Mercantile Bank Corporation — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020. The filing also reports fourth-quarter results. Mercantile is a Michigan community bank holding company, operating primarily in western and central Michigan and serving commercial and retail customers.
Financial performance and condition
| Metric | 2020 | 2019 |
|---|---|---|
| Net interest income | $122.2 million | $124.5 million |
| Provision for loan losses | $14.1 million | $1.8 million |
| Noninterest income | $45.2 million | $27.0 million |
| Noninterest expense | $98.5 million | $89.3 million |
| Net income | $44.1 million; $2.71 per diluted share | $49.5 million; $3.01 per diluted share |
| Return on average assets / equity | 1.07% / 10.32% | 1.39% / 12.52% |
| Net interest margin | 3.15% | 3.75% |
- Fourth quarter: Net income was $14.1 million, or $0.86 per basic and diluted share; net interest income was $31.8 million.
- Balance sheet at year-end: Assets were $4.44 billion, up $804 million; loans were $3.22 billion, deposits $3.41 billion, and shareholders’ equity $441.6 million.
- Liquidity and funding: Cash and cash equivalents were $626.0 million, including $563.2 million in interest-earning deposits. Deposits grew $721 million, while FHLB advances were $394 million and repurchase-agreement borrowings were $118.4 million. FHLB borrowing availability based on collateral was $354 million.
- Debt: Reported year-end funding included $394 million of FHLB advances, $118.4 million of repurchase agreements, and $47.6 million of subordinated debentures. The filing does not present a single total-debt measure.
- Cash flows: Operating activities provided $37.9 million; investing activities used $398.8 million; financing activities provided $753.2 million. Cash and cash equivalents increased $392.3 million during the year.
- Credit quality and reserves: Nonperforming loans were $3.4 million, or 0.11% of loans, versus $2.3 million, or 0.08%, a year earlier. The allowance was $38.0 million, reported as 1.18% of total loans (1.33% excluding PPP loans). Net loan recoveries were $0.1 million.
- Capital: The bank’s total risk-based capital ratio was 13.5%, compared with 13.0% in 2019; it remained “well capitalized.”
Material changes versus 2019
- Net income declined 10.8%. Management attributed the decrease to higher loan-loss provision and noninterest expense and lower net interest income, partly offset by higher fee income. After adjusting for specified branch and bank-owned-life-insurance items in both years, diluted EPS declined $0.07, or 2.5%.
- Net interest margin fell 60 basis points as lower yields on earning assets—especially variable-rate commercial loans and excess cash deposits—more than offset lower funding costs. Average earning assets rose 16.9% to $3.89 billion.
- Provision expense rose to $14.1 million from $1.8 million, primarily reflecting pandemic-related qualitative reserve factors and some commercial loan downgrades. The pandemic reserve factor added $5.3 million to the allowance at year-end.
- Noninterest income increased substantially, principally because mortgage banking income rose to $29.3 million from $8.5 million. Residential mortgage originations were $864 million, up 135%.
- Noninterest expense increased 10.3% to $98.5 million. Higher compensation, facility and equipment costs, data processing, FDIC premiums, and branch write-downs contributed.
- Loans grew $360 million, including $365 million of remaining PPP loans at year-end. Excluding PPP, commercial and industrial loans declined $66.1 million. Deposits increased $721 million, largely from local deposits and stimulus-related balances; noninterest-bearing checking rose $508 million.
Outlook, commentary, risks and unusual items
- Outlook: No formal earnings or financial guidance is provided. Management expected elevated interest-earning deposit balances to persist through at least most of 2021, and said mortgage origination volumes should remain solid. The PPP’s effects on loan and deposit composition and net interest income were expected to continue well into 2021.
- Pandemic and PPP: The company originated about 2,200 first-round PPP loans totaling $554 million. By December 31, $189 million had been forgiven; by February 26, 2021, forgiveness payments totaled $266 million. By that later date, it had also originated about 900 second-round PPP loans totaling $181 million. PPP loans carry a 1% rate, are SBA-guaranteed, and generated approximately $15 million of net origination fees to be recognized over time.
- Borrower support and reserve uncertainty: At year-end, 19 commercial borrowers with $8.0 million in loans and 14 retail borrowers with $1.8 million remained in payment-deferral programs. Management warned that pandemic effects could worsen borrower performance, collateral values, delinquencies, charge-offs, and required reserves. The allowance estimate was identified by the auditor as a critical audit matter because of subjective environmental-factor assumptions, including Covid-19.
- Interest-rate risk: Management described the bank as asset-sensitive and warned that low rates pressure net interest income. Its simulation estimated a 0.7% decline in next-12-month net interest income under a 100-basis-point rate decrease, versus increases of 5.1% and 9.4% under 100- and 200-basis-point increases, respectively; these are model estimates, not guidance.
- Other risks: Commercial real estate represented approximately 51% of total loans; economic weakness could pressure borrowers and property collateral. Other disclosed risks include dependence on local Michigan markets, funding and liquidity demands, LIBOR transition, competition, cybersecurity and operational events, and regulatory change.
- Unusual items and actions: Branch facility gains and write-downs reduced 2020 net income by about $1.1 million; comparable 2019 bank-owned-life-insurance claims and branch transactions increased net income by about $2.7 million. The bank closed three branches in late 2020, recording $1.4 million of valuation adjustments and $0.3 million of severance costs; it anticipates about $0.7 million in annual pretax savings. A $70 million FHLB blend-and-extend transaction included $0.9 million of prepayment fees embedded in new advance rates.
- Accounting and contingencies: CECL adoption was deferred to January 1, 2022, and the company continued using the incurred-loss model. Management reported no material legal proceedings or material loss contingencies. The financial statements received an unqualified audit opinion, and the auditor also reported effective internal control over financial reporting.
Important facts for investors to verify
- How quickly first- and second-round PPP balances are forgiven, and how fee accretion affects reported loan yields and future net interest income.
- Whether the $38.0 million allowance adequately reflects post-deferral borrower performance, pandemic-related credit deterioration, and commercial real estate collateral values.
- Whether deposit balances remain elevated and how excess liquidity is redeployed as low-yielding cash pressures margins.
- Trends in mortgage banking income and originations, including whether elevated 2020 refinance activity is sustainable.
- Funding concentration, available collateral-based borrowing capacity, and liquidity needs against $1.43 billion of loan commitments and standby letters of credit.
- Progress on the LIBOR transition, planned CECL adoption, branch-sale agreement, and delivery of anticipated branch-closure savings.