Mercantile Bank Corporation — Q1 2021 Form 10-Q
Business context and reporting period. Mercantile Bank Corporation is a Michigan bank holding company. This unaudited filing covers the three months ended March 31, 2021; balance-sheet comparisons are with December 31, 2020, and operating results are compared with Q1 2020. Results for the quarter are not necessarily indicative of full-year results.
Financial performance and condition
| Metric | Q1 2021 / March 31, 2021 | Comparison |
|---|---|---|
| Net income; diluted EPS | $14.2 million; $0.87 | Q1 2020: $10.7 million; $0.65 |
| Net interest income | $29.5 million | Down 2.6% from $30.3 million |
| Net interest margin | 2.77% | 3.63% in Q1 2020; 3.00% in Q4 2020 |
| Noninterest income | $13.5 million | Up about 106%; mortgage banking income was $8.8 million |
| Noninterest expense | $25.1 million | Up 9.5% from $22.9 million; includes $0.5 million in former-branch write-downs |
| Provision for loan losses | $0.3 million | $0.8 million in Q1 2020 |
| Cash flows | Operating: $(1.4) million; investing: $(237.9) million; financing: $265.7 million | Cash and cash equivalents ended at $652.3 million, up $26.3 million from year-end |
| Total assets; loans | $4.71 billion; $3.36 billion | Assets up $273 million and loans up $171 million, or 5.4%, since year-end |
| Deposits | $3.64 billion | Up $233 million, or 6.8%, since year-end |
| Borrowings and equity | FHLB advances $394 million; repurchase agreements $141.3 million; subordinated debentures $47.7 million; shareholders’ equity $441.2 million | FHLB advances unchanged; repurchase agreements increased from $118.4 million |
Interest income declined 8.3% year over year as yields fell, partly offset by growth in average earning assets. Interest expense fell 31.0%, but lower asset yields and substantial low-yielding excess liquidity reduced net interest margin. Average earning assets rose 28.9% year over year to $4.33 billion; average interest-earning deposits were $592 million, or 13.7% of average earning assets.
Q1 net income improved 33.4% year over year, primarily because higher mortgage banking and other noninterest income more than offset lower net interest income and higher expenses. Mortgage originations were $245 million, about 85% above Q1 2020. Operating cash flow was negative despite net income, reflecting, among other items, the volume and timing of mortgage loan originations and sales.
Credit, liquidity, debt, and capital
- Nonperforming loans were $2.8 million, or 0.08% of loans, down from $3.4 million at year-end. Nonperforming assets totaled $3.2 million, or 0.1% of assets.
- The allowance for loan losses was $38.7 million, equal to 1.15% of total loans and 1.33% excluding PPP loans. Net recoveries were $0.4 million in Q1. Management described portfolio quality as strong but cautioned that pandemic-related uncertainty could lead to future losses and higher provisions.
- PPP lending contributed materially to reported loan growth: first- and second-draw PPP loans totaled $455 million at quarter-end. The bank originated approximately $203 million of second-draw loans in Q1 and received $113 million in forgiveness payments on first-draw loans.
- Liquidity included $652.3 million in cash and cash equivalents and $373 million of remaining collateral-based availability on a $737 million FHLB credit line. Wholesale funding was $425 million, or 10.1% of deposits and borrowed funds. Sweep/repo balances can fluctuate and are not federally insured deposits.
- Off-balance-sheet commitments totaled $1.427 billion, including commercial unused lines of $1.053 billion, loan commitments of $176.5 million, and standby letters of credit of $25.9 million. The filing reported no reserve or liability for these commitments.
- The bank was categorized as well capitalized. At March 31, its total risk-based capital ratio was 13.3%, Tier 1 risk-based ratio 12.2%, common equity Tier 1 ratio 12.2%, and Tier 1 leverage ratio 9.5%.
Material changes, outlook, and risks
- Management outlook: No formal earnings or financial guidance was provided. Management anticipated elevated interest-earning deposits through 2021, citing pandemic-related deposit growth and subdued business and consumer spending. It described commercial lending opportunities as strong: $135 million of available construction and development commitments and approximately $177 million in new lending commitments, with much expected to fund over 12–18 months. Management remained optimistic that mortgage origination volumes would stay solid, while expecting consumer loans to decline.
- Interest-rate exposure: Management describes the bank as asset-sensitive and notes that rate reductions can hurt net interest income. Its simulation estimated next-12-month NII changes of negative 0.4% under a 100-basis-point rate decline, and positive 4.9%, 9.0%, 13.0%, and 20.9% under increases of 100, 200, 300, and 400 basis points, respectively. These are model estimates, not guidance, and depend on assumptions that may not hold.
- COVID-19 and accounting: The pandemic remains a source of economic, credit, and interest-rate uncertainty. Only two commercial borrowers with $1.8 million in balances and ten retail borrowers with $0.8 million remained in payment-deferral programs at quarter-end. The company elected to defer CECL adoption and expected to adopt it January 1, 2022; it continued using the incurred-loss model as permitted.
- Hastings branch sale: The sale to Lake Trust Credit Union was expected to close May 14, 2021, subject to completion. The agreement provides for purchase of loans at book value, the branch facility for $1.5 million, and assumption of deposits at a 5% premium. At quarter-end, related assets and liabilities held for sale were $13.2 million and $17.3 million. Management expected to record a $0.9 million deposit premium and $0.3 million facility-sale gain at closing.
- Securities and equity: Rising rates produced a $7.2 million after-tax decline in available-for-sale securities value and a corresponding reduction in accumulated other comprehensive income. The company reported $8.3 million of gross unrealized losses on securities, attributed to interest-rate changes, and stated it did not consider them other-than-temporary. The board declared a $0.29-per-share dividend payable in June. The company repurchased 118,261 shares for $3.5 million in Q1, with $6.3 million remaining under the authorized program at quarter-end.
- Other risks and contingencies: The filing identifies LIBOR transition, commercial real estate values, competition, cyber risk, regulation, customer repayment ability, local and national economic conditions, and pandemic effects as risks. LIBOR publication for remaining U.S. dollar tenors was scheduled to cease June 30, 2023; the company warned that transition could disrupt markets or adversely affect loan values, income, and expense. Management stated it was not party to material legal proceedings. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether mortgage banking income and unusually strong mortgage production can be sustained as refinancing conditions and gain-on-sale margins change.
- How excess liquidity and deposit growth affect net interest margin, and whether management’s interest-rate simulation assumptions remain appropriate.
- Credit quality trends as pandemic support and deferral programs unwind, including commercial real estate exposure, criticized loans, and allowance adequacy.
- Funding of the $1.427 billion in off-balance-sheet commitments and the availability and terms of collateralized borrowing capacity.
- Completion and final accounting for the Hastings branch sale, plus the timing and impact of CECL adoption and LIBOR transition.
- Share repurchases, dividend capacity, and capital levels after distributions and any further balance-sheet growth.