Q2 2024 Mercantile Bank Corp Earnings Call
Good morning, and welcome to the Mercantile Bank Corporation 2024 second quarter earnings Conference call. All participants will be in a listen only mode should you need assistance. Please signal a conference specialist by pressing the Starkey followed by zero.
After todays presentation, there will be an opportunity to ask questions. Please note. This event is being recorded.
I would now like to turn the conference over to Nicole Clatter first Vice President Chief Marketing Officer of Mercantile Bank. Please go ahead.
Good morning, and thank you for joining us.
For many companies.
For the quarter.
'twenty one.
Joining me this morning.
Thank you.
Okay.
Thank you Mike.
Thanks.
Our agenda will begin with.
Hi, Mark Hi, Bose, Spain.
It will include references to our presentation this quarter.
Okay.
A press release earlier today.
Thank God.
Our prepared remarks, we will then open the call to you.
Okay.
My responsibility.
Okay.
Yeah.
Protectionist revenue earnings and cash.
Capital structure.
Yes.
Yes.
Yes.
The company's actual results could differ materially.
Forward looking statements.
Right in the company's latest.
Sure.
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The company assumes no obligation.
That's right.
Paul.
That is the only assay.
I will now turn the meeting.
It is.
Right right right. Thank you Nicole my comments will focus on our loan to deposit ratio deposit growth loan growth asset quality and noninterest income.
Over the last three years commercial loan growth and mortgage loan growth has been strong and while our deposit growth has been solid it has not kept pace with total loan growth as a result, the bank's loan to deposit ratio increased to 110% at year end 2023 compared to 85% at year end 2021 when deposits.
Were elevated because of the P. P P program and the resulting excess liquidity in the system. We believe the banks elevated loan to deposit ratio is a contributing factor to our below peer valuation. Despite a strong return profile.
The following comments summarize the strategies, we believe will contribute to further reductions in our loan to deposit ratio.
We have undertaken a three pronged approach to building our deposit base with the objective of reducing the loan to deposit ratio in the mid 90% range over time.
First we plan to grow the public and municipal in the public and municipal round through strategic personnel additions with existing relationships in this space.
Second, placing additional focus on small business banking through more efficient underwriting and obtaining the full relationship that characterizes this type of business.
Third growing the retail customer focused based on total balances as opposed to activity hurdles such as transactions and card usage. These efforts led to an increase in local deposits in the first half of 'twenty 'twenty four of approximately $260 million or 14% annualized growth rate.
Local deposits grew $153 million in the second quarter alone.
Mortgage loans on the balance sheet have grown substantially over the past few years as borrowers have opted for arms, rather than fixed rates and the increasing rate environment.
We have successfully executed changes within our portfolio mortgage programs.
I'll take them, a greater portion of our mortgage production being sold rather than placed on our balance sheet.
Positive outcomes include a 76% increase in mortgage banking income during the first six months of 2024 compared to their respective 'twenty to 'twenty three period and a nominal increase in mortgage loans on our balance sheet of $12 million year to date.
Commercial loan growth in the first half of 'twenty 'twenty, four was $118 million or 7% annualized the current pipeline stands near the trend line established over the last three quarters, including commitments to fund commercial construction loans of $320 million in residential construction loans of 37 million.
Customer reductions in loan balances from excess cash flow or asset sales of $76 million also impacted our commercial loan totals taking these factors into account, we do not expect to see a deceleration in commercial loan growth in the immediate future.
Taken together these strategies produced a loan to deposit ratio of 107% as of June 32024, compared to 110% at year end 2023 is deposit growth was approximately double total loan growth year to date this ratio reduces to 102% when giving effect to our.
Sweep account balances during.
During this period the ratio of wholesale funds to total funds decreased from 13, 8% to 12.1% another demonstration of the strengthening of the funding side of the balance sheet.
Speaker Change: Asset quality remains very strong as nonperforming assets totaled $9 $1 million at quarter end or 16 basis points of total assets, consisting of 25% residential real estate and 75% non real estate commercial loans. There is no commercial real estate reps.
And patients among the nonperforming assets.
Past due loans in dollars represent 14 basis points of total loans and there is no outstanding Owari non owner occupied office exposure is $271 million or 6% of total loans. The borrowers in this asset class has performed well and continued to be monitored closely.
We remain vigilant in our underwriting standards and monitoring to identify any deterioration within our portfolio. Our lenders are the first line of observation in defense to recognize areas of emerging risk a risk rating model is robust with a continued emphasis on borrower current borrower cash flow, providing prompt sensitivity to any.
Urging challenges within our borrowers finances.
That said.
Our customers continue to report strong results to date.
Have not begun to experience the impacts of a potential recessionary environment and any systemic fashion.
Total noninterest income grew 40% during the first half of 'twenty 'twenty four compared to the first half of 2023 with growth reported in virtually every category mortgage banking income grew 76% based on the strategies outlined earlier and the resulting ability to sell a greater portion of the originations in the secondary market.
Income from interest rate swaps grew 18% as we met our customers' desire for fixed rate financing principally in the CRE market service charges on accounts grew 58%, reflecting higher activity levels and customer growth and less earnings credit offset to charges based on reduced balances and.
Transaction accounts.
Payroll services grew by 20% as our offerings continue to build traction in the marketplace.
Finally credit and debit card income income grew 4% when adjusted for the receipt of a one time payment from visa associated with our contract renewal in the second quarter of 2023 that.
That concludes my comments I will now turn the call over to Chuck.
Thanks, Ray and good morning to everybody. This morning, we announced net income of $18 $8 million or $1.17 per diluted share for the second quarter of 2024, compared with net income of $24 million or $1.27 per diluted share for the respective prior year period.
Net income during the first six months of 2024 totaled $43 million or $2 50 per diluted share compared to $41.3 million or $2 58 per diluted share during the first six months of 2023.
Noninterest income increased three in both periods net income was negatively impacted by higher provisions for credit losses and increased noninterest expenses net interest income was relatively similar.
Interest income on loans increased during the second quarter and first six months of 2024 compared to the prior year period.
Reflecting the increased interest rate environment, and solid growth in commercial and residential mortgage loans.
Our loan yields during the second quarter of 2024 was 45 basis points higher than the second quarter of 2023 with average loans up about 9% over the respective periods.
The improved loan yield largely reflects the combined impact of an aggregate 75 basis point increase in the federal funds rate during the period of March through July of 2023, and over two thirds of our commercial loans have any floating rate.
Interest income on Securities also increased during the 2024 periods.
Compared to the prior year periods, reflecting growth in the securities portfolio and the higher interest rate environment.
Interest income on interest, earning deposits a vast majority of which is comprised of funds on deposit with the federal Reserve Bank of Chicago also increase starting in 2024 periods compared to the prior year periods, reflecting a higher average balance and an increased yield.
In total interest income was $13 million and $29 $2 million higher during the second quarter and first six months of 2024, respectively compared to the prior year periods.
We recorded increased interest expense on deposits in our sweep account product during the second quarter and first six months of 2024 compared to the prior year periods, reflecting the increased interest rate environment money market and time deposit growth.
Transfers of deposits from no or low cost in deposit products to higher cost in deposit products and enhanced competition for deposits our cost of deposits. During the second quarter of 2024 was 106 basis points higher than the second quarter of 2023 with average deposits up almost.
13% over the respective periods.
Interest expense on the federal home loan bank of Indianapolis advances also increased during the 2024 periods compared to the prior year period, generally, reflecting the higher interest rate environment as well as a higher average advanced portfolio of balance in the year to date comparison.
Interest expense on other borrowed funds increased during the 2024 periods compared to the prior year periods, primarily reflecting the higher interest costs of our trust preferred securities.
In total interest expense was $13 $4 million and $37 million higher during the second quarter and first six months of 2024, respectively compared to the prior year period.
Net interest income declined zero point $5 million at $1.5 million during the second quarter and first six months of 2024, respectively compared to the prior year time periods.
Our net interest margin declined 42 basis points during the second quarter of 2024 compared to the second quarter of 2023.
Although our yield on earning assets increased 46 basis points during that time period, our cost of funds was up 88 basis points.
While we experienced rapid growth in earning asset yield during the period of March of 'twenty two through July of 'twenty three when the F. O M. C raise the federal funds rate by 525 basis points meaningful increases in our cost of funds did not begin to materialize until the latter part of 2022 when competition for.
The base balances increased deposit rates and depositors began to move funds from NAU and lower costing deposit types to higher costing deposit products.
Our net interest margin peaked during the latter part of 2022 and early stages of 2023.
Impacting our net interest margin more recently is our strategic initiative to lower the loan to deposit ratio, which generally entails deposit growth exceeding loan growth and using the additional monies to purchase securities.
A large portion of the deposit growth is in the higher costing money market and time deposit products.
The purchase securities provide a lower yield the loan products.
We recorded a provision expense of $3 $5 million and $4 $8 million during the second quarter and first six months of 2024, respectively.
The second quarter 2020 for provision expense, primarily reflects a specific allocation for a nonperforming non real estate related commercial loan relationship and allocations necessitated by net loan growth. The first six months expense also includes a specific allocation recorded during the first quarter.
Speaker Change: Oh 2024 for a different nonperforming non real estate related commercial loan relationship.
Noninterest expenses were $1 $9 million and $3 $3 million higher during the second quarter and first six months of 2024, respectively compared to the prior year time periods, the increases largely reflect higher salary and benefit costs, including annual merit pay increases market.
That's higher residential mortgage lender commissions lower residential mortgage loan deferred salary cost and increased medical insurance costs.
Data processing costs also comprised a notable portion of the increased noninterest expense level, primarily reflecting higher transaction volumes and software support costs, along with the introduction of new cash management products and services.
We remain in a strong and well capitalized regulatory capital position, our bank's total risk based capital ratio was 13, 9% at the end of the second quarter.
Lately over $200 million above the minimum thresholds be categorized as well capitalized we did not repurchase shares during the second quarter of 2024, we have $6 $8 million available in our current repurchase plan.
Well net unrealized gains and losses in our investment portfolio are excluded from regulatory capital calculations, we do regularly compute our regulatory capital ratios assuming the calculations did include that adjustment, while our regulatory capital ratios were negatively impacted by the pro forma calculations, our capital position remains strong.
As of June 30, our tier one leverage capital ratio declined from 12.2 to 11, 3% and our total risk based capital ratio declined from 13, 9% to 12, 9%.
Speaker Change: Our excess capital as measured by the total risk based capital ratio was also negatively impacted however, it's still a strong $150 million over the minimum regulatory amount to be categorized as well capitalized.
On slide 22 of the presentation, we share our latest assumptions on the interest rate environment and key performance metrics for the remainder of 2024 with the caveat that market conditions remain volatile making forecasting difficult.
This forecast is predicated on the federal funds rate being lower by 25 basis point effective October 1st we continue to project loan growth in the range of 4% to 6%. We are forecasting our net interest margin to be in a range of 3.50% to $3 six zero percent during both the third and fourth quarters.
We expect increased interest costs from continued growth in higher costing money market and time deposits and the renewal of maturing time deposits opening lower interest rate environment to be generally mitigated by the renewal replacement of maturing fixed rate commercial loans and investments that were me.
Aid obtained and considerably lower interest rate environment, we expect noninterest income and noninterest expense to be relatively stable during the remainder of 2024 and.
In closing we are very pleased with our 2024 operating results and financial condition and believe we remain well positioned to continue to successfully navigate through the myriad of challenges faced by all financial institutions. Those are my prepared remarks, I'll now turn the call back over to Ray. Thanks.
Thank you Chuck that concludes our prepared remarks from management, we will now move into the Q&A portion of the call.
We will now begin.
The question and answer session to ask a question you May Press Star then one on your Touchtone phone if youre using a speakerphone. Please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Yeah.
The first question comes from Brendan Nacelle with hub group. Please go ahead.
Hey, good morning, how are you guys doing.
Doing well.
Maybe just starting off on deposit competition.
What do you hope you're seeing there I mean, it feels like that the mix shift out of noninterest bearing has slowed pretty materially in the pace of increase in deposit pricing has as well.
Kind of curious.
Where the competitive environment stands and how much further bleed in funding costs, you might see as the year progresses.
Yeah, Brian It's a good question. This is Chuck I would I would agree with your comment that transfer some no or low cost and deposit products has definitely slowed.
So it was certainly up from where it was in the back half of last year and the beginning of this year.
We still see some of that but certainly not as what we had before.
Speaker Change: One of the things that we haven't seen that we typically do it kind of goes back to in January of each year, we lose quite a bit of noninterest bearing deposits as our commercial customers pay bonuses taxes in partnership distributions and then we generally see that ramp back up and kind of go through the same cycle again, we're not seeing the growth in.
Speaker Change: Noninterest bearing accounts that we typically would but what we are seeing is those businesses growing their money market and in some cases time deposits. So.
I think with the rates being you know with the rates being higher than obviously, what they have been over the last few years.
Our commercial customers are being more savvy and paying more attention to cash management and so I think so.
Speaker Change: So our our margin or net interest income is impacted by them, putting money into those higher money market accounts versus the noninterest bearing accounts.
I would say that interests deposit rates in our markets have remained relatively stable for the last few months.
Which obviously is a good thing.
I think you know where we're still feeling that the rates are relatively high.
In total, but we're not seeing them increase anymore.
Got it alright, that's a helpful color John.
Speaker Change: Maybe one more for me before I step out.
Just on that goal to get the lumpy deposit ratio into the mid nineties overtime I know that there is a lot of factors.
Mentally they can kind of help or hurt that but just kind of curious.
Speaker Change: How do you think about a timeframe to get towards that target.
Because of the way you opened your question, we don't think about it where the timeframe.
Speaker Change: But youre correct. There there are so many variables and.
Our our goal in general is to continue to grow the loan portfolio at a pace that you know, our our markets and customers demand of us and outgrow that with deposits at the same time and and to do that without going above market for our deposit rates.
So those are the factors that will determine how quickly we can bring it down and for the first six.
Months of the year, we've been able to grow our loan.
Book at about 7% deposit booked at about twice that of 14, and so that's an indication of what the last six months environment yielded a we don't expect that to change materially, but you know as.
As we've seen in the financial markets things do change and they will so we'll have to adjust as that happens.
Yeah fair enough fair enough alright, thanks for taking the questions.
You bet.
The next question comes from Daniel Tamayo with Raymond James. Please go ahead.
Hey, Thanks, guys good morning.
Yeah.
Digging into credit a little bit it's obviously been a strength for you guys and remains so I'm just curious if you're able to give us any information on the commercial relationship that drove the increase in reserves in the quarter.
Well it was an outlier it was a non real estate related our C&I business that you know base.
Basically ran into a management issues and that caused the credit issue.
Doesn't look like it relates to anything systemic.
The marketplace, the economy or our portfolio.
Okay, and then what's taken in terms of our reserves on that that loan and where does that stand in terms of kind of a long due.
Oh, I'm sorry in terms of coverage.
And we reserved it aggressively and fully so wouldn't expect to have a further reserve related to that credit.
Okay great.
And then I guess you know the.
The classified and critical criticized trends anything noteworthy I may not be fully.
Speaker Change: Up to speed on those yet, but just curious if from what you guys know now like what what you can expect when the.
When the rig that it comes out.
Well the the mix of classified versus and that is a pretty stable qualitatively within.
Speaker Change: The more risky end of that spectrum we.
We have a number of exit credits that are are you know working out as anticipated.
The rehab credits in that group are.
Healing as anticipated. So you know from where we sit we don't expect surprises within that group.
Okay.
And then just lastly on credit the provision and net charge offs.
Is there anything different that we should think about in terms of forecasting that loss provision number going forward or you know outside of the unusual number in the second quarter or do you still feel like that's relatively stable.
Yeah. Dan. This is Chuck I think we generally don't give guidance on provision I know all of the firms have their own different thoughts on the economy.
And certainly we can see especially as a commercial lender with some sizable credits you know occasionally we do have some one offs, which hopefully will go the other way as we continue our collection efforts.
Namely on the on the two credits that I mentioned in my prepared remarks, So I would say if you look at a combination of the first and second quarter.
Average them out is in general what our expectations would be as we sit here today.
Speaker Change: Okay terrific. Thanks for all the color guys I appreciate it I'll step back Okay you bet.
Yeah.
The next question comes from Nathan race with Piper Sandler. Please go ahead.
Yeah, Hi, guys. Good morning, Thanks for taking my questions.
Just going back to Chuck's comments previously in terms of the deposit and pricing environment being relatively stable of late just curious kind of how the trend in the.
Margin unfolded over the course of the second quarter was a relatively stable or kind of steady compression each month between April and June.
Yeah, I would say it was a downward trend throughout the quarter I think what we're seeing is that our deposits are repricing, you know a little bit faster than what our assets are repricing as we kind of get to that equilibrium state as we've gone through the timing.
Events that I mentioned, so I, but I think that we're getting we're getting close to the point here and you can see that in my guidance as we're getting close to a point of equilibrium.
You know the Cds repricing today, why they're repricing.
Theyre not repricing to the magnitude that they were you know certainly 12 months ago, even six months ago, and then again, we continue to have the repricing on the asset side as well. So we think on an overall basis with it looks like the fed is going to start lowering rates on a on a measured basis, we feel good about our balance sheet.
And that environment, so taking all of that together, we think when we get here into the third and fourth quarter is that our margin will be relatively stable at the levels that we projected.
Got it very helpful.
It's.
Just speaking of repricing on the.
Right side of the balance sheet, a truck can you remind us just in terms of what amount of non maturity deposits reprice.
Commensurate with each cut.
Yeah, I think you know you're kind of touching on something that it was going to be a very interesting.
I think overall looking at trying to forecast our net interest margins.
They call them. The deposit betas are of course, the biggest subjective number that we put into our models, we put into our forecast, but I think now that will get you know they'll become very interesting if the fed does in fact start lowering interest rates.
As we see how the competition reacts clearly you've heard from our comments today at the loan to deposit ratios strategy is very important to us.
So that's going to come into the mix as well you know I think yeah, we definitely have seen some increases in time deposits.
But the biggest level of increases by far are the money market rates. Those are the ones that have been priced most aggressively not just by us but in the marketplace as well.
So it's our expectation that I guess our hope.
That when the fed does start lowering interest rates is that we will see some meaningful declines in the rates being offered on that product within the marketplace as well.
Okay, Great very helpful. And then if I could just ask one more on kind of expenses and hiring efforts I'm. Just curious if the updated expense guide for the fourth quarter contemplates any hires that you guys are planning to make to maybe accelerate some progress on that.
Deposit gathering front.
Yeah, our forecast definitely reflects our expectations and our workforce.
You know, whether we are hiring additional people are trying to fill.
Existing spots right now you know we're always looking for people on also on all facets of our company on the sales side, whether it be commercial lenders and are primarily deposit gathers I would say that we've done some very meaningful hires in the past 12 to 18 months.
Speaker Change: On the deposit side, and we would definitely like to add to that and some is somewhat budgeted.
And put it into our forecast.
But we are a growing company, we continue to expect to grow and that will.
Pete: Pete will require increases in our workforce, but one of the things that we definitely have seen over the last couple of years is improvements in our efficiencies, especially with our data analytics team, while we have grown as a company over the last couple of years as you look at our Ftes.
So far our summer intern a program that we have that throws those numbers off a little bit from time and again you can see that our ftes have been very stable and that really is a reflection of us becoming more efficient internally, we're taking a look at all of our processes, where we're getting smarter about what we're doing but also the <unk>.
Ada analytics are the function has also had a nice impact on us, helping our efficiency there as well.
Okay great.
I appreciate all the color. Thank you.
Certainly.
Again, if you have a question. Please press Star then one.
The next question comes from Damon Delmonte with K B W. Please go ahead.
Hey, good morning, guys hope, you're both doing well and thanks for taking my questions. Here first one I just wanted to touch a little bit on loan growth. It sounds like the outlook remains pretty a pretty solid for you guys can you just talk a little bit about you know what areas of your of your footprint are providing the best opportunities and kind of you know within those opportunities what what.
I went to the economy or are providing hum.
Hi, good credits for you guys.
Yes, Damon this is ray.
The loan opportunities have been pretty well dispersed and are not concentrated in any particular part of our geography of course, we have some concentration here in Grand Rapids because of the.
Concentration of existing assets that we have here, but in terms of new opportunities that are spread around the state.
Our our search as we grow our commercial book, we're looking for good companies and good management teams and what industry. They're in is less important to us. We just absolutely want to find good management teams that are you know continue to uphold our credit quality. So we haven't.
Focused in any particular areas of the economy.
It's more company specific driven.
Gotcha, Okay, and then kind of switching to the loan yields Chuck you know I think they were kind of flat in this quarter a quarter over quarter.
Speaker Change: Is that a function of what youre seeing for new pricing opportunities in the market or.
Is that more of a function of a the majority of the portfolio has kind of been reset to the current rates.
I think it's a combination of both clearly we're up or as at the end of the quarter were up to 70% of our commercial loans are floating rate. So clearly.
You know those going up seems to be done from a market expectations on the Fed's next move we definitely have on an ongoing basis, we have fixed rate loans that were made in a much lower rate environments coming up for maturity in those are either leaving are paying off but what happens most of the time as the refinance their ballooning so the refinanced at existing <unk>.
And I would say that in the current pricing.
Marketplace is we're getting yields that are little bit higher.
And then our overall yield for sure, but you know.
The dollar amounts involved are not as significant.
Got it okay.
And then I guess lastly on capital Socs.
Fox had a very nice run lately. So I guess, you know any updated thoughts on the buyback probably probably now at current levels.
That's not where we're obviously very pleased with the stock performance over the last week or so and actually the last month or so I would say you know what are our thoughts on capital is that we want to preserve as much as we can clearly again, we're a growing company.
So as everybody knows there's different ratios that we and regulators look at when it comes to comparing that to capital levels, where we wanted to make sure that we're in good stead there.
Clearly, we want to have some dry powder.
It has taken advantage of opportunities you would never know about the economy. So.
So we're pretty comfortable kind of staying on the sidelines with the buyback program clearly the the prices are probably the biggest driver there.
Speaker Change:
So you know at these levels certainly would not expect to initiate any any of that.
As you saw we increased the dividend again as we typically do in the first and the third quarter. So.
Increasing the cash returned to our investors.
At a percent of earnings that we think makes sense for us again, making sure that we have capital for the for the items that I that I spoke of.
Got it okay, great. That's all I had thank you very much.
Thank you.
Speaker Change: Okay.
This concludes our question and answer session I would like to turn the conference back over to Ray Ray Reitsma for any closing remarks.
Yeah.
Thank you for your participation in today's call and for your interest in Mercantile Bank. We appreciate it and that concludes today's call.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
Yeah.
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