Mercantile Bank Corp (MBWM) 2021 Q3 法說會逐字稿

Good morning, and welcome to the Mercantile Bank Corporation Third Quarter 2021 Earnings Results Conference Call. Please note this event is being recorded. (Operator Instructions)

Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to the factors described in the company's latest Securities and Exchange Commission 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 third quarter '21 press release and presentation deck issued by Mercantile today, you can access it at companies -- at the company's website, www.mercbank.com.

At this time, I'll turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski.

Thank you, Anthony. Good morning, everyone. Thank you for joining our call today. Our Mercantile team continues to generate outstanding financial results that illustrates the strength of the high-touch relationship-based approach to banking that has allowed us to build long-term relationships with our clients.

For the third quarter, we earned net income of $15.1 million or $0.95 per share, a nearly 41% increase from the third quarter of 2020. Through the first 9 months of the year, net income of $47.4 million is up more than 57% from the prior year period. Driving those strong bottom line results are 2 key components: robust organic double-digit loan growth leading to healthy net interest income expansion and very strong noninterest income generation that contributes nearly 1/3 of our total revenue.

The success of these 2 revenue components starts with one thing, our people. Mercantile has a clear strategy and client-centric culture that permeates all levels of the organization. Our team executes on that strategy in our markets each and every day. We believe Mercantile will again be distinguished by our commercial loan production in the third quarter with a 25% annualized growth rate, excluding PPP loans. The growth is well balanced and diversified among the various loan categories. Ray will explore our loan portfolio in more detail later in this call, but I would like to provide some insights into how we achieved these results and why we have confidence in our ability to continue doing so.

Supporting our local communities is at the forefront of who we are. Challenging as it has been, the pandemic gave us the opportunity to prove that we can service our clients at the highest level under any circumstances. We answered the call for Michigan businesses sometimes when their incumbent banks did not, and these companies were able to experience the Mercantile way firsthand. Our responsive local decision-making and high-touch approach is clearly resonating with business leaders. Many of them need more from their bank than simply a place to conduct transactions, they need a true financial partner.

Our core commercial loan growth in the third quarter, our solid and sustained pipeline show that our approach is an effective one. I'd like to note that even as we -- we've grown loans and navigated the ongoing pandemic, our asset quality remains strong. We continue to report low levels of past due loans and nonperforming assets illustrating our commitment to sound underwriting as well as strong performance of our commercial borrowers and their management teams.

On the mortgage side, our nimbleness and in-market local lenders also contribute significantly to our success. That leads me to a second key element of our success I would like to highlight. The strength and diversity of our noninterest income, of which mortgage banking is the largest component. Our mortgage banking income totaled a solid $6.6 million for the third quarter and $23 million year-to-date, up 17% for the first 9 months of last year. These results are driven by our ability to generate those originations, which in turn, result in our success -- from our success in hiring mortgage bankers who are well connected in their communities. We believe we are well positioned to capture more market share in upcoming periods based upon our team's proven efforts and the positive application and pipeline volume trends we continue to see.

Another strategic decision that has proven beneficial was the interest rate swap program we launched in late 2020. This new revenue stream helps us ensure we remain competitive with a broader base of commercial customers. Swaps generated $3.9 million in fees for the 3 months ended September 30, 2021, making up 1/4 of our noninterest income this period.

Total noninterest income was up more than 17% from the prior year third quarter. We remain committed to the strategic focus on diversifying and growing our fee and sources. For the last 12 months, noninterest income has made up more than 31% of operating revenue compared to 22% at the median $5 billion to $10 billion bank range in the most recent quarter.

As I mentioned earlier, our people are behind these results, and we've long supported them through investment in technology. Digital adoption accelerated since 2020 and some banks find themselves playing catch-up. Within our operations, we adapt industry best practices while leveraging available data to capture efficiencies, customize unique client interactions and refine our internal systems.

We have long made investment in technology, an important aspect of our business model, and will continue to grow as our customers' needs continue to evolve. Our combination of people, products, services and technology are clearly driving financial strength and organic growth. Importantly, this supports our ongoing focus on creating shareholder value in a truly sustainable organization.

Today, we announced a fourth quarter cash dividend of $0.30 per share. Regarding our stock buyback program, we're able to repurchase an additional 288,900 shares of Mercantile stock, bringing year-to-date purchases to 635,800 shares.

Overall, we believe our strategy, talent, culture and business model all support our continued and consistent high performance for the benefit of our clients, communities and shareholders. We have a strong foundation, momentum headed into the fourth quarter and 2022 and are prepared to capitalize on the ongoing M&A-related disruption in our markets, both in terms of attracting talent and expanding client relationships.

That concludes my introductory remarks. I'll now turn the call over to Ray.

Thanks, Bob. Today, my comments will center around 3 topics and evidence in the third quarter results: Strong core commercial loan growth; strategic growth and sustainable noninterest income; and increasing efficiency in operations.

First, core commercial loan growth. For the third quarter, we are reporting core commercial loan growth of $162 million, representing a 25% annualized growth rate, 62% of which is C&I credit. Year-to-date, core commercial loan growth is $298 million, represent a 16% annualized growth rate, 60% of which is C&I credit. I'd like to stress that the growth consists primarily of C&I credit in line with our strategic objectives. This growth has been possible due to the efforts of our commercial team and their focus on relationship building in the business community bank value proposition.

The pandemic and the PPP program gave us the opportunity to prove in action what we have marketed in concept, namely that Mercantile represents the capacity and technology they need coupled with timely local decision-making and exceptional service. We delivered when many faltered. As a result of our robust growth, we increased our provision expense largely to support that growth. We have also dialed back our stock repurchase program in recognition of the fact that this robust level of growth requires robust capital support. Our backlog remains consistent with prior periods as we fund this impressive level of core growth.

Secondly, strategic growth in sustainable noninterest income. During the first 9 months of 2021, we reported year-to-date noninterest income of $42.5 million net of gain on a branch sale compared to $30.8 million last year, an increase of 38% and $11.7 million. How do we make the case that this is a sustainable performance? Swaps represented $6.1 million of the growth and represent meeting customer demand for fixed rates without taking on the balance sheet risk of a conventional fixed rate, which is very important to margin sustainability in the present environment.

Our term debt funding has been nearly 50% fixed over a long period of time, and we do not expect the mix to change meaningfully. Our mortgage activity ran $3.3 million of the growth in noninterest income year-to-date as our team has grown production from $645 million last year to $742 million this year. The case for sustainability in this business is supported by the fact that last year's volume represented a mix of 30% purchase activity to 70% of refinance activity, while the present year mix is a 50-50 split between purchase and refinance activity. And of course, purchase activity is far more sustainable than refi activity.

Lesser but important contributors to the noninterest income picture are the role of service charges on accounts and credit and debit card income, which increased by 17% and 19%, respectively, during the third quarter, reflecting the growth in the number of relationships served as well as increased activity within the accounts as the economy recovers from the pandemic. In sum, noninterest income made up 32% of revenue for the first 9 months of 2021, up from 25% in the prior period.

The final topic of my comments is increasing efficiency in operations. Year-to-date, we are reporting an efficiency ratio of 57.4% compared to 59.9% for the comparable period last year. Our consistent spending on technology over the years has served us well. allowing our customers to utilize numerous digital channels as alternatives to visiting a branch and providing the ability to reallocate resources towards further enhancements in an already up-to-date digital platform. It's worth noting that this period of robust loan and noninterest income growth, our FTE increased by only 11% from the prior year period to a total of $629 and that year-to-date revenue growth of 11.4% outpaces noninterest expense growth of 6.8%.

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

Thanks, Ray. Good morning to everybody. As noted on Slide 22, this morning, we announced net income of $15.1 million or $0.95 per diluted share for the third quarter of 2021, up over 40% from the $10.7 million or $0.66 per diluted share for the respective prior year period.

Net income during the first 9 months of 2021 totaled $47.4 million or $2.95 per diluted share, up over 57% from $30.1 million or $1.85 per diluted share during the first 9 months of 2020.

Turning to Slide 23. Interest income on loans during the 3- and 9-month 2021 period was relatively consistent with the prior year period as growth in core commercial loans and residential mortgage loans has largely mitigated the negative effects of the FOMC rate cuts totaling 150 basis points during March of 2020 and ongoing low interest rate environment since that time.

Interest income on securities in the third quarter of 2021 is 9% higher to the same period -- compared to the same period in 2020, in large part reflecting growth in the securities portfolio over the past 12 months. Securities interest income in the first 9 months of 2021 is relatively unchanged from the respective time period in 2020, with accelerated discount accretion, I'd call, U.S. government agency bonds in 2020 is excluded.

In total, interest income for the most recent quarter increased $0.3 million for the third quarter of 2020. However, it was down $4.2 million for the first 9 months of 2021 as compared to the respective prior year period, in large part reflecting a lower interest rate environment that cannot be fully offset with the growth in earning assets.

Interest expense declined or remained relatively unchanged in all categories during the 2021 period compared to the prior year period, with the reduction reflecting a low interest rate environment. In total, interest expense declined $1.3 million during the third quarter of 2021 compared to the third quarter of 2020 and was down $5.4 million between the comparable year-to-date periods.

Net interest income increased $1.6 million during the third quarter of 2021 compared to the third quarter of 2020 and was up $1.1 million during the first 9 months of 2021 compared to the respective prior year period. Overall, growth in earning assets was able to essentially offset a lower net interest margin.

We recorded provision expense of $1.9 million for the third quarter of 2021 compared to provision expense of $3.2 million for the prior year. For the first 9 months of 2021, we recorded a negative provision expense of $0.9 million compared to provision expense of $11.6 million during the respective prior year period.

The provision expense recorded for the third quarter of 2021 mainly reflected growth in core commercial loans, while the prior year provision expense was primarily comprised of increased allocations associated with the downgrading of certain nonimpaired commercial loan relationships to reflect stressed economic conditions stemming from the COVID-19 environment.

The negative provision expense recorded during the first 9 months of 2021 primarily reflects increased reserves needed for the core commercial loan growth that was fully mitigated by a lower reserve allocation associated with the economic and business conditions environmental factor that was upgraded during the second quarter, reflecting improvement in both current and forecasted economic conditions.

The relatively large provision expense during the 2020 year-to-date period primarily reflected an increased reserve allocation associated with the economic and business conditions environmental factor, the introduction of the COVID-19 pandemic environmental factor and the aforementioned third quarter 2020 commercial loan downgrades.

We elected to postpone the adoption of CECL until January 1, 2022. However, we continue to run our CECL model concurrently with our incurred loss model. Based on preliminary results, the reserve balance under the CECL methodology would be about $7.2 million lower than our reserve balance as of September 30, 2021, as determined using the incurred loss methodology. This is an increase from the $6.6 million difference at June 30 and a $2.6 million difference at year-end 2020.

The primary difference between the 2 reserve models over the last few quarters is related to the economic forecast aspect of the calculation. Under CECL, the employed economic forecast has shown significant improvement. Under the incurred model, our view of economic and business conditions is generally positive and improving, but less so than what is reflected in market economic forecasts. We will continue to assess all of the qualitative factors at the end of each quarter and we'll adjust the loan loss reserve balance via the provision expense line item on the income statement.

Continuing on Slide 25, overhead costs during the third quarter of 2021 were relatively unchanged when compared to the year ago quarter, while increasing $4.9 million during the first 9 months of 2021 compared to the first 9 months of last year.

During the third quarter of 2020, we recorded a large bonus accrual due to a change in estimate associated with the bonus plan metrics as no bonus accruals were recorded during the first and second quarters due to COVID-19 and the associated weakened economic environment. The bonus accrual in the third quarter of 2020 was $1.1 million higher than what was recorded during the third quarter of this year.

The lower bonus accrual in the third quarter of 2021 mitigated the impact of higher salary expense stemming from annual employee merit pay increases, higher medical insurance costs and increased FDIC insurance premiums, largely resulting from an increased deposit base. About 60% of the increase in year-to-date overhead cost resides in salary and benefits, with almost half of that figure being comprise of increased medical insurance costs. The remaining portion is primarily comprised of increased FDIC insurance costs and former facility valuation rate balance.

Currently, we expect fourth quarter 2021 overhead costs to approximate the third quarter expense. As far as 2022 overhead costs, we are in the initial stages of developing our 2022 budget. And while I don't have any specific guidance to provide at the current time, we are expecting larger than typical increases in salary costs due to inflationary pressures in our market and the addition of new employees to support expected ongoing loan growth and revenue initiatives.

Continuing on Slide 26. Our net interest margin was 2.71% during the third quarter of 2021, down 5 basis points from the second quarter and first quarter of 2021 and down 15 basis points when compared to the third quarter of 2020. Compared to the year ago third quarter, the yield on earning assets decreased 32 basis points while the cost of funds declined 17 basis points for the most recent quarter.

Our yield on loans has been relatively consistent over the past 5 quarters, except during the fourth quarter of 2020 when we recorded a larger than typical PPP fee income accretion. As seen on Slide 21, net PPP fee income accretion of $2.8 million during the third quarter has been very consistent since the origination of the program, except for the aforementioned fourth quarter of 2020.

As of quarter end, unrecognized PPP net fee income totaled $3.4 million, a vast majority of which is related to PPP round #2 fundings. Assuming PPP forgiveness trends remain unchanged, we expect a large majority of the remaining unrecognized PPP net fee income to be reported -- recorded as income during the fourth quarter of this year.

Our net interest margin continues to be negatively impacted by a significant volume of excess on balance sheet liquidity, depicted by low-yielding deposits with the Federal Reserve Bank of Chicago. The excess funds are a product of increased local deposits, which are primarily a product of federal government stimulus programs as well as lower business and consumer investing and spending.

Total local deposits and sweep balances increased $538 million or 15% during the first 9 months of 2021 and are up $1.4 billion or 51% since year-end 2019. Approximately 1/2 of the growth in local deposits since year-end 2019 is comprised of increased noninterest-bearing checking account balances.

Overnight deposits averaged $734 million during the third quarter and $649 million during the first 9 months of 2021, substantially higher than our typical average balance of around $75 million. This excess liquidity lowered our net interest margin during the third quarter and first 9 months of 2021 by about 40 to 45 basis points. We expect the level of overnight deposits to stay elevated well into the foreseeable future.

The cost of funds has been on an improving trend, primarily reflecting the falling interest rate environment, and we expect that trend to continue throughout the remainder of 2021 and into 2022 as time deposits and FHLB advances originated in higher interest rate environments in prior periods mature.

As shown on Slide 30, we remain in a strong and well-capitalized regulatory capital position. The Tier 1 leverage capital ratio was 9.3%, and the total risk-weighted capital ratio was 12.5% as of September 30, 2021. The Tier 1 leverage capital ratio continues to be impacted by the PPP loan portfolio and excess liquidity with no similar impact on the total risk-based capital ratios as both components are assigned a 0% risk weighting. Both our Tier 1 leverage capital ratio and the total risk-based capital ratio are impacted by the solid core commercial loan growth over the past several quarters as well as stock repurchase activity.

Our bank's total risk-based capital ratio was $94 million above the minimum threshold to be categorized as well capitalized. We repurchased about 289,000 shares for $8.9 million at a weighted average cost of $30.97 per share during the third quarter of 2021, bringing our year-to-date total up to 636,000 shares for $19.8 million at a weighted average cost of $31.14 per share. The year-to-date weighted average cost equates to about 125% of average tangible book value.

During the second quarter of 2021, our Board of Directors approved a new $20 million stock repurchase plan as we were close to exhausting our then outstanding plan. As of September 30, we had $8.4 million available in our repurchase plan.

In closing, we are pleased with our operating results during the first 9 months of 2021 and financial condition as of quarter end and believe we are well positioned to continue to navigate through the unprecedented environment created by the coronavirus pandemic and other events.

Those are my prepared remarks. I'll now turn the call back over to Bob.

Thank you, Chuck. That concludes management's prepared remarks, and we will now open the call up for the Q&A.

(Operator Instructions) Our first question comes from Brendan Nosal from Piper Sandler.

Maybe starting off on the loan growth side of things. I mean you guys have managed to kind of work your way through what was a slow growth environment for most other banks incredibly well. But even so this quarter's number just seemed exceptionally strong to me. Could you just offer a little bit more detail on kind of what you're seeing in your commercial customer base that's allowing for such strong credit generation? And then maybe your thoughts on where the pace of growth goes from here?

Yes. This is Ray. I'd be happy to address that. The case for where it goes from here is pretty strong. Right now, we've obviously funded pretty heavily over the last quarter. But the backlog that we have to fund going into this quarter is very strong as well. So the activity continues, I'd say, unabated from what we've recorded in the historical quarter.

And it's largely comprised of adding new relationships to the roster. Our existing customer base is growing to some degree. But the lion's share of the growth comes from adding new relationships for the reasons that we've outlined in all of our comments that the relationship banking approach and the ability to deliver that in spite of a challenging environment has just resonated very well in the communities that we serve. And as simple as that sounds, that has been the key because if you don't get the service you're looking for, it sense you're looking, and we've been there on the receiving end of that time after time.

It's really a strong tribute to our team. And despite the challenging work conditions for them, whether they were working remotely with a hybrid approach or in the office, they've -- they understand the importance of providing timely responses to customers and continuing to bring those new relationships to the finish line, they work very hard to do that. And again, it's a distinguishing factor that the customers are seeing as they compare Mercantile to other banks in our markets.

All right. Great. That's super helpful color. Maybe one more for me. Just trying to think about your asset sensitivity and the positioning of the balance sheet today for rising rates just given how much the structure of the balance sheet has changed over the past 1.5 years. So with the fed and the market seeming to anticipate rate hikes maybe at some point late next year, can you just remind us what each rate hike means for either NIM or net interest income?

Yes. This is Chuck. I don't have those specific numbers in front of us. But definitely, our balance sheet would be structured to provide for increased net interest income and margin under increasing interest rate environment. And I think those numbers -- I know those numbers are available in our Form 10-Q, so if you want to get them quicker or I can get them to you off-line here?

Yes. No, that's fine. Just kind of more conceptually wanted to see how you think about it.

Our next question comes from Daniel Tamayo of Raymond James.

Just wanted to maybe dive into the allowance a little bit. You talked about the COVID factor that's now in that allowance. How much of that remains? And assuming that comes out eventually, where do you think reserves could shake out over the next couple of years?

Yes. The COVID environmental factor is probably about 20% to 25% of our balance of our reserve as of September 30. And again, this is one of the qualitative items that we have on the calculation along with all the other ones. And so we're obviously hopeful that we get to a point in time where we can start upgrading that environmental and sooner than later, hopefully, eliminate that altogether.

Okay. So safe to say we could essentially -- if we put that amount out, that would be a reasonable, I guess, normal -- also including what you said about the CECL adoption that might be a normalized reserve ratio in the future?

Yes. I mean it certainly gets to a pretty low number and that's not something that, quite frankly, we're comfortable with, but that's what the world of CECL is dictating to us. That's one of the reasons why we did pull the range back as long as we could on adopting that one because it's a duration-based model. And of course, our loan portfolio is dominated by commercial loans, which by nature are relatively short term.

The duration of our commercial loan portfolio is probably just a little bit above 2 years, and that does result in a relatively -- it results in a lower level of reserves against our commercial loan portfolio than what the incurred model does. And you couple that with very pristine asset quality, it makes it a challenge to keep your reserves up as much as what you think that they should be with the CECL model.

No, that makes sense. And then switching gears here. Your comment on the increased overhead costs related to higher salary from wage inflation and incremental hiring related to your strong loan growth, understandable on both sides there. But how do you think that impacts kind of overall efficiency? Is that something you still think that revenue growth can outpace? Or how does that impact the overall thoughts on profitability?

Yes. I'll probably have -- I know I have some more specific comments for you in January once I can get through the budget season and put some longer-term forecast together given the environment that we're in currently and what we think is going to happen in the future. I think in the near term, my comment was basically to say we think there's going to be some larger than typical growth in overhead costs starting pretty much next year when the pay rates go through and the hiring continues.

Certainly, long term, we expect to leverage off of the new employees that are coming in to support that loan growth and fee revenue. And as Ray was pointing out, we've been able to demonstrate that our revenue is growing faster than what our overhead costs are. So it might get a little bit choppy on a quarter-to-quarter basis, but we think that we are well structured to continue to grow like we have been and make sure that, that revenue is growing faster than our overhead costs are.

And I think one thing I would add is on the technology side, and Bob had a couple of comments echoing this in his opening remarks is we've stayed, I'll call it, state-of-the-art since day 1 this bank was formed. And we continue to do so -- and we've got a platform that lease or exceeds than the other banks that are out there that we're competing against. And more importantly, we continue -- we have to continue to fund that program all along, and so we are current on everything that we need to be. And so we don't have any big catch-up expenses or investments that we have to do from a technology side, just the continued ongoing upgrades and the introduction of new products and services as those become available.

Our next question comes from Damon DelMonte of KBW.

So my first question regarding fee income. Could you just talk a little bit more about the outlook for mortgage banking and kind of how you see the pipeline here early in fourth quarter?

Sure. Early in the fourth quarter, the pipeline is stronger than you'd expect from a seasonal pattern standpoint. Typically, at this time of the year, the volume starts to ramp down a little bit, and our trend line has resisted that.

So the early indications for the remainder of the quarter are pretty good at this point. And the market remains strong in the communities that we serve as it relates to purchase activity. We've made successful shift from refi to purchase activity. I'd submit maybe a little bit faster than our peers. And so I feel pretty good about what the quarter will bring.

Okay. Great. And then as far as the swap income that you guys booked this quarter, obviously very strong. Do you see that pulling back a little bit and coming down to a little lower level? Or do you think that the growth in this business is going to be sustainable at this near $4 million level?

As I mentioned in my comments, I view that as sustainable for a couple of reasons. One is, over a very long period of time, half of our term funding has been in the form of fixed rates, which is what the swap accomplishes for the customer, while providing our balance sheet with debt with floating rate characteristics.

So there's plenty of opportunity to continue that the swap doesn't fit every situation. You need a certain amount of size and customer sophistication and wherewithal to bring it all together. However, our opportunities in that arena do not appear to be diminishing in the near future. And I would expect that we continue at a similar pace out into the foreseeable future.

I guess I would just add to Ray's comments, definitely going to be lumpy on a quarter-to-quarter basis, just the nature of the program that's out there. About half of the income that we recorded during the fourth -- during the third quarter, excuse me, was related to prepayment fees.

We had a couple of larger customers refinance our existing fixed rate debt into float-rate debt with a swap. And generally, in our program, what we do instead of having the customer pay that prepayment penalty in cash and we record that as interest income, we instead embed that into the swap metrics and then we'll get the fee paid by the correspondent bank that we swap out with. We get, I would say, an oversight fee, if you will, whatever you want to call it.

So there's 2 things that are going on with swap income. One obviously is activity. The other question is going to be to what degree is the refinancing of existing fixed rate loans which virtually all of them have prepayment penalties on and we are going to collect those -- how those play out.

Damon, this is Bob. I guess I'll wrap up on this topic by saying that the swap is not a good fit necessarily for every customer. Our lending team has done a really good job of identifying those client situation or this is a good fit and the sophistication is there and the attributes that Ray alluded to are present to be able to benefit the customer and allow them to get what they're after in a rate for a term loan and helps us accomplish our balance sheet objectives from a banking standpoint.

Got you. That's good color. And then just kind of one follow-up question on overall noninterest income. The other noninterest line was like a little bit over $1 million this quarter, which was higher than normal. Chuck, was there anything kind of onetime in there?

Yes, it's about $600,000 in onetime. We finally went through finalized the collection efforts on a credit that we have been working on since the Great Recession. So it finally made its way through the court system and all the appeals and we finally got our payment. So about $600,000 of that is one time.

Okay. Great. And then just kind of quickly here on the size of the securities portfolio, obviously, a decent increase quarter-over-quarter. Do you expect to keep that level of securities on the books? Or is that just going to be dictated by the pace of loan growth? Or how do we think about that?

Yes. I think the growth that we did in the third quarter is pretty similar to the growth that we've had over the last 4 quarters. Probably about this time last year, we really started adding to the portfolio when it became pretty obvious to us that the excess liquidity was going to stay on the balance sheet for quite some time. And those do we know the excess liquidity is actually built on spend even with those securities purchases and loan growth.

So I would expect that certainly here in the fourth quarter, the growth will continue as it has been over the last 4 quarters or so. At some point, that will slow down especially when we see commercial loan growth continuing and a lot of that is going to also depend on the behavior of the deposits, which is really the driver of the excess liquidity overall.

We continue to put most of that money is going into government agency bonds generally with 3 to 7, 8-year -- 3- to 8-year time bucket. So what we've been doing is basically just staying with the laddered maturity and just growing those ladders. And we certainly want -- as time goes on, we certainly would like to have that buildup of the securities portfolio that we've done, we would love nothing else than to take those investments as they mature and put those into the loan portfolio.

So we'll definitely have that opportunity from a cash flow standpoint. It's not needed for loan growth. I would think rates are probably going to be up over the next few years, and then we'll be able to refinance those monies at higher rates. So we think it's a good use of that excess liquidity, not being overly aggressive in trying to reach for yield given extended maturities. We have not bought any types of -- different types of investments than what we've ever built -- bought before. So we're staying disciplined there and think we've got a good program in the future.

Got it. Okay. Great. And then just one final question. Just to circle back on the provision/reserve outlook, we saw a larger-than-expected provision this quarter more so than what we've seen in the last few quarters, and that was in response to loan growth. Given the optimism and continued loan growth, should we expect the provision level similar to kind of what we saw this quarter?

Yes. I think like we said, a vast majority of that $1.9 million was for loan growth, and we did not touch on any of the environmentals this quarter, so I think that's important. We had loan growth in the second quarter that we had to provide for. We ended up with a negative provision for the quarter because the change in the economic environmental was more than offset the growth we had in the commercial loan portfolio and, therefore, the provision expense associated with that. But all things being equal, I think that commensurately, the loan growth will provide for a similar amount of loan provision expense going forward without messing with any of the environmentals.

Our next question comes from Bryce Rowe of Hovde Group.

Maybe one follow-up here on the swap income side of things. Wanted to get a feel for the level of prepayment income that's affected that line this year -- not just this quarter, but this year. And then if you could speak to maybe the potential for more prepaid-type income within that line as we move forward? Just trying to get a feel for how much fixed rate activity do you still have within the portfolio.

Yes. Bryce, as I mentioned before, that was going to be a tough one to budget for, especially on a quarter-to-quarter basis, just given the nature of what we're dealing with. I would say, like I said, for the third quarter specifically, about half the income was related to prepayment fees, that's definitely a higher percentage than what the $6.1 million represents.

So I'd probably say maybe 1/3 of the $6.1 million so far this year is associated with the collection or the embedding of prepayment fees into the swap and the collection of it through that means. And I think Ray mentioned, it's about half of our portfolio -- just commercial loan portfolio is fixed rate. And while we don't look to put all of those into a floating rate with a swap attached, there's definitely some opportunities there. This management team is -- I'm not -- I don't know -- that we're concerned of how much high that rates are very, very low, and we definitely see a lot of inflationary pressures.

And obviously, we're in an unprecedented environment that is causing some of those inflationary pressures. But we are very cognizant of what could happen to our income statement if interest -- medium and longer-term interest rates were to rise appreciably. And we're definitely through this program and other things trying to make sure that we position our balance sheet that would be -- that would perform well in that environment.

Clearly, there's a little bit of pain on the front end, especially on the refinance activities when we take the higher rate -- fixed rates and put them in the floating rates, but we think that, that insurance policy, if you will, is definitely the right thing to do. As both Bob and Ray mentioned already, the swap program isn't for everybody.

So we're not -- we don't really even have the opportunity to take the fixed rate commercial loans and put them into floating rates. We don't really want to do that. But we definitely look at the larger balance loans, those with more sophisticated management teams. Clearly, we want to make sure that our borrowers understand the workings around the swap, how it works and then some of the handcuffs that puts up that could potentially put on them as they continue to run their businesses. So there's plenty of opportunity there. That's -- we're talking so far about existing loans.

Certainly, when we're looking at new loans to the bank, new borrowings from existing customers, they -- many of them get really meeting those size and sophistication goalposts. If they want a fixed rate product, we're definitely talking with them about the swap program. So there's lots of opportunity out there, both in the existing portfolio as well as the growth. But trying to determine how much that's going to equal on a quarterly or even annual basis. It's just -- it's a hard one to project just given the nature of the product.

It's difficult, as Chuck said, to forecast certainly. And the way we look at the swaps, it's another tool and toolbox that we have and trying to assess what's best for the customer and what are their needs and structure a credit package that makes sense for them, it makes sense for us as well.

So it's a great program. I hats off to the team for putting this program into place because it meets the need in this environment, and it's something that provides us with some nice benefit on the income side. And as importantly, it puts the customer in a situation that meets their needs as far as their credit request.

Great. A couple more questions here for me. Just curious what you're seeing. Obviously, PPP introduces quite a noise and volatility around kind of yields and NIM. Could you give some commentary around what you're seeing from an originated yield perspective in this quarter versus recent quarters?

Yes, I've got the least in my head here. I got that the PPP program this year has been pretty consistent for us, the impact on the income statement. And on an overall net interest margin, it's about a 15 basis point positive impact, the fee accretion. I would expect, as I mentioned, I think I mentioned in my prepared remarks.

Based on the trends that we see, we would expect the vast majority of the remaining dollars to be forgiven, paid off here in the fourth quarter. That's something we have very little control over because it's all about our borrowers making the applications and the SBA funding things, but the trends seem pretty steady. So I think we'll have a little bit of a tail, I think, going into next year. But for the most part, we'll be done with the program here at the end of the year.

Okay. And then maybe last one for you, Chuck. In terms of CECL, is it still kind of go forward January '22 with that adoption?

Yes. Let's see. Give me another extension up particularly, but I don't think I'm going to get that one. So yes, January 1, 2022, is the day we will convert to CECL.

Our next question comes from Brendan Nosal of Piper Sandler.

Just one follow-up for me. Just on the COVID factor still in the reserve and then the kind of day 1 CECL reduction in reserve, I just want to make sure that those -- there is some overlap presumably between the 2 numbers, right? Meaning upon CECL adoption, you'll be releasing some of that remaining COVID reserve factor. Is that the right way to think about it?

Well, I look at those as 2 totally separate. We do have the COVID factor is part of our CECL model. And as we go from incurred to CECL, it's a separate decision as to what we really want to do with that COVID environment.

So if we keep the COVID environmentals steady and we would have adopted October 1, we got a little over $7 million excess there that we would run through capital and make that adoption to CECL. That's the way it plays out right now. But the adoption of CECL and what we do with the COVID factor are really 2 separate decisions or 2 separate impacts.

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

Thanks, Anthony, and thank you all very much for your interest in our company. We hope you and your families stay healthy and safe. And we look forward to speaking with you again at the conclusion of the fourth quarter at our conference call in January. The call has now ended.

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