Mercantile Bank Corporation (NASDAQ:MBWM) Q4 2023 Earnings Call Transcript
Mercantile Bank Corporation (NASDAQ:MBWM) Q4 2023 Earnings Call Transcript January 16, 2024
Mercantile Bank Corporation beats earnings expectations. Reported EPS is $1.25, expectations were $1.22. MBWM isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, and welcome to the Mercantile Bank Corporation Fourth Quarter 2023 Earnings Results Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would like now to turn the conference over to Zack Mukewa, Lambert Investor Relations. Please go ahead.
Zack Mukewa: Thanks, Ed. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the fourth quarter of 2023. Joining me today are members of Mercantile's management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President, and Chief Financial Officer; and Ray Reitsma, Chief Operating Officer and President of the Bank. We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open the call to questions. Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings, and capital structure, as well as statements on the plans and objectives of the company's business.
The company's actual results could differ materially from any forward-looking statements made today, due to the factors described in the company's latest Securities and Exchange Commission's filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the fourth quarter 2023 press release and presentation deck issued by Mercantile today, you can access it at the company's website at www.mercbank.com. At this time, I would like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski. Bob?
Robert Kaminski: Thank you, Zach, and thanks to all of you for joining us on the conference call today. This morning, Mercantile released its fourth quarter and full year earnings, which demonstrated a strong finish to 2023. For the quarter, Mercantile earned $1.25 per share on revenues of $57 million. For the full year, our company earned $5.13 per share on revenues of $226 million. We also announced a cash dividend of $0.35 per share payable on March 13, 2024. Headlining the news for the fourth quarter was extremely strong commercial loan growth. We remain very pleased to see the ongoing work of our lending teams to build robust pipelines bearing some meaningful fruit as we ended 2023. This growth is a prime illustration of the effectiveness of the consultative relationship banking approach employed by Mercantile.
Net interest margin for the fourth quarter was 3.92% and averaged slightly over 4% for all of 2023, continuing to demonstrate Mercantile’s ability to effectively manage loan yields and deposit costs. Asset quality remains extremely strong with non-performing assets and loan losses continuing at nominal levels during 2023. Our customer base and our markets continue to demonstrate solid metrics despite some uncertainty in the economic environment. Our lending teams remain closely engaged as always with their clients which provides the ability to quickly identify any emerging trends. Ray and Chuck will provide more detail on our financial performance next. The strength of our year in 2023 has positioned us well for 2024 and beyond. Our suite of products and services and the markets we serve set the table for our excellent staff of bankers to continue working to exceed our customers’ expectations and fulfill our strategic objectives.
I'll now turn the call over to Ray and then to Chuck for their comments. Ray?
Raymond Reitsma: Thanks, Bob. My comments will focus on commercial loan growth, asset quality and non-interest income. Commercial loan growth was very solid this year, increasing $260 million, or 8.5%. Commercial loan growth in the fourth quarter was $178 million or 22% annualized. This remarkable performance by our commercial team reflects our long-term efforts to build value-added relationships, and while the results were somewhat concentrated in the quarter, the foundation for this growth was laid over a much longer period of time. Commercial growth in the fourth quarter resides primarily in the C&I segment at $70 million and the owner-occupied real estate segment at $46 million, with the growth in each portfolio being heavily weighted toward increases in market share versus organic portfolio growth.
When taken together, these categories represent 65% of the overall growth for the quarter. The balance of the growth primarily occurred in non-owner occupied real estate at $35 million and multifamily real estate at $24 million. These increases were achieved despite payoffs totaling approximately $44 million. After the strong loan funding activity of the quarter, the commercial loan pipeline remains very strong -- at a very strong level of $573 million consisting of $311 million committed under construction facilities and $262 million under other commercial loan commitments. Retail loan growth for the year totals $120 million consisting of an increase in 1 to 4 family mortgages. Growth in this asset class moderated throughout the year and was $20 million in the fourth quarter due to our focus on increasing the portion of originated loans that are sold.
Construction commitments related to this asset type remained stable at $46 million. Asset quality remains very strong as nonperforming assets totaled $3.6 million at year-end 2023 or less than 7 basis points of total assets compared to $7.7 million one year ago and $5.9 million at the end of the prior linked quarter. Past due loans number 24 and in dollars represent 4 basis points of total loans. We remain diligent -- vigilant in our underwriting standards in monitoring to identify any deterioration within our portfolio. Our lenders are the first line of observation and defence to recognize areas of emerging risk. Our risk rating model is robust with a continued emphasis on current borrower cash flow providing prompt sensitivity to any emerging challenges within borrower's finances.
That said, our customers continue to report strong results to date and have not begun to experience the impacts of a potential recessionary environment in any systemic fashion. Total non-interest income grew 6.3% during the fourth quarter of 2023 compared to the fourth quarter of 2022, with growth reported in virtually every category. Credit and debit card income grew 3.9%. Service charges on accounts grew 5.5%, reflecting 18% growth in the overall activity levels resulting from a growing base of C&I customers, which was partially offset by an increase in the earnings credit rate. Despite very tight housing inventory in the markets we serve and increases in mortgage rates, mortgage banking income increased 5.6% as we sold a greater portion of our volume than in the comparable prior quarter and our lending team builds market share in a very competitive environment.
Swap income grew 7.3% in support of the general growth in our commercial portfolio and the subset of customers desiring fixed rate. Finally, our payroll services income grew 10.7% as we achieved greater penetration in our commercial customer base. Over the course of the year, Mercantile grew our deposit base by $224 million, including $36 million in growth in repo accounts. We were not immune to the industry-wide migration of deposits from noninterest-bearing to interest-bearing accounts. However, noninterest-bearing accounts comprise 32% of deposits. The balance of our funding requirements was financed with the Federal Home Loan Bank advances. We continue to diligently pursue a number of strategic initiatives around deposit-generating opportunities that exist within portions of our customer base and the markets we serve.
That concludes my comments. I will now turn the call over to Chuck.
Charles Christmas: Thanks, Ray, and good morning to everybody. As noted on Slide 5, this morning we announced net income of $20 million or $1.25 per diluted share for the fourth quarter of 2023, compared with net income of $21.8 million or $1.37 per diluted share for the respective prior-year period. Net income for the full year 2023 totaled $82.2 million or $5.13 per diluted share, compared to $61.1 million or $3.85 per diluted share during the full year 2022. The decline in net income during the fourth quarter of 2023 compared to the fourth quarter of 2022 primarily reflects a lower level of net interest income stemming from a lower net interest margin, which was only partially mitigated by loan growth. The increase in net income for the full year 2023 compared to the full year 2022 primarily reflects a higher level of net interest income, resulting from a higher net interest margin and loan growth.
Continued strength in loan quality metrics provided for limited provision expense in all time periods. Turning to Slide 6. Interest income on loans increased during the fourth quarter and full year 2023 compared to the prior year periods, reflecting the increase in interest rate environment and solid growth in commercial and residential mortgage loans. Our fourth quarter 2023 loan yield was 104 basis points higher than the fourth quarter of 2022 with average loans up almost 8% over the respective period. Our full-year 2023 loan yield was 175 basis points higher than for the full year 2022, with average loans up over 9% over the respective periods. The improved loan yields largely reflect the combined impact of an aggregate 525 basis point increase in the federal funds rate since March of 2022, and approximately two-thirds of our commercial loans having floating rate.
Interest income on securities also increased during the 2023 periods compared to the 2022 periods, reflecting growth in the securities portfolio and the higher interest rate environment. Interest income on other earning assets, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago was relatively unchanged during the fourth quarter of 2023 compared to the fourth quarter of 2022. While the interest rate yield increased 171 basis points during that time period, our average balance declined 34%. Interest income on other earning assets increased during the full year 2023 compared to the full year of 2022 reflecting an increased yield of 409 basis points, which was partially offset by a 76% average balance reduction.
In total, interest income was $15.5 million and $89.5 million higher during the fourth quarter and full year 2023, respectively, when compared to the prior time periods. We recorded interest expense on deposits and our sweep account product during the fourth quarter and full year 2023 compared to the prior year periods, reflecting the increase in interest rate environment, transfers of deposits from no or low-cost deposit products to higher costing deposit products, and enhanced competition for deposits. Our fourth quarter 2023 cost of deposits was 152 basis points higher than the fourth quarter of 2022, while our full-year 2023 cost of deposits were 122 basis points higher than during the full year 2022. Interest expense on Federal Home Loan Bank of Indianapolis advances also increased during the 2023 periods compared to the prior year periods reflecting growth in advance portfolio and the higher interest rate environment.
Interest expense on other borrowed funds increased during the 2023 periods compared to the prior year periods, reflecting the higher cost of our trust preferred securities. In total, interest expense was $17.5 million and $54.2 million higher during the fourth quarter and full year 2023, respectively, when compared to the prior year time periods. Net interest income decreased $2.0 million during the fourth quarter of 2023 compared to the fourth quarter of 2022, but increased $35.3 million for the full year 2023 compared to the full year 2022. Our net interest margin declined 38 basis points during the fourth quarter of 2023 compared to the same quarter in 2022 although our yield on earning assets increased to 100 basis points during that time period, our cost of funds was up 138 basis points.
Our net interest margin improved 73 basis points between full-year 2023 and full-year 2022. Our yield on earning assets was up 186 basis points, while our cost of funds increased 113 basis points. While we experienced rapid growth in our earning asset yield during the period of March of 2022 through July of 2023 when the Federal Reserve raised the federal funds rate by 525 basis points, meaningful increases to our cost of funds did not begin to materialize until the latter part of 2022 when competition for deposit balances increased deposit rates and depositors began to move funds from low -- and lower costing deposit types to higher costing deposit products We recorded a provision expense of $1.8 million and $7.7 million during the fourth quarter and full year 2023, respectively.
The fourth quarter provision expense primarily reflects additions from loan growth, slower mortgage loan prepayment speeds, a remodification to our environmental factor grid, which was partially mitigated by the elimination of a $1.2 million specific reserve on a commercial loan relationship that was placed into non-accrual status during the third quarter of 2023 and paid off in full during the fourth quarter and the elimination of a $1.7 million qualitative factor assessment that address the potential impact of the UAW strike against the three US base automobile manufacturers that was initiated during the third quarter of 2023 but was settled during the fourth quarter. The full year 2023 provision expense primarily reflects additions from loan growth, slower mortgage loan prepayment speeds and the modification to the environment factor grid, which was partially mitigated by the elimination of $2.2 million specific reserve on a commercial loan relationship that was placed into non-accrual status during the fourth quarter of 2022 and paid off in full during the first quarter of 2023, and the change in segmentation of our home equity and credit card portfolios within our model.
Updated economic forecast throughout 2023 had only a nominal impact on the reserve calculation. We recorded increased overhead costs during the fourth quarter and full year 2023 compared to the prior year periods. Overhead costs increased $1.4 million during the fourth quarter of 2023 compared to the fourth quarter of 2022 and were up $7.3 million during the full year 2023, when compared to the full year 2022. The increased overhead costs primarily resulted from larger compensation and benefit costs, increased FDIC insurance assessments, reflecting the industry-wide adjustments effective January 1, 2023, higher swap collateral holding costs and increased allocations to the reserve for unfunded loan commitments. Slide number 14 and 15 depict information on our investment portfolio.
There were only nominal changes to our investment portfolio during the fourth quarter of 2023, largely limited to ordinary purchases and maturities of municipal bonds. All of our investments remain categorized as available for sale. As of December 31, 2023, about 63% of our investment portfolio was comprised of US government agency bonds, with approximately 32% comprised of municipal bonds, all of which were issued by municipal entities within the State of Michigan, and a high percentage within our market areas. Mortgage-backed securities, all of which are guaranteed by US government agencies comprised only about 5% of the investment portfolio. The maturities of US government agencies and municipal bond segments are generally structured on a laddered basis.
As significant majority of the US government agency bonds mature within the next seven years with over three-fourths of the municipal bonds maturing over the next 10 years. The net unrealized loss totaled $64 million at year-end 2023 compared to $83 million at year-end 2022 and $93 million as of September 30, 2023. Slide 17, 18 and 19 depict data on our deposit base. You will note that we include sweep accounts in our deposit tables and calculations as those accounts reflect moneys from entities, primarily municipalities and other large customers who have elected to place their funds in a sweep account that is fully secured by US government agency bonds. Noninterest-bearing checking accounts equated to 30% of total deposits and sweep accounts at year-end 2023, similar to pre-pandemic levels.
A large portion of those -- of these funds are associated with commercial lending relationships, especially the commercial and industrial companies. While the level of uninsured deposits totaling about 48% as of year-end 2023 has remained relatively stable over many years. On slide number 18, we provide information on depositors with balances of $5 million or more. As of December 31, 2023, we had 71 relationships, which aggregated $1.1 billion. About 80% of the relationships and approximately 90% of the total deposits were with businesses and/or individuals with the remaining comprised of municipal entities. When compared to five years ago, we had 32 relationships with deposit balances over $5 million aggregating $450 million. Of those 32 relationships, 25 continue to have balances over $5 million today and have grown those deposit balances by over $160 million in aggregate.
As a commercial bank, a majority of our deposits are comprised of commercial accounts. On slide number 18, we depict our deposit balances as of year-ends 2023 and 2022. Throughout 2023, we experienced transfers of funds from no and low-cost checking and savings deposits to higher-paying money market and time deposits, a trend we expect to continue although at a reduced pace. On slide number 20, we depict our primary sources of liquidity as of year-end 2023. We do periodically use our unsecured federal funds lines of credit with a major correspondent bank. However, we have not utilized this line since late April 2023. Our deposit at the Federal Reserve Bank of Chicago equals $52 million at year-end 2023. To offset the impact of loan fundings and net deposit withdrawals during the first half of 2023 and to assist in the rebuilding of our on-balance sheet liquidity position, we obtained $111 million of brokered deposits and $90 million in FHLB advances during the second quarter of 2023 combined with $70 million in FHLB advances during the first quarter of 2023.
To offset significant commercial loan fundings in late 2023, we increased our brokered deposits and Federal Home Loan Bank advances portfolios $57 million and $10 million, respectively, during the fourth quarter of 2023. We had not obtained any new broker deposits or FHLB advances during the third quarter of 2023. Our level of wholesale funds as a percentage of total funds was 14% at year-end 2023, compared to 7% at year-end 2022. We remain in a strong well-capitalized regulatory capital position. Our bank's total risk-based capital ratio was 13.4% at year-end 2023, about $177 million above the minimum threshold to be categorized as well capitalized. We did not repurchase shares during 2023. We have $6.8 million available in our current repurchase plan.
While net unrealized gains and losses in our investment portfolio are excluded from regulatory capital calculations, on slide number 16, we depict our Tier 1 leverage and our total risk-based capital ratios assuming the calculations did include that adjustment. While our regulatory capital ratios were negatively impacted by the pro forma calculations, our capital position remains strong. As of year-end 2023, our Tier 1 leverage capital ratio declined from 12.2% to 11.3% and our total risk-based capital ratio declined from 13.4% to 12.5%. Our excess capital as measured by the total risk-based capital ratio is also negatively impacted, however, it totaled a strong $127 million over the minimum regulatory amount to be categorized as well capitalized.
On Slide number 21, we shared our latest assumptions on the interest rate environment and key performance metrics for 2024 with a caveat that market conditions remain volatile making forecasting difficult. This forecast is predicated on the federal funds rate staying unchanged for the first six months of 2024 and then declining by 25 basis points during both the third and fourth quarters of 2024. We are projecting total loan growth in the range of 4% to 6%, similar to what we experienced during 2023. While we experienced solid commercial loan fundings throughout 2023 and our commercial loan pipeline remains very strong, we continue to experience a high level of payoffs and paydowns. We are forecasting our net interest margin to remain in a narrow graph -- narrow range throughout 2024 along with fee income and overhead costs as well.
In closing, we are very pleased with our 2023 operating results and financial condition, and believe we remain well-positioned to continue to successfully navigate through the myriad of challenges faced by all financial institutions. Those are my prepared remarks, I'll now turn the call back over to Bob. Robert Kaminski Thank you, Chuck. That concludes management's prepared comments and we'll now open the call up to the Q&A session.
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