Good morning. Welcome to the Mercantile Bank Corporation Second Quarter 2020 Earnings Results Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Tyler Deur from Investor Relations. Please go ahead.

Thank you, Kate. 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 2020. I'm Tyler Deur, 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 and Ray Reitsma, President of Mercantile Bank, Michigan. We'll begin the call with management's prepared remarks and presentation to review the quarter's results, 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 second quarter 2020 press release and presentation deck issued by Mercantile today, you can access it at the Company's website ir.mercbank.com. At this time, I'd like to turn the call over to Mercantile’s President and Chief Executive Officer, Bob Kaminski. Bob?

Thanks, Tyler and good morning, everyone. On the call this morning, we’ll provide you with detailed information on the company's performance in the second quarter, as well as an update on the activities, specifically related to COVID-19. First of all, I want to recognize the efforts of the Mercantile team, for allowing us to continue maneuvering through the many challenges brought about by the pandemic, since the start of the crisis earlier this year. Our employees have risen to the occasion, quite often working remotely, to allow Mercantile to successfully serve our customers and fulfill their banking needs. Mercantile demonstrated a solid performance in the second quarter with per share earnings of $0.54, which included the strong provision building we foreshadowed at the end of the first quarter. We also announced that our Board has declared our regular cash dividend for the third quarter of $0.28 per share, furthering our achievement of ongoing financial strength, amongst the challenging environment. As one might expect, there are many moving parts in our financial statements during the quarter, and Chuck will provide much more detail on our performance momentarily. As we discussed during our call in April, the safety of our employees and customers is our top priority. The vast majority of our staff was working from home, until early June, after some physical and social distancing modifications could be made to our facilities, and was deemed safe for them to return to their offices and workstations. Mercantile Bank lobbies remain close to walk-in customer traffic until June 26. During the time our facilities were closed, our team and clients adapted extremely well to alternative methods of engagement to perform their banking activities. The full time line of COVID-related activities can be viewed on Slide 4. The Paycheck Protection Program dominated much of…

Thanks, Bob. Our loan portfolio increased $432 million in the second quarter of 2020, which consisted of over 2,000 Paycheck Protection Program loans totaling $550 million. Noted on Slide 8, and offset by $109 million in reduced outstanding under commercial lines of credit. Professional manner in which team administered the origination of these loans have resulted in significant opportunities to grow our base of commercial relationships. Additionally, our construction pipeline remain solid, $78 million of commitments in commercial construction and development loans, which we expect to fund over the next 12 to 18 months. Further details on payments relief systems for commercial retail borrowers can be found on Slide 6 and 7. Our asset quality remains strong, as non-performing assets totaled just $3.4 million, or less than one-tenth of a percent of total assets at June 30, 2020. This breakdown can be found in the financial portion of our presentation on Slide 23. Partial past due loans at quarter end are nominal in dollar terms totaling $464,000, representing 12 borrowers. Overall past due information can be found on Slide 12 and 13. However, given the uncertainty of the economic environment, we elected to record a provision for loan losses of $7.6 million. This amount was generated entirely through qualitative factors, supporting the analysis as opposed to reserves against specific credits. These actions bring the allowance for loans to -- I'm sorry the allowance for losses to total loans to 1.16%, but excluding the impact of PPP loans. Payment deferrals numbered 705 for the quarter end represented $718 million in exposure, $23 million of deferred payments. As of July 17, sanctions in place beyond June 30, numbered 33, represented $130 million of exposure and $4 million of deferred payments. We expect more requests in the near-future, however, these relatively modest numbers…

Thanks, Ray, and good morning, everyone. As noted on the Slide14, this morning we announced net income of $8.7 million, or $0.54 per diluted share for the second quarter of 2020, compared with net income of $11.7 million, or $0.71 per diluted share for the second quarter of 2019. Net income during the first six months of 2020 totaled $19.4 million, or $1.19 per diluted share, compared to $23.5 million or $1.43 per diluted share during the first six months of 2019. Proceeds from a bank-owned life insurance claim increased net income in the previous second quarter by $1.3 million, or $0.08 per diluted share. Excluding the impact of this transaction, diluted earnings per share decreased $0.09 or about 14% during the current year's second quarter, compared to the respective prior year period. Proceeds from bank-owned life insurance claims and a gain on the sale of a former branch facility, increased net income in the first six months of 2019 by $3.1 million or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share decreased $0.05 or 4% during the first six months of 2020, compared to the respective prior year period. Turning to Slide 15, interest income on loans declined in 2020 periods compared to the 2019 period, primarily due to FOMC rate cuts aggregating 225 basis points since the beginning of the third quarter of 2019, with 150 basis point of those cuts occurring in March of this year. Interest income on security during the 2020 periods benefited from accelerated discount accretion from called U.S. government agency bonds, totaling $0.9 million during the second quarter and $2.7 million during the first six months of 2020. In total, interest income declined $2.7 million during the second quarter of 2020, compared to the second quarter of…

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

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Brendan Nosal from Piper Sandler. Go ahead.

Very good morning, guys. How are you?

Good morning, Brendan.

Just want to start off on deferral trends here. So just help me think about how we should kind of interpret the two buckets, the $740 million that's three months or less versus $130 million that's three to six months. Is the expectation here that that $740 million number will decline as we move forward, with some moving into a three to six month bucket, but hopefully, more of that just no longer being on deferral at all?

Well, I guess the biggest perspective around this is that, we were fairly liberal in providing deferrals early out of the crisis, and the guidance was consistent with that from those who regulate us, and the experience around the industry. On the second go around, we were much more concerned with the credit dynamics that surrounded that. We had the opportunity to review more information, financial information from those borrowers, and as a result, we saw that a trend decreased rather significantly. If you look at some of the buckets that were paying particular attention to the number of the deferrals, for instance, automotive dealers went from 17 to 7, restaurants went from 55 to 1, hotels went from 19 to 3. So, in those categories, we’re seeing the ability, at least, through July 17 to function well without further deferrals. Now I would be remiss if I didn't mention that it is July 17, and there are days ahead which could include requests for more referrals, however, the liquidity within the system is such that in total it provides some cause for optimism. But unprecedented is the right term for these times and what the future holds remains to be seen. But as we evaluate deferrals as of this date, they’re down considerably or less than 20% of what they were on the first quarter.

Okay, understood. And then, just one more for me and then I’ll step back. We’d just be curious to hear an update on how some of the larger, let’s call them, at risk portfolios are doing today versus three months ago, in areas like hotels, restaurants, entertainment, just any color on things like occupancy rates or capacity in restaurants today versus two months ago will be quite helpful?

Yes. As it relates to restaurants, they opened under the governor's orders in Michigan, and most of them are active, and operating at a percentage of the normal occupancy. But the take-out business is just absolutely thriving as is the drive through business. So we've seen results that range from better than they were before the crisis to similar and slightly worse. And so, that's an area that I think we will see no more stress [indiscernible] in the future, but it hasn’t happened yet and to be able to quantify that is absolutely impossible. As it relates to hotels, occupancy in many of those has made a turn and started to come up a bit, still well below the levels that you have observed prior to the crisis. And so, the experience there is that the performance is still going to be diminished in the next few months that we'll see and where it goes from there, will hinge on the pace of the recovery.

All right, great. Thank you for taking my questions.

Thank you.

Our next question is from Damon DelMonte from KBW. Go ahead.

Great. Okay. So, first question kind of on the margin here, probably for Chuck. So your reported margin was 3.17% this quarter, and you noted that there was a 10 basis point benefit from the salaries accretion from the called agency securities. So then that would put the core margin kind of like around call it 3.0%, 3.07% or so and you're kind of guiding down to 2.85% to 2.90% is that right?

Yes. I think part of that is the impact of the excess liquidity that we have on our books, which is going to be higher. And the excess liquidity as we have today, and that we've had over the last few weeks is quite a bit higher than the average excess that we had during the second quarter. So what you're seeing there is the impact of the ongoing and increased excess level of balance sheet liquidity.

Got you. Okay. And you expect that to kind of stay on through the end of 2020, and then eventually move off once the PPP proceeds are deployed? Is that correct?

Yes. I mean, yes, that's been the difficulty of -- the impossibility of trying to predict. I think all of us bankers thought that, hey, once PPP money hits within eight weeks, 10 weeks, a lot of that money would be out of the bank. And what we've seen and I know talking to other bankers, they've seen the same thing is that a large portion has remained in the bank. So when we made the loans, we went ahead and credited deposit accounts like we typically would. And we certainly have seen some money leave the bank. But if you just very simply look at the going ons of your balance sheet changes, we can definitely see that some of those proceeds remain with the bank, and it's impossible for us to predict when those monies would go out for operational use. We have over 2,100 loans that we did. As you know, money is very fungible, so trying to trace proceeds for one credit would be very difficult, 2,100 would be simply impossible. So, my assumption is that a lot of that money is going to be staying at least for some time. I think, when we can get past the COVID-19 environment, I think we'll see businesses start to expand, obviously bring all their employees back. So I think, I would expect more movement. But I would say that over the last few weeks, the movement of our deposit balances has been pretty steady.

I think what it does point to also Damon, is it points to the strength of much of our customer base. And as they were really good positioned as we headed into the pandemic, they took advantage of the various offerings and the government programs through SBA to help fund their payroll costs. And as their businesses have contracted, due to some of the stay-at-home orders and business shutdowns, they're sitting in a pretty hefty cash position right now. But as we talked about in our comments, as the economies continue to open back up around the country, and hopefully, continue with the phased reopening they'll go back to more of a normal operating environment as much as we can at this point in time. But I think the factor of the strength of our customer base is also one that I don't want to escape mention in the conversation as well.

Got you. Okay. It's helpful. And then with respect to this quarter's provision and kind of how you're looking at the reserve going forward, you noted, if you exclude the impact on the PPP loans the reserve is actually 1.16%. So, pretty sizable build this quarter. You feel like you're at an adequate level, or do you think that additional reserve building is likely as we progress through 2020?

I think that's the question that we're all hinging on right now, David, is that we feel really good about our reserve at June 30. We did the provision building through the qualitative factors that Chuck had outlined and Ray outlined in their comments, and it was a prudent thing to do. That aligns us up very nicely with the CECL model will continue to show throughout the rest of the year. But really going forward, we'll continue to monitor that and make adjustments to qualitative where we find it necessary. And also with specific quantitative adjustments that we need to make based on deterioration of the specific loans in the portfolio. We haven't seen that as of yet, and we're very pleased with that. But we know that where the pandemic continue on the shutdowns lasts a lot longer and deeper into 2020, there is going to be some detrimental effect to our client base. And so the qualitative factors help with that at the moment. But then if we get some specific deterioration with specific credits, we'll address that appropriately too. But right now, we feel really good about the reserve. With a prudent provision build at the end of the -- throughout the second quarter and where we stood at June 30 was where we felt we needed to be at. And we will react appropriately as this quarter continues on and surely in the fourth quarter. But we feel good about it.

Okay, great. And then just one final question. I want to make sure I'm reading this properly. So, the initial 90 day deferrals on the commercial portfolio is the total of $790 million. Then you have another $130 million that's from four to six months. So in total that's around call it $850 million, so basically 30% of the commercial portfolio is deferred right now?

Yes. I would say, when you look at three months or less, a lot of those have runoff now, Damon. And so what we see is the four to six, those are mostly what we would call second round, so a vast, vast majority if not all of the original payment relief for three months. And then those customers that seek additional payment relief were generally giving them another three months. And so that other three months is really what you’re seeing on Page 7. So, I don’t think you really want to add those two slides together, because there’s going to be a lot of -- anybody that's on Page 7 was also included on Page 6. That’s a better way of seeing it.

And all the ones on Page 6 that there were three months or less both payments have resumed.

Okay. So, is there a way based on this information I can look at your portfolio and say x% of the commercial portfolio is deferred right now? Or no, because they overlap?

What I would say, if you wanted to simply do that Damon, look at Page 7. I think as Ray indicated, we’re definitely having ongoing conversations with certain borrowers to talk about potential additional needs. So, as we sit here today, Page 7 would be the number you want to use.

Okay. So, Page 6, gives you a snapshot of what your initial round of deferment request were, and then subsequent to that some of that has gone back to performance and then others have migrated into the four to six months?

Right. The vast majority have gone back to making payments and then what you see on Page 7, at this point in time, these are the ones that have said, I need additional help.

Got you. Okay, that’s all I had for now. Thank you very much, guys.

Thanks, Damon.

[Operator Instructions]. Our next question is from John Rodis, from Janney. Go ahead.

Good morning, everybody. So, just back to the previous question. So Page 7. So if you include retail that’s $132 million. So that's roughly 5% of core loans excluding PPP, correct?

That’s correct, John.

Okay. So, that’s what's on deferral right now?

As we speak today, yes. As of Friday, I need to mention.

The 17.

Yes, 17.

Chuck, your margin guidance 2.85% to 2.90% for the second-half, does that include your "normal amortization" I guess of the PPP loans that you outlined?

That’s correct. Yes, that includes that schedule that I provided.

Okay. And then, I guess what is your assumption as far as forgiveness? What percent? I know it’s a guess, but what percent do you think is ultimately forgiven? And as far as timing, is it a third quarter, fourth quarter or mostly fourth quarter, first quarter? What are you sort of thinking today?

I think John, the assumption by our customers and we believe that there are so many that their loans are going to be forgiven. But since the fact that there’s been some guidance but not complete guidance by the SBA and the government odds on how the forgiveness part will work, we're just lick -- we’re trying to make our best guess at this point in time. But the assumption of our customers that their loans were used for a payroll as the program prescribed, their loans will be forgiven. But until you have the actual guidance you can’t make that final determination, so it is a big question mark.

It seem to me, John, if I could add, it doesn’t seem like it's going to be a lot of a third quarter activity. We don’t even the guidance out yet as to how to apply or help our borrowers apply for forgiveness. We have been hearing maybe early August that will be published, but we have heard dates before. And then I see that the treasury has allowed up to 90 days to go ahead and approve the request, or to act on the request. So certainly, Congress and other banking trade groups are trying to, at least, for the smaller loans are trying to get more of an automatic forgiveness or at least a much simpler form. That would obviously speed up the process if there is something like that. But if its loan-by-loan, it's going to take quite a while, and I would think it's going to be more of a fourth quarter or first quarter activity without some way of streamlining the smaller loans forgiveness program.

Chuck what percent of your loans are under a $125,000 balances?

I had that with me. I did bring it with me to the room here. I think what you would find is that if you look at the number of loans, a majority fall under that dollar amount. But if you look at the dollars, a majority of the dollars that we lent out our larger customers or larger borrowers.

Yes. Okay. One other question just obviously mortgage has obviously did very well in the quarter. As we go forward, do you expect to see some normal seasonality? Clearly, I would think in the fourth quarter, maybe. But third quarter, do you think just directionally, do you think mortgage is down from the second quarter? Or just what are you thinking?

Yes, this is Ray. The mortgage backlog has been rather steady for the last six weeks or so. So that would portend similar results into at least the beginning of the third quarter, or at the end of the third quarter in the fourth quarter seasonality will certainly take an effect. But particularly, as it relates to purchases, but if rates continue as they are, refinance activity will be a strong contributor. And so in sum, I think the answer to your question is the seasonal pattern will persist, but it will be at a higher level than it's been in the past.

Okay, fair enough. Okay. Thank you guys.

Our next question is from Kevin Swanson from Hovde Group. Go ahead.

Hi, guys.

Hey, Kevin. Good morning.

Hey, I appreciate the commentary around the NIM and the guidance there. But I'm sorry if I missed this, but was there any guidance around what it actually means for spread income?

I'll let you guys do those calculations. So I feel comfortable with assumptions that I gave to talk about the spread and margin. Under my assumptions, I don't think we're going to see a huge change in average earning assets. So, I think those two combined will probably get you to where you want it to be to go.

Okay, fair enough. Yes, I appreciate that, because as much as the margin contracts, if NII doesn't really change all that much, then I guess there's some moving points there. But just one more question, I appreciate the increase in the balance sheet from the liquid assets and the PPP. But you guys kind of jumped pretty far ahead of the $4 billion number. Given, how do you think that shapes out longer-term? Are you now considered yourself north of $4 billion for the longer-term? Just kind of curious in your thoughts on how that all shakes out.

No, I don't think we'll see that. We certainly expect all or a vast, vast majority of our PPP loans to be forgiven. I think maybe where you're going is that while they're forgiven, so that means our loans now become overnight investments to the Federal Reserve. And we'll have to work those off over time. So, I think it's going to be quite a while for that money to work its way out of our balance sheet. But I don't think a majority of that's permanent. But having said that, and Ray kind of touched on that, we're still talking to current customers about loan needs. We're certainly talking to prospects. Ray touched on the PPP program prospects, some opportunities there. So we certainly would expect over time that our commercial loan portfolio will continue to grow. But when you have $550 million in PPP portfolio, that's a slug of money to have to work through.

Got it. Okay. Thanks, guys.

Thank you.

Our next question is from Brendan Nosal from Piper Sandler. Go ahead

Hey. Just one follow-up for me on the margin. I appreciate that the 2.85% to 2.90% includes both typical PPP fees as well as the excess level of liquidity. And then the 3.10% to 3.15% that you gave does that exclude both excess liquidity as well as any impact of PPP? In other words, does that kind of be the expected underlying run-rate for the NIM going forward?

No. Brendan, the 3.10% - 3.15% still includes the PPP accretion. But it brings us our balance sheet back normal on excess balance sheet liquidity. So just the latter.

Got it. Okay. Thanks.

As there are no more questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Bob Kaminski for closing remarks.

Thank you, Kate. Thank you all very much for your interest in our company. We hope you and your families stay healthy and safe. We look forward to speaking with you next at the conclusion of the third quarter. This call is now concluded. Thank you.

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