Mercantile Bank Corp

NASDAQ:MBWM

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, and welcome to the Mercantile Bank Corporation First Quarter 2023 Earnings Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note that, this event is being recorded.

I would now like to turn the conference over to Zach [indiscernible] Lambert Investor Relations. Please go ahead.

[Unidentified Company Representative]

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 first quarter.

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 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 first quarter 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'd like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski.

[Bob Kaminski, President & CEO]

Thank you, Zach. Thanks to all of you for joining us on the conference call today. Mercantile released its March 31, financial results this morning, which reported a strong quarter and a great start to 2023. Importantly, this information demonstrates continued strength and stability of Mercantile Bank Corporation and its subsidiary Mercantile Bank. As we have witnessed during the latter part of the first quarter, events have happened in our industry that have caused concerns about the health of the banking system in this country.

Today we will share with you our quarterly results and other detailed information that illustrates the solid foundation on which Mercantile is based and the continuation of the strong fundamentals that have been a consistent trade of Mercantile, irrespective of the economic environment and other external factors.

During the call this morning, we'll provide you with details on our deposit base from the first quarter, which will illustrate the attractive diversification of our funding base. We'll discuss our strong capital levels, solid liquidity, loan portfolio composition and stratification, and asset quality, as well as efficient overhead management. Ray and Chuck will have complete details on these items in their comments.

For the first quarter, Mercantile posted earnings of $1.31 per share on revenues of $55.3 million compared to $0.73 per share on revenues of $40.2 million for the same period in 2022. This morning, we also announced a cash dividend of $0.33 per share, payable on June 14 to 2023, the same dividend that was paid during the first quarter.

Our team has been able to a deathly managed net interest margin and as a result of the composition of our asset base, net interest income continued to show nice growth compared to the respective prior year period. Deposit costs continue to perform favorably compared to expectations will those costs have risen during the first three months of 2023; the pace of the increase has been slower than has been anticipated. This has continued to benefit net interest margin, allowing Mercantile to maintain this profitability measurement at a higher level than we would consider normalized.

Overhead expenses remain well managed. Net long growth was lighter than expectations during the first quarter, as the timing of some advances was pushed back due to normal closing scheduling situations. Some borrowers are also taking additional time before embarking on projects to reassess and ensure that the economics are still appropriate given the levels of inflation and higher borrowing costs.

Loan pipelines remain at solid levels, however, and many credits whose funding has been pushed back will fund early in the second quarter. Asset quality continues to be extremely strong, however, with normal levels of past dues and non-performing loans and only 661,000 in other real estate with the vast majority being a former bank branch.

The Mercantile commercial loan portfolio remains extremely well balanced between C&I and commercial real estate with the CRE comprised of very risk appropriate segmentations among the various real estate types, including low levels of exposure in the retail and office types. Our lending teams remain heavily engaged with our clients, which is the hallmark of a relationship-based community banking approach, and overall basis our clients continue to manage through macro and industry specific challenges that emerge and remain confident in their business' ability to perform successfully in the near term and the long term.

Ray will have more color on the loan portfolio shortly. The Michigan economy continues to perform in steady fashion with overall unemployment remaining unchanged as of February 28th at 4.3% compared to year end 2022. Non-farm employment is up 2.1% at February 28 from the prior 12-month period, including manufacturing jobs up 2.6%, trade, transportation and utilities up 0.8%, education and health services up 2.5%, and leisure and hospitality up 5.3%.

The mercantile team of bankers continues to represent our company as a dependable and trusted partner for our clients and communities. The successes that we enjoy would not be possible without the incredible work and dedication of our team members.

Time and time again, despite the challenges that emerge, Mercantile has stepped up to provide financial advice, guidance, and solutions to clients and potential clients. Relationship banking manifests itself in many different forms to different constituents. Our business partners know that the relationship with Mercantile is based upon our culture of excellence.

Those foundational principles allow customers to rely upon us regardless of economic conditions and other external forces that will affect them in our communities. It is relationships that are established on trust and developed with years of experience that provide the basis for successful performance by our company, which benefits all of our stakeholders. Those are my prepared comments. Ray will now take the microphone next, followed by Chuck.

[Ray Reitsma, COO & President of the Bank]

Thanks Bob. My comments will center upon the dynamics in our commercial loan, mortgage loan, and deposit portfolios, as well as the components of non-interest income. Core commercial loan growth was relatively flat for the quarter as we posted growth of $8 million. This modest level of growth was impacted by $41 million in pay downs from excess cash flow or cash reserves and $19 million from asset sales.

Our commercial backlog has grown sequentially over the last four year ends to an all-time high at December 31st, 2022, ended at March 31st, 2023 the backlog remains at similar levels to that reported at year-end. The pipeline for commercial construction commitments that we expect to fund over the next 12 to 18 months totals $285 million compared to $197 million last quarter reflecting the bank's support of the need for light industrial and multi-family projects in the markets we serve.

The portfolio has been well positioned for the rising rate environment as 64% of the portfolio is comprised of floating rate loans compared to 50% one year ago accomplished largely through our SWOT program. Asset quality remains strong with nominal levels of pass due loans and non-performing loans to total loans of 20 basis points unchanged from the prior quarter. While we are proud of our strong asset quality metrics, we remain vigilant in our underwriting standards and monitoring efforts to identify any sign of deterioration in our loan portfolio.

Our lenders are the first line of defense to recognize areas of emerging risk. Our risk rating model is robust with an emphasis on current borrower cash flow and our rating model, providing sensitivity to any challenges emerging within a borrower's finances. All that said, our customers continue to report strong results to date and have not begun to experience the impacts of a potential recessionary environment.

We continue to monitor concentration limits within our non-owner occupied commercial real estate loan portfolio, including office buildings, which presently comprise 6% of total loans, multifamily at 6% of total loans and retail at 4% of total loans.

The mortgage business continues to be impacted by the raising rate environment, seasonality and a lack of available housing inventory in the markets we serve. Higher rates have led to more demand for arms and the lack of inventory has led to more construction activity. We hold each of these types of loans on our balance and as a result residential mortgages have increased 52% over the prior year. Compared to a gain on sales event and immediate recognition of revenue, a portfolio loan takes about 24 months to generate an equal amount of income.

We continue to pursue share in the purchase market with originations in the first quarter decreasing 44% compared to the first quarter last year, due to the increase in rates since that time. Availability under residential construction loans is $58 million this quarter compared to $72 million last quarter, refinance activities 23% of last year's comparable quarter.

Non-interest income for the first quarter is down 25%, compared to the respective year-ago quarter. The primary contributor to the overall reduction was the previously described decrease in mortgage banking income of 63%, along with a 31% decrease in service charges on accounts, which resulted from higher earnings credit rates and a 23% decrease in swap income.

In sum, decline in these categories more than offsetting increases in credit and debit card income of 9.5%, and in payroll services income of 17%. During the quarter, deposits decreased by $115 million or 3%. This decrease was in evidence primarily in non-interest-bearing accounts. An analysis of accounts, which displayed a material balance decrease revealed that the vast majority were attributable to normal business activity.

The remainder consisting of eight relationships totaling $26 million or less than 1% of total deposits was attributable to customers who reacted to the headlines surrounding the banking industry and move deposits to another bank or a non-bank investment. We have developed a number of strategic initiatives around deposit opportunities that exist within portions of our customer base and the markets that we serve.

That concludes my comments. I will now turn the call over to Chuck.

[Chuck Christmas, EVP & CFO]

Thanks, Ray, and good morning to everybody. As noted on Slide 10, this morning we announced net income of $21 million or $1.31 per diluted share for the first quarter of 2023, compared with net income of $11.5 million or $0.73 per diluted share for the respective prior year period. The improved operating results were in large part driven by higher net interest income, stemming from an improving net interest margin and ongoing robust loan growth, and continued strength in asset quality metrics providing for limited provision expense.

Turning to Slide 11. Interest income on loans increased significantly during the first quarter of 2023, compared to the prior year period, reflecting the increase in interest rate environment and strong growth in core commercial and residential mortgage loans. Our first quarter 2023 loan yield was 203 basis points higher than the first quarter of 2022, reflecting the combined impact of an aggregate 475 basis point increase in the federal funds rate since March of 2022, and approximately two-thirds of our commercial loans have a floating rate.

Interest income on securities also increased during the first quarter of 2023 compared to the prior year period, primarily reflecting growth in the investment portfolio and the higher interest rate environment. Interest Income and interest 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 first quarter of 2023 compared to the prior year period.

While the rate paid by the FRB of Chicago has increased substantially, our average balance was considerably lower. In total interest Income was 24.6 million higher during the first quarter of 2023 when compared to the prior year period. We recorded increased interest expense on deposits and our sweep accounts during the first quarter of 2023 compared to the prior year period, reflecting the increasing interest rate environment and enhanced competition for deposits.

Interest expense on other borrowed money, increased during the first quarter of 2023 compared to the prior year period, reflecting the higher cost of our trust preferred securities. Interest expense on FHLB advances declined slightly reflecting the net impact of a lower average balance outstanding, but higher average rate. In total, interest expense was $7.1 million higher than the first quarter of 2023 when compared to the prior year period. Net interest income increased $17.5 million during the first quarter of 2023 compared to the prior year period.

We recorded a credit loss provision expense of $0.6 million during the first quarter of 2023 compared to $0.1 million in the prior year period. Provision expense in both periods mainly reflected reserve allocations necessitated by loan growth with the recording of net loan recoveries and ongoing strong loan quality metrics in large part mitigating additional reserves associated with the loan growth. We did not adjust any qualitative reserve factors during the first quarter of 2023 and the impact of the updated economic forecast was less than $0.1 million.

Continuing on Slide 13, overhead costs increased $2.9 million during the first quarter of 2023 compared to the prior year period. Salary and benefit expenses were $1.2 million higher during the first quarter of 2023 compared to the prior year period. Bonus accruals totaled $1.4 million during the first quarter of 2023. No bonus accruals were recorded during the first quarter of 2022. Lower mortgage lender commissions mitigated the impact of annual merit increases.

Other overhead costs increased $1.4 million during the first quarter of 2023 compared to the prior year period. Included in this dollar amount is a $0.4 million write down on a former branch facility that is under agreement to be sold. FDIC insurance expense increased $0.3 million due to the industry-wide assessment increase that became effective at the beginning of 2023. While the interest costs of swap cash collateral and the credit reserve on swaps increase in aggregate $0.5 million.

Continuing on Slide 14, our net interest margin was 4.28% during the first quarter of 2023, up 171 basis points compared to the prior year period. The improve that interest margin is primarily a reflection of increased yield on earning assets, in large part, reflecting the increase in interest rate environment over the past 12 months. Our yield on loans has increased 203 basis points since the first quarter of 2022, reflecting the combination of the increase in interest rate environment and approximately two-thirds of our commercial loans have been floating rates.

Our average commercial loan rate has increased 284 basis points over the past 12 months. A significant increase on a portfolio that averaged $3.1 billion during that time period. After increasing only about three basis points per quarter over the first three quarters of 2022 our cost of funds has increased 17 basis points during the fourth quarter of 2022 and another 42 basis points during the first quarter of 2023. Despite the increase in interest rate environment, our deposit rates and those of our competitors were not meaningfully raised during the first nine months of 2022, which we believe reflected a relatively low level of competition for deposits given the excess liquidity positions of most financial institutions during that time.

However, as interest rates continue to rise and excess liquidity positions decline, deposit rates are now increasing and we believe deposit rate betas will ultimately return to historical levels. We added a couple of slides to our presentation to pick information on our investment portfolio, which are slides numbers 20 and 21.

All of our investments are categorized as available for sale as of March 31st, 2023 about 64% of our investment portfolio was comprised of US Government Agency bonds with approximately 31% comprised of municipal bonds, all of which were issued by municipal entities within the state of Michigan in a high percentage within our market areas. Mortgage backed securities, all of which are guaranteed by a US government agency comprise only 5% of the investment portfolio. The maturities of the US Government Agency and municipal bond segments are generally structured on a laddered basis.

A 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. On slide 18, we depict the unrealized gain and loss of the investment portfolio from the first quarter of 2021 to the first quarter of 2023. The net unrealized loss started to increase meaningfully during the first quarter of 2022.

To date, the net unrealized loss peaked at $92 million at September 30th, 2022 and has since declined to $71 million as of March 31st, 2023. The significant increase in the net unrealized loss reflects the increase in interest rate environment. It is important to note that the same increase in interest rate environment has had a substantial impact on our net interest margin leading to significant growth in net interest income and net income.

Turning to slide 19, we have provided repricing data on our loan portfolio. Nearly two-thirds of our commercial loans have a floating rate, while about 87% of our fixed rate commercial loans mature within five years. Our retail loans are largely comprised of 7-1 and 10-1 adjustable rate mortgage loans with most subject to adjustment within the next seven years. In aggregate, approximately 83% of our total loans are subject to repricing within the next five years.

On slides 23, 24, and 25, we provide data on our deposit base. You will note that we include sweep accounts in our deposit tables and calculations as those accounts reflect monies from entities, primarily municipalities that elect to place their funds in a sweep account product that is fully secured by US Government Agency Bonds. Even with the seasonal decline we experienced during the first quarter of each year, non-interest-bearing checking accounts comprised a significant 36% of total deposits in sweep accounts. A large portion of these funds are associated with commercial lending relationships, especially commercial and industrial companies. The level of uninsured deposits, which totaled 48% as of March 31, 2023 has remained relatively stable over many years.

On Slide 24, we provide information on depositors with balances of $5 million or more. As of March 31, 2023, we had 69 relationships with aggregated $1.1 billion. Almost 80% of the relationships and approximately 85% of the deposits were with businesses and or individuals with the remaining comprised of municipal entities. Of those 69 relationships, 30 of them have had balances exceeding $5 million for at least five years. As a commercial bank, a majority of our deposits are comprised of commercial accounts.

On Slide number 25, we depict our deposit balances as of March 31, 2023, and year-end 2022. This is deposit of down $124 million in the first quarter, primarily reflecting business customer seasonal payment of taxes, and bonuses, and partnership disbursements. Aggregate personal deposit totals increased slightly during the first quarter.

On Slide #26, we depict our primary sources of liquidity as of March 31, 2023. We do periodically use our unsecured federal funds line of credit with a major corresponding bank, as we did on March 31, 2023, at $17 million. The FHLB of Minneapolis has been our only source of wholesale funds since June of 2022 when our last remaining broker deposit matured. We obtained advances from the Federal Bank of Minneapolis as needed to manage loan and deposit flows. It is also our primary vehicle to manage interest rate risk associated with fixed rate commercial loans, and the residential mortgage portfolio as we generally obtain fixed rate bullet advances with 10 years of four to seven years.

We remain in a strong and well-capitalized regulatory capital position. As of March 31, 2023, our Bank's total risk-based capital ratio was 13.8% and was $175 million above the regulatory minimum threshold to be categorized as well capitalized. We did not repurchase shares during the first quarter of 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 22, we depict our Tier 1 leverage and 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 March 31, 2023, our Tier 1 leverage capital ratio declines from 12.2%, down to 11.1% and our total risk-based capital ratio declines from 13.8%, down to 12.7%. Our excess capital as measured by the total risk-based capital ratio is also negatively impacted. However, it totals a strong $125 million over the minimum regulatory to be categorized as well capitalized.

On Slide 27, we share our latest assumptions on the interest rate environment and key performance metrics for the remainder of 2023. With a caveat that market conditions remain volatile, making forecasting difficult. The forecast is predicated on no changes to the federal funds rate during the remainder of 2023, at no significant recessionary pressures on asset quality and provision expense.

We are projecting total loan growth in the range of 6% to 8% with commercial loan growth of around 5%. While our commercial loan pipeline remains strong, we experienced a high level of payoffs in pay downs in 2022, especially in a latter part of the year, which continued into the first quarter of this year. We are forecasting our net interest margin to decline as 2023 progresses as we experience increases in our cost of funds from competitive pressures and growth in interest-bearing liabilities to fund long growth, while our earning asset yield remains relatively stable.

In closing, we are very pleased with our first quarter 2023 operating results and believe we remain well positioned to continue successfully navigate through the myriad of challenges faced by all of us. Those are my prepared remarks.

I'll now turn the call back over to Bob.

[Bob Kaminski, President & CEO]

Thank you, Chuck. Now that concludes management's prepared comments and will now open the call to the Q&A session.

[Operator]

[Operator Instructions] Our first question will come from Brendan Nosal with Piper Sandler.

[Brendan Nosal, Piper Sandler]

Hi. Good morning, guys congrats on the next quarter. Just to start off here on the margin, I mean, I think, the name held it a lot better this quarter than I would've thought. But it looks like you kind of tempered the outlook by about 15 basis points over the next couple of quarters despite the higher starting point. Maybe just kind of walk us through the major moving pieces and the new guidance as you see it and how you ended up at a, lower go forward level despite the strong first quarter result.

[Chuck Christmas, EVP & CFO]

Thanks, Brendan. This is Chuck. Yeah, the margin ended up being better than the guidance that I had provided in January, and a lot of that was just more timing is the deposit price rate increases that I was projecting for the first quarter really didn't come into play until during the back half. So, if you look at, if you were to look at us on a monthly basis, our margin for the back half of the quarter, especially March, would've been much closer to what we had budgeted for the entire quarter.

I think as far as some additional degradation in a margin per the guidance that I'm giving today versus what we did in January is a reflection primarily of the deposit rate pressures that we are seeing out there. And that's especially true on CD products as well as our money market accounts.

I think, one of the things that the banking industry is facing with this deposit pricing is the short-term rates that are very, very high relative to certainly medium- and longer-term trends when it comes to just basic treasury products. So, it's a lot more than just other banks that we're having to face competitive pressures. It's also non-bank products that are also out there, especially on a short-term basis, given the inverted yield curve that are placing pressure on deposit rates as well.

[Brendan Nosal, Piper Sandler]

Got it. Thanks for the color, Chuck.

[Chuck Christmas, EVP & CFO]

You're welcome.

[Brendan Nosal, Piper Sandler]

Maybe moving on to, to deposits itself, some pressure on the overall balance over the past couple of quarters, but clearly still well above pre-covid levels. Yeah. I know that it's tough to pinpoint, but do you have any sense of how much more overall runoff you're expecting over the balance of year? And then kind of the remixing as well out of non-interest bearing, and then just how that plays into the overall equation of funding versus loan growth?

[Chuck Christmas, EVP & CFO]

No, great. Great question. A lot of points there, but, I think our expectation is that deposits in general remain relatively stable for the remainder of this year. We do expect some increases. We get that seasonality in January of every year. So, we saw that money leave, but obviously that those funds have to be built up, throughout the year as, those same customers and depositors expect to make similar withdrawals in January of next year. So, I think on an overall basis, we would expect our core deposits, especially in a non-interest-bearing area to increase not graduate, but steadily over time. I think, -- it's very difficult to try to figure out what's going on with core deposits other than that. As I mentioned, my comments, our personal deposits were unchanged.

We were, we saw the withdrawals as Ray touched on more specifically in his comments were on the business side. We are definitely seeing some deposits go back into you’re higher yielding money market accounts as well as time deposits. I think that that's just kind of a reverse of what we saw in 2020 and 2021 when rates got so low. I think those monies were originally in CD products. They just went into savings or other, another deposit product and got parked there.

But now with CD rates increasing as they have, we're starting to see those funds migrate back to the time deposit product, which of course is, going to cost us more money. And that's what's factored into that margin calculation is the fact that, we expect continued migration, from lower yielding, non-maturing deposits into the higher yielding CDs.

And then of course we have existing CDs, that have been open over the last couple years, are maturing into the higher rate environment as well. That's really the big driver of the cost of funds going forward.

[Brendan Nosal, Piper Sandler]

Got it. Thanks for taking the questions.

[Chuck Christmas, EVP & CFO]

Welcome.

[Operator]

Our next question will confirm Daniel Tamayo with Raymond James, you may now go ahead.

[Daniel Tamayo, Raymond James]

Hey, good morning, everybody. First of all, thank you for all the disclosures. I know that was sure a ton of work to put together, but that's very helpful for all of us. I guess, first on just following up on deposit costs, you talked about that, the margin being lower in March. I was wondering if you could put a little bit more of a finer point on kind of what that was at the end of the period or in March, and specifically in terms of deposit costs, what you were seeing towards the end of the quarter.

[Chuck Christmas, EVP & CFO]

Yeah, let me grab that for you really quick. So, what we saw in deposit costs, our cost of all of our deposits were about 104, for March. And at our total cost, if you look at it as a percent of average assets, it was about 1.15%. So, it is just kind of more of a, what we're expecting for the rest of this year is just a continuation of those types of calculations.

[Daniel Tamayo, Raymond James]

Okay. And did you have an overall margin in March or [ph]?

[Chuck Christmas, EVP & CFO]

Oh, I'm sorry. Yeah, it was 4.17%.

[Daniel Tamayo, Raymond James]

Okay. So, it's still pretty high. I guess just following up on that. The mix shift that you talked about being baked into your guidance, I think you said, you are expecting non-interest bearing in core deposits to grow overtime. But fair to assume that, you are expecting that mix shift to take place as well over the rest of the year. Kind of just curious, how much do you think that 38% of non-interest-bearing changes over the coming year or what you are baking in?

[Chuck Christmas, EVP & CFO]

Yes. I think we are expecting that percentage of non-interest bearing to stay relatively stable, if not increase a little bit, because as I mentioned, we have got to have these companies build those balances back up in anticipation of the tax and bonus and partnership disbursement that they would expect to make in January. So, my expectation on an overall basis is that, noninterest-bearing checking accounts would hold steady at least, maybe increase a little bit throughout the year, as we see that typical seasonality work through our balance sheet.

One of the things that, as I mentioned, we are definitely seeing some non-maturing deposit funds go into the CD products, which is driving an increase in cost of funds. The CDs that are repricing are generally speaking below 1% and they are going into products that are in the upper 3s and low 4s. So, there is a lot of repricing going on just with CD products. And then as I mentioned, seeing some migration from savings accounts and those types of deposits into the CD products as well, which is also a significant repricing.

I think what we try to do, as we typically do is, try to be pretty conservative on our expectation of non-maturing deposits. And when we build our balance sheets from a projection standpoint, try to do that with some of our higher costing funds, whether that's time deposits, borrowings, some high yielding money market account products. Clearly, we are out there, as hard as we can day in and day out, trying to grow all of our deposits, but certainly from a projection standpoint want to be conservative.

[Daniel Tamayo, Raymond James]

Okay, great. And then lastly on the loan side, just curious, where the new loan yields were coming in kind of towards the end of the quarter. You mentioned that those would -- we would expect those to continue to go up given the variable nature, but I'm just curious where those settle relative to what's on the portfolio now. And then kind of a bigger picture question around with deposits stable, loan deposit ratio of 110% and 6% to 8% loan growth in the forecast. How high do you expect that value to get or, I mean, it's it seems already somewhat elevated. So just curious how you are thinking about that ratio.

[Chuck Christmas, EVP & CFO]

Yes. And as I mentioned in my comments, we always throw sweep accounts into that because those really truly are deposit accounts in our mind. But it's still a little bit over 100% so not trying to change your question. I think if you look at us historically, especially in excluding the last couple of years, with the pandemic and all those impacts on our balance sheet, our loan-to-deposit ratio or however you want to calculate that, has always been the highest at the end of the first quarter, because of that seasonality withdrawal that we see. We are a commercial bank and a lot of our deposits are commercial.

And so that seasonality we see with our customers is very noticeable within our balance sheet. So, I think we would -- we don't expect that ratio to go any higher. I thought our intent to play games with that ratio, so to speak. As I mentioned in my comments, we're not using broker deposits right now and haven't for almost a year. Instead, we relied on borrowing from the FHLB. If we were to go and get broker deposits instead, clearly that would help our number. We're not interested in doing something specifically to help or assist one particular number when we're out there managing our balance sheet, we want to do it in effective and obviously as efficient and low cost as possible.

And what we have found, especially going longer term like we do with the FHLB advances the rates that we get from the Federal Home Bank of Indianapolis are considerably lower than the rates we're going to get on broker deposits of the similar tenure. And the biggest reason for that is in the brokered market, at least up until most recently, there's not been a lot of supply of three- and five-year money out there as everybody had decided to keep short in a low interest rate environment.

So, it makes sense for quite a few reasons, and certainly on an overall basis for us to use the FHLB using broker deposits as we had done throughout Mercantile’s history up until last year. But on an overall basis my expectation is that loaner deposit ratio will not go up any higher. And hopefully, some of, we'll get some nice wins with all the different initiatives that Ray briefly mentioned in his comments, and we can see that ratio decline. But having said all that, our company has almost always been somewhere around 95%, 100% loan of deposit ratio, maybe 105%, especially at the end of the first quarter.

On an overall basis, it's a position that we're comfortable managing. We've got a lot of experience with it. As Bob mentioned in his opening remarks, we are a relationship driven company. We don't get very many surprises. We're not transactional or try not to be transactional. And those were where the surprises come within the balance sheet when you're in that type of business. So, given all that, I think we're pretty comfortable with where we're at. But clearly, growing deposits is a big challenge. It's always really been a big challenge because we've been, so successful at growing our loan balances. Deposit growth has always been a challenge for this company, and we really don't see that any different now than we had in the past.

Certainly, the activities that took place in March and throughout, at least the early part of April got everybody's attention and we spent even more time especially with our larger depositors giving them comfort and the strength of our company and making sure that they understood that we -- our bank and like virtually every other bank was nothing like silicon. And as Ray mentioned, very limited withdrawals that we saw out of our bank from that episode.

So yeah, it's a big challenge. We're going to continue to grow our deposits as best we can but we're going to manage the balance sheet, which makes the most sense on a long-term basis, uh, as we manage interest rate risk along with our liquidity positions.

[Daniel Tamayo, Raymond James]

Sorry if I missed it. Did you have the new loan yields at the end of the quarter?

[Chuck Christmas, EVP & CFO]

Basically, what we do on the fixed rate basis, we have a very strategic loan pricing model that we use. And basically, on the fixed rate we're going to do it a spread over cost of funds. I think, looking at the five years and we use the FHLB of Indianapolis Advance rates. So, I think, the current rate is right around 4%, I think. So, you would add 250 to 300 basis points to that, and that would be I think a standard rate that we would do on a five-year balloon or on some equip financing over five to seven years.

[Daniel Tamayo, Raymond James]

Perfect, thanks. That's it for me.

[Chuck Christmas, EVP & CFO]

You're welcome. Denny.

[Operator]

Our next question will come from Eric Zwick with Hovde Group. You may now go ahead.

[Eric Zwick]

Good morning, everyone. Wanted to start maybe a question for either Bob or Ray, just given the pipeline for construction at this point. And I guess conventional wisdom might suggest that, lending to construction at the, end of an economic cycle or impending slowdown, could have an elevated level of risk. So, wondering if you could just talk about maybe the differences in that, the Michigan market that you're seeing there on the industrial side and multi-family in terms of the in demand for these projects and, that leads to your confidence to, extend new credit at this point, and additionally your confidence that they will, move to completion and move to the permanent market at some point.

[Ray Reitsma, COO & President of the Bank]

Yeah, this is Ray. There’re really two elements in that. There's a light industrial construction element, and then there's the multi-family. On the light industrial side, the buildings that are being constructed, have tenants and the space is required. It's in very high demand here in West Michigan. So, we feel very good about that sector.

Moving to the multi-family side, the recent evidence has been pretty strong that the inventory shortage continues to exist in terms of housing, from studies that have been done for the city of Grand Rapids to information that we're hearing from realtors about how intense the competition is for homes when they go up for sale. All those things support anecdotally the need for more housing units, and in the form of multi-family.

So, I would offer that, yesterday we took 14 apps in the bank for mortgages. 12 of those had no address associated with them, so they were pre-qualifications. And that would speak to the shortage of inventory. Occupancy rates are extremely high in the existing inventory. So, all those factors together make us comfortable along with sponsors of these projects that are very strong and experienced and have the ability through their existing portfolio to accurately ascertain the conditions in the market.

[Bob Kaminski, President & CEO]

Yeah, this is Bob and I certainly underscore what Ray just said. And as we talked about all through the pandemic and even going back further than that, coming out of the great recession, we had implemented many concentrations, reports, examination of what's going into the portfolio, what's coming out, and looking at those diversification levels of our real estate. And as Ray said, partnering with experienced developers who've got many years in working on the projects that they're engaged with at the current time.

And it's something that we've historically watched, had a very close watch on, and continue to do so today, especially with what's some people are predicting in the form of recession coming up. So, we feel really good about our entire portfolio and certainly the CRE gets, captures a lot of our attention on an ongoing basis, but we feel really good about what's comprising that bucket of loans at the current time.

[Eric Zwick]

That's great color. Thanks, guys. Next on I guess for Chuck, maybe just looking at what the futures, the Fed funds kind of futures curve and the yield curve is suggesting that we're getting towards the end of the rate hiking cycle and potentially see, a normalization maybe starting at the end of ‘23 or into ‘24 with rates coming back down.

With the balance sheet still being constructed with their relativity kind of asset sensitive positioning, how do you think about that longer-term, if rates were to start to come back down? And would you potentially look to utilize any -- is there anything to protect the downside or limit the negative impacts there?

[Chuck Christmas, EVP & CFO]

Yes. I don't think we have any specific programs on our balance sheet with derivatives, specifically speaking to your question there. I think what we have tried to do on an overall basis is, shorten the duration of our balance sheet as much as we possibly can. One of the things that, when you look at any graph out there, even over Mercantile's existence, which isn't that long. And what we see is just a tremendous amount of volatility in interest rates for a myriad of reasons. A couple of -- nobody probably would have ever put into any type of analysis.

And so, I think the best defense is to make sure our balance sheet is as short as it can. So, if there is any timing mismatches within our balance sheet, it's only relatively short lived. And that if we do see a rate environment decline, yes, it's going to impact our floating rate commercial loans. But we also are looking at the liability side to make sure that we're matching up the duration and repricing opportunities on those liabilities as best we can. But on an overall basis trying to match up the duration repricing opportunities of our assets with our liabilities. And on an overall basis, in addition to that, is try to just shorten the duration of our entire balance sheet.

[Eric Zwick]

Got it. Thank you. And just one last one for me. I think you mentioned about 6.8 million shares available under you repurchase authorization. Just curious about your appetite for potentially buying back some shares in '23 relative to other uses of capital at this point?

[Chuck Christmas, EVP & CFO]

Yes. So, we have $6.8 million in our current plan. We didn't buy back any shares last year. And as I mentioned, and as you just repeated, we don't do anything this year. I think given what took place in March, capital is incredibly important and we have made the decision at least to date that we will maintain our capital position as best we can and not engage in any repurchase activity. We come out of our blackout period on Friday of this week.

And clearly, admittedly, when we look at our stock price and our valuations, this is definitely very tempting to get into the market and start buying back our stock. We have certainly been active in buying back our stock over time in previous periods, although I would say, it's never been incredibly active. We are not trying to be out there to purchase back a significant number of shares. I think we want to be out there, be opportunistic, and also support our current shareholders by trying to support the price as best we can. And at the end of the day, we look at that, as a finance transaction and it does that better company on an overall basis.

So, I think right now we are reticent to engage in any buybacks. But obviously, that's up for re-evaluation at any time going forward and we certainly have the plan available to us, if we want to endeavor back into buying some shares back.

[Eric Zwick]

Thanks, so much for taking my questions today.

[Operator]

[Operator Instructions]. Our next question will come from Damon DelMonte with KBW. You may now go ahead.

[Damon DelMonte, KBW]

Good morning guys. Thanks for taking my questions and thanks for all the disclosures in the slides today. I guess just with respect to the outlook for loan growth, I think you guys are saying 6% to 8% over the remaining quarters of this year. And Ray, you may have said this, in your prepared remarks, but could you just kind of go over the kind of the split between the commercial side and the retail side for that expected growth?

[Ray Reitsma, COO & President of the Bank]

Yeah. We have the retail side growing about 180 million, I think for the year. And a similar amount for the commercial side. So, they're fairly balanced in the growth. Right now, as I mentioned, arms are more popular, and then fixed rates. So those are finding their way under our balance sheet as opposed to being sold. If the inverted yield curve is correct, we'll have an opportunity to refinance many of those into 15- and 30-year obligations and maybe reduce the weight of those on our balance sheet at some point in the future. I mean, obviously, that's dependent on rates, so, time will tell. But for the near term, I'd say a fairly equal representation between the two.

[Damon DelMonte, KBW]

And then with respect to the outlook for expenses any internal discussions about ways to maybe kind of shave some, some expenses out of that overall expense structure?

[Chuck Christmas, EVP & CFO]

I think -- Damon, this is Chuck. I think that, is something we endeavor to do every day. I wouldn't think that there's anything, any type of fluff or anything within our overhead structure. We're very dutifully trying to become as an efficient bank as we possibly can rationalize our branch system, making sure we're employing technology whatever we can, whether that's how customers interact with our company, whether it's automated -- the new automated teller machines or online banking or anything like that. We're always endeavoring to become more efficient in how we deliver our products and services to our customers makes it more efficient and more cost effective for us.

I think, not sure what else to say except we're doing as best we can and I think if you look at our overhead costs on an overall basis, especially from say, occupancy equipment in some of those areas, I think we're doing a really good job and we're going to continue to do that.

The swap, -- swap program, obviously, just because of where rates were and cash collateral and interest rates going up there were some additional costs there. The FDIC didn't do us any favors by raising our assessment 58%, just for being, just for opening our doors. So, of course, inflation had a big impact on our salary and benefits as well. So, I don't think there's anything that we can say, Hey, let's cut this out. Let's cut that out. I think on an overall basis, we continue to look for ways to run more efficiently and utilize our resources as best we can.

[Bob Kaminski, President & CEO]

This is Bob, I'll add to that, by saying we certainly look at efficiencies all the time, and that's where you've seen, for instance, the branch right now because we're able to shed a particular branch. And we've done that numerous times over the last couple of years. I will also say, however, that we're committed to attracting and retaining the best employees we can because they're really who allow us to do the things that we can do from a customer standpoint and also continue that forward investment in technology, as Chuck mentioned, the digital frame the use of data the ability to automate processes or something that we continue to take a look at.

And for that, we need to make the investment in technology, which we always have been committed to. That's an important part of who we are. So, we never defer investments in technology or expenses, because we do not want to get behind and we have not and we never will.

[Damon DelMonte, KBW]

Got it. That's helpful. Thank you. And then I guess just lastly, credit continues to be extremely strong for you guys. And Chuck, could you kind of help frame out expectations for the provision, kind of balancing off loan growth and potentially a softer economic backdrop as we go through the remainder of 2023?

[Chuck Christmas, EVP & CFO]

That's a roller loaded question.

[Bob Kaminski, President & CEO]

Hey, no, Dave, there's a reason why I didn't put, there's a reason why I didn't put provision expense on page 27. Yeah, I think, -- clearly, the -- our loan portfolio is going to react to that of our market, right? I mean, I think we do a really good job of selecting our borrowers, customers we want to do business with, structuring them properly, that's mutually beneficial. So, I think, our, my humble opinion, I think the guys here would agree is that our asset quality has generally been stronger than that of the industry. And we would think that would continue to be the case regardless of what the economic environment is out there. I think, certainly the economic environment's going to be the big determinant there.

Two ways it's going to impact the provision. One is, specifically on our portfolio, if there's a bunch of downgrades that we have to do, clearly that's going to require a higher reserve through provision expense. And then of course with our, our friend CECL, we've got that economic forecast out there that's independent and we get that forecast and we compare it to other forecasts to make sure that it's, I call it, kind of the check system and just to make sure it makes sense that our forecast is similar to that of others.

But clearly, that forecast can have a big weighting on our provision. I think one of the things that we've seen, and in talking with other bank CFOs who use different models and different forecasters than what we do, but the similarity is, is what's driving these forecasts is the unemployment rate.

We've seen a degradation in GDP forecast over the last few years, and we really haven't seen, an overlay significant impact to the reserve calculation as a result of that. What we have seen is a relatively steady, or just slightly over time increasing unemployment rate. And as I mentioned, the impact in the first quarter from the updated economic forecast was literally less than a hundred thousand dollars, at a loan portfolio, that's, close to $4 billion. So pretty nominal there.

So, I would say it's the economic forecast, especially in regard to those unemployment expectations. And obviously the, the impact to our specific customers. And as we, have to go in there and change any loan grades, we still have all of our qualitative factors as well. We didn't make any changes, as I mentioned in the first quarter. I think most of those kinds of represent the overall environment that we have. So, I think that those would kind of move in similar fashion to the overall upgrades, downgrades within our portfolio as well as the economic forecast that we put into the model.

[Damon DelMonte, KBW]

Okay. And then just from like a reserving level, I mean if things remain relatively healthy do you feel that your 108 level is a adequate reserve or do you feel like that's going to kind of grow a little bit as you continue to grow loans this year?

[Bob Kaminski, President & CEO]

Yeah, that's an interesting question, but certainly, I believe that my reserve right now is very adequate given the shift in the portfolio. But, again, I think the coverage ratio is just, an outcome of what we have to do, granularly well to the items that we just talked about. So yes, certainly if there is a downgrade, certainly if we see a degradation in the forecast, we are going to have to add provision expense and that would cause an increase in the coverage ratio.

But given where we are at now and a very, very strong loan portfolio and an overly good, I would call it economic forecast with continued, I think the forecast that we see out there is an unemployment rate that I think overall now 3.5%. We see that growing to 4.5% in most of the forecast over the next couple of years. But I would say that 4.5% is still a really strong unemployment number.

So again, we will just see how the economies react to what the Fed is doing, what they may do in the future, obviously any other stresses that we see in the financial markets. I guess I would say, I don't see that coverage ratio going any lower, given where we are at right now in regards to the economic forecast and the overall condition of our loan portfolio. But clearly, if there are stresses within the economy and or our loan portfolio, I think you would expect, and I would certainly expect to see that coverage ratio have to increase.

[Damon DelMonte, KBW]

Got it. Okay. No more questions on credit. Everything else that I had has been asked and answered. So that's all I had. Thank you very much.

[Operator]

This concludes our question-and-answer session. I'd like to turn the conference back over to Bob Kaminski for any closing remarks.

[Bob Kaminski, President & CEO]

Thank you very much for your interest in Mercantile Bank Corporation. We look forward to speaking with you next, after the end of the second quarter in July. This call has now ended. Thank you.

[Operator]

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