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Edited Transcript of MBWM earnings conference call or presentation 18-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Mercantile Bank Corp Earnings Call

Grand Rapids Apr 18, 2017 (Thomson StreetEvents) -- Edited Transcript of Mercantile Bank Corp earnings conference call or presentation Tuesday, April 18, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bob Burton

Lambert, Edwards & Associates - IR

* Bob Kaminski

Mercantile Bank Corporation - President & CEO

* Chuck Christmas

Mercantile Bank Corporation - EVP, CFO & Treasurer

* Michael Price

Mercantile Bank Corporation - Executive Chairman

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Conference Call Participants

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* Matthew Forgotson

Sandler O'Neill & Partners - Analyst

* Brian Zabora

Hovde Group - Analyst

* Damon DelMonte

Keefe, Bruyette & Woods - Analyst

* John Rodis

FIG Partners - Analyst

* Daniel Cardenas

Raymond James - Analyst

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Presentation

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Operator [1]

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Good day and welcome to the Mercantile first-quarter 2017 earnings conference call. (Operator Instructions). Please note this event is being recorded. I would like now to turn the conference over to Bob Burton of Lambert Edwards. Please go ahead.

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Bob Burton, Lambert, Edwards & Associates - IR [2]

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Thank you, Ryan. Good morning, everyone and thank you for joining the Mercantile Bank Corporation's conference call and webcast to discuss the Company's financial results for the first quarter of 2017.

I am Bob Burton with Lambert Edwards, Mercantile's Investor Relations firm and joining me are members of their management team, including Michael Price, Chairman; Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, President of Mercantile Bank of Michigan.

We will begin the call with management's prepared remarks and then open the call up 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 important 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 would like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski.

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [3]

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Thank you, Bob and good morning, everyone. Thank you for joining us. On the call today, I will review the quarter and provide an update on loan activity, growth initiatives and asset quality. Then our CFO, Chuck Christmas, will provide details on the financial results followed by Q&A.

Mercantile's track record of strong financial performance continued in the first quarter of 2017. I am pleased to report that positive operational trends stemming from our strategic initiatives have continued during the first two months of 2017.

In particular, let me highlight several accomplishments in the areas of strategic focus that underscore our optimism. During the quarter, total loans grew approximately $63 million, representing an annual growth rate of nearly 11%, which is at the high end of our guidance and outlook.

As we have commented in the past, the timing of commercial loan funding can be rather uneven and in that regard, it should be noted that the vast majority of the growth in total loans took place during the last half of March.

Commercial term loan originations to new and existing clients remained strong, totaling $130 million during the quarter. This performance reflects both ongoing efforts on the part of our lending team and an underlying Michigan economy that continues to improve.

Overall, our pipelines continue to be solid and we are encouraged by the opportunities that we see over the remainder of 2017, both in our well-established Western and Central Michigan markets and in our new operations in Southeast Michigan.

Net interest income was stronger in the quarter. Year-over-year comparisons reflect a bank-owned life insurance claim during the first quarter of 2017, which increased our current net income by approximately $1.1 million or $0.06 per diluted share and the repurchase of $11 million in trust-preferred securities at a discount during the first quarter of 2016, which increased reported net income by about $1.8 million or $0.11 per diluted share.

In the first quarter of 2017, mortgage banking activity income, debit and credit card fees, service charges on accounts and payroll processing fees were ahead of last year. Chuck will touch on this further in his comments, but let me note that we continue to gain momentum with production, operational excellence and product array in our retail market area.

The net interest margin stayed steady against our guidance. We remain very pleased with the strength and stability of our core net interest margin, reflecting our continued focus on loan pricing discipline. It is worth noting that our net interest income is expected to benefit from any further rate hikes initiated by the Federal Open Market Committee.

We continue to experience peer-leading asset quality, which is reflected in the very low level of nonperforming assets, representing only 0.26% of total assets. The bank continues to be in an extremely strong position here.

As evidence of our strong capital position and demonstrating our continued commitment to shareholder return, we earlier today announced a quarterly cash dividend of $0.18 per share for the second quarter, providing an annual yield of about 2.2% based on our current marketshare price.

While the underlying financial performance is very good, Mercantile has been active on the strategic front as well. In late February, we announced the opening of a commercial loan office in Troy, Michigan, which we see as a great opportunity for Mercantile to bring our brand of customer relationship-focused banking to a new and growing market.

The Greater Detroit area is a logical extension of Mercantile's current service area and we are encouraged by the strength of the region's economy and business environment.

We are also very fortunate to commence operations there with a team of experienced commercial lenders led by Violet Gintsis with decades of commercial experience in the Greater Detroit market.

We also continue to make progress toward expanding operations to include full-service banking at the Troy location.

We have also strengthened our leadership team and operations by adding Nancy Turtle as Community Bank President for the Kalamazoo, Southwest Michigan market. Nancy's 20 years of commercial banking experience in Southwest Michigan and her understanding of Mercantile's relationship-based approach to business are terrific assets for the bank as we look to grow our base of business in these key markets.

Entering 2017, our financial condition is strong and our operating metrics are healthy. Looking forward, we see additional opportunity to participate in the economic strength of our markets as Michigan's premier community bank. Our outlook is that the overall healthy employment and business expansion being reported for Michigan will continue, particularly within our largest markets. The Michigan economy overall continues in a positive direction.

That concludes my initial remarks. At this time, I would like to turn the call over to Chuck.

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [4]

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Thanks, Bob and good morning to everyone. As was already noted, this morning, we announced net income of $7.6 million or $0.46 per diluted share for the first quarter of 2017. During the first quarter of 2016, we earned $8.5 million or $0.52 per diluted share.

A bank-owned life insurance benefit claim during the first quarter of 2017 increased diluted earnings per share by $0.06 while the repurchase of trust-preferred securities at a large discount during the first quarter of 2016 increased diluted earnings per share by $0.11.

Therefore, on a more core basis, earnings per diluted share equaled $0.40 per share during the first quarter of 2017 compared to $0.41 during the first quarter of 2016.

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

Our net interest margin was 3.73% during the first quarter continuing a relatively stable trend. Our loan yield is benefiting from the recent rate hikes from the FOMC with each 25 basis point increase in the federal funds rate equating to about a 9 basis point increase in the loan yield. Although interest rates have increased in recent periods, the overall interest rate environment remains low and when combined with strong competition for loans, there remain some downward pressure on our loan yields.

Alternatively, our cost of funds, which has been stable for the past few years, has increased only slightly during the past several quarters as interest rates offered on liquid deposits have changed very little.

We recorded loan discount accretion totaling $0.8 million during the first quarter of 2017 compared to $1.3 million during the first quarter of 2016. To a large degree, the lower level of discount accretion reflects a change in accounting treatment for our pool of purchased CRE impaired loans to the cost recovery methodology as of year-end 2016 as we discussed on our last conference call.

As a reminder, as of year-end 2016, payments received since the merger lowered the recorded investment on this particular pool to zero. In accordance with the cost recovery methodology, a net deferred gain of $1 million was immediately recorded as interest income. Starting on January 1 of this year, accretion income is no longer recorded on this pool, but instead all payments made by borrowers are immediately recorded as interest income.

We currently expect to receive a minimum of $6 million in principal payments on CRE pooled loans in future periods, which will be recorded as interest income upon receipt. Based on our most recent valuation and cash flow forecast on purchase loans, we expect to record further quarterly interest income totaling about $0.5 million during the remainder of 2017. Please note that this forecast ignores scheduled balloon maturity dates of the purchased loans that formerly comprised of CRE impaired loan pool. Instead we assume those loans would be renewed at terms similar to current rate terms on the balloon date.

As a result, interest income related to the former CRE pools recorded in future periods may differ from this forecast. We expect our net interest margin to be in a range of 3.75% to 3.80% throughout the remainder of 2017. This forecast assumes no further changes in the prime and LIBOR rates. Our interest rate risk measurements continue to reflect an approved net interest margin in an increasing interest rate environment.

The overall quality of our loan portfolio remains very strong. Nonperforming assets as a percent of total assets equaled only 26 basis points at the end of the first quarter and net loan charge-offs equaled only $0.3 million during the first quarter or 5 basis points as an annualized percent of average total loans.

We recorded a provision expense of $0.6 million during the first quarter in large part driven by commercial loan growth. We expect to record quarterly provision expense of $0.5 million to $1.0 million during the remainder of 2017.

Our loan loss reserve totaled $18.3 million at the end of the first quarter or 92 basis points of total originated loans. This coverage ratio has remained steady for many quarters and no significant changes are expected for at least the remainder of 2017.

We recorded non-interest income of $5.9 million during the first quarter of 2017 compared to $7.1 million during the first quarter of 2016. We recorded increases in virtually every fee income category led by a $0.5 million increase in mortgage banking income. We also recorded $1.4 million in income resulting from a bank-owned life insurance claim and during the first quarter of 2016, we recorded $2.9 million and $0.3 million gains from the repurchase of certain trust-preferred securities and the sale of an equity investment respectively. Therefore, on a more core basis, non-interest income totaled $4.5 million during the first quarter of 2017 compared to $3.9 million during the first quarter of 2016.

Subject to potential fluctuations in mortgage banking income, for the remainder of 2017, we expect non-interest income to total $4.7 million to $4.9 million during the second and third quarters and $4.4 million to $4.6 million for the fourth quarter.

We recorded non-interest expense of $19.8 million during the first quarter of 2017 compared to $19.9 million during the first quarter of last year. Salary and benefit costs were up 2.5% in large degree reflecting merit increases effective January 1, which were essentially offset by a decline in our FDIC insurance premiums, mainly resulting from changes in the deposit insurance assessment calculation.

Currently, we expect quarterly non-interest expense to total between $19.7 million and $20.2 million during the remainder of 2017 with our effective tax rate at just under 31%.

We have remained a well-capitalized banking organization. As of quarter-end, our bank's total risk-based capital ratio was 13.0% and in dollars was approximately $81 million higher than the 10% minimum required to be categorized as well-capitalized.

Those are my prepared remarks. I will now turn the call back over to Bob.

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [5]

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Thank you, Chuck. At this time, we will now take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Matthew Forgotson, Sandler O'Neill & Partners.

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Matthew Forgotson, Sandler O'Neill & Partners - Analyst [2]

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Good morning, everybody. So I just thought I would start high level. Historically, your focus on Western Michigan has insulated you relatively speaking from volatility in auto. Having said that, in light of the softening in auto sales and your recent expansion into Southeastern Michigan, I was wondering if you might give us a little update on your direct and indirect exposure to auto and just tell us a little bit about what you are hearing from your lenders and from your customers.

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [3]

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Thanks for the question, Matt. I think if you look at our overall portfolio and the balance is something that we watch very closely and continually to make sure that we don't have any undue concentrations in any area, whether it be the auto industry, commercial real estate or any of the sub-buckets each of those contain.

I think the overall exposure to the auto industry hasn't really changed and we don't expect it to change a lot with the entrance to Southeast Michigan because, although we are in West Michigan, we still have a fear of indirect reliance upon the auto business for some of the C&I customers that we bank here in West Michigan and we expect that balance to continue with the credits that we would entertain in Southeast Michigan as well.

But you raise a good point. We continue to be very careful in monitoring all of our loan concentrations in whatever buckets they may be in to make sure we don't have any undue balance or imbalance in any of those areas. So it's something we watch very closely.

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Matthew Forgotson, Sandler O'Neill & Partners - Analyst [4]

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Okay. Thank you. I guess just next on loan growth, wondering if you'd just shine a little bit of light on the loan pipeline. Talk to us a little bit about its size and its complexion and just your growth expectations as we move throughout the year.

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [5]

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I think we stand firm by our guidance that we've established and Chuck outlined. And if you recall back in the conversation we had at the end of the fourth-quarter conference call, we talked about a healthy pipeline and the fact that there were timing differences and that really bore itself out in the first quarter here as well when we had nice growth uptick for the quarter overall. But, as I mentioned in my comments, most of that growth took place at the end of March.

As we have discussed in the past, commercial loan funding can be rather uneven in terms of its timing, choppy, whatever you may call it and that's just the nature of the beast and so while we had a very strong first quarter, it was late in the quarter growth. Pipelines continued very strong and consistent with what they had been throughout most of 2016.

I think you can look at what we see out there. We see good activity in all of our markets, especially our largest markets. I think you look at the balance -- we've got good balance in terms of C&I, in terms of CRE and all those pipelines as well.

So we are very encouraged for the growth to remain consistent with the guidance that we've established for the whole year. Although, as we saw in the first quarter, some of that growth and the timing may be rather uneven and just because a particular quarter may not see the growth that we are expecting on an overall basis long term, we expect it to be consistent with the guidance.

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Matthew Forgotson, Sandler O'Neill & Partners - Analyst [6]

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Okay, great. And then just lastly for me and then I will hop out. Clearly some seasonality in terms of deposit flows, but your stated loan to deposit ratio now is 107%. And when I back out the sweep accounts classified as repo, I'm at 102%. Can you talk to us about your deposit growth expectations for this year and ultimately your tolerance for running these ratios higher from here?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [7]

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I think from the ratio standpoint, we expect that longer term to be right where it typically is, right around that 95%, maybe 97%. You are obviously looking at just a quarter-end number and certainly if you look at our interest-bearing assets, which is really our Fed account, we were down lower than typical and a lot of that had to do right at the end of the quarter with all the loan growth that we had.

So I think funding the loan growth is the same thing that we've been talking about on many calls now is we looked at raising local deposits as much as we can from a lot of different areas. Certainly, as we continue to bring out some C&I credits, which we have, those bring some really strong demand deposits. You can see the trends with our non-interest-bearing checking account continues to be very, very strong. Yes, it's typically down at March because of the tax payments that we see going out, especially in January, but if you step back a little bit, you can see the very strong trend there and again, a lot of that is because of C&I growth, as Bob just touched on with the pipeline. We expect further C&I growth as we go into future periods.

Certainly, we look under every rock to gain additional deposits, whether it is [co-line] on municipalities, making sure we've got the right products that are out there that are competitively priced. We try to be in the top third. We are never the leader in regards to our deposit pricing, but we are definitely in the top third.

We are not a big bank when it comes to things like CD campaigns; although we do run them periodically. We don't do things like teaser rates where you can have a money market account at some special rate for an extended period of time. We typically don't do that either. But we certainly look at that. We have a group that meets every month to talk about trends, talk about different products, how those are being sold and the successes and maybe some of the weaknesses in there.

And of course, then we have the backdrop of the wholesale funding program, whether that be FHLB advances with well over $300 million -- over $325 million in additional availability and certainly can tap the broker CD market if need be. So a long-winded answer to your question, but there's no area that we don't look at and I think, on an overall basis, notwithstanding the very strong loan growth that we had at the end of the first quarter and the impact that that had on some of our overnight liquidity, we would expect our deposit structure to stay relatively consistent as it has been over the last couple years as we go into future periods.

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Matthew Forgotson, Sandler O'Neill & Partners - Analyst [8]

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Thank you very much.

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Operator [9]

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Brian Zabora, Hovde Group.

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Brian Zabora, Hovde Group - Analyst [10]

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Thanks, good morning. Just one question on expenses. You moved the guidance just a little bit up, a little higher and it's maybe some of the investments that you've done in Southern Michigan, or are there other factors? Moving expenses again just a bit up.

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [11]

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Yes, Brian, you are right on. The increase in the guidance is primarily related to our move into Southeast Michigan.

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Brian Zabora, Hovde Group - Analyst [12]

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Okay. And then a question on mortgage, twofold. One, how is the pipeline looking today versus maybe the end of fourth quarter? And then, second, what type of mortgage loans are you portfolioing? There's a nice increase this quarter. Is it ARM production and I guess how much of the ARM production are you choosing to portfolio versus sell?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [13]

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Thanks for the questions. That's an area that we talked about the last year and half has been a strong area of strategic focus for us here at Mercantile and the results are reflective of that. The pipeline at this point remains significantly ahead of where it was in 2016, really reflecting the traction that is being gained by the initiatives that we started back over a year ago now. And I think we will continue to see that throughout all of 2017 with it being up quite a bit over where it was last year.

I think in terms of the loans that we are portfolioing now, I think in the past, as we've talked about, we've missed some good opportunities to retain some loans in the portfolio that we in the past either would pass on or would never have the opportunity to book in the first place and it's strategically being crafted so that we can at least maintain the levels of our mortgage portfolio instead of seeing the continued contraction that we have in the last couple years.

So it's not a major growth area for us in terms of the overall bank, but it's an area that we can see contributing as we saw in the first quarter going forward.

I think along with being based with ARMs, particularly from an interest rate standpoint, will really add to the mix because we've introduced some new mortgage products that have really started to get some notice as we talk to clients and customers about what we have to offer here at Mercantile Bank.

So this is an area that we are really positive on and we are seeing some good results now. We've hired some new mortgage lenders as we've mentioned in the past and they are starting to, as we head into the spring months now, to really see some good activity there as customers are out and about looking to either sell their homes, refinance their homes or whatever. So it's an area of strong focus for us and we are very pleased with the results of what we saw in the first quarter.

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Brian Zabora, Hovde Group - Analyst [14]

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Great. Thanks for taking my questions.

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Operator [15]

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Damon DelMonte, KBW.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [16]

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My first question, Bob, I think you had mentioned about you are reiterating your outlook for the loan growth. Could you just remind us again what the loan growth was? Is it high single digits for 2017?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [17]

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Yes, that's correct.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [18]

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Okay. And just with regards to following up on a question earlier about the outlook for pipelines and stuff, I think the C&I balances jumped pretty significantly here in the first quarter after a down fourth quarter. Was the fourth-quarter decline, was that more just seasonal in nature and is this a decent run rate or a decent level to build from going forward?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [19]

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I think as we talked about for the fourth quarter conference call, we had that large loan pay off through the syndicated loan. That reduced our C&I totals for the end of the year. You saw the recovery in that as we continued to book the loans in the pipeline and also we had some lines of credit that were up during the first quarter as well.

So you are going to see some fluctuation in that. As we talked about a couple questions ago, we look at the balance of C&I and commercial real estate all the time making sure there is a good balance and what we see in the pipeline is a continuing good balance between real estate and commercial/industrial types of loans.

So you are going to see some fluctuations there as we saw the last couple of quarters, but that is natural. I think overall the trend is upward in all of our buckets because we are having to focus on all kinds of loans throughout our markets.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [20]

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Got you. Okay. And then with respect to the margin, probably a question here for Chuck. Could you just repeat what you said the accretable yield was that was included in the margin this quarter?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [21]

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The accretable -- can you repeat -- I guess I'm not sure exactly which number you are after. There's a bunch of them.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [22]

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I guess so you reported a margin of 3.73%, but if we took out the accretable yield impact, what would be the core margin? That's basically what I'm asking.

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [23]

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I don't have that right in front of me. I can certainly get it to you off-line. I did indicate that our total loan accretion was $0.8 million. I just have to go back and calculate that for you.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [24]

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Okay. All right. That's good enough. I can work with that number. And then I guess my last question, just following up on the expansion efforts into Southeast Michigan. I think you mentioned you are in the process of trying to make it a more full-service location. What is the outlook for three, four, five quarters down the road? Is this going to be an area that you will look to actually open up more branches, or potentially maybe look to do an acquisition in?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [25]

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At this point, Damon, we opened an LPO, loan production office, because of the timing of that type of structure allowed us to open fairly quickly. The plans are for later this is year to make that into a full-service branch. Beyond that in terms of additional bricks and mortar, we have no plans to do that at this point in time.

As you know, the history of Mercantile Bank is in the commercial lending side. We've always operated from the standpoint of fewer branches, fewer bricks and mortar. Especially these days with the abilities to contact and communicate with customers through technology, online banking, other types of ways that they don't need to come in your offices, I think that model will serve us very well in that Southeast Michigan market. So no additional plans for additional locations at this point in time and very pleased with the team we've assembled there and their ability to grow that office at a successful pace.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [26]

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Okay. That's helpful. Thank you. And then I guess just last question, with respect to the deposit competition, we've seen a couple rate hikes in a shorter amount of time than we have in the last handful of years or so. Are you guys seeing any change in behavior from the larger banks that you guys compete against as far as deposit pricing goes?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [27]

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As I mentioned in my prepared remarks, really haven't seen anything in the liquid rates, but we definitely are starting to see a pickup in competition on CD rates. As rates have gone up, [Austin], I think virtually every bank has raised CD rates to some degree and we are starting to see a lot more CD specials out there, very various in terms. Some are relatively short term; some are longer term.

So I think the competition on the deposit side in regards to anybody changing their methodology of whether it be rate and/or different products, definitely on the CD side, but interest-bearing checking accounts, savings, money market accounts, it's been pretty quiet.

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Damon DelMonte, Keefe, Bruyette & Woods - Analyst [28]

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Okay. Great. Thank you very much for the color this morning, guys. That's all that I had for questions. Thanks.

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Operator [29]

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(Operator Instructions). John Rodis, FIG Partners.

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John Rodis, FIG Partners - Analyst [30]

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Good morning, guys. Chuck, maybe just back to the yield accretion. So it was roughly $832,000 this quarter and I think -- did I hear you correctly? You said that should be around $500,000 going forward per quarter?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [31]

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Yes, let me make sure I get that right for everybody. The $500,000 is based on scheduled payments, contractual payments with the assumption that if there's maturities or balloons coming up that that loan will be rewritten at its current terms. So that's the scheduled cash flow expectation. That's where that $0.5 million comes from.

So they are impaired loans, but a vast majority are paying, so I guess that would be more of a minimum amount and then, of course, if there is any additional payouts, if somebody pays us off, refinances elsewhere, sells assets or anything else that provides us cash, that will be in addition. So basically you are looking at about $300,000 in additional cash flow above and beyond scheduled payments on those particular loans.

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John Rodis, FIG Partners - Analyst [32]

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For this quarter, right, Chuck?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [33]

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Yes. So the $500,000 is kind of a minimum and then any additional cash flow on top of that would be obviously in addition.

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John Rodis, FIG Partners - Analyst [34]

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Okay. And you said the total that you expect of yield accretion is the $6 million, but that would exclude any recoveries too?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [35]

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That's correct.

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John Rodis, FIG Partners - Analyst [36]

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Okay, okay. Just back to the Troy location, can you guys just give an update on how many lenders are there now and then how big conceivably from a lending standpoint could that LPO be -- slash branch?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [37]

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The current team consists of five lenders and a couple support people. We are very satisfied with the level of activity that we believe that these folks can bring into the bank.

In terms of additional lending staff, that's a bit premature at this point. As we've always talked about here at Mercantile Bank, it's all about the people. When we identify good people, we tend to bring them onboard. That was the strategy with this market as well and if we saw new additional lenders in that market that popped up that were a good fit for our culture, then we would take a look at them, but if not then we are very satisfied with what we have right now. So no plans in the works to grow that staff with additional lending team members at this point in time.

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John Rodis, FIG Partners - Analyst [38]

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I'm sorry, Bob. I was more along the lines of how big from loans outstanding do you think that location could be?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [39]

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Again, that's a little bit premature. We've got obviously some good expectations for what we feel they can generate from the standpoint of the size of the loans that five lenders are able to generate within their portfolio. Not making any prognostication at this point in terms of dollar levels, but we feel pretty enthused and excited about what we feel they can bring to the table in terms of loan growth in that market.

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John Rodis, FIG Partners - Analyst [40]

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Okay. And then, Chuck, just for you, I guess, are you still thinking as far as expenses for that location around $500,000 a quarter?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [41]

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Yes.

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John Rodis, FIG Partners - Analyst [42]

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Okay. And one other question for me, guys. Just on the credit front, credit quality looks very good for you guys, but you have seen a small increase in non-accruals the past two quarters and I know it's off very low levels, but are you seeing any significant issues or anything in the portfolio at this time?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [43]

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Well, you hit the nail on the head. It is very low. If you look back to where we were a year ago, it's about almost exactly the same level of nonperforming loans/nonperforming assets. So when you get numbers that low, if you have any increase in terms of percentage, it's eye-popping, but I think if you look at the overall level of nonperforming assets, it's very good and we are very pleased with those results.

We are going to see some fluctuation from time to time. It may tick up; may tick down, but I'm not seeing any trends to answer your question directly in the portfolio that are giving us concern that there are inherent problems either in the markets or the portfolio as we see it today.

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Michael Price, Mercantile Bank Corporation - Executive Chairman [44]

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John, this is Mike. Bob describes it pretty accurately and while we don't disclose what our watchlist is numerically, that's always the precursor of where we think things are happening and that watchlist number continues to be very manageable and trending in the right direction.

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John Rodis, FIG Partners - Analyst [45]

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Okay. Thanks, guys. That's helpful, Mike. Thank you.

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Operator [46]

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(Operator Instructions). Daniel Cardenas, Raymond James.

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Daniel Cardenas, Raymond James - Analyst [47]

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Good morning, guys. Just a couple questions here. On the loan growth we saw this quarter, can you maybe give us some sense as to what percentage of that was just a marketshare grab versus maybe growth coming from new or existing customers?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [48]

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I think what you saw was a good healthy amount of new loans coming from new customers. And as we talked about in the past, relationship banking is something that -- it takes time. It takes time for relationships not only to develop, then to be able to get them to the point where we can make a presentation, have that presentation accepted.

We had a nice confluence of that activity happen in the first quarter where we had some new clients we've been calling on for a long time, developing the relationships and those all came to bear in terms of loan fundings in the first quarter. That's how the process works here at Mercantile and I think we also had some nice [interesting] credit relationships with existing clients.

So it's been a good balance and that's what makes us very excited about the overall portfolio of trends is that we are seeing some nice new clients come onboard. We are seeing some good healthy growth with existing clients looking to put up a new building or to buy some equipment. And so it's giving us overall optimism on the Michigan economy as well.

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Daniel Cardenas, Raymond James - Analyst [49]

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Okay, good. And then looking at your margin, I guess really more just looking at given the recent rate hike, how much of the March hike, if any, do you expect to pass on to your deposit customer base and if little or none, when do you expect to see that occur?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [50]

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Like I said before, on the liquid rates, we've done very little as our competition has done the same, or not done anything. Definitely seeing some increases on the CDs. Obviously, that takes impact over time especially with the renewals. So there's some passing of the rate hike into our deposits. Certainly we see a little bit on the federal home bank side as well in our trust-preferreds, but a majority of it definitely is a positive to our net interest income and to our bottom line.

I guess it's our opinion that when rate hikes are few and far between, there is not much attention garnered by depositors, but if it picks up, which so far it has, where the rate hikes become more frequent, maybe it garners additional attention. But, again, overall interest rates are still very, very low and whether you are paying someone 10 basis points or 15, you increase it up to 20 or 25, it's still not incredibly significant and eye-catching, but we will just see what the trends are and go from there.

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Michael Price, Mercantile Bank Corporation - Executive Chairman [51]

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Dan, this is Mike. The neat thing about it as well is the first couple of rate hikes, as Chuck was explaining, in the past, we weren't able to take the entire benefit from them because there were some loans that were below the floor, so we are just about past that now. So we know that somewhere along the line, we are not quite sure where, we will probably have to pass some of those rate hikes down to our depositors, but we will be able to more effectively do that because we are going to gain almost 100% when we can on those floating-rate loans from the increase on the loan side.

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [52]

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Yes, and just let me add the number color to what Mike just said. As we go forward, at the next rate hike, 95% of our loans are no longer on floors. It was 87% for the March rate hike and now we are up to 95%. Those last five will fall off over the next couple rate hikes and that's about -- 53% of our commercial loans are floating.

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Michael Price, Mercantile Bank Corporation - Executive Chairman [53]

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That gives us a little ammunition that we know we are going to have to probably pack some of that down into the deposit side.

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Daniel Cardenas, Raymond James - Analyst [54]

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Got you. All right, perfect. And then just a couple questions on the credit quality side. Have you guys started work on [CECIL] yet and is that something that you plan to do in-house or maybe outsource to a third party?

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Chuck Christmas, Mercantile Bank Corporation - EVP, CFO & Treasurer [55]

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That's still pretty early in the game, Dan. Obviously, we keep our eye on the ball. There's lots of vendors out there that are trying to sell us the solution. I think it's their solution and not necessarily anybody else's. Obviously, we talk to our auditors. I talk to them every quarter about it. They do what I do and the rest of us do. We snicker when we get these emails about the solution because I don't think the rules -- or the expectations have really been set yet for what that is going to look like.

Obviously, every quarter, we are a quarter closer to the implementation date. I think what we are doing is what everybody else is doing is waiting for some additional guidance. But, in the meantime, we are making sure that we are gathering all the data that we need to. I think we already were before CECIL became a concept, but clearly having your database filled with as much data as possible is going to be a big help, whether it's something you do internally, or whether you want to go out there externally and get some assistance there.

So we're just making sure we've got the data and we will just see where it goes in regards to the guidance and expectations that hopefully we get as we get closer to implementation.

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [56]

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It's not unlike things that have happened in the past whether it be Sarbanes-Oxley or other types of legislation that's come down or regulations that have come down. We will remain pretty adaptable and look to see what the expectations are, what the guidance is and then look to see what vendors, if any we partner with, to make sure that we are fully implemented with whatever expectations may be for our organization.

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Daniel Cardenas, Raymond James - Analyst [57]

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Okay. Fair, fair. And then you may have said this. I jumped on the call a couple minutes late, but the sequential quarter increase in NPLs, what was that related to?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [58]

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Dan, as we talked about the previous couple calls, you are going to see some movement up or down in a range as work on the portfolio happens, as loans that are more [cost-pass] come to conclusion and you may get some new blips on the screen, but if you look at overall the level of NPAs, it's almost exactly what it was at the first quarter, or at the end of 2015, first quarter of 2016 and so not concerned about any trends or anything there. It's just the usual movement that you see with loans that may be in the workoff process or in a stage of distress that you work through and very manageable, very appropriate for the level that we see in the overall level of NPLs in the portfolio.

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Daniel Cardenas, Raymond James - Analyst [59]

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Okay. But was this related to one credit, or was this a handful of credits that just blipped up this quarter?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [60]

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No, I think the increase was a net result of changes in a couple different credits. We had some credits that went to conclusion, had a drop in the NPAs and a couple other ones went in (inaudible) that [blipped] back up, but it wasn't related to one specific credit, a couple different credits.

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Daniel Cardenas, Raymond James - Analyst [61]

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Okay, good. And then last question. Maybe you could comment on the M&A environment. What's it look like right now? Are you guys getting more phone calls than a year or so ago?

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Bob Kaminski, Mercantile Bank Corporation - President & CEO [62]

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No, it remains consistent about what it has been the last few quarters; not a whole lot of activity out there. We remain obviously open to conversations that -- things as they cross our desk, but nothing that we see as imminent in any case whatsoever. But, obviously, as the economy changes and the market changes, that could change, but not seeing a whole lot right now.

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Daniel Cardenas, Raymond James - Analyst [63]

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Okay, great. Thanks, guys.

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Operator [64]

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This 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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Bob Kaminski, Mercantile Bank Corporation - President & CEO [65]

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Thank you for your interest in our Company. We look forward to talking to you again after the second quarter. Thank you very much.

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Operator [66]

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Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.