Mercantile Bank Corporation — Q3 2022 Form 10-Q
Business context and reporting period. Mercantile Bank Corporation is a Michigan-based bank holding company. This unaudited filing covers the quarter and nine months ended September 30, 2022; balance-sheet comparisons are with December 31, 2021. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 / September 30, 2022 | Comparable period / prior date |
|---|---|---|
| Net income | $16.0; diluted EPS $1.01 | Q3 2021: $15.1; $0.95 EPS |
| Nine-month net income | $39.3; diluted EPS $2.48 | Nine months 2021: $47.4; $2.95 EPS |
| Net interest income | Q3: $42.4; nine months: $107.6 | Q3 2021: $31.1; nine months 2021: $91.5 |
| Net interest margin | Q3: 3.56%; nine months: 3.00% | Q3 2021: 2.71%; nine months 2021: 2.76% |
| Noninterest income | Q3: $7.3; nine months: $24.3 | Q3 2021: $15.6; nine months 2021: $43.6 |
| Noninterest expense | Q3: $26.8; nine months: $79.4 | Q3 2021: $26.2; nine months 2021: $77.5 |
| Total assets | $5,016.9 | December 31, 2021: $5,257.7 |
| Loans, gross | $3,881.0 | December 31, 2021: $3,453.5 |
| Deposits | $3,846.1 | December 31, 2021: $4,083.2 |
| Shareholders’ equity | $416.3 | December 31, 2021: $456.6 |
- Q3 net income increased about 6% year over year, while nine-month net income declined about 17%. Nine-month net interest income rose about 18%, but lower mortgage banking and swap income, higher credit-loss provision, and increased expenses more than offset that gain.
- Q3 interest income was $48.1 million versus $35.9 million a year earlier. Rising rates and loan growth lifted asset yields; management reported that about 64% of commercial loans were variable-rate at quarter-end.
- Provision for credit losses was $2.9 million in Q3 2022 versus $1.9 million in Q3 2021; for the first nine months it was $3.5 million versus a $0.9 million provision release in 2021. The 2022 provision reflected loan growth, higher specific reserves for certain distressed commercial relationships, slower mortgage prepayments, and weaker economic forecasts.
- Mortgage banking income fell to $1.8 million in Q3 from $6.6 million, and to $7.0 million for nine months from $23.0 million. Higher mortgage rates reduced refinancing and loan-sale activity. Service charges, card income, and payroll-processing fees together grew about 14% in Q3 and 15% year to date.
- Operating cash flow was $82.8 million for nine months, versus $19.2 million in 2021. Investing activities used $503.0 million, principally reflecting net loan growth; financing activities used $270.9 million. Cash and cash equivalents declined $691.1 million to $284.0 million.
- At September 30, debt and funding included $338.3 million of FHLB advances, $198.6 million of repurchase agreements, $48.8 million of subordinated debentures, and $88.5 million of subordinated notes. The bank reported $659 million of remaining collateral-based FHLB borrowing availability and unused correspondent-bank lines of up to $70 million.
- The bank remained “well capitalized”: total risk-based capital was 13.4%, common equity Tier 1 was 12.5%, and Tier 1 leverage was 11.1%. The filing reports $416.3 million of GAAP shareholders’ equity; regulatory capital measures differ from GAAP equity.
Material changes and notable items
- Loans grew $427.5 million, or 12.4%, from year-end. Commercial loans rose $194.6 million; one-to-four-family mortgages increased $262.9 million in the loan-class table. The filing attributes much of mortgage growth to adjustable-rate loans retained on the balance sheet as borrowers shifted away from fixed-rate products.
- Deposits fell $237.1 million, or 5.8%. Management attributed most of the local deposit decline to one customer withdrawing funds deposited after a business sale; excluding that withdrawal, local deposits were described as relatively steady. Money-market balances declined $231 million.
- Available-for-sale securities had a $91.8 million pre-tax net unrealized loss at quarter-end, compared with $4.7 million net unrealized gains at year-end 2021. Management attributed the losses to higher interest rates, reported no securities credit-loss allowance, and stated it did not intend, and did not expect to be required, to sell before recovery. The after-tax decline in securities value reduced nine-month equity by $68.7 million.
- Nonperforming loans were $1.4 million, or 0.04% of loans, versus $2.5 million at year-end. The allowance was $39.1 million, or 1.01% of loans; Q3 had no charge-offs and $0.2 million of net recoveries.
- CECL was adopted January 1, 2022. The transition reduced the allowance by $0.4 million and increased retained earnings by $0.3 million, net of the stated tax effect.
- Unusual or nonrecurring items included a $0.5 million contribution to The Mercantile Bank Foundation and a $0.3 million loss on sale of a former Lansing branch facility in 2022. The 2021 comparison included a $1.1 million branch-sale gain in the nine-month period.
Outlook, risks, and contingencies
- The filing provides no formal full-year earnings or revenue guidance. Management described the commercial lending pipeline as strong: approximately $309 million of new lending commitments were expected to be accepted and funded, mostly over the following 12 to 18 months; $169 million of construction and development commitments were already in the construction phase. These are expectations, not guaranteed funding.
- Management expected remaining-2022 securities purchases to consist generally of municipal bonds, with the portfolio maintained at about 12% of total assets. It also noted that excess cash balances were declining as funds supported loan growth and maturities.
- Interest-rate sensitivity modeling estimated next-12-month net interest income changes of +3.2% under a 100-basis-point rate increase and −3.3% under a 100-basis-point decrease; a 300-basis-point increase was modeled at +10.0%, while a 300-basis-point decrease was modeled at −12.3%. These are model scenarios, not forecasts, and depend on assumptions about rates, balances, pricing, and customer behavior.
- Principal stated risks include rate and funding-cost changes, inflation and slower growth, commercial real estate values, borrower repayment and asset quality, deposit behavior, competition, regulation, cyber and information-security events, litigation, and economic or pandemic-related disruption. The company reported no material change in previously disclosed risk factors and no material pending legal proceedings.
- Off-balance-sheet commitments totaled $1.79 billion, including unused lines, loan commitments, and $24.5 million of standby letters of credit. Contractual amounts do not necessarily represent future cash outflows; commercial lending commitments were described as unconditionally cancellable.
Important facts for investors to verify
- Whether the large customer deposit withdrawal was isolated, and how deposit balances, mix, and funding costs evolve.
- Whether the commercial pipeline converts to funded loans without weakening underwriting or credit quality, particularly in commercial real estate and construction lending.
- How the $91.8 million securities unrealized loss and related accumulated other comprehensive loss affect capital, liquidity flexibility, and results if securities are sold.
- Whether higher rates continue to support net interest margin after deposit and borrowing costs adjust, including the impact of variable-rate loans and excess liquidity.
- Whether mortgage banking income remains depressed and whether retained adjustable-rate mortgage growth compensates over time for lower loan-sale gains.
- Changes in the allowance, specific reserves, nonperforming assets, and economic forecasts under the newly adopted CECL methodology.