Mercantile Bank Corp (MBWM) 2021 Q2 法說會逐字稿

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

I would now like to turn the conference over to Jeff Schoenborn, Lambert Investor Relations. Please go ahead.

Thanks, Gary. 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 second quarter of 2021.

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, President of Mercantile Bank, Michigan.

We will review the call with management's prepared remarks and presentation to review the quarter's results, then open the call up to questions.

However, before we can begin today's call, 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 second quarter 2021 press release and presentation deck issued by Mercantile today, you can access it at the company's website, www.mercbank.com.

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

Thanks, Jeff, and good morning, everyone. On the call this morning, we will provide you with detailed information on the company's performance in the second quarter. Mercantile has once again accomplished a strong quarter and along with progress being made with the COVID-19 pandemic, including widespread availability of vaccinations across the country and the reopening of the Michigan economy specifically, we remain very optimistic about our future performance.

Although we have spent the better part of the last 1.5 working remotely, our dedicated teams did not miss a beat. As we continue to return to an environment of normalcy in our communities, the extraordinary work that was done by our team in '20 and into 2021 has set the stage to allow us to remain intensely focused on our mission of acquiring new customers and servicing existing ones to the highest level of standards.

With businesses working to reopen more fully as they strive to return to pre-pandemic performance, we continue to closely monitor COVID-19-related developments, while always prioritizing the health and safety of our customers and employees. We seek to consistently find ways to operate effectively within whatever the current conditions and environment may be.

Our full-time line of COVID-19 related activities can be found on Slide 10 of our deck.

Our teams demonstrate continued resiliency and investability as we close out the second quarter, delivering another very strong period of financial performance. We achieved net income of $18.1 million and per share earnings of $1.12, which includes a negative provision for loan losses for the quarter reflecting the continuing improvements in both current and forecasted economic conditions. Our focus on achieving strong and sustained growth has positioned us well for ongoing creation of shareholder value.

Today, we also announced the third quarter cash dividend of $0.30 per share as we remain committed to delivering the consistent high performance our shareholders have come to expect.

During the second quarter, we also continued with purchases under our stock buyback program. Chuck will dive deeper into the details of our financial statements for the quarter, which again highlight our ongoing strength in mortgage banking income, sound asset quality, strong growth in core commercial loans as well as managed overhead costs.

We remain persistent in identifying new ways to improve our fee income, especially growing the bank -- while growing the bank to create additional value for all of our stakeholders. Especially in light of improving COVID-19 conditions, we have been able to leverage our strategic initiatives that are designed to increase market share.

Over the past few months, we have seen great progress achieved by our cities and communities to resume economic activity as the effects of the pandemic subside. We remain encouraged by these steps and are enthused about our ability to meet the changing needs of our customers as we have prioritized our efforts to further strengthen our relationships within these markets in support of transitions towards economic growth and recovery.

Throughout the quarter, we demonstrated strong core loan growth by meeting the credit needs of our existing customers while fostering relationships with our new and prospective clients. Our loan pipelines remain solid, and our asset quality continues to be extremely strong. Our mortgage banking team continues their incredible performance in the second quarter. While refinance activity remains robust, our volume of loans to finance home purchase exceeded refinances during the quarter. We believe we are well positioned to capture an even greater share of the mortgage banking market in upcoming periods as a result of our team's proven record of fast, effective delivery of mortgage products to our markets, supplemented by our recent strategic hires of seasoned lenders, both in our current and new markets.

Ray will provide you with the highlights of the operations of our company in his comments.

We are pleased with our ongoing activities to adapt industry best practices while leveraging available data to capture efficiencies, customize unique client interactions and refine our internal systems. The success of our commercial loan interest rate swap program delivers value to our clients and help position us to improve our long-term loan yields. Our sustained growth and other key fee income categories and the increase in debit and credit card income above pre-pandemic levels demonstrates our focus on noninterest income, revenue streams and our continual efforts to gain additional profitability for our company.

Digital delivery remains a primary focus for Mercantile Bank as we look to leverage the momentum built during closures necessitated during the pandemic, when alternative delivery channels were fully implemented and successfully served our client base. We have prudently invested in technology over the years, which continues to serve us well as we meet and exceed the evolving needs and expectations of our clients. We strive to transform our locations into customer relationship centers where routine transactions can be performed efficiently, allowing staff to focus on relationship building with all clients, including the exploration and fulfillment of financial service needs. Our current footprint can be viewed on Slide 3 of the deck.

In closing, I want to express my thanks and appreciation to the Mercantile staff for the dedication and excellent work during the first half of 2021. We remain committed as an organization to seizing the wide range of opportunities before us so that we may continue our successes for the benefit of our customers, communities and shareholders for the balance of this year and beyond.

Those are my introductory remarks. I'll now turn the call over to Ray.

Thanks, Bob. Strong core commercial loan growth, net of PPP activity is one of the central stories of the quarterly and year-to-date performance. Year-to-date, core commercial loan growth is $135 million, as shown on Slide 14, comprised of $83 million in the first quarter and $52 million in the second quarter.

Note that the second quarter growth was offset by nearly $20 million in payoffs related to the sale of borrowing entities. The year-to-date annualized growth rate of core loans is 11%. The quarterly growth rate is 8%. Additionally, our construction pipeline remains solid with $167 million of commitments in commercial, construction and development loans, which we expect to fund over the next 12 to 18 months, representing an increase of $32 million over the prior quarter.

Accruing commercial past due loans at quarter end are nominal in dollar terms, totaling $1.5 million, representing 4 borrowers. Overall, past due information can be found on Slides 17 and 18.

Asset quality remains strong as nonperforming loans totaled just $2.7 million or 0.08% of total loans at June 30, 2021. The breakdown of nonperforming assets can be found on Slides 25 and 26.

During the second quarter of 2021, we recorded a negative provision expense of $3.1 million, primarily reflecting a reduced allocation associated with the economic conditions, environmental factors amid a recovering economy. As you'll recall, during 2020, we built up our loan loss reserves significantly, in large part due to the unique challenges and economic uncertainty caused by the pandemic. As of June 30, 2021, our allowance for losses to total loans was 1.2%, net of PPP loans.

Payment deferrals at the peak of the program in mid-July 2020 impacted 738 borrowers and represented $719 million in exposure. Presently, as of June 30, there are no payment deferrals in place for commercial loans. There are extensions in place beyond that date for 5 mortgage borrowers, representing $0.5 million of exposure, as seen on Slide 11. The current deferral numbers, when combined with our expectations for no future deferral requests and our strong past due performance are positive indicators.

The risk rating process depicts a portfolio with solid characteristics reflecting strength similar to that of the pre-crisis economy as seen in Slide 16. Maintaining accurate risk ratings will remain a key focus in the upcoming quarters, as our borrowers continue to report results impacted by the pandemic. We continue to monitor the financial condition and performance of credits, particularly in the following segments: hotels and lodging, assisted living, restaurants and entertainment. None of these individual segments account for more than 5% of commercial loans. The composition of these segments can be seen in Slide 13.

We recorded noninterest income during the second quarter of $14.6 million, up $3.5 million or 33% from the prior year second quarter, which includes $1.1 million from the sale of a branch. As can be seen on Slide 21, mortgage banking of $7.7 million continues to be the primary driver of noninterest income. However, it is important to note that during the current quarter, purchase activity represented 61% of originations compared to the second quarter of last year when purchase activity represented 21% of originations as seen in Slide 24. This significant shift from refinance volume towards purchase volume will greatly enhance our ability to sustain strong mortgage banking performance as refinance activity diminishes in future periods.

July applications and backlog suggest that refinance opportunities were persistent to the near future and purchase applications are at seasonally high levels. Continuing to enhance mortgage banking income through increased market share, including the expanding share in the purchase market remains a priority. And we will continue to hire proven mortgage loan originators as we are able as in the case of our new mortgage office in the Cincinnati area, which opened during the fourth quarter of 2020 and the Petoskey, Michigan, loan production office, which opened during the second quarter of 2021.

The primary contributors to the growth of noninterest income include interest rate swap income, card income, payroll services and service charges on accounts as seen on Slide 21. We reported $1.1 million of swap income, reflecting interest rate risk management products put into place for clients during the quarter.

Credit and debit card income increased by 39.7% on a quarter-over-quarter basis as activity within the accounts recovered from reduced activity during the pandemic and the base of activity grew as new relationships came to the bank and existing relationships were more fully developed. Service charges on accounts grew 15.7%, reflecting increased economic activity and a broader base of relationships utilizing our suite of treasury management products. Payroll services income increased 9.5% as existing customers rebuilt their employment base and new relationships were established.

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

Thanks, Ray. As noted on Slide 19, this morning, we announced net income of $18.1 million or $1.12 per diluted share for the second quarter of 2021 compared with net income of $8.7 million or $0.54 per diluted share for the second quarter of 2020.

Net income for the first 6 months of 2021 totaled $32.3 million or $2 per diluted share compared to $19.4 million or $1.19 per diluted share during the first 6 months of 2020.

Turning to Slide 20, interest income on loans declined in the 2021 period compared to the prior year period, primarily due to FOMC rate cuts totaling 150 basis points during March of 2020 and a low interest rate environment since that time.

Interest income on securities during the 2020 periods benefited from accelerated discount accretion on called U.S. government agency bonds totaling $0.9 million during the second quarter and $2.7 million for the first 6 months.

In total, interest income for the most recent quarter declined $1.4 million from the second quarter of 2020 and was down $4.5 million for the first 6 months of 2021 as compared to the prior year period, in large part, reflecting a lower interest rate environment that could not be fully offset with growth in earning assets.

Interest expense declined in all categories during the 2021 periods compared to the prior year period, reflecting the declining and low interest rate environment. In total, interest expense declined $1.7 million during the second quarter of 2021 compared to the second quarter of 2020 and was down $4.1 million during the comparable year-to-date period.

Net interest income increased $0.3 million during the second quarter of 2021 compared to the second quarter of 2020, but was down $0.5 million during the first 6 months of 2021 compared to the first 6 months of 2020. Overall, growth in earning assets was able to essentially offset a lower net interest margin.

As Ray noted during his remarks, we recorded a negative provision expense of $3.1 million during the second quarter of 2021 compared to provision expense of $7.6 million during the second quarter of 2020, while a negative provision expense of $2.8 million was recorded during the first 6 months of this year compared to provision expense of $8.4 million during last year, first 6 months.

The negative provision expense recorded during the second quarter of 2021 was mainly comprised of lower reserve allocation associated with the economic and business condition environmental factor, reflecting improvement in both current and forecasted economic conditions. The relatively large provision expense during the second quarter of 2020 primarily reflected an increased reserve allocation associated with the economic and business conditions, environmental factor as well as the introduction of the COVID-19 pandemic environmental factor.

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 $6.6 million lower than our reserve balance as of June 30, 2021, as determined using the incurred loss methodology. This is an increase from the $4.9 million difference at March 31, 2021, and a $2.6 million difference at year-end 2020.

The primary difference between the 2 reserve models over the last few quarters 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 the economic and business conditions is generally positive and improving, but less so than what is reflected in market economic forecast.

We will continue to assess all of the qualitative factors at the end of each quarter and will adjust the loan loss reserve balance via the provision expense line item on the income statement.

Continuing on Slide 22, overhead costs increased $3.0 million in the second quarter of 2021 compared to the year ago quarter and increased $5.2 million during the first 6 months of 2021 compared to the first 6 months of last year. A majority of the increase in overhead costs is in salary and benefit costs, which were up $2.1 million and $3.6 million during the second quarter and first 6 months of 2021 when compared to the respective 2020 period, in large part, reflected increased health insurance costs, annual merit, employee merit pay increases and a lower level of deferred salary costs related to PPP loan originations.

In addition, we accrued for our bonus programs during the second quarter and first 6 months of 2021, which we did not do in the first half of last year, given the onset of the coronavirus pandemic.

Continuing on Slide 23, our net interest margin was 2.76% during the second quarter of 2021, virtually unchanged from the first quarter of 2021, but down 41 basis points when compared to the second quarter of 2020. Compared to the second quarter of last year, the yield on earning assets decreased 65 basis points while the cost of funds declined 24 basis points for the most recent quarter. The yield on loans declined during the second quarter of 2021 by 4 basis points from that of the first quarter of 2021.

As seen on Slide 12, net fee income accretion of $2.9 million during the second quarter was almost identical to that of the first 3 months of the year. As of quarter end, unrecognized PPP net fee income totaled $6.2 million, a vast majority of which is related to our PPP Round #2 fundings.

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 increased $276 million or 8% during the first 6 months of 2021 and are up $1.1 billion or 42% since year-end 2019. Approximately 2/3 of the growth in local deposits over the past 18 months is comprised of increased noninterest-bearing checking account balances.

Overnight deposits averaged $610 million during the second quarter and first 6 months of 2021, substantially higher than our typical average balance of around $75 million. This excess liquidity lowered our net interest margin during the second quarter and first 6 months of 2021 by about 35 to 40 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 as time deposits originated in higher interest rate environments and prior periods mature.

As shown on Slide 27, we remain in a strong and well-capitalized regulatory capital position. The Tier 1 leverage capital ratio was 9.5% and the total risk-based capital ratio was 13.1% as of June 30. The Tier 1 leverage capital ratio continues to be impacted by the PPP loan portfolio and excess liquidity with no similar impact on the risk-based capital ratio as both components are assigned a 0% risk weighting. The total risk-based capital ratio was $110 million above the minimum threshold to be categorized as well capitalized.

We repurchased about 229,000 shares for $7.3 million at a weighted average cost of $31.99 per share during the second quarter of 2021, bringing our year-to-date total up to 347,000 shares for $10.9 million at a weighted average cost of $31.28 per share.

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. With this new authorization, as of June 30, we had $17.3 million available in our stock repurchase plan.

In closing, we are pleased with our operating results during the first 6 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. And that concludes management's prepared comments. And we will now open the call up for the question-and-answer period.

(Operator Instructions) The first question is from Brendan Nosal with Piper Sandler.

Maybe just want to start off on this quarter's strong commercial loan growth. I think it definitely stands up for you folks, where they are still continuing to struggle to see good loan growth. So just kind of curious to hear from you guys, where it came from this quarter and what you're hearing from commercial customers at this point?

Yes. This is Ray. I'll address that. The pandemic and the PPP program gave us the opportunity to really put our money where our mouth is, so to speak, as it relates to the community banking proposition. And the service and support that we demonstrated through that process, not only to our existing clients but also to clients that we had been calling on previously but have not done business with, was delivering a way that really showed that we do what we say we're going to do, and we act with speed and precision.

And those things have been very warmly received in the marketplace, and we've been able to increase our market share and get some prospects over the fence to being customers based on those interactions. And that activity has been strong, and it's not concluded yet. We have more runway with similar types of activities. So we expect to continue to grow our commercial core outstandings in a similar fashion going forward to the way we have in the first 2 quarters of the year.

All right. Fantastic. That's helpful color. And then maybe as a follow-up, just on loan growth more broadly, something that was different this quarter than in recent ones. It looks like you guys put in more 1 to 4 family production on sheet. So just kind of curious, what drove that decision? And what is the appetite to put more residential production on sheet going forward? And then how that ties into your thoughts about kind of total loan growth for the next couple of quarters?

Yes. This is Chuck. I can address the mortgage loan, and I'll let Ray to speak on the growth of commercial loans. But -- on mortgage loans, what we have done in the last quarter was what we have been continuing to do is, we sell a vast majority or virtually all of our fixed-rate mortgage loans but when we do ARM loans, which are typically 5/1 and 7/1 ARMs, we generally put those on the balance sheet.

So the growth that you happen to see in the second quarter is just more of a reflection of the originations that we did in the quarter, the composition of those originations. And I think -- at least as we sit here now, we'll continue to employ that methodology going forward.

The next question is from Damon DelMonte with KBW.

First question regarding the outlook for the margin, Chuck. I think you laid out a good backdrop of what's going on and everything. So it's probably fair to say that, you're going to continue to see some modest erosion on the core margin over the next couple of quarters before maybe finding a footing by the end of the year, is that fair?

Yes. I think that's a pretty good conclusion there, Damon. I think the margin spend in the mid-270s so far this year, I think, primarily because I expect a little bit of -- or some drop in PPP fee income accretion, I think we're looking at a margin probably closer to 265, 270 for the rest of this year. There's a lot that goes into that.

Certainly, the excess liquidity, that calculation that I just provided assumes that excess liquidity stays unchanged. And of course, that remains to be unseen, but we'll obviously see over time. So expect a little bit of a reduction, some softness in the back half of this year. But we'll see what happens as we go forward, especially in regards to the excess liquidity, which, again, is really backed by the growth in local deposits that we've seen, and we do have some pretty relatively significant runoff of managed funds, broker deposits and some FHLB advances as we get into late this year and throughout a good chunk of next year.

Got it. Okay. And then with respect to the outlook on credit, I mean, I don't think you can get much better than what you guys are putting up for numbers right now. So as we think about the loan loss provision going forward, obviously you're going to have a good pipeline for the loan growth. Do you feel that, on a net basis, you'll need to provide something for loans or do you feel that any reserve release can be kind of scooped up with what you would provide for that new loan growth and it would kind of be close to 0 or negative again?

Yes. I think, certainly, we expect net loan growth, as we go forward, excluding PPP, of course, and that will require some level of reserves. I guess the magic question, of course is what ends up happening with the environmental factors as we go forward. While we improve the economic and business conditions trend, we improved it from severely deteriorating to moderately deteriorating. So we'll continue to assess that one.

It certainly seems like we're on a good trajectory there. The numbers are kind of very difficult to assess, given the poor economic conditions of this year and obviously some level of recovery this year. And it seems like everybody's got an opinion on that.

Certainly, the fed seems like they're pretty confident that the inflation that we're seeing is -- in some of these numbers are like we've never seen before as using their terminology, transitory, and it seems like many economists agree with them and none of us sitting here at this table are economists. But when we look at the volume of the money supply, for example, it's up 30% with all the stimulus. That money is never going to leave the economy. And to us, novices on the economic forecasting, that seems inflationary to us.

So I think we all agree that there's some level of transitory inflation in there, but we're somewhat skeptical about the inflationary expectations going forward. The reason why I bring that up is because that environmental factor is economic and business conditions and inflation is certainly a big component of that.

Lastly, we still have a COVID-19 factor in there. Obviously, we all hope one day that we can take that one out, that was obviously meant to be more temporary than permanent, of course. There's a couple of things going on there. Of course, what is the -- what's going on with COVID-19 itself and you read the news as much as anybody else to see what's going on there and the ups and downs that we continue to see. But I think it's also one of the things that we look at with that factor is with this tremendous amount of stimulus that's been provided over the last 12 to 15 months is that, hiding some stress sets out there within the economic environment and including our own loan portfolio.

And obviously, with our loan review and our lenders themselves, we continue to scour the loan portfolio to understand the impact of COVID-19 on all of our borrowers, but that's just kind of one of those question marks that we have going out. So that's why we still have that factor in there. And so we're confident that the impacts are known and obviously, gone at some point, will likely continue to keep that factor in there.

So I bring up those 2 factors because those are probably the 2 that will be a driving force of any reserve release as we go forward. And we'll just see -- at the end of each quarter, we'll assess that and make any determinations. My guess would be that, if we do release any reserves, especially related to those 2 factors that the release will out -- will be a larger number than what the reserve increase would be associated with new credits.

And I'll put a ribbon on that by just going back to the basic premise of the reserve or the point of the reserve that looks at our asset quality, and that continue to be extremely strong. As Chuck mentioned, we continue to remain vigilant and examining the portfolio, looking for any signs of stress. And we're very pleased with the performance of our client base, throughout the pandemic when it started last year, continuing to this year.

Customers are dealing with their challenges, which relates in a lot of cases to the labor market and some of the challenges that we all know are going on there. But continue to do the things that they do -- need to do to get their company performing as strong as they can as we continue to fight through toward the end of this pandemic.

Yes. And I guess just lastly, the elephant in the room is CECL. And as I mentioned in my prepared remarks, we are going to be adopting CECL on January 1 of next year. And at least as of January 30, there was about a $6.5 million difference between our reserve now and the lower amount that, at least, again, as of June 30, CECL was indicating our reserve should be.

The next question is from Daniel Tamayo with Raymond James.

First, maybe if you can quantify perhaps the pipeline -- I know you mentioned that it's going to -- it remained solid, but kind of relative to prior periods, if that's something that you guys do on a regular basis?

Yes. This is Ray. The commercial pipeline is very, very similar to what it's been over the first 2 quarters. And the mortgage pipeline actually dipped a bit at the beginning of the quarter and has recovered to equal to the prior part of the quarter and beyond. So it's a little bit stronger than what we were experiencing, say, in April. So that kind of gives you a bit of color on where we are relative to historical pipeline levels.

I think despite the fact that we've enjoyed and produced some very strong core loan growth, the great work of our lending teams have been able to replenish and remain -- make that pipeline remain at the level that Ray was talking about, again, points to strategic initiatives, the work of our staff to gain that new client acquisition and to keep that pipeline at a really solid number despite what we've already put on the books.

Terrific. And then maybe changing gears here, just around the remaining repurchase authorization of the $17.3 million, how are you thinking about utilizing that? Is that something you'd expect to utilize somewhat regularly or is that something you'd look at to be more of an opportunistic tool from a capital management perspective?

Yes. I think we look at it more as opportunistic. Certainly, the price of our stock is going to be a driving factor in what we're doing. For most of the year, we've been kind of in the low 30s. And we've been buying back somewhere between $100,000 and $125,000 a day in stock, about 4,000 shares on average. Clearly, at levels that we're at right now, we would get more aggressive, and which we will come out of our blackout period on Friday.

We're in our plan right now and continuing to buy every day in a relatively modest way, but it's going to be price-driven. And the lower the price, the more aggressive we're going to be. And that's kind of what we've been doing really since late last year. And we'll likely continue to go -- to do going forward. We feel really comfortable with our capital position. And so we've got to take advantage of that opportunity.

The next question is from John Rodis with Janney.

Chuck, maybe just a question for you on expenses. They were up a little bit over $26 million for the quarter. Can you just talk about your thoughts there going forward? And I know that you mentioned the bonus accrual this quarter. Was there any catch up, I guess, in this quarter as far as that impact?

Yes. On the bonus, I take that one, first. The bonus accrual was the same in the second quarter it was in the first quarter. It continues to reflect our expected payout under our various bonus programs that we have in January of next year. So that's unchanged when you compare it with first quarter. Again, when you look at last year, we didn't accrue for any bonuses in the first or second quarters, although we did later in the year.

One of the drivers of noninterest expense is our mortgage commissions. And of course, we've already talked plenty about the mortgage area, which is doing great. So that does spill over into the overhead cost component.

The other -- probably the really driver right now is on our insurance -- car health insurance costs. We are self-insured, although we do have cap insurance per employee as well as an aggregate cap for the entire bank. One of the things we started seeing at late last year, and it's really continued throughout -- definitely in the first 6 months of this year is some increased claims activity. Some of it COVID-related, some of it just normal type activity. But as we see the claims coming in with our weekly invoice, we did increase our accrual at the end of the first quarter by putting an additional $250,000 in. And then during the second quarter, we continue to see the increasing claims. And so we put additional, I think, about $600,000 in compared to what we typically would. So about $350,000 over the first quarter.

So we'll see where that goes. We continue to increase our monthly accruals on that and reassess where we're at the end of each quarter. As we speak, we're caught up. But again, the trends are not what we want to see, but hopefully that turns here in the back half of the year.

As far as guidance, if you will, I think the overhead costs for the third and fourth quarters will be closer to what we saw in the first quarter. I think what you see, the increase in the second quarter is more of a blip, if you will. And especially with our expectation that in the back half of the quarter, we will -- we expect to see lower mortgage banking activity income. As Ray mentioned, over -- almost 2/3 of it now is purchase. And as we get into the back half, especially the fourth quarter, we would expect a decline there just from a typical seasonality standpoint.

Okay. So Chuck, if I heard you right. So it sounds like closer to $25 million for the next 2 quarters?

Yes. Closer to the first quarter. Yes.

The next question is from Bryce Rowe with The Hovde Group.

Chuck, I think I talked -- I asked this question on the first quarter conference call. But just curious how you're thinking about these cash balances relative to the securities portfolio? You may be commented in your prepared remarks that you expect liquidity to remain elevated. So I'm wondering if you're going to continue to add to the securities portfolio here? And is there a certain level? Is it a percentage of assets that you kind of target for a ceiling on those purchases or is that also more opportunistic along with some other things that we've talked about this morning?

Yes. I think overall, we generally historically run our investment portfolio at about 12% or 13% of securities. We had allowed that to go down about 9% or 10%, and this will be excluding PPP, around 9% or 10%. So we've been building that back up. I think we're getting closer to the high end of that.

It is -- we do plan on continuing to buy securities and build that and support that investment portfolio. It's not going to be like we're going adopt path of our excellent liquidity into the securities portfolio, but we will be probably regular investors there.

What we have been buying is what the portfolio was and what I expect we will continue to buy, and that continues to be government agency bonds and municipal bonds issued from entities in the State of Michigan. And we're not doing anything different, buying the same type of bonds. We're not extending the maturities, the duration at all. The agencies, which is the bigger dollar amounts, we continue to buy primarily in the 3 to 7 time frame and basically just maintaining a latter.

So when we get into those years, we'll have a good level of cash coming off, and we can continue to manage our interest rate risk position and margin when we get into those periods.

My comment about the excess liquidity, staying relatively unchanged. I think that has more to do just with the local deposits that has created that excess liquidity. And it's more of a question of what our depositors do on the business side to the degree that they're going to invest in their businesses, expand their businesses. On the consumer side, what are their spending habits going to be? What are they going to purchase? Are they going to start spending it on leisure activities, which, of course, a lot of this is driven by COVID.

In regards to the businesses, I'm sure it's this way throughout the country. But certainly here, businesses continue to struggle to find employees. So any opportunities that they might see with the opportunity to expand their business is somewhat tempered by the fact that they can't find the employees to support that, those expansion opportunities.

We'll see -- we know that customers are buying equipment. Historically, that would have been mostly financed. But what we know, especially on the lower end of equipment purchases, what we're seeing and what we're hearing is that they're just using deposits. So maybe there's some future decline there. But on an overall basis, it's going to be driven by what the local deposit -- what the depositors do with their funds, at least, in the next 6 to 12 months.

Okay. That's helpful. And then maybe a question here on PPP balances and obviously, you saw even some of the Round 2 PPP loans get forgiven here in the second quarter. What are your expectations? And what are you hearing from those customers in terms of what their plans might be to pursue the forgiveness route?

Yes. I think we were already seeing, as we saw -- as we noted on Page 12, we've already hit about $30 million as of June 30 forgiveness. And so that has already started. As you would expect, some customers are quicker to apply for forgiveness and use those funds as they need to. And of course, then we have the federal government involved, and they need to do their processes.

And I would just say, with update anymore, that has been very, very inconsistent on a day-to-day, week-to-week basis as to when we actually get paid, when they process those applications. So we can look at the trends on a longer-term basis and see what's going on and try to project what we see going into the future. But it is -- like many other things, it is hard to predict. But we're down really on our PPP Round #1. We had, as of June 30, only 237 loans remaining to get forgiven. And that is obviously declining almost on a daily basis.

So it's hard to tell. I would say that, a good chunk of that will be gone by the end of the year, but we certainly expect to have PPP balances, especially for Round #2 on the books at year-end and then hopefully paid off in full by the end of the first quarter. Those are my thoughts.

Okay. And you did say, Chuck, $6.2 million remaining on the fee side to deferred fees?

Yes. $5.9 million of that is Round 2, just about $300,000 on Round 1.

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

Yes. Thank you very much for your interest in our company. We look forward to speaking with you next at the conclusion of the third quarter, and we hope the rest of your summer is enjoyable. The call has now concluded.

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