Mercantile Bank Corporation — 2021 Form 10-K
Reporting period: Fiscal year ended December 31, 2021; comparisons are primarily with 2020. Mercantile is a Michigan-based community bank holding company serving businesses and consumers mainly in western and central Michigan, with operations in southeastern Michigan and mortgage production offices in Michigan and Ohio.
Financial results and condition
| Metric | 2021 | 2020 | Change and context |
|---|---|---|---|
| Net income | $59.0 million | $44.1 million | Up 33.7%; diluted EPS was $3.69 versus $2.71. |
| Net interest income | $124.1 million | $122.2 million | Up $1.8 million, as lower funding costs and asset growth more than offset lower asset yields. |
| Net interest margin | 2.76% | 3.17% | Down 41 basis points, reflecting lower yields and substantial low-yielding cash balances. |
| Noninterest income | $56.2 million | $45.2 million | Growth reflected mortgage banking, interest-rate swap fees and a $1.1 million branch-sale gain. |
| Noninterest expense | $110.9 million | $98.5 million | Higher compensation and $4.0 million of foundation formation and contribution costs were notable factors. |
| Total assets at year-end | $5.26 billion | $4.44 billion | Up $820 million. |
| Total loans at year-end | $3.45 billion | $3.19 billion | Up $260 million; core commercial loans grew $481 million while PPP balances declined. |
| Total deposits at year-end | $4.08 billion | $3.41 billion | Up $672 million, driven by local deposits, including substantial money-market growth. |
| Operating cash flow | $64.6 million | $37.9 million | Cash and cash equivalents ended 2021 at $975.2 million. |
- Profitability: Return on average assets was 1.23% (1.07% in 2020); return on average equity was 13.11% (10.32%). Foundation-related costs and contribution reduced 2021 net income by about $3.2 million, or $0.20 per diluted share. Management reported adjusted diluted EPS growth of 43.5% excluding those effects.
- Credit quality: Nonperforming loans were $2.5 million, about 0.07% of loans, compared with $3.4 million in 2020. There were no foreclosed assets at year-end. Net recoveries were $1.7 million in 2021. The allowance was $35.4 million, or 1.02% of loans, versus 1.18% in 2020.
- Funding and debt: Year-end balances included $374 million of Federal Home Loan Bank advances, $197.5 million of repurchase agreements, $48.2 million of subordinated debentures and $73.6 million of subordinated notes. The company issued $75 million of 3.25% fixed-to-floating subordinated notes in December 2021 and contributed $70 million of proceeds to the bank as capital. It issued a further $15 million in January 2022.
- Liquidity and capital: Year-end cash and cash equivalents were $975.2 million, including $915.8 million in interest-earning deposits. The bank had $509 million of remaining FHLB borrowing availability based on collateral. Its total risk-based capital ratio was 13.6%, above the 10.0% well-capitalized threshold; the bank was reported well capitalized.
Material changes versus 2020
- Net income increased as a $4.3 million negative provision for loan losses (a benefit) replaced the $14.1 million provision expense recorded in 2020, while noninterest income and net interest income also rose. Expenses increased and partially offset these gains.
- Net interest margin fell from 3.17% to 2.76%. Average interest-earning deposits rose to $671 million from $357 million and reduced 2021 net interest margin by an estimated 39 basis points.
- Core commercial loans increased nearly 20%. Total commercial loans rose by $156 million despite a $325 million net decline in PPP balances. Residential mortgages grew $105 million.
- Available-for-sale securities increased to $592.7 million from $387.3 million. Their year-end fair value included a $4.7 million net unrealized loss; the after-tax securities valuation decline reduced 2021 equity by $9.2 million.
- Shareholders’ equity increased to $456.6 million from $441.6 million, after $59.0 million of net income, $18.5 million of dividends, $21.4 million of repurchases and the securities-related valuation decline. The company repurchased approximately 683,000 shares at an average all-in cost of $31.29.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no formal earnings or revenue guidance. Management described the commercial loan pipeline as strong, citing $212 million of new lending commitments expected largely to close and fund over 12–18 months, plus $182 million of construction-phase commitments available to be drawn. Management expected elevated interest-earning deposits to decline gradually during 2022 but remain high through 2022 and into 2023.
- Interest rates: Management described the balance sheet as asset-sensitive. Its year-end simulation estimated a 6.6% increase in next-12-month net interest income for a 100-basis-point rate rise and a 2.1% increase for a 100-basis-point decline; results depend on model assumptions and actual rates, balance-sheet mix and customer behavior.
- CECL: The company used the incurred-loss allowance model through December 31, 2021 and adopted CECL on January 1, 2022. It expected adoption to reduce the allowance by $0.2 million to $2.0 million, with the COVID-19 reserve assumption the main source of variability.
- COVID-19 and credit: Commercial loan deferments had ended by year-end; eight retail borrowers with $0.4 million in balances remained in deferment. Management cautioned that pandemic effects, new variants, inflation, supply-chain issues, borrower stress and collateral values could affect credit quality and earnings. Commercial real estate represented about 53% of total loans.
- Other risks: Results are exposed to interest-rate and liquidity changes, regional economic and real-estate conditions, competition, cybersecurity and operational events, regulation, climate-related effects and the transition from LIBOR to SOFR. New floating-rate commercial commitments used CBM Term SOFR beginning January 1, 2022; existing 30-day LIBOR loans were expected to transition around June 30, 2023.
- Unusual items and legal matters: The 2021 results included foundation costs and contribution, branch and former-branch sale-related gains or losses, and increased swap-program fees. Management said it was not party to legal proceedings material to its financial condition. Auditors issued unqualified opinions on the financial statements and internal controls; the allowance’s qualitative reserve estimates were identified as a critical audit matter.
Important facts for investors to verify
- Whether strong loan growth and the pipeline translate into funded loans and sustainable earnings, and whether the unusually high deposit balances persist or leave.
- How the 2022 CECL adoption affected the allowance and retained earnings compared with the estimated $0.2–$2.0 million allowance reduction.
- Whether credit quality remains sound as COVID-related support fades, particularly in commercial real estate and the $17.5 million troubled-debt-restructuring portfolio.
- How higher rates affect net interest margin, deposit pricing and the valuation of the enlarged securities portfolio; compare actual performance with the filing’s simulation assumptions.
- Subsequent-period use of capital: dividends, share repurchases, the subordinated-note issuance and the bank’s capital and liquidity ratios.