Mercantile Bank Corp (MBWM) 2021 Q1 法說會逐字稿

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

I would like now to turn the conference over to Tyler Deur from Lambert, Mercantile's Investor Relations firm. Please go ahead.

Thanks, Matt. Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the first quarter of 2021. I'm Tyler Deur with Lambert IR, Mercantile's Investor Relations firm. And joining me today are members of their 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 of Michigan.

We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open up the call to questions. However, before I 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 first 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?

Thank you, Tyler, and good morning, everyone. On the call this morning, we will provide you with detailed information on the company's performance in the first quarter as well as updates on the current operating environment, which continues to be impacted by the COVID-19 pandemic. As has been outlined in our release this morning, Mercantile had an extremely strong quarter to start 2021. The wonderful work of our team across all fronts throughout 2020 and during the first quarter positioned us well for success in the rest of this year and beyond.

Despite the recent surges of COVID experienced throughout the country and specifically in the state of Michigan, we remain optimistic due to the increasing pace of vaccinations. We continue to closely monitor pandemic-related developments while prioritizing the health and safety of our customers and employees and are constantly finding ways to seamlessly transition as needed to navigate these new and changing environments. Our full-time line of pandemic-related activities can be found on Slide 10 of our deck.

The Mercantile team once again demonstrated resiliency and adaptability during the first quarter, delivering another solid financial performance. We achieved net income of $14.2 million and per share earnings of $0.87 per share. We also announced this morning the declaration of a cash dividend in the amount of $0.29 per share payable on June 16. Later in this call, Chuck will dive deeper into the details of our financial statements as of March 31, which includes the ongoing strength in mortgage banking income, solid asset quality, solid growth in core commercial loans and managed overhead costs.

In addition to our commercial lending team's continued efforts on the forgiveness phase of round 1 PPP in the first quarter, we also worked to assist past and new loan recipient clients with second round PPP funding requests. These new opportunities for relationship building speak to not only the dedicated and efficient efforts of our lending group, but also the adaptability and perseverance of the local economies and businesses throughout our communities.

We are fully engaged to meet the evolving needs of our customers as we understand their challenges related to the pandemic. We also continue to evaluate new product and service opportunities to further strengthen our relationships within these markets in support of our communities as they transition to a recovery from the pandemic and a more robust economic growth.

While our dedication to the needs of our new and existing customers requires a significant amount of time and effort, we remain committed to growing our customer relationships. This work is demonstrated by our solid and sustained new business pipelines. Ray will provide you with an update on our growth and ongoing new business development later in this call.

The ongoing success of strategic initiatives in mortgage banking that we designed to boost market share and increase revenue was especially evidenced in the first quarter. Our mortgage team, including those at our new lending offices, exceeded expectations and continue to leverage opportunities to produce solid loan production numbers. Their work has allowed us to position ourselves extremely well to leverage the strong demand and capitalize on this market to deliver robust mortgage banking income. Additionally, higher levels of refinance activity remain persistent through the first quarter in light of the historically low interest rate environment.

Once again, the relationship-based approach of Mercantile will provide us the ability to generate consistently solid mortgage production in times when interest rate and market conditions are favorable, such as we currently enjoy, but also at times when conditions aren't as accommodating. Ray will share more details on this in his comments.

Turning to our operations. We are constantly evaluating our processes across the board to ensure adaptation of industry best practices while leveraging available debt to capture efficiencies, customize unique client interactions and optimize our internal systems. We remain focused on expanding our noninterest income revenue streams and continuing to identify opportunities to build on the strength of this income as we have over the past 5 years.

While noninterest income growth has been strongly driven by our robust mortgage banking production, we have also implemented ongoing initiatives with a strategic focus on enhancing the customer experience through digital delivery and the development of advancing technology. For years, Mercantile is focused on investments in the evolution of banking. And this change in the manner in which banks do business has been -- has only been accelerated in the current environment.

This investment in new ways of banking has enabled recent branch consolidations, while ensuring the efficient optimization of each of our relationship centers. This allows our staff to fully engage clients so we can meet their new banking needs, while more routine and repetitive transactions can be serviced at their convenience through our digital channels. Mercantile's current footprint can be viewed on Slide 3 of the deck.

All of our initiatives illustrate our resolute focus on our people, which continues to heighten our commitment to pursuing best practices in environmental, social and governance, with particular emphasis on the social component as we work to meet the needs of our shareholders, customers and communities.

In the first quarter, we approved a supplier diversity program and diversity equity and inclusion policies, while our entire DEI team has been continuously providing access to enrich learning and growth opportunities for the Mercantile staff through a wide variety of methods. These include live virtual speaking engagements, videos, books, articles, group discussions, training and creating safe spaces for employees to ask questions and engage in conversations. All of our supervisors have been provided with best practice overviews, resources and other tools to engage their teams in DEI work and are strongly encouraged to collaborate with other supervisors to share ideas across the organization.

Bank's Diversity Council comprise of a wide cross-section of employees and departments is also actively working to implement additional supportive DEI strategies and constantly developing new ideas. We remain committed to providing enhanced knowledge on growth opportunities for all of our team members to ensure that diversity, equity inclusion are not reactive measures, but a natural part of our workspace culture where everyone is equipped to be a leader in their specific roles.

As I close my comments, I want to reemphasize our optimism for the year ahead across all of our markets and business lines, as our team has proven their leadership capabilities well beyond traditional banking. We remain focused on building on these foundational efforts throughout our company, capitalize on sustained strategies for future success of all of our customers, employees, communities and shareholders.

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

Thanks, Bob. Our total loan portfolio increased to $171 million during the quarter, comprised of $89 million in growth of PPP loans and $84 million in growth of core commercial loan categories, $49 million of which related to C&I categories. Core commercial loan growth is 14% on an annualized basis. In general, our C&I loan funding, net of PPP activity, remained similar to pre-pandemic levels as we continue to add targeted new commercial relationships around our PPP activity and also serve existing relationships.

Additionally, our construction pipeline remains solid with $135 million of commitments in commercial construction and development loans, which we expect to fund over the next 12 to 18 months. Accruing commercial past due loans at quarter end are nominal in dollar terms totaling $1.2 million, representing 4 borrowers. Our overall past due information can be found on Slide 17 and '18.

Asset quality remained strong as nonperforming loans totaled just $2.8 million or 0.8 -- I'm sorry, 0.08% of total loans at March 31, 2021. This breakdown can be found in the financial portion of our presentation on Slides 25 and 26. The following recaps our provisioning activities during the COVID-19 impacted time periods. In the second quarter of 2020, provision expense of $7.6 million was generated entirely through increases to environmental factors.

The third quarter of 2020 provision expense of $3.2 million was driven by risk rating adjustments to 159 specific credits, 8 of which moved to the watch list. Fourth quarter 2020 provision expense of $2.5 million was driven by a $3.9 million increase in qualitative and environmental factors. Our loan loss provision expense for the current quarter totaled $300,000, primarily driven by loan growth. These actions bring the allowance for losses to total loans to 1.33%, net of PPP loans, up 55% from 86 basis points at March 31, 2020.

Payment deferrals at the peak of the program in mid-July impacted 738 borrowers and represented $719 million in exposure. Presently, as of March 31, extensions are in place beyond that date for 12 borrowers, representing $2.6 million of exposure as seen on Slide 11. The current modest deferral numbers, when combined with our expectations for limited future requests and our strong past due performance, are positive indicators.

The risk rating process depicts a portfolio of 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 4.8% of commercial loans, and the composition of these segments can be seen on Slide 13.

We recorded noninterest income during the first quarter of $13.5 million, up $6.9 million or 106% from the prior year first quarter. As can be seen on Slide 21, this improved level of noninterest income was largely driven by a 235% quarter-over-quarter increase in mortgage banking income, reflecting the success of our ongoing strategic initiatives designed to increase market share, a higher level of refinance activity stemming from historically low rates and increased share in the purchase market and an increased percentage of loans sold.

For the first quarter of 2021, purchase mortgage loans originated were up 75% over the comparable quarter in the prior year, while refinance activity increased by 90%, as can be seen in Slide 24. April applications and backlog suggest that refinance opportunities will exist into the near future and purchase applications are at seasonally high levels. Continuing to enhance mortgage banking income through increased market share, including an 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.

Noninterest income from payroll services decreased 3.5% due to high levels of unemployment during the quarter relative to the prior year comparable quarter. Service charges on accounts for the year decreased 5.5% due primarily to larger balances offsetting charges. Credit and debit card income increased by approximately 23% 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. Finally, we reported $653,000 of swap income, reflecting interest rate risk management products put into place for clients during the quarter.

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

Thanks, Ray, and good morning to everybody. As noted on Slide 19, this morning, we announced net income of $14.2 million or $0.87 per diluted share for the first quarter of 2021 compared with net income of $10.7 million or $0.65 per diluted share for the first quarter of '20. Generally speaking, increased mortgage banking income more than offset a lower level of net interest income and higher overhead cost during the quarter.

Turning to Slide 20. Interest income on loans declined in the first quarter of 2021 compared to the first 3 months of 2020, primarily due to the FOMC rate cuts totaling 150 basis points during March of 2020. Interest income on securities during the first quarter of 2020 benefited from accelerated discount accretion on called U.S. government agency bonds totaling $1.8 million. In total, interest income declined $3.1 million during the first quarter of 2021 compared to the first quarter of 2020, primarily 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 first quarter of 2021 compared to the first 3 months of 2020, reflecting the decline in interest rate environment. In total, interest expense declined $2.4 million during the first quarter of 2021 compared to the first quarter of 2020. Net interest income decreased $0.8 million during the first quarter of 2021 compared to the first 3 months of 2020.

The provision expense recorded during the first quarter of 2021 totaled $0.3 million compared to $0.7 during the first 3 months of last year. Combined with net loan recoveries of $0.4 million, the loan loss reserve increased $0.7 million during the first quarter of this year. We have 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 is about $5 million lower than our reserve balance as of March 31 as determined using the incurred loss methodology. The primary difference between the 2 reserve models as of March 31 is with the economic forecast aspect of the calculation. Under CECL, the employed economic forecast has shown significant improvement over the past couple of quarters.

Under our incurred model, we have not modified our economic qualitative factor rating as we believe it is premature to do so given the spike in COVID cases in Michigan over the past several weeks and the ongoing state-mandated restrictions.

Continuing on Slide 22. Overhead costs increased $2.2 million during the first quarter of 2021 compared to the first 3 months of 2020, primarily reflecting higher salary and benefit costs as well as $0.5 million in onetime costs associated with 2 of our branch facilities. Salary and benefit costs were up $1.6 million during the first quarter of 2021 compared to the prior year first quarter, mainly reflecting increased mortgage banking-related compensation costs and employee merit pay increases. In addition, we accrued for our bonus programs during the first quarter of 2021. We did not accrue any monies for the bonus programs during the first quarter of last year given the onset of the coronavirus pandemic.

Continuing on Slide 23. Our net interest margin was 2.77% during the first quarter of 2021, down 23 basis points from the fourth quarter of 2020 and down 86 basis points when compared to the first quarter of 2020. The yield on earning assets decreased 29 basis points, while the cost of funds declined 6 basis points during the first 3 months of 2021 when compared to the fourth quarter.

The yield on loans declined 31 basis points, in large part, reflecting a lower level of PPP net fee income accretion, which had spiked during the fourth quarter due to forgiveness activity. As seen on Slide 12, net fee income accretion totaled $2.8 million during the first 3 months of 2021 compared to $5.4 million during the fourth quarter of 2020. The yield on loans during the first quarter of 2021 was equal to the yield on loans during the third quarter of 2020. The level of PPP net fee income accretion was similar during these 2 periods.

As of quarter end, unrecognized PPP net fee income totaled $8.2 million, a majority of which is related to PPP round #2 fundings made during the first quarter. 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 and a correspondent bank. 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.

Overnight deposits averaged $587 million during the first quarter of 2021, up from the $560 million during the -- average during the fourth quarter of 2020 and substantially higher than our typical average balance of $50 million to $75 million. The excess liquidity lowered our net interest margin during the fourth quarter -- or first quarter of 2021 by about 37 basis points. We expect the level of overnight deposits to stay elevated well into the foreseeable future.

The cost of funds has also been on a declining trend, primarily reflecting the falling interest rate environment. And we expect that trend to continue throughout 2021 as time deposits originated in the higher interest rate environments in 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 9.7%, and the total risk-based capital ratio was 13.5% as of March 31. The Tier 1 leverage capital ratio continues to be impacted by the PPP loan portfolio and excess liquidity, with no similar impact on risk-based capital ratios as both components are assigned a 0% risk weighting.

The total risk-based capital ratio was $124 million above the minimum threshold to be categorized as well capitalized. We repurchased about 118,000 shares for $3.5 million at weighted average cost of $29.91 per share during the first quarter of 2021. As of quarter end, we had $6.3 million available in our repurchase plan.

On Slide 28, and to conclude my prepared remarks, we have some comments on the 2021 forecast. Due to the high degree of uncertainty that currently exists, we will again not be providing earnings performance guidance. However, we are able to offer key considerations that should be factored into any earnings forecast on our company. Clearly, economic conditions, asset quality, PPP forgiveness activity and mortgage banking operations are expected to have the most impact on our operating results for this year.

In closing, we are pleased with our first quarter of 2021 operating results 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 comments, and we will now open the call for the Q&A session.

(Operator Instructions) Our first question will come from Brendan Nosal with Piper Sandler.

I just want to start off here on the excess liquidity that you folks mentioned, and I appreciate your comments that it's probably going to stick around for quite some time. I was wondering if you guys have considered using those excess funds to pay down some of the wholesale borrowings that you have on the sheet to try, by the way, to support the margin.

Yes, Brendan, this is Chuck. I'll tackle that one. And the short answer is yes. We definitely have considered that, and we continue to consider that. The broker deposits are about $30 million, and we don't have the capacity to prepay them, but they are scheduled to mature over the next 12 months or so, 12 to 15 months. So those will take care of themselves.

Most of our wholesale funding is in Federal Home Loan Bank advances. We have -- the average rate is about 2.06%. There are some advances in there that are well below 1% that were taken out earlier in 2020. And then there are some other advances that are over 3%, which were taken out in higher rate environments and, of course, some in between.

I think it's important to remember that the reason why we got those FHLB advances is to manage interest rate risk. And while we don't match fund on a loan-by-loan basis, we certainly match fund on a portfolio-by-portfolio basis. And it's rather common that we do 5-year fixed rate balloon nodes, especially on commercial real estate loans. And occasionally, we'll do some 7-year stuff. And those advances were obtained when we needed the liquidity, but also in reflection of our fixed rate lending operations.

So we did have to protect our margin in the event of an increasing interest rate environment. And it's important to note that a vast majority of those loans are still out there. So the portfolio, at least based on the original intent, is still doing its job. It is matched to funding those longer-term fixed rate loans. And so if we do prepay the FHLB advances, and again it's something that we look at pretty regularly, we do need to do that knowing that we are exposing -- potentially exposing at least part of our balance sheet to an increasing interest rate environment when, of course, the idea of inflationary pressures is out there every day in regards to what's going on in our economy and whether there's inflation to be out there that will result in higher interest rates as we move forward.

So that is something we -- again, we are carefully considering, doing lots of calculations, lots of analysis. And we'll just see where we go from here, but it is something on our radar.

Yes. That's fantastic, Chuck. Thank you so much for those thoughts. That's helpful. And then one more for me and I'll step back. It looks like outside of all the PPP noise, loan growth was quite strong this quarter, which makes for 2 pretty healthy quarters in a row, which is just not something that many community banks are seeing these days. So definitely nice to see strong trends there.

Just help us understand kind of where the commercial growth is coming from, what your commercial customer sentiment is today and how you guys figure out loan growth for the remainder of the year.

Yes, this is Ray. I'd be happy to tackle that one. The funding that we see in the very near future that we can point to with some specificity is similar to what you pointed out in the last couple of quarters, and much of that comes from new relationships. This environment that we've all been through has really differentiated our approach as a bank. And that differentiation and approach has led to more and more opportunities to pick up relationships that we had been calling into for a number of years. And so that has provided a nice bit of momentum.

Also, the economy is fairly decent here in West Michigan, and the trend toward the shortage of labor has led to greater investments in equipment than we've seen in the past. So that's been somewhat of a trend fueling our balance sheet. And of late, we've seen increased usage in line of credit facilities, not in a big major way, but in a subtle way that's been big enough to increase the overall trends on our balance sheet.

Our next question will come from Damon DelMonte with KBW.

Hope everybody's doing well today. First question, just wanted to circle back on the margin, Chuck. So the reported was 2.77%. I think you said there was 37 basis points of a drag from the liquidity. What was the impact from PPP?

I don't have that in basis points, but we did record about $2.8 million in PPP fee income. And of course, we have the 1% on top of that, our average balance was $433 million during the first quarter. So sorry, I can't give you a specific number, but I can give you the components of that calculation.

That's fine. I could -- yes, I can back into it from there. That's fine.

Okay.

And then, I guess, just with regard to the outlook for loan growth, are you seeing any benefit from the market disruption that may be going on from the TCF deal that was announced with HBAN? Or that not really started yet?

No, that's definitely been an opportunity for us, and there is disruption from that announcement.

And are you seeing that in the way of new lending relationships or possibly hiring of commercial bankers?

Both of those are opportunities. The obtaining of relationships comes a little bit faster than the people, but there are definitely both opportunities.

Okay. Great. And then, I guess, just on the fee income side, I think, Ray, your commentary was pretty positive for mortgage banking that things continue to trend well. Pipelines are strong. Housing market remains healthy. You had a much stronger quarter in the first quarter than we had -- we were expecting, and it seems to be better than what the broader index may have been forecasting for the year. How has your outlook changed for the remainder of the year? Do you think you could kind of outperform the broader mortgage index?

Yes. I think that is possible. I think we're well positioned relative to both arms of the market, the refi and the purchase. We've seen some shifting toward the purchase market as being more active as the rates have begun to tick up a little bit. And we have put focus on that particular portion of the market, the purchase market over a number of years and took the refinancing activity as the rates offered it. But the real work is to get a bigger and bigger share of the purchase market. And given that we focused on that for some period of time, I think that's where we're distancing ourselves from those around us.

Our next question will come from David Long with Raymond James.

Looking at the backdrop, obviously, the economic outlook continues to improve. Can you talk a little bit about some of your risky areas, especially with the state of Michigan now going back to at least some type of modified shutdowns here, thinking specifically about your hotel portfolio and the restaurant portfolios and how they are performing here?

Yes. This is Bob. I'll start off and then hand off to the other guys for their commentary amplification. While the case load in Michigan has certainly surged, the state government of Michigan has not implemented new restrictive measures as they had done during a great portion of 2020. And it's a complicated story, and there's a lot going on there behind the scenes. But I think the state government is content with the pace of vaccinations and looking to address the rising cases that way. We'll continue to emphasize the restrictive measures that are still on the books and still being recommended, but a lot of those measures aren't mandates.

And I think because of it, I think many segments of the economy are doing very well. The industries that you mentioned, the hospitality, the entertainment, that certainly continues to be challenged in the state of Michigan. But there are some signs of life there in terms of the activities that people are able to do within the current environment given the guidelines and the restrictions that continue to remain in place. So it's kind of an unusual situation that while the cases are very high, I think we're getting national attention for the way that the cases have increased here, and that's certainly the case.

As you saw during the large portion of 2020, those cases had dropped quite substantially down to one of the strongest performances in the country and the dynamics of why the cases are increased and is open for debate. But I think, overall, the economy continues to do pretty darn well, given all those complicating factors and it is a pretty complicated situation.

Got it. Okay. I appreciate that color. And then separately, looking at the first round and now the second round of the PPP, thanks for giving us the amount of fees that are still left. But as far as timing on forgiveness, what are you expecting with the remaining round 1 forgiveness? And then what about your expectations for timing on round 2 and how that plays out?

Yes. This is Chuck. I'll take a first swing at that. The forgiveness activity has been quite frustrating, not only for us and myself trying to put numbers together, but for the borrowers as well. Especially over the last 4 to 6 weeks, the level of forgiveness payments, transactions, how we want to term it, from the SBA have been incredibly slow. There are many days, I would say, probably 2 days out of the week that we don't get any payments. And the days that we do, we're getting like 4 or 5.

So it's been painfully slow. I'm not really sure what's going on. There's lots of work -- lots of guesses out there as to what's going on. And certainly, it's a tremendous amount of volume that the SBA has to go through. We're kind of hoping that coming out of spring break, it would speed up. But based on what we've seen late last week and so far, well, at least yesterday, nothing has really changed there.

From an overall numbers perspective, the slowest part -- slowest segment continues to be those over $2 million. Again, those are the ones that get extra scrutiny, I guess, if you want to call it that. And there's lots of additional questions and additional information that has to be provided.

We did 50 of those loans and only 5 so far have been forgiven. So we still have 45 out there. A vast majority of those 45 had completed applications for quite some time. One of the guidelines that was from the original program was that within 90 days of receiving a full application, the SBA was supposed to make a determination. We and my understanding is all banks have very -- quite a few loans that are well in excess of the 90 days.

So with regards to round 1, it's just kind of a drip, drip, drip. In regards to getting those payments through a large percentage of the dollar amount, again, is wrapped up in those loans that are over $2 million.

In regards to PPP round #2, we're still making loans under that program, but we're maybe doing 1 to 3 loans a day. We were very active, very busy at the end of January, and I would say, at least half of February in making those loans, but it's been relatively slow since. And like I said, it's very slow now.

In regards to forgiveness, not a lot of guidance out there in regards to that. But assuming we go through the same process or similar process that we did with round 1, perhaps during the third quarter -- later on in the third quarter, we might start seeing some forgiveness activity come through. And my expectation would be that the fourth quarter is probably going to be the busiest quarter in regards to forgiveness activity on the round 2 loans.

Excellent. I appreciate the color. I know you don't have a lot of guidance there on round 2. And then lastly, with the PPP program overall, how have you guys been able to leverage that to bring in prospects? And have you been able to add new clients from the PPP, both round 1 and now with round 2?

Yes, this is Ray. We certainly have been able to leverage that. And it kind of boils down to speed and responsiveness within the process, strong communication as the parameters of the program evolve, shall we say. And those types of things demonstrate what a relationship with us looks like. And there has been some frustration with some of our competitors around those points.

And since we've had dialogues with these prospects for a lengthy period of time, a number of years, this has been a great platform to kind of prove what we say about how we do business is actually how we do business. And that's been a nice contributor to the growth -- some of the growth that you've seen in our numbers over the past few quarters.

Our next question will come from Bryce Rowe with Hovde Group.

Just a few questions here. One, Chuck, I wanted to ask kind of again around the excess liquidity. We've seen you all build up the bond portfolio methodically over the last several quarters. And was curious if you thought that could continue as we move throughout 2021?

Yes. That is a good observation, is something that we have been doing and we continue to do so. Buying the same type of bonds we always have, we're just buying more of them. We kind of lead with U.S. government agency bonds, generally callable bonds, usually of stated maturities of 3 to 10 years and just building out a ladder as part of that portfolio, just not wanting to go too long, but knowing that, of course, the longer you go a little bit, better rate you get.

Also been adding to the municipal bond portfolio, tax exempts as well as taxable, we continue to stay within the state of Michigan and generally within our markets. There's usually enough product out there that we can build the portfolio and help with the excess liquidity, but also do our part in assisting our communities as well with their financing needs. We tend to -- the same idea with the maturity is we ladder those out.

So -- and we have been buying some mortgage backs that primarily are CRA qualified that we can pick up from time to time. It's nice. Those help our CRA efforts, but it's also nice with the rate environment that they're not so pricey instead of paying 105%, 107%, like it had been over quite a few years, the prices are down to 101% or so. So that helps on the prepayment risk there. But yes, I think what you have been seeing, I think you'll continue to see at least for the next couple of quarters.

Okay. That's helpful. And then kind of wanted to follow up on the mortgage question. Obviously, good volume coming in here and certainly appreciate the focus on purchase versus refinance markets. So I was curious if you could kind of break out the newer markets that you've added and how much they might account for some of the volume? And then any appetite you might have to further expand the mortgage offices, whether it be in some of the Michigan markets or even outside of Michigan like the Cincinnati effort?

Well, yes, we certainly will be on the lookout for more talent and add where that's available. The markets are of interest, but of more interest is getting the right people to add to the team. We feel like we've been successful in the case of Cincinnati and the new group up in Petoskey that we did add people who fit in with the way we do business. And the Cincinnati office has provided very close to what we expected. The Petoskey office is just lifting off, but we expect to have that add, maybe depending on the environment, between $75 million and $125 million over a year coming up.

We're in discussions with teams in a number of markets right now and very early. But the interest is certainly there. Our team and the production side has a very good reputation. That's one of the hot points with producers that they aren't able to get the volume that they produce through the system that they're in currently. So that has been an attractive element. And as they talk to their colleagues who've moved over here, they hear good things about our team. So we expect to continue to add them as the opportunity arises, that's extraordinarily difficult to quantify, but it's a definite opportunity.

Okay. That's great. Maybe 1 or 2 more from me. Interesting to hear the CECL commentary relative to the incurred loss model and, obviously, the discrepancy between those 2 in terms of the reserve level. So just curious how you -- I mean, how you might be able to, I guess, tweak that dynamic or manage the dynamic? Is there something that you thought about to line those reserve levels up more appropriately maybe with a special COVID bucket or something along those lines? Just trying to understand how you think about that as you approach CECL adoption?

Yes. This is Chuck, I'll pick that one. Up until December, our CECL calculation and our incurred loss calculation was pretty similar. What ended up -- what's happened is that really starting in September, but certainly with December and now what we see in March, is the economic forecasts are improving on the -- which, of course, is very important on CECL. We also have an economic factor. It's an important factor from a number of basis points we put through it and are incurred.

And what we have not done on the incurred is we haven't changed that economic factor yet. And to put it in a matter of perspective, and it varies a little bit by portfolio. But on average, we put 35. Right now, the way that we have the economic factor rated, which is very low, is 35 basis points applied to almost every loan. On average, I think that's a good number to have.

So when we feel comfortable -- and I think we're definitely in the right direction. When we feel more comfortable with the economic situation, which, of course, is driven by COVID, we'll definitely start improving that rating, which will bring that 35 basis points down over time. And we'll just have to analyze that at the end of each quarter and you see where we're at and see where the levels and direction and magnitude and how our borrowers are doing and put that into our calculations and our thought processes. We just saw, as I mentioned in my prepared remarks, it was just a little bit premature, especially what we already talked about this morning, just what's going on in Michigan with the cases in the surge and all that.

The other big part of our incurred calculation is a new factor. So we went to 10 factors in the second quarter of last year, we call it the COVID-19 factor, which was just kind of a -- there's just a big unknown what's going to happen with COVID-19. Obviously, it's unprecedented. At that point in time, we were directionless, quite frankly, and had -- didn't have a vaccine or anything like that. That's definitely a one-time type factor.

Right now, that's 20 basis points applied to all loans. We would expect over time, as hopefully sooner than later, COVID gets in our rearview mirror. And ultimately, over time, we'll start dropping that, the ratings on that -- which would improve the ratings on that, which will drop the basis points along the way. And then at some point, we'll drop that factor altogether.

So it's really those 2 factors that we haven't changed since the second quarter. So I think long answer to your question is, I think, over time, probably the next few quarters, based on the current trends and expectations, is that as we get closer to the end of this year and the adoption of CECL, when we start modifying those 2 factors alone, we would think that the incurred model and the CECL model will be closer, just like they were before COVID hit.

That's great detail, Chuck. I appreciate that. Maybe one more from me for Bob. Bob, just curious if there's any appetite for M&A. I know you all have been super acquisitive in your history, but with the, I guess, the environment seemingly heating up from any acquisition perspective, any opportunities on the horizon and maybe speak to Mercantile's appetite?

Fine. Bryce, I think I would respond to that similar to as we've responded in the past is that we're certainly open to M&A. We have an appetite for M&A. The big question for us is the culture of another organization and how that culture lines up with the Mercantile culture. It was touched on by the guys within the framework of this call that related to the mortgage area and going into new markets, hiring additional lenders.

It's about the culture of the people and how those people fit into the way we do business because that has been a very successful recipe for Mercantile and leads to the performance that you see quarter-after-quarter with solid performance and you're seeing good core loan growth now because of the way we do business. And so really, as the M&A question for us keeps going back to the culture, if we find potential M&A partners that culture is a good match for ours, then something we've certainly been interested in. And if the cultures do not match, something we would be less interested in.

(Operator Instructions) Our next question will come from John Rodis with Janney.

Chuck, just a question on expenses. You highlighted the $500,000, I guess, in branch write-downs. So excluding the $500,000 to sort of that $24.6 million, is that a pretty good area sort of run rate going forward?

Yes. I think the big caveat would be, of course, the mortgage banking with the -- a vast majority of our lenders are commission based. So we need to correlate that expense with the volume that's out there. But aside from that adjustment, matching that up with our -- with mortgage income, excluding those 2 branch write-downs, yes, I think that's a good run rate.

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

Thank you, Matt, and we thank you all for your continued interest in our company. We hope that you and your families stay healthy and safe. And we look forward to speaking with you again at the conclusion of the second quarter. This conference call has now concluded. Thank you.

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