Operator: Good morning and welcome to the Mercantile Bank Corporation 2026 Second Quarter Earnings Results 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 Clatter, Chief Marketing Officer of Mercantile Bank. Please go ahead.
Nicole Clatter: Hello, and thank you for joining us. Today, we will cover the company's financial results for the second quarter of 2026. 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 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. 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 will differ materially, excuse me, 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. Let's begin, right?
Ray Reitsma: Thank you, Nicole. Our results for the second quarter of 2026 continue to build on the theme of commercial expertise generating a strong return profile. The consummation of the purchase of Eastern Michigan on December 31, 2025 represents execution of our strategic objectives around deposit growth, loan growth, and margin stability, paired with strong asset quality and overall financial performance. We continue to demonstrate top quartile ROA performance relative to our peers built around the following traits. A strong and durable net interest margin. Over the last five quarters, the SOFR 90 day average rate has dropped 71 basis points while our margin increased by 11 basis points to 3.59%. This illustrates effective execution of our strategic objective to maintain a steady margin via match funding of our assets and liabilities and refutes the notion that we have an asset sensitive balance sheet despite the relatively large portion of floating rate assets. Very strong asset quality. Non-performing assets to total assets remain at the low levels typical of our company at nine basis points of total assets as of June 30, 2026. Non-performing loans to total loans over the last six and a half years averaged 12 basis points. The allowance for credit losses stands at 1.13% of total loans as of June 30, 2026, and on a dollar volume basis was nearly 10 times the level of non-performing loans, providing a very strong coverage relative to past due non-performing loan levels. These numbers demonstrate our longstanding commitment to excellence in loan underwriting and administration. Improved on-balance sheet liquidity and loan-to-deposit ratio. At the end of the second quarter of 2026, our loan to deposit ratio stood at 93% compared to 100% at June 30, 2025, and 91% on December 31, 2025, 98% on December 31, 2024, and 110% on December 31, 2023. As of June 30, 2026, our deposit mix included 27% non-interest-bearing deposits and 24% lower-cost deposits, up from 25% and 20%, respectively, at the end of the second quarter of 2025, which has contributed to the stability of our net interest margin. Our acquisition of Eastern Michigan contributed positively to these measures. Deposit growth during the 12 months ended June 30, 2026. was 12.4% with growth in the non-interest-bearing accounts outpacing the growth in interest-bearing accounts during that period. Our recent focus on deposit growth is not new to our bank. In fact, the last five year-end periods demonstrate a deposit compounded annual growth rate of 9.2%. Strong commercial loan growth. Commercial loan growth in the second quarter of 2026 was $115 million, an annualized growth rate of 11.7%. As foreshadowed in the prior quarter's commentary, loan payoffs did moderate from the prior four quarters experience, reducing by $60 million compared to the prior quarter. June 30, 2026 commitments to make new commercial loans total $224 million and commitments to fund existing commercial and residential construction loans total $283 million with each amount at or near five quarter highs. We expect that loan growth for 2026 will fall within the range of previously defined expectations of mid single digit percentages. continue strong growth in key fee income categories. Growth in commercial deposit relationships has supported growth in treasury management services resulting in a 35% increase in service charges on accounts during the second quarter of 2026 compared to the second quarter of 2025. Our credit and debit card offerings report growth of 21% in the first six months of 2026 compared to the respective 2025 period. Well-Managed Expenses. and salaries and benefits increased from 34% to 35% of net revenue, primarily reflecting our investment in the Southeast Michigan market. In sum, these traits have allowed us to report a quarter over quarter EPS growth of 10% in the second quarter of 2026 compared to the prior year second quarter, a 1.52% return on average assets and a 14% return on average equity in the second quarter of 2026, and an annualized 11.6% increase in the tangible book value per share in the current year second quarter compared to the first quarter of 2026. Additionally, our five-year tangible book value per share compounded annual growth rate of 9%, and five-year earnings per share compounded annual growth rate of 15.1%, historically placed us in the top tier of our proxy group. We remain excited about the recently completed combination with Eastern Michigan. The integration of operations is well underway, and the cultures have meshed very well. That concludes my remarks, and I'll now turn the call over to Chuck.
Chuck Christmas: Thanks, Ray. This morning, we announced net income of $25.9 million, or $1.50 per diluted share, for the second quarter of 2026 compared with net income of $22.6 million or $1.39 per diluted share for the second quarter of 2025. Net income during the first six months of 2026 totaled $48.6 million or $2.82 per diluted share compared to $42.2 million or $2.60 per diluted share during the first six months of 2025. Growth in net income during both timeframes primarily reflected increased net interest income and lower provision expense that more than offset higher non-interest expense costs and federal income tax expense. Excluding non-recurring costs associated with the year-end 2025 acquisition of Eastern Michigan and previously announced core and digital banking system conversion, adjusted net income was $26.4 million or $1.53 per diluted share for the second quarter of 2026 and $51.7 million or $2.99 per diluted share for the first six months of 2026. Adjusted diluted earnings per share increased 14 cents or approximately 10% in the second quarter of 2026 compared to the second quarter of 2025 and increased 39 cents per diluted share or approximately 15% during the first six months of 2026 compared to the first six months of 2025. We believe using these non-GAAP measurements reflects our core earnings performance and provides for more accurate current period versus prior period comparisons. Interest income on loans was relatively unchanged during the second quarter and first six months of 2026 compared to the prior year periods, reflecting loan growth that was offset by a lower yield on loans. Average loans totaled $4.89 billion during the second quarter of 2026 compared to $4.70 billion during the second quarter of 2025 An increase of $197 million. Mercantile banks robust commercial loan fundings of $535 million during the last 12 months were largely mitigated by significant levels of payoffs and partial pay downs on certain larger commercial loans during those periods, which aggregated $459 million. Our yield on loans during the second quarter of 2026 was 28 basis points lower than the second quarter of 2025, primarily reflecting the 75 basis point aggregate decline in the federal funds rate during the last four months of 2025. Interest income on securities increased during the second quarter and first six months of 2026 compared to the prior year periods, reflecting growth in the securities portfolio and a higher yield. The growth and higher yield reflect the acquisition of Eastern Michigan, along with ongoing portfolio growth and reinvestment of mature lower-yielding investments at Mercantile Bank. Average balances were at $325 million, and the average yield increased 54 basis points quarter over quarter. Interest income on other earning assets, a large portion of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, increased during the second quarter and first six months of 2026 compared to the prior year periods, reflecting a higher average balance that more than offset a lower average yield. The average balance was up $178 million, while the average yield declined 87 basis points quarter over quarter, latter which largely depicts the aggregate 75 basis point decrease in the federal funds right there in the last four months of 2025. In total, interest income was $4.7 million and $9.8 million higher during the second quarter and first six months of 2026 compared to the respective prior year periods. Interest expense on deposits decreased during the second quarter and first six months of 2026 compared to the prior year periods, reflecting a lower cost of deposits that more than offset interest bearing deposit growth. The growth in interest-bearing deposit balances and the lower costs of these funds reflect the acquisition of Eastern Michigan along with growth and lower deposit costs at Mercantile Bank. Costs of interest-bearing deposits at both banks were positively impacted by the aforementioned decline in the Fed funds rate in the latter part of 2025. Average interest-bearing deposits total $3.96 billion during the second quarter of 2026 compared to $3.46 billion during the second quarter of 2025, an increase of $493 million. The cost of all deposits was down 50 basis points during the second quarter of 2026 compared to the second quarter of 2025. Interest expense on Federal Home Loan Bank of Indianapolis advances declined during the second quarter and first six months of 2026 compared to the prior year periods, largely reflecting a lower average balance. interest expense on other borrowed funds increased during the second quarter and first six months of 2026 compared to the prior year periods, largely reflecting the impact of a term loan we obtained in late 2025 to assist in the cash portion of the Eastern Michigan acquisition. In total interest expense was $3.0 million and $5.3 million lower during the second quarter and first six months of 2026 compared to the prior year periods. Net interest income increased $7.8 million and $15.1 million during the second quarter and first six months of 2026, respectively, compared to the prior year periods, primarily reflecting growth in earning assets and a higher net interest margin. Average earning assets totaled $6.43 billion during the second quarter of 2026, compared to $5.73 billion during the second quarter of 2025, an increase of $699 million that largely reflects the acquisition of Eastern Michigan at year-end 2025, along with the securities and overnight funds growth at Mercantile Bank. The net interest margin was 3.59% during the second quarter of 2026 compared to 3.48% during the second quarter of 2025. The improvement is largely due to the Eastern Michigan acquisition. The yield on earning assets declined 33 basis points while the cost of funds declined 44 basis points during the second quarter of 2026 compared to the prior year second quarter. Impacting our net interest margin over the past couple of years was our strategic initiative to lower the loan and deposit ratio, which generally entailed deposit growth exceeding loan growth and using additional monies to purchase securities. A large portion of deposit growth was in higher-costing money market and time deposit products, while the purchase securities provided a lower yield than loan products. Despite that strategic initiative and declines in the federal funds rate during the latter parts of 2005 and 2024, Our quarterly net interest margin has remained relatively stable. Over the past eight quarters, our net interest margin has averaged 3.49% with a high of 3.59% and a low of 3.41%. We remain committed to managing our balance sheet in a manner that minimizes the impact of changing interest rates environment on our net interest margin. Basic funds management practices such as match funding combined with scheduled maturities of lower yielding fixed rate commercial loans and securities and higher rate time deposits along with scheduled rate adjustments on residential mortgage loans should provide for a relatively stable net interest margin in future periods. We recorded provisions for credit losses of negative $1.8 million and negative $3.6 million during the second quarter and first six months of 2026, respectively. The second quarter negative provision expense mainly reflected the elimination of a $2.7 million specific allocation associated with the resolution of a non-performing commercial construction loan, which was partially offset by changes in the economic forecast General allocations necessitated by net loan growth and an increase in certain qualitative factor allocations. The reserve balance decreased $1.3 million during the second quarter of 2026, reflecting the negative $1.8 million provision expense and net loan recoveries of $0.5 million. The reserve balance equals 1.13% of total loans at June 30th, 2026. Our sustained strength and loan quality metrics continues to be impactful to our loan loss reserve calculations. The baseline allowance largely determined from historical net loan charge off activity represents only one third of our current reserve balance reflecting a low level of net loan charge off activity during our look back period from the beginning of 2011 through the end of the second quarter of 2026. Specific reserve allocations on non-performing loans totaled just $0.9 million or about 2% of the reserve balance at the end of the second quarter. Non-interest expenses were $6.0 million and $17.0 million higher during the second quarter and first six months of 2026, respectively, compared to the prior year periods. Excluding one-time costs associated with the ongoing core and digital banking system conversion, and year-end 2025 acquisition of Eastern Michigan that aggregated $0.6 million and $3.9 million during the second quarter and first six months of 2026 respectively. Non-interest expenses increased $5.4 million and $13.1 million compared to the prior year-end periods. Eastern Michigan Bank's non-interest expenses totaled $4.0 million and $8.0 million during the second quarter and first six months of 2026, respectively. The increase in core operating costs largely reflects higher salary and benefit costs with the remaining growth generally depicting the impacts of inflation and a larger balance sheet. In addition, we recorded a $1.4 million decrease in allocations to the reserve for unfunded loan commitments primarily reflecting a lower level of commercial loan commitments largely stemming from the high level of commercial loan fundings that took place during the second quarter. Federal income tax was $1.9 million and $2.0 million higher during the second quarter and first six months of 2026 respectively compared to the prior year periods. Largely reflecting a higher level of pre-tax net income and a lower level of net benefits from transferable energy tax credits. The effective tax rate was 16.9% during the second quarter and first six months of 2026 compared to 12.9% and 15.7% during the respective time periods in 2025. The 2025 periods had higher levels of transferable energy tax credit activity given carryback opportunities. Additional acquisitions of transferable energy tax credits may be made from time to time subject to our investment policy, tax credit availability, and tax credits derived from our low-income housing and historical tax credit activities. Both Mercantile Bank and Eastern Michigan Bank have strong and well-capitalized regulatory capital positions. Mercantile Bank's total capital ratio, risk-based capital ratio was 13.5% as of June 30, 2026, $205 million above the minimum threshold to be categorized as well capitalized. Eastern Michigan Bank's total risk-based capital ratio was 23.1% as of June 30, 2026, $36 million above the minimum threshold to be categorized as well capitalized. We did not repurchase shares during the second quarter of 2026. We have $6.8 million available in our current repurchase plan. Thoughts on the remainder of 2026. On slide number 23 in the investor presentation, we share our assumptions on the interest rate environment and key performance metrics for the remainder of 2026, with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on no changes in the federal funds rate during the remainder of 2026, although we believe our net interest margin will remain relatively stable in a changing interest rate environment as it has over the past eight quarters. We are projecting loan growth in a range of 5% to 7% annualized during each quarter, which encompasses a strong commercial loan pipeline, as well as expected fewer commercial loan payoffs during the remainder of the year. We are forecasting a higher net interest margin during the last six months of 2026 compared to the first six months of 2026 as we benefit from commercial loan growth, lower levels of monies at the Federal Reserve Bank of Chicago, and maturing low-yielding fixed-rate commercial real estate loans and investments. We are projecting a federal tax rate of 17%, which encompasses continued growth and net benefits from our low-income housing and historical tax credit activities along with additional transferable energy tax credit investments. Expected quarterly results for non-interest income and non-interest expense are also provided for your reference. Non-interest expense projections reflect personnel investments that were made in the latter part of 2025 and first six months of 2026 and expected during the remainder of 2026 to support expansion in Southeast Michigan, as well as to support operational areas as we switch core and digital banking providers to enhance the durability, efficiency and experience for our customers and employees. Costs associated with the core and digital banking system conversion are not included. In closing, we are very pleased with our operating results during the second quarter and first six months of 2026 and continued strong financial condition and believe we remain well positioned to successfully navigate through the myriad of challenges and uncertainties faced by all financial institutions. That concludes my prepared remarks. I'll now turn the call back over to Ray.
Ray Reitsma: Thank you, Chuck. That concludes the prepared remarks from management and we'll now move to the question and answer portion of the call.
Operator: We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then one. At this time, we will pause momentarily to assemble our roster. The first question comes from Daniel Tamayo with Raymond James. Your line is now open.
Daniel Tamayo: All right. Thanks, guys. Good morning. Maybe we can just start on the expense increase and the guidance there. I hear what you were saying there, Chuck, in the commentary about the increased personnel investments and the expansion in Michigan. Maybe you could just parse out kind of what's related to the hirings in Southeast Michigan and what's related to the core conversion and as much as you could help us find the settling point after the costs come out post-conversion Post-core conversion, that would be helpful. Thanks.
Chuck Christmas: Yeah, good morning, Danny. This is Chuck. I'm glad to answer your questions. You know, there's definitely a lot going on that impacts our overhead costs. The costs associated with our core conversion, you know, we want to make sure that it's a big lift for our team. and we want to make sure that we do it effectively and accurately. So we made the determination early on is to make sure that we are, I would say more than fully staffed, especially in certain operational areas to help with not only the core conversion, but especially the training. Clearly, there's going to be a time period where we have to make sure that all of our employees are trained on their respective areas of the new system, both the core and the digital system. And so we have been very aggressive in hiring in those areas to make sure that we're fully staffed, at least. We're very excited about our expansion into southeast Michigan that started quite a few years ago. But really within the last, I would say, 12 months has really taken off. We've hired exceptional personnel, both on the commercial side as well as the treasury side in that market. And we continue to talk to additional folks to join our team. And, you know, we expect, you know, as Ray has said on several occasions, Southeast Michigan is one third of Michigan and we are but a tiny, tiny blip there. Given the size of that market and where we're at now, we've made huge strides already over the last 12 months. If you look at our net loan growth, obviously, Southeast Michigan doesn't have much in the way of payoffs. But when you look at their growth, that equals about our net growth. Obviously, we've had a lot of payoffs here, notwithstanding the strong fundings we've had in this market. So I can't give you a number specifically as we go forward in regards to the Southeast Michigan market. We think it's a strong market for us. And we expect to continue to build that market out as we have our last 12 months in the future period. So that's where most of that additional expense is coming from. Obviously, we want to continue to build out our company in all of our markets as the opportunities present themselves. We're very pleased with the markets. I think when we look at the loan growth, all of our markets are showing growth. And we want to continue to support that with additional people at all levels and all positions throughout the company.
Daniel Tamayo: Thanks, Chuck. And then just in terms of like post core conversion, the savings still kind of on pace for what you guys were talking about before. Maybe just remind us where. what type of expenses you expect to recoup?
Chuck Christmas: Yeah, Danny, the savings are really going to start in the second quarter of next year. When we do flip the switch in February and we get through all the testing and validations and exit our current providers in both those areas. It's kind of hard to put a specific number on the savings. I mean, we can look at different contracts, but obviously there's growth and volume that has impacts. And we are switching providers on both digital and core, which are different platforms. And as we look to our teams and make sure that we are set up and our framework is designed to best fit that new framework, we've been making changes there as well. We do know that the savings on the core itself, just on the contract, is pretty significant. But there's a lot of moving parts that make it very difficult to say this is going to be our cost going forward. And it will be a while before we get to that point.
Daniel Tamayo: Okay, fair enough. On the credit side, so obviously really nice story. You talked about kind of the puts and takes within the reserves. and sounds like you're getting down towards the end of the specific reserves or at least those are much more modest at this point but you still have net recoveries. I guess if you have any thoughts on where you think reserves could stabilize or if when you think the loan loss provision might turn positive or any guidance on that number would be helpful.
Chuck Christmas: Yeah, I mean, certainly we enjoy negative provisions, especially when they're because of recoveries and the resolution of loan situations that, you know, we like to remind everybody we did, you know, have provision expense associated with building up those specific reserves as we felt appropriate. I think the relatively low level of specific reserves on non-performing loans that we have right now is really a reflection of two things. One, foremost, is not very much at all in just gross dollars of non-performing loans that we have on the books. But I think it's also reflective of the way that we underwrite loans. There's always a risk of loss. But when we have a loan go sideways, that we go into collection mode, We've got quite a bit of collateral. We've got guarantees that we can rely on, which obviously then minimize the specific reserves that we need to establish. But overall, it's a reflection of the fact that we just don't have a lot of loans on non-performing. And we haven't had for quite a while now, certainly past most of our look-back period, and many more. The economy has the biggest impact on the overall quality of our loan portfolio at any given time. So if we did enter into a period of stress, you know, our reserve, like all banks reserves are designed to reflect that with increased reserve level requirements, which would lead to, you know, obviously bigger or potential sizable positive provision expenses. So Overall, we feel very solid and feel very good about the quality of our loan portfolio. It's been very consistent at its relative current level now, and we don't see anything in the near term, at least, that is going to change that. We don't have a lot of charge-offs, so we generally don't have a lot of recoveries, but we do try to recover every dollar that we do charge off. and have expectations that while on the accounting side we've had to eliminate it, the borrower still owes us money and we're gonna work through any channels that we can, that we have available to us to maximize those recoveries.
Daniel Tamayo: All right, terrific. Well, thanks for the call, Chuck. Appreciate it. You're welcome, Danny.
Operator: The next question comes from Brendan Nozzle with Hovde Group. Your line is now open.
Brendan Nozzle: Hey, good morning, guys. Hope you're doing well. Hey, Brendan. Morning. Let me just start off here on kind of funding and kind of the environment. Can you just update us on the competitive landscape for core funding and how that has evolved across your footprint over the past couple of months?
Chuck Christmas: Yeah, I would say that, you know, this is Chuck again. I would say it's been pretty consistent. We really haven't seen much in the way of deposit rates changing. You know, we always have, you know, the credit union issue to deal with, especially on the CD side of things. But our CD portfolio has stayed pretty steady. We've had really solid growth. We grew very significantly on a net basis during the first quarter. and I think we did see some deposit reductions in the second quarter on a local basis, but that was really seasonality, especially on the public unit side, as well as obviously April 15th with tax payments being due with primarily our business, but also some consumer customers as well. The third quarter is usually pretty good, mostly because of the public units when they start getting their taxes in on the property tax side of things here in Michigan. So we do expect some very solid local deposit growth here in the third quarter from that. But we've also seen very significant growth and Ray kind of touched on some of the numbers. Thank you. Thank you. and then the myriad of different cash management, treasury management products that we have. And you can see from the improvement or the growth, I should say, on service charges where that treasury management income gets recorded on our income statement, the solid growth there is really a reflection of the growth on the commercial side with those loan balances coming over with the associated deposits but also the expanded use as we continue to market our ever-growing suite of products to our existing customers as well. So on an overall basis, the deposits are growth, we're very pleased about that. I think that deposit growth along with bringing Eastern Michigan on board is letting us get out of the brokered CD market. We had significant levels of maturities here in the second quarter to the degree that we're down to only about $20 million left. There's two CDs there that both mature in December. So we're hopeful that we will be out of the brokered CD market by the end of this year. And again, that's really strongly attributed to the local deposit growth that we've been experiencing and expect to continue to have.
Brendan Nozzle: All right, thanks for the call, Chuck. One more from me, just turning to capital. Ratios continue to build nicely this quarter, even with kind of a return to more robust long growth. Is there a point at which the capital bill becomes something you want to more actively manage and kind of talk about the path through which you would do that and then kind of whether shared purchase is something you would be interested in if we continue to see ratios build?
Chuck Christmas: Yeah. Appreciate you noticing our calculations. Obviously, we're very pleased with that. Notwithstanding the strong growth that we do have on the asset side, we're able to grow our overall Capital ratios. It makes us feel good to have strong capital ratios. You never know what's going to happen from an economic standpoint, but it allows you to take advantage of the opportunities that come, whether it's acquisitions, loan growth, expansions in the markets, all those things. A position of strong capital gives you the ability to take advantage of those opportunities as they come about. I think from a buyback standpoint, clearly it's been quite a while since we bought back any shares. We do have a plan in place. Our board has always been supportive of management's recommendations with its buyback plans. I think a big part of that clearly is our stock price, and we're very pleased with the run that we've had. where we think that we're finally getting close to where we think we should be valued. We've been frustratingly below some of the benchmarks that we look at. So we're obviously pleased with what we've seen over the last few months there. I think the other thing that we're looking at, making sure we have capital to take advantage of those opportunities again, we do have our subordinated notes that do flip to a floating rate and become callable in January. You know, we're obviously looking at that. That is on our radar. We've made no decisions whatsoever in regards to that. Quite frankly, we would love to earn our way out of that position that we've got there. And I think we're definitely going in the right direction from that potential opportunity there. I think the other thing that we had very favorable pricing. We're not going to keep the 3.25% fixed rate that we have come January. Our spread over 90-day LIBOR, I'll say, is only 212 basis points, which if you did the math today, that's a rate that's still under 6%, which I think is very favorable compared to if you wanted to refinance that with a new sub note. I'm not saying we will or won't. We're not at that point yet. If we do start looking at the capital haircut, doing some calculations, that's about 30 basis every year. losing 20% of the balance. That's about 30 basis points off our total risk-based capital ratio. So looking at those numbers, looking at the environment today, all the forecasting that we're doing, we're comfortable with at least one year of letting that float, if not even a year after that or who knows more as we look at our capital stack each quarter end and certainly at each year end. So that's kind of our thoughts on capital is obviously we want to continue to augment it with a strong net income. pay a competitive and growing cash dividend, making sure that we've got lots and lots of capital to take advantage of the opportunities and continue to grow the company, which obviously is the foundation for additional net income growth. Awesome.
Brendan Nozzle: Thanks for taking my questions, Jeff.
Chuck Christmas: You're welcome.
Operator: The next question comes from Nathan Race with Piper Sandler. Your line is now open.
Nathan Race: Hey guys, good morning. Thanks for taking the questions.
Ray Reitsma: You bet.
Nathan Race: Chuck, I was wondering if you can unpack some of the specific margin drivers for the expansion that you alluded to over the next couple quarters, specifically around what amount of loans you have repricing upwards that are currently fixed, and also just in terms of securities cash flow coming off and kind of what that repricing looks like as well, assuming that's reinvested.
Chuck Christmas: Yeah, I know I gave one of the slides and there has the amount, oh, it's on slide nine. So yeah, there's definitely a few things that are going on that are having a positive impact on our net interest margin. On slide nine, we give the volume of fixed rate CRE, as well as our agency bonds that are scheduled not only to mature the rest of this year, but also into 2027. So a lot of opportunity for continued yield enhancement from that activity. The other thing that happened and it was, you know, it started really, really doing, having a bigger impact in the back half of the second quarter than the first half of the second quarter was our level of deposits at the Federal Reserve coming down. And that's really a strong reflection of the net loan growth. So, you know, obviously we've been, we've been, you know, dealing with some pretty sizable payoffs. Quite frankly, we had some sizable payoffs again. in the second quarter, especially with some line paydowns that came in with borrowers having excess cash in their operations. But as we continue to grow our loan portfolio, especially on the commercial side, we'll be able to use our existing excess funds that we've got at the Federal Reserve to fund that. So going from 3.65% that we get on our funds at the Federal Reserve to something probably in the sixes somewhere on the loan side. So as we continue to forecast that transition happening, that certainly buoys the net interest margin along with the repricing that we talked about. I would say those are the main drivers for the expected improvement in the margin.
Nathan Race: In short, Gene. Could you just help us in terms of kind of what that upward repricing looks like on the 100 million or so of loans that are expected to mature in the back half of this year? Are we talking about like something north of 6% kind of where like the blended rate on new loans are coming on the portfolio at or just any thoughts on kind of what the blended rate of New Loan Production is these days.
Chuck Christmas: Yeah, I say we would probably be looking at about a 200 basis point, give or take, obviously, improvement on the existing average rate of about 4.6%. So somewhere in the mid-sixes is where we would think that we would reprice on an average basis. And then we've got $38 million in agency notes. agency bonds at just a little over 1%. And based on our strategy right now, a buy-in net yield is a little over 4%. So we'll pick up about 300 basis points on those dollars for the rest of the year.
Nathan Race: Gotcha. And then if I could just ask one more on kind of deposit growth expectations going forward. And I appreciate the commentary earlier on some of the seasonality that impacted 2Q around tax payments and so forth. But Any visibility into the core deposit gathering pipeline? I know you guys have some excess liquidity you can use to fund loan growth, but just any thoughts on how deposit gathering can trend over the next few quarters as well?
Chuck Christmas: Yeah, like I mentioned, we'll definitely see some seasonality as we did in the second quarter. When you get to the end of the second quarter, and I'm speaking for all banks, basically, the public funds, especially here in Michigan, Public units in Michigan collect most of their taxes during the summertime, July and August and September. So you kind of get to the end of June and it's kind of at the low point with deposit balances. And then you kind of get to September and it's kind of the high point. And then obviously, you know, it goes up and down from there. I would say, you know, on a core basis, on an average basis, if you will, like I said, June 30th is a low point. So we would expect higher average balances from our public unit customers. in the future quarters just from the seasonality. Again, we continue to get very strong local deposit growth. Certainly, especially on the non-interest bearing checking, that's coming from our commercial activities, our commercial lending activities, especially on the C&I side. And as we talked about, that was really the leader of the growth on the commercial lending side. So looking at borrowers paying anywhere from funding 10 to 20% of their own loans with their deposit balances. So getting those obviously helps the cost of deposits, but also again, allows us to cross sell the treasury management products that we have, which helps the fee income side as well. We're also doing a really good job of just bringing in, finding deposit only customers and making sure that we've got, as we believe we do, a complete suite of products that is attractive to those types of customers as well. So a lot of us just, you know, blocking and tackling, you know, doing what Mercantile does, what a community bank does every day is out there selling our products and services and our values, driving relationships. We are a relationship bank on everything that we do. and so you know when we have a customer we want the whole ball of wax and you know deposits has to be a big part of that and so that that's you know that's we don't have any secret sauce magic bullets or anything like that we just do basic banking and making sure we're getting the entire relationship and when the customers come in making sure that we're taking really good care of them.
Nathan Race: I appreciate all the color. Thank you.
Operator: The next question comes from Damon Del Monte with KBW. Your line is now open.
Damon Del Monte: Hey, good morning, guys. Hope everybody's doing well today. So most of my questions have been asked and answered, but just a few quick ones here. Chuck, appreciate the color and the outlook there for the margin. If we were to see a rate hike in 2027, how would you expect the margin to respond to that?
Chuck Christmas: I think overall we think that we're pretty well stable on our net interest margin. We work very hard to make ourselves agnostic. We use that term all the time to interest rate changes. We specifically manage the structure of our balance sheet that when rates go up, we see yields go up, we see costs go up. When rates go down, we see the opposite happening. It's basic banking. It's match funding and looking at The structure of your loan portfolio, looking at your deposit base and then using your investment portfolio to kind of bridge any gaps you might have in there from a repricing perspective. I think if we have super aggressive cuts or increases, there'll be a little more change there just as some things have to catch up. But if we're looking at, you know, 25 basis points a quarter, 50 basis points a quarter, my expectation, our modeling supports the fact that we would expect our margin to stay relatively stable.
Damon Del Monte: Got it. Okay. That's helpful. Thanks. And then in your commentary around the kind of like the loan loss reserve outlook going forward, did you say that, you know, in the last couple of years, you've been kind of in the 120 range? Reitzman, and
Chuck Christmas: Factors, you know, our reserve factors for commercial loans is a little bit under 1%, while on residential mortgage loans is a little over 2%, which it really reflects, well, reflects a lot of things. But one of the things that definitely reflects is duration. I won't get on my soapbox this morning. But, you know, CECL is a duration based model, we're a commercial lender. And commercial loans are short term, and we're not allowed to while we have to take into account prepayments, and we definitely do that on the mortgage side. We're not allowed to look at ourselves as a relationship bank and make the assumption that we're going to renew loans. We're going to renew lines of credit when they mature in a year. We're not allowed to do that. So that's the biggest hindrance that we have when we're trying to build a reserve under the CISO framework is this duration expectation. And when your biggest asset has a duration of maybe two years, it's difficult to build a reserve. But we do. We got the different allocations and different and many more. and certainly if any of that downplay in the economy starts impacting specific customers and we have to start, you know, putting, you know, having some loans go out, you know, a higher volume of non-accruals and starting to do specific reserves, things like that, you know, would obviously result in a reserve build as well. I think all things being equal with a steady economy, our non-performers staying, you know, relatively stable, which they have. I would expect, you know, using your question, probably mid-teens. on a coverage ratio.
Damon Del Monte: Got it. Okay. That's helpful. Thanks for that color. And then I guess just lastly, when you think about the investments that you made in Southeast Michigan and you think about the outlook for growth, is that becoming a more key component of the overall driver of the portfolio growth or are you still seeing good looks in the greater Grand Rapids area and other parts of your footprint as well?
spk04: The answer is all the above. The outlook in southeast Michigan is good. We have a really strong team there. and they're early in their timeframe with us. So bringing over lots of customers and they've been very successful at it. It's a huge market with lots of potential. And yet in markets like Grand Rapids and the rest of West Michigan, Central Michigan, Northern Michigan, we're more mature in those markets, but there's plenty of opportunity there. So the originations are fairly well spread out across our footprint. on an even basis.
Matt: Curious, what was the spot cost of deposits in the spot NIM at the end of the quarter? And just curious how you feel about your ability to either maintain or further lower deposit costs from here.
Chuck Christmas: You know, Matt, I would say that when you look at our yields for the quarter, I think that's really reflective of our deposit rates. We didn't change deposit rates, I don't think, at all during the quarter. You know, there's some opportunity for some repricing on the CD side, but it's not a huge component. and I don't think the repricing is overly significant. So I think if you look at the yields on our deposits for the quarter, I think that's reflective of where our rates are even today.
Matt: Okay. And then on commercial real estate, you'd mentioned, you know, you expect some slowdown and payoff prepayment activity. What gives you that confidence? And, you know, what is expectation for commercial real estate growth in the coming quarters?
spk04: Thank you for joining us. Of course, they reserve the right to change their mind. So, you know, who knows exactly what the future will bring, but the communication has been that those should continue to moderate.
Matt: Okay, and then just last one. You've spoken a couple of times about kind of the mix shift of cash into loans and how that's accreted to the NIM. Just curious what your definition is of excess cash. Tends to move around a little bit with seasonal deposits, but from where we sit today at about 5% cash to assets, how much of that do you think is excess?
Chuck Christmas: Yeah, if you looked at our balance sheet, I think if you looked at interest earning assets that we have that we mark on our balance sheet, that number would be somewhere between $100 and $125 million.
Matt: Do you have a timeframe expectation to kind of mix shift that?
Chuck Christmas: You know, we'd love to be able to do it by the end of this year. Of course, that's really, you know, net commercial loan growth is going to drive that based on our fundings and any of the payoffs that we do get. But I would think that by early next year, we would be able to get there, if not by the end of this year.
Matt: Okay, great. I'll leave it there. I appreciate all the answers.
Operator: You betcha. This concludes our question and answer session. I would like to turn the conference back over to Ray Reitsma for any closing remarks.
spk04: Just want to thank you for your participation in today's call and for your interest in Mercantile Bank Corporation. And that concludes today's call.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
