Mercantile Bank Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 15, 2024

There are 8 speakers on the call.

Operator

Mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

Operator

I would now like to turn the conference over to Nicole Klatter, First Vice President, Chief Marketing Officer of Mercantile Bank. Please go ahead.

Speaker 1

Good morning and thank you for joining us. Today, we will cover the company's financial results for the Q3 of 2024. The team members joining me this morning include Ray Reisma, President and Chief Executive Officer as well as Chuck Christmas, Executive Vice President and Chief Financial Officer. Our agenda will begin with prepared remarks by both Ray and Chuck and will include references to our presentation covering this quarter's results. You can access a copy of the presentation as well as the press release sent earlier today by visiting merckbank.com.

Speaker 1

After our prepared remarks, we will then open the call to your questions. Before we begin, 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 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. That is all I have for you today.

Speaker 1

I will now turn the meeting over to our President and Chief Executive Officer, Ray Reissma. Ray?

Speaker 2

Thank you, Nicole. My comments will focus on our significant reduction in the loan to deposit ratio, very strong local deposit growth, strong local loan growth, excellent asset quality and steadily growing non interest income. Over the last 3 years, commercial loan growth and mortgage loan growth has been strong. And while deposit growth has been solid, it has not kept pace with loan growth. As a result, the bank's loan to deposit ratio increased to 110% at year end 2023.

Speaker 2

We believe the bank's elevated loan to deposit ratio is a contributing factor to our below peer valuation despite a strong return profile. The following comments summarize the strategies we believe will contribute to further reductions in our loan to deposit ratio. We have undertaken a 3 pronged approach to building our deposit base with the objective of reducing the loan to deposit ratio into the mid-ninety percent range over time. First, we have broadened our focus on business deposits, including entities that have limited or no borrowings. 2nd, we plan to grow in the governmental and public realm through strategic personnel additions with existing relationships in this space.

Speaker 2

3rd, we are growing the retail customer focus based on total balances as opposed to activity hurdles such as transactions or card usage. These efforts led to an increase in local deposits in the 1st 3 quarters of 2024 of approximately $600,000,000 a 21 percent annualized growth rate. Local deposits grew $339,000,000 in the 3rd quarter alone. Mortgage loans on the balance sheet have grown substantially over the past few years as borrowers have opted for ARMs rather than fixed rates in the increasing rate environment. We have successfully executed changes within our portfolio mortgage programs, resulting in a greater portion of our mortgage production being sold rather than placed on our balance sheet.

Speaker 2

Positive outcomes include a 49% increase in mortgage banking income during the 1st 9 months of 2024 compared to the respective 2023 period and a nominal increase in mortgage loans on our balance sheet of $7,000,000 year to date. Commercial loan growth in the 1st 3 quarters of 2024 was $233,000,000 or 9 percent annualized. The current pipeline stands at $236,000,000 slightly below the trend line established over the last three quarters, reflecting the strong funding activity in the Q3. Commitments to fund commercial construction loans totaled $241,000,000 and residential construction loans of $34,000,000 at quarter end. Customer reductions in loan balances from excess cash flow or asset sales of $106,000,000 also impacted our commercial loan totals.

Speaker 2

Taking these factors into account, we expect a slight deceleration in the commercial loan growth in the immediate future. Taken together, these strategies produced a loan to deposit ratio of 102% as of September 30, 2024, compared to 110% at year end 2023, as deposit growth was approximately double total loan growth year to date. The ratio reduces to 97% when giving effect to our sweep account balances. During this period, the ratio of wholesale funds to total funds decreased from 14% to 11%, another demonstration of the strengthening of the funding side of the balance sheet. Asset quality remains very strong as non performing assets sold $9,900,000 at quarter end or 17 basis points of total assets consisting of 32% residential real estate and 68% non real estate commercial loans.

Speaker 2

There is no commercial real estate representation among the non performing assets. Past due loans in dollars represent 13 basis points of total loans and there is no outstanding ORE. Non owner occupied office exposure is $271,000,000 or 6% of total loans. The borrowers in this asset class had performed well and continue to be monitored closely. We remain vigilant in our underwriting standards and monitoring to identify any deterioration within our portfolio.

Speaker 2

Our lenders are the first line of observation and defense to recognize areas of emerging risk. Our risk rating model is robust with continued emphasis on current borrower cash flow, providing prompt sensitivity to any emerging challenges within a 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 27% during the 1st three quarters of 2024 compared to the 1st three quarters of 2023 with growth reported in several categories. Mortgage banking grew 49% based on the strategies outlined earlier and the resulting ability to sell a greater portion of originations on the secondary market.

Speaker 2

Service charges on accounts grew 46%, reflecting higher activity levels and customer growth and less earnings credit offset to charges based on reduced balances and transaction accounts. Payroll services grew 20% as our offerings continue to build traction in the marketplace. Finally, credit and debit card income grew 3% when adjusted for the receipt of a one time payment from Visa associated with our contract renewal in the Q2 of 2023. Income from interest rate swaps declined 8% as demand for interest rate protection by borrowers shifted with the borrowers' future rate expectations. That concludes my comments.

Speaker 2

I will now turn the call over to Chuck.

Speaker 3

Thanks, Ray. This morning, we announced net income of $19,600,000 or $1.22 per diluted share for the Q3 of 2024 compared with net income of $20,900,000 or $1.30 per diluted share for the respective prior year period. Net income during the 1st 9 months of 2024 totaled $60,000,000 or $3.72 per diluted share compared to $62,200,000 or $3.89 per diluted share during the 1st 9 months of 2023. While non interest income increased during both periods, net income was negatively impacted by expected lower net interest income and increased non interest expenses. Provision expense was lower during the Q3 of 2024 when compared to the Q3 of 2023 and was the same during the 1st 9 months of 2024 as it was during the 1st 9 months of 2023.

Speaker 3

Interest income on loans increased during the Q3 and 1st 9 months of 20 24 compared to the prior year period, reflecting the increased interest rate environment and solid growth in commercial and residential mortgage loans. Our loan yield during the Q3 of 2024 was 32 basis points higher than the Q3 of 2023 with average loans up about 10% over the respective periods. The improved loan yield largely reflects the combined impact of a 25 basis point increase in the federal funds rate in July of 2023 and over 2 thirds of our commercial loans having a floating rate along with strong commercial and residential mortgage loan growth over the past 15 months in the higher interest rate environment. The 50 basis point reduction in the federal funds rate in mid September partially mitigated the higher levels of loan yield and interest income on loans for the quarter. Interest income on securities also increased during the 2024 periods compared to the prior year periods, reflecting growth in the securities portfolio and the higher interest rate environment.

Speaker 3

Interest income on interest earning deposits, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, also increased during the 2024 periods compared to the prior year period, reflecting a higher average balance and an increased yield. In total, interest income was $12,300,000 $41,500,000 higher during the Q3 and 1st 9 months of 2024, respectively, compared to the prior year periods. We recorded increased interest expense on deposits and our sweep account product during the Q3 of Q3 and 1st 9 months of 2024 compared to the prior periods, reflecting the increased interest rate environment, money market and time deposit growth and transfers of deposits from no or low cost in deposit products to higher cost in deposit products. Our cost of deposits during the Q1 of 2024 was 85 basis points higher than the Q3 of 2023, with average deposits up about 13% over the respective periods. Interest expense on Federal Home Loan Bank of Indianapolis advances during the Q3 of 2024 was similar to that of the Q3 of 2023, reflecting an offsetting lower average balance and higher average cost.

Speaker 3

Interest expense on the Federal Home Loan Bank of Indianapolis advances during the 1st 9 months of 2024 was higher than during the 1st 9 months of 2023, reflecting a higher average balance and average rate. Interest expense on other borrowed funds during the 2024 periods was similar to the prior year periods. In total, interest expense was $12,900,000 $43,600,000 higher during the Q3 and 1st 9 months of 2024, respectively, compared to the prior year periods. Net interest income declined $700,000 $2,200,000 during the Q3 and 1st 9 months of 2024, respectively, compared to the prior year periods. Impacting our net interest margin is our strategic initiative to lower the loan deposit ratio, which generally entails deposit growth exceeding loan growth and using the additional monies to purchase securities.

Speaker 3

A large portion of deposit growth is in the higher costing money market and time deposit products, while the purchase securities provide a lower yield than loan products. Our net interest margin declined 46 basis points during the Q3 of 2024 compared to the Q3 of 2023. Although our yield on earning assets increased 30 basis points during that time period, our cost of funds was up 76 basis points. While we experienced rapid growth in earning asset yield during the period of March of 2022 through July of 2023, when the Federal Reserve raised the federal funds rate by 5 25 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 no and lower costing deposit types to higher costing deposit products. Our net interest margin peaked during the latter part of 2022 early stages of 2023.

Speaker 3

While loans increased $249,000,000 during the 1st 9 months of 2024 or almost 8% on an annualized basis. Deposits grew $555,000,000 or about 19% on an annualized basis during the same time period, providing a net surplus of funds totaling about $300,000,000 We used that net surplus of funds to grow our securities portfolio $86,000,000 and reduce our Federal Home Loan Bank of Indianapolis Advanced portfolio $51,000,000 during the 1st 9 months of 2024. The remainder of the net surplus of funds is on deposit with the Federal Reserve Bank of Chicago with the deposit balance totaling $218,000,000 as of September 30. We recorded a provision expense of $1,100,000 $5,900,000 during the Q3 and 1st 9 months of 2024, respectively. The Q3 2024 provision expense primarily reflects an increase in environmental factor allocations and allocations necessitated by net loan growth, which were partially offset by decreases in the calculated allowance stemming from the payoffs of 2 larger problem commercial lending relationships.

Speaker 3

The provision expense recorded during the 1st 9 months of 2024 also includes specific allocations for 2 non performing non real estate related commercial loan relationships that were established during the 1st

Speaker 4

and second

Speaker 3

quarters along with allocations necessitated by net loan growth. Non interest expenses were $3,400,000 $6,600,000 higher during the Q3 and 1st 9 months of 2024 respectively compared to the prior year periods. The increases largely reflect higher salary and benefit costs, including annual merit pay increases, market adjustments, higher residential mortgage lender commissions, lower residential mortgage loan deferred salary costs and increased medical insurance costs. Higher data processing costs also comprise a notable portion of the increased non interest expense levels, primarily reflecting higher transaction volumes and software support costs, along with the introduction of new cash management products and services. We remain in a strong and well capitalized regulatory capital position.

Speaker 3

Our bank's total risk based capital ratio was $13,900,000 at the end of the 3rd quarter, about $211,000,000 above the minimum threshold to be categorized as well capitalized. We did not repurchase shares during the Q3 of 2024. We have $6,800,000 available in our current repurchase plan. On Slide 24 of the presentation, we share our latest assumptions on the interest rate environment and key performance metrics for the Q4 of 2024 with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on the federal funds rate being lower 25 basis points effective both on November 7 December 18.

Speaker 3

We continue to project loan growth in the range of 4% to 6%. We are forecasting our net interest margin to be in a range of 3.35 percent to 3.45%. Our yield on earning assets and our cost of funds are projected to decline due to the recent and expected further reductions of the federal funds rate, with additional compression likely due to our ongoing deposit growth initiatives. Expected results for non interest income and non interest expense are also provided for your reference. In closing, we are very pleased with our 2024 operating results and financial condition and believe we remain well positioned to continually successfully navigate through the myriad of challenges faced by all financial institutions.

Speaker 3

That concludes our prepared remarks. We will now move to the question and answer segment of this morning's call.

Operator

We will now begin the question and answer session. Our first question comes from Brendan Nosal with Hovde Group. Please go ahead.

Speaker 5

Hey, good morning folks. Hope you're doing well.

Speaker 3

Thanks, Brennan.

Speaker 5

Maybe just to start off here on the balance sheet, really strong loan growth on both sides of the sheet this quarter and the liability side was particularly impressive. Maybe kind of digging a little bit deeper beyond the 3 pronged approach that you guys laid out, just kind of curious the drivers of deposit growth for this quarter in particular, especially as it relates to non interest bearing balances, I think it was the Q1 of sequential growth for that category since mid-twenty 22? Thanks.

Speaker 3

Yes.

Speaker 2

Well, it really is driven by new client acquisition and the deposits that come along with those relationships. And also, to go into opportunities that aren't necessarily characterized predominantly by loan opportunities, but by deposit opportunities as well. And that's purely a matter of focus. Commercial bankers tend to go where loan opportunities are and we're making a concerted effort to go where deposit opportunities are as well. When you look across the entirety of the deposit growth, if you look at what we expected compared to what we delivered and by expected, I mean our budget at the beginning of the year, the growth is really spread across all three of the categories that I mentioned, but it's predominantly in the business, but it's predominantly in the business, banking, deposits.

Speaker 2

And that is really the strength of our company and we've just tried to really tap into that vein in a deeper way over the course of the beginning of this year.

Speaker 3

Hey, Brennan, this is Chuck. In regards to the comment and question on non interest bearing deposit accounts, I think, first of all, we always have lots of the commercial bank, there tends to be a lot of volatility in that deposit balance on a daily basis. But I think the increase is primarily reflective of seasonal factors as businesses start building up their deposit balances to fund anticipated bonus payments and tax payments towards the end of the year and into early next year.

Speaker 5

Got it. That's super helpful color. Maybe one more for me before I step back. Just kind of curious how deposit pricing reacted in the immediate aftermath of the Fed's 50 basis point rate cut, both for your own book and just the market at large?

Speaker 3

Yes. I think we were reflective of the markets. It was pretty consistent that deposit pricing on items such as money market accounts and CD products went down about 50 basis points similar to the decline in the fed funds rate. And so we see a lot of consistency in our marketplace currently.

Speaker 5

All right, fantastic. Thank you for taking the questions.

Speaker 3

You're welcome.

Operator

And the next question comes from Daniel Tamayo with Raymond James. Please go ahead.

Speaker 6

Thank you. Good morning, guys. Good morning. Yes, maybe just kind of following up on the conversation on deposits and then taking a step further on the NIM. Just curious, I know you've mentioned a lot of information on the deposits over year to date and over the last 12 months.

Speaker 6

But did you mention what the cost of deposits was in the Q3 and specifically?

Speaker 3

Are you talking about the growth or just the overall cost of the deposits?

Speaker 6

Yes, just the rate.

Speaker 3

Yes, I would say that rates were probably closer to, I would say, 4.75% in the low 5s, during the quarter, obviously, until the Fed reduced rates in mid September. And then as I just mentioned, those rates came down about 50 basis points.

Speaker 6

So you're talking about new kind of new deposits deposit costs with those rates?

Speaker 3

Yes. And what I would say for the money markets, I would say that was the cost of the entire portfolio. So it's obviously those repriced whenever we move the rates. On the CD rates, that comment was what we're paying for new CD rates.

Speaker 6

Got it. Yes. I was just curious if you had the over like the blended rate of deposits in the Q3?

Speaker 3

I don't have that in front of me, Danny. I can certainly get that to you. I would say, as you saw the and as we commented on, large percent of the growth was in the money market and time deposits. So I would say that that fact would have a big impact on the overall cost. But as we just talked about, we also saw some growth in non interest bearing deposits, which of course is going to help that calculation.

Speaker 6

Understood. Okay, great. And then your comment on additional NIM compression expected after the Q4 due to your strategic lowering of the loan to deposit ratio. Can you kind of just put some color around how you're thinking about what type of compression you might be looking at after the Q4?

Speaker 3

After the Q4?

Speaker 6

Yes. I mean, just kind of just curious what was going into your comments there about additional compression?

Speaker 3

Excuse me. Well, my comment specifically were what I thought would happen in the Q4, again taking into account what the Fed did in mid September and what we think the Fed will do in November December. I think as far as going in the future, I didn't make any specific comments or guidance today because we are, as you might expect, right in the middle of putting our budget together. I would say on an overall basis, when we look at our simulation results and just our knowledge of the balance sheet, notwithstanding additional notwithstanding additional deposit growth, which obviously we want, the compression that happened due to the Fed cut that we think is going to happen in the 4th quarter is primarily the fact that we expect 100 basis points within 3 months. As I look at what the market is projecting currently, which is equal to what the Fed has provided, in their guidance, We're looking at 25 basis points per quarter throughout next year, obviously a much slower pace than what we saw in the Q4 of or and expect in the Q4 of this year.

Speaker 3

With the projection that's out there now in the market for next year, from a rate perspective, we would expect the margin to stay relatively steady.

Speaker 6

Okay. All right. That's helpful. Appreciate that. Sorry, I guess I misheard what your original comment was.

Speaker 6

I appreciate the clarification. And then just lastly, just on the credit side on reserves, kind of steady increase in prior quarters until this quarter where you kind of stabilized around that $125,000,000 number. Just does that feel like a pretty good number for you guys given it looks like the economy is in a decent spot here? Just any kind of color you have on reserve levels going forward would be helpful.

Speaker 3

Yes. And as you know and as you talk to, I'm sure, all your companies out there, the reserve is much more of an art than it is a science. We continue to be blessed with very strong credit quality. We basically are in a net neutral charge off position over the last 10 plus years, which means a lot of our reserve is predicated on qualitative factors. As I mentioned in my comments, we did adjust one qualitative factor, specifically that was to increase the allocation factor associated with our C and I credit segment of our portfolio.

Speaker 3

Nothing drastic. We look at the numbers. I know we provided an updated slide in our deck as well. We are seeing some I don't want to overplay it, but we are seeing some softness in automotive industry as the big manufacturers have slowed new models coming out, which is a big part of has a big impact on companies such as TOOLANDI. So we have seen some degradation in that particular segment.

Speaker 3

So we decided to allocate some additional dollars going through that process. Also, as I mentioned, one of the benefits we definitely had in the 3rd quarter was we had 2, 8 rated, but accruing commercial loan relationships that paid off, that released about $1,000,000 in reserve. So we obviously built that reserve up over time to account for those credits they paid off. So there was some give back there. I would say it's management's intention of keeping the reserve as strong as we possibly can, obviously taking into account the calculation rules that we have to deal with as well as our ongoing assessment of the overall health of the loan portfolio, looking at great changes, levels of non accruals, past dues, charge offs and those types of things.

Speaker 2

Yes. If I could, I'd like to underscore Chuck's comment about the slight change in the automotive risk profile. This slide on Page 31 lays that out, but our risk rating from the end of 2023 to currently on that particular group move from 4.17 to 4.49. So we recognize some deterioration, but in this environment, we're looking closely at everything. And this is the group that stood out with a change of that magnitude.

Speaker 2

So I just kind of wanted to underscore that point about the slight change there.

Speaker 3

And just for perspective, a 7 rated is watch list for us.

Speaker 2

Yes, 4 is average credit quality.

Speaker 6

Okay. Well, guys, that's great color. Appreciate all that. And thanks for that Slide 31, that's helpful to give us a sense of size of those loans. That's all I had.

Speaker 6

I'll step back. Appreciate it.

Speaker 3

Thanks, Dan. Thank you.

Operator

And the next question comes from Nathan Race with Piper Sandler. Please go ahead.

Speaker 7

Yes. Hi, guys. Good morning. Thanks for taking the question. Good morning.

Speaker 7

Just going back to the previous question around kind of margin expectations for next year. I appreciate it's still a fluid time in terms of thinking about the forecast for 2025. But if I heard you correctly, Chuck, did you indicate that it's likely more of a stable margin outlook if there's more of a gradual bed cutting cycle into 2025?

Speaker 3

Yes, that's correct. Exactly.

Speaker 7

Okay, great. And just curious how you guys are thinking about money market deposit pricing in particular. When I look at some of your posted rates, it seems like you're still toward the top of the market relative to some competitors in your footprint. So just curious how you're thinking about that product pricing in particular as we get additional divest going forward within the context of the goal to get the loan deposit ratio consistently around 95% going forward?

Speaker 3

Yes, it's a great question. I think one of our strategies that this company has always been since we opened was to be in the top tier of deposit pricing. We obviously are very good at growing our asset base, our loan base, and we know we need to be competitive on the deposit side to bring in those deposits to help fund that loan growth. We also, as you know, we build ourselves and we are a relationship bank. And what we tell our loan customers is that, as part of our relationship, we're going to pay you to bring your entire wallet to us.

Speaker 3

So we want to be competitive on all of our deposits. And obviously, money markets has everybody's attention now, and where I think the industry continues to see most of its growth, notwithstanding that a lot of that money is coming out of lower costing deposit products. That's definitely a slowdown from what we saw 12, 18 months ago, but that is still some transition that we're seeing within our balance sheet. I think that one of the things that we talk about with our money market account customers, when we talk to them when we're opening up their accounts that in large part, this rate is going to be tied to the Fed funds rate. And matter of fact, some of those accounts are by agreement, by deposit agreement are actually tied to the Fed funds rate.

Speaker 3

But even if they're not, we have conversations with those depositors that the rate that we're paying on our money market account would be heavily influenced by whatever the Federal Reserve may do. So we did lower as I mentioned, we did lower those rates by 50 basis points. And I think that was from all indications, that was widely accepted by the depositors. So not expecting any concern if the Fed continues to lower interest rates, we will continue to look to lower the money market rate as well, again, in a fairly equal manner. And that's at least for the first fifty, that's what we have seen our competitors do as well.

Speaker 7

Got it. That's very helpful. Great color. Maybe just one last one for me. You guys are continuing to build capital at pretty strong clips.

Speaker 7

And as Ray alluded to in his prepared comments, you guys are still trading at discounted peers. So just curious how you guys are thinking about maybe potentially stock buybacks going forward?

Speaker 3

I'll probably just kind of repeat what we've said before in our capital. We think it makes sense to have as much capital that buffers our company, if there's anything that's in a potential significant downturn in the economy. It's always good to have extra capital. And when we look at the environment that we're operating in, which is very difficult to predict, and we just think it's good practice and good governance of our balance sheet to maintain strong capital positions. So I think the stock buybacks are there.

Speaker 3

We have a plan. We have an active plan. We have the ability to buy back shares. But at least as we go through the current environment, look at our balance sheet, we've as we talked about, we've seen some solid loan growth. And of course, that puts pressure on capital ratios as well.

Speaker 3

Good pressure to have. But we want to make sure that we've got enough capital. If there is a rainy day that's coming, we want to make sure that we've got sufficient capital to support our growth, especially commercial loan growth, which of course on the risk weighted basis is more expensive than other types of growth. We continue to pay what we believe is an appropriate cash dividend. We want to continue to maintain that cash return to our shareholders as well.

Speaker 3

So it's a good question. It's something that executive management, the Board talks about every quarter. But I think right now, we're comfortable with our current capital position. And clearly, we'll look at our stock price. And if the opportunity presents itself that we think it's a good buy from a valuation standpoint, we're ready to step in at any point in time.

Speaker 3

But where we are currently, we're comfortable with continuing to grow the capital base as we have been.

Speaker 7

Okay, understood. I appreciate the color. Thanks, guys.

Operator

Our next question comes from Damon DelMonte with KBW.

Speaker 3

Please go ahead.

Speaker 4

Good morning guys. Hope everybody is doing well today and thanks for taking my question. So just Chuck for you, just wanted to understand a little bit better the dynamic on the balance sheet here. If you guys are continuing to grow deposits and it's outpacing obviously the pace of loan growth, should we be forecasting then higher security balances and higher cash balances over the coming quarters?

Speaker 3

Yes. I think that's exactly what you should do, Damon. That is definitely my expectation. As we talked about, as you can see in the deck, we definitely have been building the securities portfolio, which obviously is the offset to is part of lowering the loaner deposit ratio. So, I'm not all that excited about keeping over $200,000,000 at the Fed, but we want to make sure that we're using those monies effectively.

Speaker 3

So we're growing our securities portfolio probably, I would say, about $10,000,000 a month. And obviously, we can change that at any time. But we pretty much have bet on that pace. Don't expect at this point in time to change that pace. So that I bring that up because that is one of the impacts that how much money we have at the Fed.

Speaker 4

Got you. Okay. And then, so despite the kind of the lower guide on the margin, do you feel like you can kind of hold NII relatively flattish, maybe kind of ease some of the pressure just given the larger balance sheet then?

Speaker 3

Yes. I think we actually have the opportunity as we just saw in the Q3, we could actually increase net interest income. Clearly, our strategy to lower the loan deposit ratio has a negative impact on performance measures such as margin, return on average assets, those types of things. But when you're looking at just the pure income statement, it still has a positive impact, on the bottom line net income number. And so I wouldn't expect that to change at all.

Speaker 3

And while certainly, the Fed continues to lower rates, which it looks like they're on that path and the degree and with the timing obviously is up in the air, that will put some pressure on our loan yields. But we also have a securities portfolio that has quite a bit of maturities coming up over the next several years that has the opportunity to reprice in a very significant way. Obviously, on the flip side, on the liability side, we'll have CDs that on average next year, to put things in perspective, are looking at a 4.6% current rate and those should be priced down meaningfully. And we also have we don't have a lot, but we do have some fixed rate loans on our books, especially on the commercial side. That loans that are going to mature next year for to put things in perspective is the 4.3% average rate currently.

Speaker 3

So some opportunities, some repricing opportunities on the good side as well, that we believe should offset, neutralize anyways, any yield pressure that we see because of reduction in the fed funds rate.

Speaker 4

Got it. That's great color. Do you happen to have a dollar amount on the fixed rate loans that you expect to mature in 2025?

Speaker 3

Yes. It's 150,000,000 Okay. And on the liability side, between time deposits and FHLB advances, we have about $700,000,000 at 4.6%.

Speaker 4

Got it. Okay, great. Appreciate that color. And then I guess just lastly, with rates moving down a little bit, it seems like mortgage banking was stronger than we were looking for this quarter. I guess what's your outlook here over the back half of this year?

Speaker 4

Do we expect normal seasonality in the winter months? Or do you think that the lower rate environment will spur enough activity to kind of keep that line item moving positively?

Speaker 2

Yes. It's been an interesting year because during the typical peak summer season that we experienced here in Michigan, our mortgage activity was at a given level. And then when the rates dropped in the fall, the seasonality that you typically expect to see didn't occur. It actually bumped up a notch. So as we sit here right now today, the backlog looks similar to what we had during this summer.

Speaker 2

So, I think we'll see a little bit stronger, late fall Q4, I guess, than we typically would seasonally and how much more so depends on what happens with rates. But we certainly saw an uptick when rates got a bit better and it was strong enough to kind of overwhelm what's the usual seasonal pattern.

Speaker 4

Got it. Okay. That's great. That's all that I had. Thank you very much.

Speaker 3

Thanks, Dan.

Operator

And the next question comes from Brendan Nossel with Hub Group. Please go ahead.

Speaker 5

Hey, just one follow-up for me. I guess getting back to your comments on excess deposit growth being placed into securities for the time being, just kind of curious how you think about the trade off versus investing into securities versus reducing wholesale borrowings more meaningfully?

Speaker 3

Yes. I think we're definitely looking at reducing our wholesale funding portfolio. Clearly, we don't have a need to have those types of funds on our balance sheet in general when we're bringing in as much deposits as we were. Now one of the things I will say is the Federal Home Loan Bank Advance Portfolio that is in part, in a large part, historically been used to offset the interest rate risk associated with doing fixed rate loans. Like I said, we don't do a lot of fixed rate loans, but we do some, typically 5 year balloons on the commercial side.

Speaker 3

So we do occasionally go to the Federal Home Loan Bank and obtain 5 year advances to match fund that. That's something that we will continue to do. But I would say in general, if we have the surplus of funds like I explained that we had in the Q3, in general, we don't really see a need to have wholesale funds on our books. And as those come up for maturity, we definitely look to retiring those, if you will, without replacing them with new funds. But obviously, that's a dynamic situation and we'll continue to look at our overall balance sheet as those events do come take place.

Speaker 5

Yes, yes, makes sense. All right. Thank you for taking the follow-up.

Speaker 3

You're welcome.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Ray Reitzma for any closing remarks.

Speaker 2

Just want to thank you for your participation in today's call and your interest in Mercantile Bank and that concludes today's call. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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Earnings Conference Call
Mercantile Bank Q3 2024
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