Mercantile Bank Corporation — Q2 2022 Form 10-Q
Business context and period: Unaudited consolidated results for the three and six months ended June 30, 2022, compared with the corresponding 2021 periods; balance-sheet comparisons are against December 31, 2021. The company is a Michigan-based bank holding company. Amounts below are in U.S. dollars.
Financial performance and condition
- Q2 earnings: Net income was $11.7 million, or $0.74 per diluted share, versus $18.1 million, or $1.12, a year earlier. For the first half, net income was $23.2 million, or $1.47 per diluted share, versus $32.3 million, or $2.00.
- Interest income and margin: Q2 net interest income rose 11.2% to $34.3 million; net interest margin increased to 2.88% from 2.76%. First-half net interest income rose 8.0% to $65.2 million, while margin eased to 2.73% from 2.76%. Rising rates and earning-asset growth supported Q2 results; lower PPP fee accretion and excess liquidity weighed on first-half margin.
- Other income and expenses: Noninterest income fell to $7.7 million in Q2 from $14.6 million, and to $17.0 million for the first half from $28.0 million. The principal driver was lower mortgage banking income as refinance activity declined. Noninterest expense was $26.9 million in Q2 and $52.7 million for the first half, up $0.8 million and $1.4 million, respectively.
- Credit costs and asset quality: Provision for credit losses was $0.5 million in Q2 and $0.6 million for the first half, versus reversals of $3.1 million and $2.8 million in the comparable 2021 periods. Management cited loan growth, higher reserves on certain commercial relationships and longer expected residential mortgage lives. Nonperforming loans were $1.8 million, about 0.05% of loans, versus $2.5 million at year-end; there were no foreclosed properties. The allowance was $36.0 million, or 0.97% of loans.
- Balance sheet and funding: Total assets were $5.06 billion, down $199 million since year-end. Loans grew $270 million, or 7.8%, to $3.72 billion; deposits fell $209 million, or 5.1%, to $3.87 billion. Management attributed much of the deposit decline to one customer withdrawing funds deposited after a business sale. Cash and cash equivalents declined to $479 million from $975 million.
- Cash flow: First-half operating cash flow was $50.0 million; investing cash outflow was $336.4 million and financing cash outflow was $209.7 million. The resulting cash decrease was $496.1 million.
- Debt, liquidity and capital: At June 30, FHLB advances were $362.3 million, repurchase agreements $203.3 million, subordinated debentures $48.6 million and subordinated notes $88.5 million. The bank had $564 million of collateral-based availability on its $932 million FHLB line and unused correspondent-bank lines of up to $70 million. The bank was reported well capitalized; its total risk-based capital ratio was 13.4%, compared with 13.6% at year-end.
- Equity and securities: Shareholders’ equity declined to $429.0 million from $456.6 million, despite first-half net income, mainly due to a $43.9 million after-tax decline in available-for-sale securities value recorded in other comprehensive income. The portfolio had $60.6 million of gross unrealized losses, which management attributed to interest-rate changes; it reported no securities credit-loss allowance and did not expect to sell securities before recovery.
Material changes, outlook and risks
- Earnings declined year over year as lower mortgage banking revenue and the shift from 2021 credit-loss reversals to 2022 provisions outweighed higher net interest income. Mortgage banking income fell $5.7 million in Q2 and $11.3 million in the first half. Treasury-management-related fee categories grew approximately 16% in both comparisons.
- Commercial loans increased $121 million in the first half, while residential mortgage loans excluding home-equity lines rose $148 million. About 64% of first-half residential mortgage production was adjustable-rate, versus about 30% in 2021; this shift increased loans retained on the balance sheet and reduced loans sold.
- Management described the commercial lending pipeline as strong: approximately $253 million in new commitments were expected to be largely accepted and funded over 12 to 18 months; $175 million of construction and development commitments were already in the construction phase. No specific earnings guidance was provided.
- Interest-rate simulations projected next-12-month net interest income of about $140 million under the baseline assumptions. The model indicated a 9.5% increase in a +300-basis-point scenario and a 7.2% decrease in a -200-basis-point scenario. These are model estimates, not guidance, and depend on uncertain assumptions. Management characterized the company as asset-sensitive.
- Key risks cited include inflation, slower economic growth, commercial real-estate values, borrower repayment and credit quality, interest-rate movements, liquidity and deposit changes, competition, cybersecurity, regulation, litigation, and continuing pandemic-related and supply-chain effects. The company noted the pandemic and inflation as sources of uncertainty.
- Unusual items included adoption of CECL on January 1, 2022, which reduced the allowance by $0.4 million; a $0.5 million foundation contribution in Q2; and a $0.4 million loss related to a Lansing facility sale. A $15 million subordinated-note issuance in January 2022 added capital to the bank. The board declared a $0.32-per-share dividend payable in September 2022. No shares were repurchased in the first half.
Most important facts for investors to verify
- Whether loan growth and the anticipated commercial pipeline convert to funded loans without weakening underwriting or asset quality.
- Whether deposits stabilize after the large customer withdrawal, and how cash balances and wholesale funding needs evolve.
- Whether higher rates improve net interest income as modeled, while monitoring the effect on deposit costs, borrower credit quality and securities values.
- Whether mortgage banking income continues to fall, and how the growing adjustable-rate mortgage portfolio affects earnings and risk.
- How unrealized available-for-sale securities losses, capital levels and dividend capacity change; the filing reports the securities losses as interest-rate-related, not credit-related.
- That 2021 comparisons reflect different credit-loss accounting and substantial loan-loss provision reversals; CECL adoption also limits direct comparability.