Participants

Nichole Kladder; Chief Marketing Officer; Mercantile Bank Corp

Raymond Reitsma; President, Chief Executive Officer, Director; Mercantile Bank Corp

Charles Christmas; Chief Financial Officer, Executive Vice President and Treasurer of Mercantile, and Executive Vice President and Chief Financial Officer of the Bank; Mercantile Bank Corp

Daniel Tamayo; Analyst; Raymond James

Nathan Race; Analyst; Piper Sandler

Damon P. DelMonte; Analyst; KBW

Presentation

Operator

Good morning and welcome to the Mercantile Bank Corporation 2024 fourth quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance? Please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.
I would now like to turn the conference over to Nicole Kladder. First Vice President, Chief Marketing Officer of Mercantile Bank. Please go ahead.

Nichole Kladder

Happy New Year everyone and thank you for joining us today. We will cover the company's financial results for the fourth quarter of 2024.
The team members joining me this morning include Ray Reitsma, 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 we'll 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 Mercbank dotcom.
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 filings.
The company assumes no obligation to update any forward-looking statements made during the call. Let's begin. Right.

Raymond Reitsma

Thank you, Nicole. My comments will focus on the changes that have been made to the funding side of our balance sheet and the resulting impacts on the income statement as well as our strong loan growth, excellent asset quality and growing noninterest income taken together.
These performance traits have allowed us to compile attractive, compounded annual growth rates for the benefit of our shareholders from the year end 2021 to year end 2023 commercial and mortgage loan growth was strong and while deposit growth was solid, it did not keep pace with loan growth.
The outflow of deposits from the banking system, POSTCOVID contributed to this trend as a result, the bank's loan to deposit ratio increased from 110%, increased to 110%. At year end 2023. In 2024 we focused on reducing this ratio with the goal of to strengthen our unbalance sheet liquidity and overall financial profile.
As described in previous calls. We undertook our three pronged approach to building our deposit base with the objective of reducing the loan to deposit ratio into the mid 90% range over time to reiterate. First, we broadened our focus on business deposits including entities that have limited or no borrowings. Second, we plan to grow in the governmental and public realm through strategic personnel additions with existing relationships in this space.
And third, 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 2024 of $816 million.
A growth rate of more than 20%. Local deposits grew $216 million during the fourth quarter alone. The growth in local deposits not only funded our strong loan growth but also allowed reduction in wholesale funding sources for the year including an $81 million reduction in FHLB advances and a $19 million reduction in brokered deposits.
Commercial loan growth for the fiscal year end was $292 million or 8.5% over the prior year end and was $59 million for the fourth quarter.
Customer reductions in loan balances from excess cash flow or sale of assets of $88 million during the fourth quarter impacted our commercial loan tolls. The pipeline stands at $296 million and commitments to fund commercial construction loans totaled $245 million which is slightly increased from the prior quarter end. Taking these factors into account.
We expect commercial loan growth in the immediate future to approximate the pace of the recent past mortgage loans on the balance sheet have grown substantially in the increasing rate environment experienced over the past few years as borrowers have opted for arms which reside on our balance sheet rather than fixed rate loans which are sold in the secondary market. We have successful 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.
The positive outcomes include a 62% increase in mortgage banking income during fiscal 2024 compared to fiscal 2023 and a nominal decrease in mortgage loans on our balance sheet.
Our mortgage team continues to build market share despite a challenging rate environment allowing results that diverge from average in the market. While mortgage banking is certainly rate dependent. The level of earnings from this activity that can be considered core or somewhat independent of the rate environment is increasing the 22% growth in local deposits coupled with the 7% growth in the loan portfolio drove our loan to deposit ratio from 110% at year end 2023 to 98% at year end 2024 and contributed to a reduction in our reliance on wholesale funding from 14% at fiscal year end, 2023 to 10%.
At fiscal year end, 2024 asset quality remains very strong as nonperforming assets sold $5.7 million at year end or nine basis points of total assets consisting primarily of residential real estate and nonreal estate commercial loans. There is only $42,000 in commercial real estate representation among nonperforming assets past due loans in dollars represent 16 basis points of total loans and there is no outstanding o we remain vigilant in our underwriting standards and monitoring to identify any deterioration within our portfolio. Our lenders are the first line of observation and defense 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 a borrower's within a borrower's finances that said our customers continue to report strong results to date and have not begun to experience impacts of a potential recessionary environment in any systematic way.
Total noninterest income grew 26% during 2024 compared to 2023 with gross reported in several categories. Mortgage banking income grew 62% based on the strategies outlined earlier and the resulting ability to sell a greater portion of originations on the secondary market service charges on accounts grew 38% reflecting higher activity levels and customer growth and less earnings credit offset charges based on reduced balances and transaction accounts.
Payroll services grew 22% as our offerings continue to build traction in the marketplace. Finally, credit and debit card income grew 2% when adjusted for the receipt of a onetime payment from Visa associated with our contract renewal. In the second quarter of 2023 income from interest rate swaps declined 18% as demand by borrowers for interest rate protection shifted with borrowers future rate expectations.
The results for 2024 described above contribute to a solid five year track record of compounded annual growth rates across key metrics including total loans of 10% total deposits of 11.8% earnings per share of 10.1% and tangible book value per share of 8.4%. That concludes my remarks and I will now turn the call over to Chuck.

Charles Christmas

Thanks and good morning to everybody this morning, we announced net income of $19.6 million or $1.22 per diluted share for the fourth quarter of 2024 compared with net income of $20.0 million or $1.25 per diluted share for the respective prior year period.
Net income for the full year. 2024 totaled $79.6 million or $4.93 per diluted share compared to $82.2 million or $5.13 per diluted share during the full year 2023. While noninterest income increased during both periods, net income was negatively impacted by expected lower net interest income and increased noninterest expense interest income on loans increased during the fourth quarter of 2024 compared to the respective prior year period, reflecting strong loan growth that more than offset a lower yield on loans.
Average loans totaled $4.57 billion during the fourth quarter of 2024. Compared to $4.18 billion. During the fourth quarter of 2023 our Yulan loans during the fourth quarter of 2024 whilst was 12 basis points lower than the fourth quarter of 2023. Largely reflecting the aggregate 100 basis point decline in the federal funds rate during the last four months of 2024 interest income on loans increased during the full year 2024 compared to the full year 2023 reflecting strong loan growth and higher loan yields. Average loans totaled $4.43 billion during 2024 compared to $4.05 billion in 2023.
The yield on loans was 36 basis points higher in 2024 than it was in 2023. Primarily reflecting the aggregate 100 basis point increase in the federal funds rate during the first seven months of 2023 which more than offset the aggregate 100 basis point decline in the federal funds rate during the last four months of 2024 interest income on securities increased during the fourth quarter and full year 2024 compared to the respective prior year periods, reflecting growth in the securities portfolio and a higher interest rate, environment 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 periods. Largely reflecting a higher average balance in total interest income was $8.7 million and $50.1 million higher during the fourth quarter and full year 2024 respectively. Compared to the respective prior year time periods, we recorded increased interest expense on deposits during the fourth quarter and full year 2024 compared to the respective prior periods, primarily reflecting a higher interest rate environment and growth in money market and time deposit products.
Our cost of deposits was 42 and 92 basis points higher during the fourth quarter and full year 2024. Compared to the respective prior year periods.
Average deposits totaled $4.52 billion during the fourth quarter of 2024 compared to 3.8 billion $8 billion during the fourth quarter of 2023. While average deposits totaled $4.23 billion during the full year of 2024 compared to $3.76 billion during the full year 2023 interest expense on federal home loan Bank of Indianapolis advances during the fourth quarter of 2024 was similar to that of the fourth quarter of 2023 reflecting an offsetting lower average balance and higher average cost interest expense on federal home loan Bank of indianapolis' advances during the full year 2024 was higher than during the full year 2023 reflecting a higher average balance and average rate interest expense on other borrowed funds during the 2024 periods was similar to the respective prior year periods.
In total interest expense was $9.0 million and $52.6 million higher during the fourth quarter and full year 2024 compared to the respective prior year time periods, net interest income declined $0.3 million and $2.5 million during the fourth quarter and full year 2024 compared to the respective prior year time periods impacting our net interest margin was our strategic initiative to lower the loan to deposit ratio which generally entails deposit growth exceeding loan growth and using the additional monies to purchase securities. A large portion of the deposit growth was 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 51 basis points during the fourth quarter of 2024 compared to the fourth quarter of 2023.
Our yulun earning assets declined 14 basis points during that time period, largely reflecting the aggregate 100 basis point decline in the federal funds rate during the last four months of 2024. While our cost of funds was up 37 basis points primarily reflecting an increased mix of higher cost in money market and time deposits.
Our net interest margin declined 47 basis points during the full year 2024 compared to the full year 2023. While our yield on earning assets increased 34 basis points during that time period, our cost of funds was up 81 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 in 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 and early stages of 2023 while loans increased $297 million during 2024 or almost 7%. The projects grew $797 million or over 20% during the same time period, providing a net surplus of funds totaling $500 million.
We use that net surplus of funds to grow our securities portfolio by $113 million and reduce our federal home loan Bank of Indianapolis advances by $81 million.
A majority of the remainder of the net surplus of funds is on deposit with the Federal Reserve Bank of Chicago.
We recorded a provision expense of $1.5 million and $7.4 million during the fourth quarter and full year 2024 respectively.
The fourth quarter, 2024 provision expense primarily reflects an increased allocation for slower prepayment speeds on residential mortgage loans and allocations necessitated by net loan growth.
The provision expense recorded during the full year 2024 also includes specific allocations for two nonperforming nonreal estate related commercial loan relationships that were established during the 1st and 2nd quarters along with allocations necessitated by net loan growth.
Noninterest expenses were $3.9 million and $10.5 million higher in the fourth quarter and full year 2024. Compared to the respective prior time periods.
The increases largely reflect higher salary 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 noninterest expense levels, primarily reflecting higher transaction volumes and software support costs. Along with the introduction of new cash management products and services contributions to the mercantile bank foundation totaled $1.0 million and $1.7 million during the fourth quarter and full year 2024 respectively, compared to $0.3 million and $0.7 million during the respective prior year periods.
We remain a strong and well capitalized regulatory capital position. Our bank's total risk-based capital ratio was 13.9% at the end of 2024. About $214 million above the minimum threshold to be categorized as well capitalized. We did not repurchase shares during 2024. We have $6.8 million available in our current repurchase plan on slide. 23 of the presentation, we share our assumptions on the interest rate environment and key performance metrics for 2025 with the caveat that market conditions remain volatile making forecasting difficult.
This forecast is predicated on no changes in the federal funds rate during 2025.
We project loan growth in a range of 5% to 7% and we are forecasting our net interest margin to be in a range of 3.3% to 3.4%. During all time periods, expected results for noninterest income and noninterest expense as well as our federal income tax rate are also provided for your reference.
In closing, we are very pleased with our 2024 operating results and financial condition and believe we remain, we remain wellpositioned to continue to successfully navigate through the myriad of challenges faced by all financial institutions that concludes my prepared remarks. I'll now turn the call back over to Ray.

Question and Answer Session

Operator

Thank you, Chuck. That concludes our prepared remarks for management. We will now move to the question and answer portion of the call. (Operator Instructions)
Brendan Nosal with HOVDE group.

Hey, good morning guys. This is John on for Brandon.
Morning morning. So I wonder if we could just start with the margin. I know your your guide calls for no changes in short term rates. Can you maybe just add some color on how the margin outlook would change if we end up getting say 1 to 2 rate cuts this year?

Charles Christmas

Yeah, sure. This is Chuck. We've, as you would expect we've been through a lot of different scenarios as we put our budget together for the year. And if we were looking at a, one or two declines in the fed funds rate during the first half of this year, we'd be looking at somewhere a margin of about five basis points lower than what we're projecting if rates don't change.

Very helpful. Okay. That's very helpful. And then maybe just pivoting to loan growth, the outlook looks pretty healthy and definitely keeping with what you generated in 2024 can you maybe just offer a little bit of detail on where you might be seeing pockets of strength and, and maybe areas of weakness.

Raymond Reitsma

So this is Ray the areas of weakness, the automotive suppliers that we bank are coming out of the weakness that we've identified in prior quarters. But I'd say they're still under their average state of being. So I'd say that's probably the area that we're watching the closest, but they do report that they've picked up work and that the outlook is improving and then everything else is fairly even c and I opportunities around transition and ownership and, and the like continue to be strong. And the real estate markets that we serve are, pretty firm as well. So I'd say there really isn't much change to what we've experienced in the recent past.

Fantastic. That's all for me and congrats on the quarter.
Thank you.

Operator

Daniel Tamayo with Raymond James.

Daniel Tamayo

Thank you. Good morning guys.
Yeah, maybe we start just on the on the loan deposit initiative. Ray, you guys have really made some some significant progress there and, and not a lot of time and, and gotten the loan deposit ratio down to 98% already. So curious, I know you've talked about in the past and that's a mid 90s range. If that's still the goal. And then you know, as we think about that bigger picture, is there any impact that that's having on loan growth in your mind? And and as you get or approach that that goal is there, is there some kind of change in the way that you would be thinking about loan or deposit growth following that? Thanks.

Charles Christmas

I appreciate the question. What we've tried to do is is focus on our deposit base in a way that is not to the detriment of long growth. And one of the key components of that is the rather artful way that our mortgage department has continued to meet the needs of the community in an increasing way and increase market share and yet put fewer of those on the balance sheet. So we end up in a position where we actually shrunk that portfolio slightly in this environment.
On the commercial side, we really haven't talked about reining that in at all, but it's more of a shift in focus to clients that have stronger deposit characteristics than average in our prospecting efforts. And as a result, we've been able to, make the mathematical moves that you see in this entire year, the first quarter of next year is a seasonally challenging one for us as tax payments and bonuses flow out of our commercial clients accounts. But we expect to continue the progress that we've made in the mid 90s is, is still the goal?

Daniel Tamayo

Great. And, and do you have thoughts on what you expect to achieve or, or think is a reasonable number for deposit growth next year? This year?

Charles Christmas

I think that to repeat this year is a tall order. So probably something, in the low double digits would be more along the lines of expectations, certainly won't stop our efforts there. But that's where our expectations lie.

Daniel Tamayo

Terrific. And then just one more for me on CRE concentration. So you had the mix shift in the loan portfolio that, that caused the that concentration to go up a little bit. I mean, you're still not at or near 300% but you're closer. Does that enter your mind as you think about lung growth? I'm just curious how you guys, I mean, you've got a slide on it but just curious how you're, how you're thinking about that in the overall. .

Charles Christmas

Yeah, the way we haven't thought of the way we think about it hasn't changed at all. And, c and I was a little bit less at the end of this year, but we don't expect that to necessarily persist. We think our mix will remain fairly consistent in the 5,545 sort of split that we've shown for a large number of years.

Raymond Reitsma

And I'll add a somethings while it's still relatively significant. Our volume of construction loans to fund as we sit here today compared to what was, 12 and 18 months ago is down quite a bit. I would say about $100 million to $120 million.
So it's still a significant number, I think overall the fund, but it's not as significant because in 2024 we funded a lot of that and the pipeline just isn't quite as strong as it was in the past. So long way, long way of saying that the growth in the CRE will be a little bit lessened because of less funding of construction loans.
In general, housing stock is in short supply in the markets that we serve. And that's really what pushed that number slightly up.
And I think that that's still a true statement about our, our markets that they're short on housing stock. But you know, we expect our proportions to follow what we've shown historically.

Daniel Tamayo

Terrific. Thanks, Ray. Thanks Chuck.

Operator

Nathan Race with Piper Sandler.

Nathan Race

Hey guys, good morning. Hope you're staying warm lately.
Thanks. Just a question kind of the size of the securities portfolio going forward. Obviously, you've grown it here in 4Q and you have, still pretty strong deposit growth aspirations going forward. So just curious how you're thinking about the size of the securities portfolio going forward and what you're seeing or expecting in terms of some investment rates there.

Charles Christmas

Yeah, this is Chock, we're expecting continued growth in the securities portfolio this year as it is the recipient of the additional funding with deposits exceeding loans. I would expect in the long term that that probably kind of goes up to maybe the 15% 16% perhaps the 17% range and that's where we would be with a loan deposit ratio in the mid 90s. So I would expect that, if we keep loan deposits around the mid 90s, which is likely our expectation, at least in the near term, the securities portfolio would be somewhere in that 15% to 17% range. Part of that is how much money we continue to keep at the Federal reserve. When we look at on balance sheet liquidity, we look at the environment regulatory encouragement and those types of things. If we bring that down, it might add another basis point or two to the Secures portfolio, but at least in the short term, say 2025 we expect our on balance sheet liquidity, primarily that balance of the fed to remain relatively high.

Nathan Race

Got it. That's helpful. And just going back to the margin discussion, curious how we can kind of think about the trajectory of loan yields just given what you're seeing in terms of new loan pricing these days, assuming the fed remains on pause at least over the next quarter or two.

Charles Christmas

Yeah, I think, we continue to be very vigilant in how we price loans. That's something we learned during the great recession is that we needed to be vigilant and making sure that we were getting paid for the risk and obviously taking into account our cost of funds. So I think our loan pricing when we look at our spread, which a lot of that's driven by the loan grade obviously as well as competition. I think we continue as we employ that formula and we maintain our discipline.
I think we've continued to get the loan rates that are commensurate with the risk as well as what's going on with market rates. So really no concern on how we're pricing loans and then on the deposit side, especially with growth, a lot of our loans are floating rate as we talk about a lot.
But what we have seen is on the deposit side of that deposit structure, especially with the growth in the money market, which in large is not legally, very little of it's legally tied to fed funds rate, but the way we manage it will be tied to fed funds rate. We get some really good strong matching regardless of what rates do.
And again, our goal is to be as interest rate agnostic as we possibly can to build our balance sheet that whether rates go up or down or sideways, whatever they do, that has a nominal impact on our net interest margin. And then really, think that that's, that's, that's our strategy and we think that that makes sense. And I think what we've seen over the last couple of years, especially 2024 that that is a successful strategy for us.

Nathan Race

Okay, great. Thanks for that, Chuck and maybe one last one for me, just curious how, comfortable you guys are allowing capital levels to build over the course of this year before, maybe before, maybe contemplating some more significant deployment of excess capital. Just any thoughts on just kind of the comfort range for maybe TC or some of the other capital levels as 2025 progresses.

Raymond Reitsma

Yeah, I think, I don't really foresee any significant change in our capital the way that we've been managing it, certainly in 2024. And I would say before that least a year or two, we want to be very judicious in maintaining, I would say relatively strong capital ratios. I think for most of that is just to make sure we're supporting our loan growth, 5% to 7% loan growth is still, a very solid number. And of course, it takes capital to manage that.
You know, we do, we have and we announced today that we continue to increase our cash dividend. We typically do that twice a year and don't have any plans to change that. Notwithstanding, obviously, anything that's going on with our performance or anything in the marketplace. So I would say if you looked at our capital position, we look at our growth rate and our overall earnings expectations is that our capital will remain relatively steady as we go forward, that our retained earnings basically supports our capital growth, Rxs loan growth and overall asset growth. And we're pretty comfortable with where the capital ratios are at currently.

Nathan Race

Okay, great. I appreciate all the color. Thanks guys.

Raymond Reitsma

You're welcome.

Operator

(Operator Instructions)
Damon Delmonte with KBW.

Damon P. DelMonte

Hey, good morning guys. Hope you guys are all doing well and the new year is off to a good start. Just a couple of quick follow ups here. And you know, as we think about credit and provisioning, obviously very strong credit trends with very low NPL S and seems like the underlying trends continue to support that kind of outlook. So how Chuck, could you give us a little insight on how to think about the provision going forward? Seems like it'll just be driven by the pace of loan growth. Is that a fair way to look at it?

Raymond Reitsma

That's the way that we're looking at Damon, is that a large percent of the provision that we're expecting for 2025 is necessitated by loan growth. We think the economic environment will be, will remain relatively stable, knock on wood. So we don't see a lot of provision one way or the other because of great changes in those types of trends that we might see in the loan portfolio.
And yeah, we're budgeting, and is what we have seen from this company for a decade now. Is relatively low loan losses and we think that will looking at our our current asset quality again, an expected steady economic environment, at least in the near term, we expect a pretty low level of net charge offs for 2025.

Damon P. DelMonte

Okay, great. And then I know there's seasonality here through the winter months with mortgage banking. But could you just give us an update on the mortgage banking pipeline and kind of, with the shift in the approach to that business line, kind of what the outlook is for for '25.

Raymond Reitsma

So the current state of the pipeline is, I'd say seasonally strong, it's held up quite well through this quarter and in spite of a material deterioration in the weather and the ability to, view a home that you consider purchasing. And I think I'll let Chuck speak to how we view that and factor it into next year.

Charles Christmas

Yeah, I think if you look at, the guidance that we give on page 23 I think when you look at that change quarter to quarter in fee income, that really is reflective of the seasonality of the mortgage operation.

Damon P. DelMonte

Got it. Okay. Great. And then I guess just lastly kind of a modeling question here for your guidance for the tax rate is 19% next year. This quarter was, was lower. Was it just some year end true up items that could cause a lower tax rate this quarter?

Raymond Reitsma

Yeah, mostly some true up. And it was really related to what we started about 18, almost 24 months ago is our, our activity associated with low income housing tax credits and historical tax credits.
That operation has gone fantastically, we're very, very happy with the trends that we see and those types of things take a while before they start selling into our income statement. And we saw some of that happening in 2024 but really didn't book much of that until the last quarter as we made sure that we understood the entries and the performance of the activities that we're engaged in. We think that that will continue to be, an increasing impact on our overall profitability. And we see that with the tax rate of say that was 20% over the last few years getting down to 19%. And we're hopeful that as we go forward and that operation continues to be successful, that we can bring that rate down even more. But for the, for the fourth quarter, there was definitely some true up and most of that was related to those activities.

Damon P. DelMonte

Got it great. That's all that I had a nice quarter. Thank you.

Raymond Reitsma

Thanks, Damon. Thank you.

Operator

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

Raymond Reitsma

Thank you for your, for your participation in today's call and for your interest in the bank that concludes today's call.

Operator

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