Mercantile Bank Q3 2024 Earnings Report

Mercantile Bank EPS Results

• Actual EPS: $1.22
• Consensus EPS: $1.18
• Beat/Miss: Beat by +$0.04
• One Year Ago EPS: $1.30

Mercantile Bank Revenue Results

• Actual Revenue: $93.08 million
• Expected Revenue: $56.83 million
• Beat/Miss: Beat by +$36.25 million
• YoY Revenue Growth: N/A

Mercantile Bank Announcement Details

• Quarter: Q3 2024
• Date: 10/15/2024
• Time: Before Market Opens
• Conference Call Date: Tuesday, October 15, 2024
• Conference Call Time: 10:00AM ET

Mercantile Bank (NASDAQ:MBWM) is a bank holding company headquartered in Grand Rapids, Michigan. Through its principal subsidiary, Mercantile Bank, the company provides banking and financial services to businesses, individuals and organizations.

The bank’s offerings include commercial and industrial lending, commercial real estate financing, construction loans, residential mortgage loans and consumer credit. It also provides deposit accounts, treasury and cash-management services, online and mobile banking, and other financial services designed to support business and personal banking needs.

Founded in 1997, Mercantile Bank has developed a community-oriented banking model focused primarily on commercial relationships and local markets. The company operates through a network of full-service banking offices serving communities across Michigan and select markets in Ohio.

Mercantile Bank Q3 2024 Earnings Call Transcript

Key Takeaways

• Deposit Growth and LTD Ratio Improvement: Deposits increased by $600 million (21% annualized) in the first nine months, lowering the loan-to-deposit ratio to 102% (97% including sweep balances) from 110% at year-end 2023.
• Mortgage banking income rose 49% YTD 2024, with only a $7 million increase in mortgage loans on the balance sheet as a greater portion of originations were sold.
• Net interest margin compressed by 46 basis points in Q3 2024, causing net interest income to decline by $0.7 million amid higher-cost deposit growth and increased securities purchases.
• Noninterest income grew 27% YTD 2024, led by a 46% increase in service charges, 20% in payroll services, and 3% in card income (adjusted), offsetting an 8% drop in swap income.
• Asset quality remains strong: nonperforming assets are 17 bps of total assets, past-due loans 13 bps of total loans, with no CRE in NPAs and ongoing vigilant underwriting.

Presentation

[Operator]

Followed by zero. After today's 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 Nichole Kladder, First Vice President and Chief Marketing Officer of Mercantile Bank. Please go ahead.

[Nichole Kladder, VP and CMO at Mercantile Bank]

Good morning, and thank you for joining us. Today, we will cover the company's financial results for the third quarter of 2024. The team members joining me this morning include Ray Reitsma, President and Chief Executive Officer, as well as Chuck Christmas, Executive Vice President and Chief Financial Officer. Our agenda will begin with prepared remarks by both Ray and Chuck, and will include references to our presentation covering this quarter's results. You can access a copy of the presentation, as well as the press release sent earlier today, by visiting mercbank.com. After our prepared remarks, we will then open the call to your questions. Before we begin, 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.

[Nichole Kladder, VP and CMO at Mercantile Bank]

The company's actual results could differ materially from any forward-looking statements made today due to 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. That is all I have for you today. I will now turn the meeting over to our President and Chief Executive Officer, Ray Reitsma. Ray?

[Ray Reitsma, President and CEO at Mercantile Bank]

Thank you, Nicole. My comments will focus on our significant reduction in the loan-to-deposit ratio, very strong local deposit growth, strong local loan growth, excellent asset quality, and steadily growing non-interest income. Over the last three years, commercial loan growth and mortgage loan growth has been strong, and while deposit growth has been solid, it has not kept pace with loan growth.

[Ray Reitsma, President and CEO at Mercantile Bank]

As a result, the bank's loan-to-deposit ratio increased to 110% at year-end 2023. We believe the bank's 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 into the mid-90% range over time.

[Ray Reitsma, President and CEO at Mercantile Bank]

First, we have broadened our focus on business deposits, including entities that have limited or no borrowings. Second, we plan to grow in the governmental and public realm through strategic personnel additions with existing relationships in this space. Third, we are growing the retail customer focus based on total balances as opposed to activity hurdles, such as transactions or card usage. These efforts led to an increase in local deposits in the first three quarters of 2024 of approximately $600 million, a 21% annualized growth rate. Local deposits grew $339 million in the third 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 in the increasing rate environment.

[Ray Reitsma, President and CEO at Mercantile Bank]

We have successfully executed changes within our portfolio mortgage programs, resulting in a greater portion of our mortgage production being sold rather than placed on our balance sheet. Positive outcomes include a 49% increase in mortgage banking income during the first nine months of 2024, compared to the respective 2023 period, and a nominal increase in mortgage loans on our balance sheet of $7 million year-to-date. Commercial loan growth in the first three quarters of 2024 was $233 million, or 9% annualized. The current pipeline stands at $236 million, slightly below the trend line established over the last three quarters, reflecting the strong funding activity in the third quarter. Commitments to fund commercial construction loans total $241 million and residential construction loans of $34 million at quarter end.

[Ray Reitsma, President and CEO at Mercantile Bank]

Customer reductions in loan balances from excess cash flow or asset sales of $106 million also impacted our commercial loan totals. Taking these factors into account, we expect a slight deceleration in the commercial loan growth in the immediate future. Taken together, these strategies produced a loan-to-deposit ratio of 102% as of September 30, 2024, compared to 110% at year-end 2023, as deposit growth was approximately double total loan growth year-to-date. The ratio reduces to 97% when giving effect to our sweep account balances. During this period, the ratio of wholesale funds to total funds decreased from 14% to 11%, another demonstration of the strengthening of the funding side of the balance sheet.

[Ray Reitsma, President and CEO at Mercantile Bank]

Asset quality remains very strong, as non-performing assets total $9.9 million at quarter end, or 17 basis points of total assets, consisting of 32% residential real estate and 68% non-real estate commercial loans. There is no commercial real estate representation among the non-performing assets. Past due loans in dollars represent 13 basis points of total loans, and there is no outstanding ORE. Non-owner occupied office exposure is $271 million, or 6% of total loans. The borrowers in this asset class have performed well and continue 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 and defense to recognize areas of emerging risk.

[Ray Reitsma, President and CEO at Mercantile Bank]

Our risk rating model is robust, with continued emphasis on current borrower cash flow, providing prompt sensitivity to any emerging challenges within a borrower's finances. That said, our customers continue to report strong results to date and have not begun to experience the impacts of a potential recessionary environment in any systemic fashion. Total non-interest income grew 27% during the first three quarters of 2024 compared to the first three quarters of 2023, with growth reported in several categories. Mortgage banking grew 49% based on the strategies outlined earlier and the resulting ability to sell a greater portion of originations on the secondary market. Service charges on accounts grew 46%, reflecting higher activity levels and consistent and customer growth and less earnings credit offsets to charges based on reduced balances in transaction accounts.

[Ray Reitsma, President and CEO at Mercantile Bank]

Payroll services grew 20% as our offerings continued to build traction in the marketplace. Finally, credit and debit card income grew 3% when adjusted for the receipt of a one-time payment from Visa associated with our contract renewal in the second quarter of 2023. Income from interest rate swaps declined 8% as demand for interest rate protection by borrowers shifted with the borrower's future rate expectations. That concludes my comments. I will now turn the call over to Chuck.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Thanks, Ray. This morning, we announced net income of $19.6 million, or $1.22 per diluted share for the third quarter of 2024, compared with net income of $20.9 million, or $1.30 per diluted share for the respective prior year period. Net income during the first nine months of 2024 totaled $60 million, or $3.72 per diluted share, compared to $62.2 million or $3.89 per diluted share during the first nine months of 2023. While non-interest income increased during both periods, net income was negatively impacted by expected lower net interest income and increased non-interest expenses.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Provision expense was lower during the third quarter of 2024 when compared to the third quarter of 2023, and was the same during the first nine months of 2024 as it was during the first nine months of 2023. Interest income on loans increased during the third quarter and first nine months of 2024 compared to the prior year periods, reflecting the increased interest rate environment and solid growth in commercial and residential mortgage loans. Our loan yield during the third quarter of 2024 was 32 basis points higher than the third quarter of 2023, with average loans up about 10% over the respective periods.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

The improved loan yield largely reflects the combined impact of a 25 basis point increase in the federal funds rate in July of 2023, and over two-thirds of our commercial loans having a floating rate, along with strong commercial and residential mortgage loan growth over the past 15 months in the higher interest rate environment. The 50 basis point reduction in the federal funds rate in mid-September partially mitigated the higher levels of loan yield and interest income on loans for the quarter. Interest income on securities also increased during the 2024 periods compared to the prior year periods, reflecting growth in the securities portfolio and a higher interest rate environment.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

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 increased during the 2024 periods compared to the prior year periods, reflecting a higher average balance and an increased yield. In total, interest income was $12.3 million and $41.5 million higher during the third quarter and first nine months of 2024, respectively, compared to the prior year periods. We recorded increased interest expense on deposits and our sweep account product during the third quarter and first nine months of 2024, compared to the prior periods, reflecting the increased interest rate environment, money market and time deposit growth, and transfers of deposits from no or low-cost deposit products to higher-cost deposit products.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Our cost of deposits during the first quarter of 2024 was 85 basis points higher than the third quarter of 2023, with average deposits up about 13% over the respective periods. Interest expense on Federal Home Loan Bank of Indianapolis advances during the third quarter of 2024 was similar to that of the third quarter of 2023, reflecting an offsetting lower average balance and higher average cost. Interest expense on the Federal Home Loan Bank of Indianapolis advances during the first nine months of 2024 was higher than during the first nine months of 2023, reflecting a higher average balance and average rate. Interest expense on other borrowed funds during the 2024 periods was similar to the prior year periods.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

In total, interest expense was $12.9 million and $43.6 million higher during the third quarter and first nine months of 2024, respectively, compared to the prior year periods. Net interest income declined $0.7 million and $2.2 million during the third quarter and first nine months of 2024, respectively, compared to the prior periods. Impacting our net interest margin 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 deposit growth is in the higher costing money market and time deposit products, while the purchased securities provide a lower yield than loan products.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Our net interest margin declined 46 basis points during the third quarter of 2024 compared to the third quarter of 2023. Although our yield on earning assets increased 30 basis points during that time period, our cost of funds was up 76 basis points. While we experienced rapid growth in earning asset yield during the period of March of 2022 through July of 2023, when the Federal Reserve raised the federal funds rate by 525 basis points, meaningful increases to our cost of funds did not begin to materialize until the latter part of 2022, when competition for deposit balances increased deposit rates and depositors began to move funds from no and lower costing deposit types to higher costing deposit products.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Our net interest margin peaked during the latter part of 2022 and early stages of 2023. While loans increased $249 million during the first nine months of 2024, or almost 8% on an annualized basis, deposits grew $555 million, or about 19% on an annualized basis during the same time period, providing a net surplus of funds totaling about $300 million. We used that net surplus of funds to grow our securities portfolio $86 million and reduce our Federal Home Loan Bank of Indianapolis advances portfolio $51 million during the first nine months of 2024.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

The remainder of the net surplus of funds is on deposit with the Federal Reserve Bank of Chicago, with the deposit balance totaling $218 million as of September 30th. We recorded a provision expense of $1.1 million and $5.9 million during the third quarter and first nine months of 2024, respectively. The third quarter 2024 provision expense primarily reflects an increase in environmental factor allocations and allocations necessitated by net loan growth, which were partially offset by decreases in the calculated allowance stemming from the payoffs of two larger problem commercial lending relationships.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

The provision expense recorded during the first nine months of 2024 also includes specific allocations for two non-performing, non-real estate related commercial loan relationships that were established during the first and second quarters, along with allocations necessitated by net loan growth. Non-interest expenses were $3.4 million and $6.6 million higher during the third quarter and first nine months of 2024, respectively, compared to the prior year periods.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

The increases largely reflect higher salary and benefit costs, including annual merit pay increases, market adjustments, higher residential mortgage lender commissions, lower residential mortgage loan deferred salary costs, and increased medical insurance costs. Higher data processing costs also comprise a notable portion of the increased non-interest expense levels, primarily reflecting higher transaction volumes and software support costs, along with the introduction of new cash management products and services.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

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 third quarter, about $211 million above the minimum threshold to be categorized as well-capitalized. We did not repurchase shares during the third quarter of 2024. We have $6.8 million available in our current repurchase plan. On Slide 24 of the presentation, we share our latest assumptions on the interest rate environment and key performance metrics for the fourth quarter of 2024, with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on the federal funds rate being lowered 25 basis points, effective both on November 7th and December 18th. We continue to project loan growth in the range of 4%-6%.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

We are forecasting our net interest margin to be in a range of 3.35%-3.45%. Our yield on earning assets and our cost of funds are projected to decline due to the recent and expected further reductions of the federal funds rate, with additional compression likely due to our ongoing deposit growth initiatives. Expected results for non-interest income and non-interest expense are also provided for your reference. In closing, we are very pleased with our 2024 operating results and financial condition and believe we remain well positioned to continually successfully navigate through the myriad of challenges faced by all financial institutions. That concludes our prepared remarks. We will now move to the question and answer segment of this morning's call.

[Operator]

We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question comes from Brendan Nosal with Hovde Group. Please go ahead.

[Brendan Nosal, Director at Hovde Group]

Hey, good morning, folks. Hope you're doing well.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Thanks, Brendan.

[Brendan Nosal, Director at Hovde Group]

Maybe just to start off here on the balance sheet. You know, really strong loan growth on both sides of the sheet this quarter, and the liability side was particularly impressive. Maybe kind of digging a little bit deeper beyond the three-prong approach that you guys laid out. Just kind of curious the drivers of deposit growth for this quarter, in particular, especially as it relates to non-interest-bearing balances. I think it was the first quarter of sequential growth for that category since mid-2022. Thanks.

[Ray Reitsma, President and CEO at Mercantile Bank]

Yeah, well, it really is driven by new client acquisition and the deposits that come along with those relationships. Also, to go into opportunities that aren't necessarily characterized predominantly by loan opportunities, but by deposit opportunities as well, and that's purely a matter of focus. You know, commercial bankers tend to go where loan opportunities are, and we're making a concerted effort to go where deposit opportunities are as well.

[Ray Reitsma, President and CEO at Mercantile Bank]

When you look across the entirety of the deposit growth, if you look at what we expected compared to what we delivered, and by expected, I mean, our budget at the beginning of the year, the growth is really spread across all three of the categories that I mentioned, but it's predominantly in the business banking deposits. That is really, you know, the strength of our company, and we've just tried to really tap into that vein in a deeper way, over the course of the beginning of this year.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Brendan, this is Chuck. In regards to the comment and question on non-interest-bearing deposit accounts, I think, first of all, we always have lots as a commercial bank, there tends to be a lot of volatility in that deposit balance on a daily basis. But I think the increase is primarily reflective of seasonal factors as businesses start building up their deposit balances to fund anticipated bonus payments and tax payments towards the end of the year and into early next year.

[Brendan Nosal, Director at Hovde Group]

Got it. That's super helpful color. Maybe one more from me before I step back. Just kind of curious how deposit pricing reacted in the immediate aftermath of the Fed's 50 basis point rate cut, both for your own book and just the market at large?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, I think we were reflective of the market. It was pretty consistent that, you know, deposit pricing on items such as money market accounts and CD products went down about 50 basis points, similar to the decline in the Fed funds rate. And so we see a lot of consistency in our marketplace currently.

[Brendan Nosal, Director at Hovde Group]

All right. Fantastic. Thank you for taking the questions.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

You're welcome.

[Ray Reitsma, President and CEO at Mercantile Bank]

You bet.

[Operator]

And the next question comes from Daniel Tamayo with Raymond James. Please go ahead.

[Daniel Tamayo, Director at Raymond James]

Thank you. Good morning, guys.

[Ray Reitsma, President and CEO at Mercantile Bank]

Good morning.

[Daniel Tamayo, Director at Raymond James]

Yeah, maybe just kind of following up on the conversation on deposits and then taking a step further into the NIM. Just curious, I know you've mentioned a lot of information on the deposits and over the year-to-date and over the last 12 months, but did you mention what the cost of deposits was in the third quarter, and specifically?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Are you talking about the growth or just the overall cost of the deposits?

[Daniel Tamayo, Director at Raymond James]

Yeah, just the rate.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, I would say that I would say the rates were probably closer to, I would say, 4.75 in the low 5s. During the quarter, obviously, until the Fed reduced rates in mid-September, and then, as I just mentioned, those rates came down about 50 basis points.

[Daniel Tamayo, Director at Raymond James]

So you're talking about new kind of deposits, deposit costs with those rates?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, and but I would say for, you know, money markets, I would say that was the cost of the entire portfolio, since obviously those reprice whenever we move the rates. On the CD rates, that comment was what we were paying for new CD rates.

[Daniel Tamayo, Director at Raymond James]

Got it. Yeah. No, I was just curious if you had the, like, the blended rate of deposits in the third quarter.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

I don't have that in front of me, Danny. I can certainly get that to you. I would say, you know, as you saw and as we commented on, you know, a large percent of the growth was in the money market and time deposits. So, I would say that that fact would have a big impact on the overall cost. But as we just talked about, we also saw some growth in non-interest-bearing deposits, which of course is going to help that calculation.

[Daniel Tamayo, Director at Raymond James]

Understood. Okay, great. And then, your comment on additional NIM compression expected after the fourth quarter, due to your strategic lowering of the loan-to-deposit ratio, can you kind of just put some color around how you're thinking about what type of compression you might be looking at after the fourth quarter?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

After the fourth quarter?

[Daniel Tamayo, Director at Raymond James]

Yeah, I mean, just kind of curious what was going into your comment there about additional compression?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Excuse me. Well, my comments specifically were what I thought would happen in the fourth quarter. Again, taking into account what the Fed did in mid-September and what we think the Fed will do in November and December. I think, as far as going in the future, I didn't make any specific comments or guidance today because we are, as you might expect, right in the middle of putting our budget together. I would say on an overall basis, when we look at our simulation results and just our knowledge of the balance sheet, additional deposit growth, which obviously we want. If the compression that happened due to the Fed cut that we think is going to happen in the fourth quarter is primarily the fact that we expect 100 basis points within three months.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

As I look at what the market's projecting currently, which is equal to what the Fed has provided in their guidance, we're looking at 25 basis points per quarter throughout next year. Obviously, a much slower pace than what we saw in the fourth quarter and expect in the fourth quarter of this year. With the projection that's out there now in the market for next year, from a rate perspective, we would expect the margin to stay relatively steady.

[Daniel Tamayo, Director at Raymond James]

Okay. All right. That's, that's helpful. Appreciate that. Sorry, I guess I misheard what your original comment was. I appreciate the clarification. And then just lastly-

[Chuck Christmas, EVP and CFO at Mercantile Bank]

No, by all means.

[Daniel Tamayo, Director at Raymond James]

Yeah, yeah. Lastly, just on the credit side, on reserves. Kind of a steady increase in prior quarters until this quarter, where you kind of stabilized around that 125 number. You know, just does that feel like a pretty good number for you guys, given, you know, it looks like the economy is in a decent spot here? Just any kind of color you have on reserve levels going forward would be helpful.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, and as you know, and as you talk to, I'm sure all the, all your companies out there, you know, the reserve is, is much more of an art than it is a science. We continue to be blessed with very strong credit quality. We basically are in a net neutral charge-off position over the last 10+ years, which means a lot of our reserve is predicated on qualitative factors. As I mentioned in my comments, we did adjust one qualitative factor, specifically that was to increase the allocation factor associated with our C&I credit segment of our portfolio. Nothing drastic. We look at the numbers. I know we provided an updated slide in our deck as well. We are seeing some.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

I don't wanna overplay it, but we are seeing some softness in automotive industry as the big manufacturers have slowed new models coming out, which is a big part of has a big impact on companies such as tool and die. So we have seen some degradation in that particular segment, so we decided to allocate some additional dollars going through that process. Also, as I mentioned, one of the benefits we definitely had in the third quarter was we had two eight-rated, but accruing commercial loan relationships that paid off that released about $1 million in reserve. So we obviously built that reserve up over time to account for those credits they paid off, so there was some give back there.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

I would say it's management's intention of keeping the reserve as strong as we possibly can, obviously, taking into account the calculation rules that we have to deal with, as well as our ongoing assessment of the overall health of the loan portfolio, looking at grade changes, levels of non-accruals, past dues, charge-offs, and those types of things.

[Ray Reitsma, President and CEO at Mercantile Bank]

Yeah, if I could, I'd like to underscore Chuck's comment about, you know, the slight change in the automotive risk profile. This slide on Page 31 lays that out, but our risk rating from the end of 2023 to currently on that particular group moved from 4.17 to 4.49. So we recognize some deterioration, but, you know, in this environment, we're looking closely at everything, and this is the group that stood out with a change of that magnitude. So, I just kind of wanted to underscore that point about the slight change there.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Just for perspective, a seven rating is watchlist for us.

[Ray Reitsma, President and CEO at Mercantile Bank]

Yeah, four is average credit quality.

[Daniel Tamayo, Director at Raymond James]

Okay. Well, guys, that's great color. Appreciate all that, and thanks for that Slide 31. That's helpful to give us a sense of size of those loans. That's all I had. I'll step back. Appreciate it.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Thanks, Dan.

[Ray Reitsma, President and CEO at Mercantile Bank]

Thank you.

[Operator]

The next question comes from Nathan Race with Piper Sandler. Please go ahead.

[Nathan Race, Managing Director and Senior Research Analyst at Piper Sandler]

Yeah. Hi, guys. Good morning. Thanks for taking the question.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Hi.

[Nathan Race, Managing Director and Senior Research Analyst at Piper Sandler]

Just going back to the previous question around kind of margin expectations for next year. You know, I appreciate it's still a fluid time in terms of thinking about the forecast for 2025, but if I heard you correctly, Chuck, did you indicate that it's likely more of a stable margin outlook, if there's more of a gradual Fed rate cutting cycle into 2025?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, that's correct.

[Ray Reitsma, President and CEO at Mercantile Bank]

Exactly.

[Nathan Race, Managing Director and Senior Research Analyst at Piper Sandler]

Okay, great. And just curious how you guys are thinking about money market deposit prices in particular. When I look at some of your posted rates, it seems like you're still toward the top of the market relative to some competitors in your footprint. So just curious how you're thinking about that product pricing in particular, you know, as we get additional digest going forward within the context of the goal to get the loan-to-deposit ratio consistently around 95% going forward?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, it's a great question. I think one of our strategies at this company has always been, since we opened, was to be in the top tier of deposit pricing. You know, we obviously are very good at growing our asset base, our loan base, and we know we need to be competitive on the deposit side, to, you know, bring in those deposits to help fund that loan growth. We also, as you know, we bill ourselves, and we are, a relationship bank. And what we tell our loan customers is that, as part of our relationship, you know, we're gonna pay you to bring your, your entire wallet to us, so we wanna be competitive...

[Chuck Christmas, EVP and CFO at Mercantile Bank]

On all of our deposits, and obviously, money markets has everybody's attention now, and where I think the industry continues to see most of its growth, notwithstanding that a lot of that money is coming out of lower-costing deposit products. That definitely has slowed down, from what we saw, you know, 12, 18 months ago, but that is still some transition that we're seeing within our balance sheet. I think that one of the things that we talk about with our money market account customers, when we talk to them, when we're opening up their accounts, that, you know, in large part, this rate is going to be tied to the Fed funds rate. As a matter of fact, some of those accounts are, by agreement, by deposit agreement, are actually tied to the Fed funds rate.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

But even if they're not, we have, you know, conversations with those depositors that the rate that we're paying on our money market account would be heavily influenced by whatever, you know, the Federal Reserve may do. So, we did lower, as I mentioned, we did lower those rates by 50 basis points, and I think that was, you know, from all indications, that was widely accepted by the depositors, so not expecting any, you know, concern. If the Fed continues to lower interest rates, we will continue to look to lower the money market rate as well, again, in a fairly equal manner, and that's, at least for the first 50, that's what we have seen our competitors do as well.

[Nathan Race, Managing Director and Senior Research Analyst at Piper Sandler]

Got it. That's very helpful. Great color. Maybe just one last one for me. You know, you guys are continuing to build capital at pretty strong clips, and as Ray alluded to in his prepared comments, you know, you guys are still trading at a discount to peers, so just curious how you guys are thinking about maybe potentially stock buybacks going forward?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

You know, I'll probably just kind of repeat what we've said before in our calls. We think it makes sense to have as much capital that you know, buffers our company. If there's anything that's you know, in a potential significant downturn in the economy, you know, it's always good to have extra capital. And when we look at the environment that we're operating in, which is very difficult to predict, and we just think it's good practice and good governance of our balance sheet to maintain strong capital positions. So I think you know, the stock buybacks are there. We have a plan. We have an active plan.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

We have the ability to buy back shares, but at least as we go through the current environment, look at our balance sheet, you know, we've, as we talked about, we've seen some solid loan growth, and of course, that puts pressure on capital ratios as well. Good pressure. Good pressure to have, but we want to make sure that we've got enough capital, if there is a rainy day that's coming, we want to make sure that we've got sufficient capital to support our growth, especially commercial loan growth, which, of course, on the risk-weighted basis, you know, is more expensive than other types of growth. You know, we continue to pay what we believe is an appropriate cash dividend, and we want to continue to maintain that cash return to our shareholders as well.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

So it's, you know, it's a good question. It's something that, you know, executive management and the board talks about every quarter, but I think right now, we're comfortable with our current capital position and, you know, clearly, we'll look at our stock price and, you know, if the opportunity presents itself that we think it's a good buy from a valuation standpoint, we're ready to step in at any point in time, but where we are currently, we're comfortable with continuing to grow the capital base as we have been.

[Nathan Race, Managing Director and Senior Research Analyst at Piper Sandler]

Okay, understood. I appreciate the color. Thanks, guys.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

You're welcome.

[Operator]

Again, if you have a question, please press star and then one. Our next question comes from Damon DelMonte with KBW. Please go ahead.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Hey, good morning, guys. Hope everybody's doing well today, and thanks for taking my question. So just, Chuck, for you, just wanted to understand a little bit better the dynamic on the balance sheet here. You know, if you guys are continuing to grow deposits, and it's outpacing, obviously, the pace of loan growth, should we be forecasting then, you know, higher security balances and higher cash balances over the coming quarters?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, I think that's exactly what you should do, Damon, and that is definitely my expectation. You know, as we talked about, and you can see in the deck, we definitely have been building the securities portfolio, which obviously is the offset to, you know, is part of lowering the loan-to-deposit ratio.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Yep.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

You know, we're you know, I'm not all that excited about keeping over $200 million at the Fed, but we want to make sure that we're using those monies effectively. So we're growing our securities portfolio, probably, I would say, about $10 million a month. And, you know, obviously, we can change that at any time, but we pretty much have been on that pace. Don't expect at this point in time to change that pace. So that I bring that up because that is one of the impacts to how much money we have at the Fed.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Gotcha. Okay. And then, so despite the kind of lower guide on the margin, do you feel like you can kind of hold NII, you know, relatively flattish, maybe? Kind of ease some of the pressure, just given the larger balance sheet, then?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, I think we actually have the opportunity, as we just saw in the third quarter, we could actually increase net interest income. You know, clearly, our strategy to lower the loan-to-deposit ratio has a negative impact on performance measures such as margin, return on average assets, those types of things. But when you're looking at just the pure income statement, it still has a positive impact on the bottom line net income number, and so I wouldn't expect that to change at all. You know, if the Fed continues to lower rates, which it looks like they're on that path, and the degree and with the timing obviously is up in the air, you know, that will put some pressure on our loan yields.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

But we also have, you know, a securities portfolio that has quite a bit of maturities coming up over the next several years that has the opportunity to reprice in a very significant way. Obviously, on the flip side, on our liability side, we'll have CDs that on average, next year, to put things in perspective, are looking at a 4.6% current rate, and those should reprice down meaningfully. And we also have, you know, we don't have a lot, but we do have some fixed-rate loans on our books, especially on the commercial side. You know, loans that are gonna mature next year, to put things in perspective, is a 4.3% average rate currently. Some opportunities, some repricing opportunities on the good side as well, that we believe should offset, neutralize anyways, any yield pressure that we see because of reduction of Fed funds rate.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Got it. That's great color. Do you happen to have a dollar amount on the fixed-rate loans that you expect to mature in 2025?

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, it's $150 million.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Okay, great.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

On the liability side, between time deposits and FHLB advances, we have about $700 million at 4.6%.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Got it. Okay, great. Appreciate that color. And then I guess just lastly, you know, with rates moving down a little bit, you know, it seems like the mortgage banking was stronger than we were looking for this quarter. I guess, what's your outlook here over the back half of this year? Do we expect normal seasonality in the winter months, or do you think that the lower rate environment will spur enough activity to kind of keep that line item, you know, moving positively?

[Ray Reitsma, President and CEO at Mercantile Bank]

Yeah, it's been an interesting year because, you know, during the typical peak summer season that we experience here in Michigan, our mortgage activity was at a given level, and then when the rates dropped in the fall, the seasonality that you'd typically expect to see didn't occur. It actually bumped up a notch. So as we sit here right now, today, the backlog looks similar to what we had during this summer. So, I think we'll see a little bit stronger late fall, fourth quarter, I guess, than we typically would seasonally. And how much more so depends on what happens with rates. But we certainly saw an uptick when rates got a bit better, and it was strong enough to kind of overwhelm what's the usual seasonal pattern.

[Damon DelMonte, Managing Director of Equity Research at KBW]

Got it. Okay, that's great. That's all that I had. Thank you very much.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Thanks, Damon.

[Operator]

And the next question comes from Brendan Nosal with Hovde Group. Please go ahead.

[Brendan Nosal, Director at Hovde Group]

Hey, just one follow-up from me. I guess, getting back to your comments on excess deposit growth being placed into securities for the time being. Just kind of curious how you think about the trade-off of, you know, versus, you know, investing into securities versus reducing wholesale borrowing more meaningfully.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

Yeah, I think, you know, we're definitely looking at reducing our wholesale funding portfolio. Clearly, we don't have a need to have those types of funds on our balance sheet in general, when we're bringing in as much deposits as we were. Now, one of the things I will say is the Federal Home Loan Bank advance portfolio, that is, in part, in a large part, historically been used to offset the interest rate risk associated with doing fixed-rate loans. Like I said, we don't do a lot of fixed-rate loans, but we do some, typically five-year balloons on the commercial side. So we do occasionally go to the Federal Home Loan Bank and obtain five-year advances to match fund that. That's something that we will continue to do.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

But I would say in general, you know, if we have the surplus of funds, like I explained that we had in the third quarter, in general, we don't really see a need to have wholesale funds on our books. And as those come up for maturity, we definitely look to, you know, retiring those, if you will, without replacing them with new funds. But obviously, you know, that's a dynamic situation, and we'll continue to look at our overall balance sheet, as those events do come take place.

[Brendan Nosal, Director at Hovde Group]

Yep, yep, makes sense. All right. Thank you for taking the follow-up.

[Chuck Christmas, EVP and CFO at Mercantile Bank]

You're welcome.

[Operator]

This concludes our question and answer session. I would like to turn the conference back over to Ray Reitsma for any closing remarks.

[Ray Reitsma, President and CEO at Mercantile Bank]

Just want to thank you for your participation in today's call and your interest in Mercantile Bank, and that concludes today's call. Thank you.

[Operator]

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

Participants

Executives

• Nichole Kladder, VP and CMO
• Ray Reitsma, President and CEO
• Chuck Christmas, EVP and CFO

Analysts

• Brendan Nosal, Director at Hovde Group
• Daniel Tamayo, Director at Raymond James
• Nathan Race, Managing Director and Senior Research Analyst at Piper Sandler
• Damon DelMonte, Managing Director of Equity Research at KBW