opportunities we expect to continue to fund loans at a similar pace to what we have done in the past. We've been very consistent over a fairly large number of quarters in what we fund. As always, the payoffs and pay downs that we receive in the normal course of business are unpredictable, but will occur and so it's very hard to predict those. But we feel very confident in the backlogs that we have and in the outlook that we have that we'll continue to fund at a pace very similar to what we've funded in the past.

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [17]

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And in regard to the loan-to-deposit ratio, it's not -- I know it's the ratio that's looked at a lot. And we certainly pay attention to it. We look more at our wholesale funding programs on an overall basis, which obviously takes into account Federal Home Loan Bank advances. And as we've talked before, we've made it a significant principle and practice on our part is that over the last few years as we were occasionally booking -- or regularly booking 5-year fixed rate balloons on the commercial loan side we wanted to make sure that we were, from a portfolio basis, match funding that. As we look at the cost of Federal Home Loan Bank advanced versus broker deposits in that 4- to 7-year category, which is where we generally go, it was probably on average 20 to even 40 basis points cheaper to take down FHLB advances versus broker deposits. So that obviously helps our margin. We're doing the right thing from a longer-term perspective and doing some match fundings. But when you do calculate things like the loan-to-deposit ratio, obviously it has a negative effect if you will or results of that ratio being relatively high versus if we would have gone more to the broker deposits. So I think it's -- I think that 110% -- we've always been -- Dan you know, we have always been a bank that's probably been between 95% and 105%, so we're comfortable with that. I think any deviation from that general range is more of a reflection of how we're managing our wholesale funding program more than anything else. On an overall basis, the structure of our balance sheet has stayed quite consistent over time.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [18]

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Okay. Got it. got it. And then just jumping over to credit quality, I mean it doesn't look like things can get too much better than where they stand right now. Is there any sector of the loan portfolio that's causing you any concern or you're beginning to pay -- may be beginning to pay a little bit closer attention to?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [19]

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As we've said on prior calls, this year and last year, we'll continue to diligently monitor the portfolio, the numbers really speak for themselves as far as the strength and our assessment of we feel the quality of the portfolio. It doesn't mean that we're looking for issues and making sure we're staying plugged in very closely to our borrowers, looking for signs of stress and strain. But I think the quality of the portfolio reflects that management team and our lenders diligently administering the portfolio and the overall strength of the economy, which continues to be quite high.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [20]

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Great. Last question from me. In terms of just capital utilization I noticed you guys didn't buy back any shares this quarter, was that just purely a mathematical decision -- based decision?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [21]

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Yes. This is Chuck, Dan. One of the things when -- when we look at our capital ratio as we know that's probably a little bit on the high side, obviously we want to have some powder for our growth, want to make sure that we've got sufficient capital. If the economy is slowing down, we just want to make sure we got sufficient capital for any of those types of periods. We've talked about M&A before, we're not very -- we definitely look at any books that are provided to us but don't have a strong interest in doing M&A, but if we did it would be helpful to have a little bit of excess capital on our balance sheet to help that potential transaction. But I think we realize we're a little bit on the high side. As a reminder, we were relatively aggressively buying back our stock in the fourth quarter of last year until the first couple of weeks of this year. And at the same time we did the special dividend in the fourth quarter. So we have paid attention and we continue to pay attention to our capital ratios. And I'm sure all of you saw we did replace our existing stock buyback plan with a new one. The reason why we did that was because the old one or the existing one at that time was only down to about $6 million in availability. So we went ahead and did a new plan for $20 million that terminated the existing plan. So we have the ability to buy back stock. Obviously, we're taking a look at our price.

The one thing we also look at is we do a lots of calculations internally. For example, the one that we keep a close eye on is the level of our commercial real estate portfolio as a percent of our risk-based capital. Obviously, you get over 300%. And there is a whole new layer of scrutiny that is put on by regulators and various investors as well. We're right around 250% on a book balance basis, and we stay there consistently. We kind of like that spot, it's a little bit higher, but we really don't want to go above 300%. And if we look at our pipeline, we still have some additional opportunities on nonowner-occupied commercial real estate, we always will. Obviously, we need to be diligent in who we partner with and the pricing and the structure that we do. But -- so when we look at capital and we're looking at our regulatory capital ratios, looking at tangibles, that's very, very important, of course, but also some of these other measurements that we do. We want to make sure that we maintain in good stead with the expectations that are out there as well. On a regular basis, we continue to dividend about 40% of our net income, which is right now producing a yield of over 3%. So we think that, that's relatively attractive to existing and potential new shareholders. As a go forward, we're always talking with our corporate board in regard to our capital levels and what we should do with our dividend, obviously we got to talk about the dividend level at least every quarter, but also look at the potential for using the buyback plans, doing a special cash dividend. Those are part of the mix, part of the recipe as well and they'll continue. And we'll continue to take a look at that and again, in relation to some of the other internal measurements that we use capital with.

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Raymond E. Reitsma, Mercantile Bank of Michigan - President & Director [22]

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As Chuck kind of summarized, there are a lot of things that go into the soup regarding capital management, something that we are constantly watching and in conversation with our board to make sure that capital and all the other levels are at levels that we want them to be at the current time and into the future as well.

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Operator [23]

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(Operator Instructions) Our next question comes from Damon DelMonte with KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [24]

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Lot of good color, a lot of good questions asked and answered on the call. So just a couple of quick follow-ups. Chuck, on the margin guidance, I think you said 3.70% to 3.75%, that's sort of full year from where we are after the first half of the year?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [25]

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That would be for the third quarter and for the fourth quarter of this year. And that assumes the one rate cut here at the end of July.

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Daniel Edward Cardenas, Raymond James & Associates, Inc., Research Division - Research Analyst [26]

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Okay. So...

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [27]

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Let me -- since you asked the question, let me add a little color. One of the things that's going to be helping our margin as we continue to see replenishment of our business checking accounts that is helping to -- for the rest of this year until we go through the whole cycle again. That is helping to mitigate the negative impact of a lower interest rate environment for the remainder of this year.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [28]

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Okay. So all -- if nothing else happen, the margin could be impacted by 7 to 9 basis points after this quarter's 3.79%, but you have some benefit from that offset to that I guess from the inflow of lower-cost deposits?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [29]

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Yes, which obviously are free deposits and also as I mentioned, in my prepared remarks that will help us have some reduction in our wholesale funding program as well.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [30]

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Got it. Great. Okay. Great. And then just kind of looking at the loan portfolio. I know it's a small percentage, it's only 12%, but it is taking higher talking about residential mortgage this year. What are your thoughts on continuing to grow that segment? Are you trying to kind of leverage the investments you've made in the mortgage area and keep some more of these loans on the books?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [31]

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Really what we do, Damon, is relatively simple, is if we're going to make a fixed-rate mortgage loan we want to sell it, and so we'll structure that, that we can generally sell it to Freddie Mac or Federal Home Loan Bank. We do have some other private investors that will buy jumbos and some of those other things. As we work with the prospective borrowers, new homebuyers or folks that are refinancing and it looks like for whatever reason they're not going to be sellable, we'll go ahead and put them into generally a 5 1 or 7 1 ARM and then we'll put those on to the balance sheet. So it's quite rare if we put a long-term fixed-rate mortgage on to our balance sheet, it's kind of more of the catch basin if you will of those that can't be sold and we go ahead and put them into in an ARM product. And usually why we can't sell them is generally not because of the borrowers' financial health, it's usually something to do with the property or some other metric that Fannie or Freddie or Federal Home Loan Bank does not like. So on an overall basis, we saw a nice pickup in the percentage of loans that were originated during the second quarter that were sellable. I think we are over 70%. We had been running more recently in the last couple of years around 45%. So it's good to see that. We would rather be able to sell every mortgage loan that we make, but we know that that's not possible, but if it is not possible we have the ARM products that we can put our folks into and put those on the balance sheet for that 5- or 7-year period, when they'll probably look to refinance or look otherwise and maybe at that point in time they'll be sellable loans.

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Operator [32]

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Our next question is from John Rodis of Janney.

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John Lawrence Rodis, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [33]

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Just a quick question. I guess just loan floors, what percent of your loans have floors on them? And then I guess how far down your rates have to go before they sort of kick in, in general?

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [34]

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Yes. I don't think -- we've gotten -- occasionally we've gotten some floors. I think rates would have to go down always before some of them started to kick in. That was something that we were trying to get in the loans as we saw rates going up knowing that at some point rates are going to go down. But that makes for a little bit of a difficult discussion with the borrowers while rates are going up, why you are asking to put floors on. So we do have some, I don't have the actual mathematics in front of me, but my guess just from looking at the loans the way that I do, John, is that it's not a high percentage and that it would take some cuts before we start hitting those floors.

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John Lawrence Rodis, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [35]

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Okay. So probably, what, less than 20%, Chuck, or...

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [36]

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Yes. I would say it's probably a pretty good number and it would probably take 3 or 4 rate cuts before we start seeing the impact of those.

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John Lawrence Rodis, Janney Montgomery Scott LLC, Research Division - Director of Banks and Thrifts [37]

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Yes. So down 75 or 100 or something, so...

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Charles E. Christmas, Mercantile Bank Corporation - Executive VP, CFO & Treasurer [38]

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Yes, that is when we start seeing the impact.

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Operator [39]

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This now concludes our question-and-answer session. I would like to turn the conference back over to Bob Kaminski for any closing remarks.

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Robert B. Kaminski, Mercantile Bank Corporation - President, CEO & Director [40]

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Thank you, very much for joining us on the call today and for your interest in our company. We look forward to speaking with you again in October. So the call is now concluded. Thank you.

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Operator [41]

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Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.