Mercantile Bank Corporation — Q3 2020 Form 10-Q
Business context and reporting period
Unaudited consolidated results for the quarter and nine months ended September 30, 2020; balance-sheet comparisons are with December 31, 2019. The Michigan-based bank reported amid the COVID-19 pandemic, unusually low interest rates, and significant participation in the Paycheck Protection Program (PPP).
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $29.5 million | $31.6 million | $90.4 million | $93.4 million |
| Provision for loan losses | $3.2 million | $0.7 million | $11.6 million | $2.5 million |
| Noninterest income | $13.3 million | $6.7 million | $30.8 million | $19.6 million |
| Noninterest expense | $26.4 million | $22.0 million | $72.6 million | $65.9 million |
| Net income | $10.7 million | $12.6 million | $30.1 million | $36.1 million |
| Diluted EPS | $0.66 | $0.77 | $1.85 | $2.20 |
| Net interest margin | 2.86% | 3.71% | 3.19% | 3.79% |
- Balance sheet: Total assets were $4.42 billion, up $788 million from year-end 2019. Loans rose $494 million to $3.35 billion; deposits increased $682 million to $3.37 billion. Shareholders’ equity was $431.9 million.
- Cash flow: For the first nine months, operating activities provided $16.3 million, investing activities used $452.4 million, and financing activities provided $756.9 million. Cash and cash equivalents increased $320.9 million to $554.6 million.
- Liquidity and borrowings: Besides deposits, period-end funding included $157.0 million in repurchase agreements, $394.0 million in Federal Home Loan Bank advances, and $47.4 million in subordinated debentures. FHLB collateral-based borrowing availability was $337 million. Wholesale funds were 11.7% of deposits and borrowed funds, down from 15.5% at year-end 2019.
- Credit and capital: Nonperforming loans were $4.1 million, or 0.12% of loans, versus $2.3 million at year-end 2019. The $35.6 million allowance equaled 1.1% of total loans and 1.27% excluding PPP loans. The bank’s total risk-based capital ratio was 13.5%; it remained classified as well capitalized.
Material changes versus comparable periods
- Net income declined 15% in Q3 and 17% for the first nine months. Management attributed lower earnings principally to higher credit-loss provisions and operating expenses and lower net interest income. The 2019 nine-month comparison included $3.1 million of net income from life-insurance claims and a former-branch sale; excluding those items, 2020 diluted EPS was down $0.16, or about 8%.
- Net interest margin fell as lower asset yields outweighed reduced funding costs. Q3 yield on earning assets was 3.45% versus 4.73% a year earlier; average earning assets grew 21.2%. Lower rates on variable-rate commercial loans and increased low-yield cash balances were important factors.
- Mortgage banking income rose substantially: $9.5 million in Q3 versus $2.9 million, and $19.7 million year to date versus $5.3 million. The increase reflected strong refinancing activity and higher loan-sale volumes. Compensation and other operating expenses also rose.
- Loans grew 17.3% from year-end, largely reflecting $555 million of PPP originations. PPP loans were 0% risk-weighted and fully SBA-guaranteed; approximately $15 million of net origination fees were being accreted into interest income. Through November 4, $37.1 million in forgiveness transactions had been recorded.
Outlook, commentary, risks and unusual items
- No formal earnings or financial guidance was provided. Management cited a strong commercial lending pipeline, including $232 million of new lending commitments expected largely to close and fund over 12–18 months, and nearly $100 million of construction and development commitments in the construction phase. It remained optimistic about mortgage origination volumes.
- Management warned that pandemic-related economic stress could worsen asset quality and require additional provisions. It also stated that the bank is asset-sensitive: its simulation estimated next-12-month net interest income changes of negative 0.5% under a 100-basis-point rate decline and positive 3.9%, 7.5%, and 11.2% under increases of 100, 200, and 300 basis points, respectively. These are model estimates, not guidance.
- At the mid-July peak, nearly 750 commercial borrowers with $719 million of loans were in payment-deferment programs; by October 30, five borrowers with $7.0 million remained. Retail deferments fell to 20 borrowers with $1.0 million outstanding. The company elected to postpone CECL adoption as permitted and continued using its incurred-loss model.
- Commercial credit reviews led to downgrades of 159 relationships and about $3.0 million of additional reserves in Q3; eight relationships were moved to the watch list. Management said the allowance build also reflected pandemic and economic-condition factors.
- The company planned to close three branches in Q4 2020. It had recorded a $0.3 million pretax severance charge and expected about $1.5 million in facility valuation costs, with anticipated annual pretax savings of approximately $0.7 million. Separately, a Hastings branch sale, including approximately $16 million in deposits, was expected to close in early 2021 for an estimated $11.8 million, subject to approvals and closing conditions.
- FHLB advances were extended in a June blend-and-extend transaction; $0.9 million of prepayment fees were embedded in the new rates. Off-balance-sheet commitments and standby letters of credit totaled approximately $1.36 billion. Management reported no material ongoing legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether PPP forgiveness and fee accretion, and the unusually high mortgage-banking activity, persist or reverse.
- Whether pandemic-related credit downgrades translate into higher delinquencies, charge-offs, or further allowance provisions, particularly as deferment programs end.
- Deposit stability and liquidity needs, including the availability and collateral requirements of borrowing facilities and the sizable unfunded commitments.
- Actual costs, timing, approvals, and savings from the planned branch closures and Hastings branch sale.
- Future margin performance under changing rates; management’s sensitivity estimates depend on uncertain model assumptions and balance-sheet behavior.