Mercantile Bank Corp (MBWM) 2022 Q1 法說會逐字稿

Good morning, and welcome to the Mercantile Bank Corporation First 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 Kate Croft, Lambert Investor Relations. Please go ahead.

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 2022. Joining me today are members of Mercantile's management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, Chief Operating Officer and President of the bank.

We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open the call up to questions. Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ release 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 2022 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.

Thank you, Kate, 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.

We are pleased to begin the year with a solid first quarter performance, highlighted by operating profit, prudent expense management, continued growth in core commercial loans contributing to a higher net interest income and pristine asset quality. The dedicated efforts of our team in tandem with strong -- with the strong foundation we have built are the keys to our continued success.

In the first quarter, we reported net income of $11.5 million or $0.73 per share. Total assets were $5.18 billion with loans growing to $3.56 billion at March 31. Our performance was once again headlined by growth in commercial -- in the commercial loan portfolio. New loan opportunities continue to be cultivated in all of our markets, including requests from borrowers with smaller credit needs which is a characteristic of our rural markets in addition to larger, more complex loan needs, which are typical in our metro markets.

These opportunities are possible because of the superb work of our lending staff and gain familiarity with businesses of prospective clients, understanding their opportunities, challenges and needs and then adding value to the relationship as a trusted adviser. Ray will provide more details on the loan portfolio metrics in his comments.

While our mortgage banking income is down year-over-year from 2021, when low interest rates allowed for significant refinance volume, our keen focus on purchase business and the addition of a commission-based real estate lenders are providing benefit to us during this time of rising interest rates. Mortgage production has migrated to loans retained in the portfolio and construction loans as many customers are opting to build new houses since the availability of existing homes is limited.

Despite the reduction in mortgage banking income, we are confident in our ability to continue to be a top performer in this area during 2022. We made a number of strategic lender hires throughout our footprint during 2021. Together with new offices in Petoskey, serving a very attractive Lake Michigan second home region, as well as the economically vibrant Cincinnati market, we believe our team is well positioned to be the bank of choice for new and existing customers.

Our team was successful in generating growth in several fee income categories during the first quarter compared to the same period in 2021, including service charges, credit and debit cards, interest rate swaps and payroll services. This growth is the result of ongoing strategic initiatives to understand our customers' needs and ensure that customers are aware of the full suite of Mercantile products that can help to fulfill those needs. Ray and Chuck will provide more specific details following my comments.

We continue to make appropriate investments to recruit and retain high-performing talent that has been and will remain the key to growing the number and depth of Mercantile customer relationships. This includes our exceptional branch and customer service staffs. Accordingly, in February, we have implemented a $1 per hour wage increase for all non-exempt employees. At the same time, office optimization, plus the shift to a remote work option for certain employees, should allow us to reduce our facilities costs, which will help offset the increases to our salaries and benefits. We aim to strike the right balance between investing smartly in our team and technology while managing expenses to enhance our profitability.

Regarding the Michigan economy. While the overall statewide unemployment rate is 4.4%, down from 6.3% of a year ago in the metro markets, which contains the most significant concentrations of assets in mercantile and business opportunities, the unemployment rate is below 4%. With this low unemployment rate, many companies face challenges in attracting new employees. In the construction industry, for example, many firms are having a difficult time identifying skilled workers, and this is slowing productivity.

With a tight supply of housing inventory, many new homeowners and consumers desiring to upgrade their dwellings are to new construction. With current housing market conditions and supply chain challenges, construction productivity creates yet another issue. Capital expenditures continue to trend upward as companies look to implement technological upgrades to their equipment and plant expansions.

Our clients have advertently directly managed through the challenges over the past 2 years since the onset of the COVID-19 pandemic, and we expect it will continue to do so in 2022. While we remain closely engaged with them, of course, to assess the effects of rising costs, including anticipated increased borrowing costs.

Finally, I want to compliment the Mercantile team for their spectacular performance to start 2022. Their tireless work to ensure that Mercantile's relationship-based approach, which is the hallmark and the foundation of our culture, is reflected in our daily engagement with our customers and potential customers. Those are my prepared remarks. I'll now turn the call over to Ray.

Thanks, Bob. Today, my comments will center around 3 topics and evidence in our quarterly results for 2022, strong commercial loan growth, strategic diversity of sustainable noninterest income and pristine asset quality.

For the first quarter, we are reporting core commercial loan growth of $82 million or 11% annualized. This growth was achieved despite payoffs related to asset or business sales of $46 million and has been possible due to the efforts of our commercial team and their focus on relationship building and the business community bank value proposition. Our backlog remains consistent with prior periods as we fund this impressive level of growth. Availability under construction commitments that we expect to fund over the next 12 to 18 months totals $184 million.

Secondly strategic diversity and sustainable noninterest income. For the first quarter, we are reporting noninterest income of $9.3 million compared to $13.5 million in the comparable period last year, a reduction of $4.2 million. Mortgage banking income decreased by $5.5 million to $3.3 million. This reduction occurred due to a 60% decrease in refinancing originations, which masked a 24% increase in purchase originations, indicating that our mortgage production team continues to successfully pivot to the purchase market.

Our other diverse noninterest income categories reported total increases of $1.3 million, led by a 107% increase in interest rate swap income, a 23% increase in service charges on accounts, a 15% increase in payroll services and a 12% increase in credit and debit card income. Each of these income streams are sustainable as the interest rate environment fluctuates.

Finally, the bank continues to experience pristine asset quality with 0 ORE and 3 basis points of nonperforming assets at the end of the first quarter of 2022 compared to $0.4 million of ORE and 7 basis points of nonperforming assets at the end of the comparable prior year period. This level of asset quality supports an allowance to loans ratio of 0.99% as of March 31, 2022, and a provision for a credit loss expense of $0.1 million during the first quarter compared to $0.3 million in the comparable period last year.

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

Thanks, Ray, and good morning to everybody. As noted on Slide 24, this morning, we announced net income of $11.5 million or $0.73 per diluted share for the first quarter of 2022 compared to $14.2 million or $0.87 per diluted share for the respective prior year period.

Ongoing strong core commercial loan growth, continued strength in asset quality metrics and increases in several key fee income revenue streams in large part, mitigated a significant decline in mortgage banking revenue as industry-wide originations come off of 2020 and 2021, record levels, driven by low mortgage loan rates and results in refinance activity.

Turning to Slide 25. Interest income on loans during the first quarter of 2022 increased $0.3 million from the year ago first quarter as growth in core commercial loans and residential mortgage loans offset lower PPP net loan fee income accretion. Interest income on securities in the first quarter of 2022 increased $0.6 million from the first quarter of 2021 in large part reflecting growth in the securities portfolio over the past 12 months to meet internal policy guidelines and deploy a option of the excess liquid funds position.

Interest income and other earning assets, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, increased $0.2 million during the first quarter of 2022 compared to the year ago first quarter, primarily reflecting increased balances. In total, interest income for the most recent quarter increased $1.1 million from the first quarter of 2021. Interest expense on deposits during the first quarter of 2022 decreased $0.9 million from the year ago first quarter as lower deposit rates more than offset increased interest-bearing deposit balances.

Interest expense and other borrowed money in the first quarter of 2022 increased $0.8 million from the first quarter of 2021, in large part reflecting the issuance of $75 million in subordinated notes in December of 2021 and a $15 million follow-on issuance in mid-January. In total, interest expense for the most recent quarter declined $0.3 million from the first quarter of 2021.

Net interest income increased $1.4 million during the first quarter of 2022 compared to the first quarter of 2021. We recorded a credit loss provision expense of $0.1 million for the first quarter of 2022 compared to the provision expense of $0.3 million during the prior year first quarter. Net loan recoveries and continued strong loan quality metrics, in large part, mitigated additional reserves associated with the loan growth. We adopted CECL effective January 1, 2022, with a onetime reduction of $0.4 million to the reserve balance recorded on that date.

Continuing on Slide 27. Overhead costs during the first quarter of 2022 increased $0.6 million from the year ago first quarter. Salary and benefit costs were up $0.4 million, in large part reflecting merit pay increases, market adjustments and promotions over the past 12 months.

Continuing on Slide 28. Our net interest margin was 2.5% -- 2.57% during the first quarter of 2022, down 17 basis points from the fourth quarter of 2021 and average during all of 2021. Compared to the year ago first quarter, the yield on earning assets decreased 27 basis points, primarily reflecting a decline in loan yields associated with lower PPP net fee accretion.

As noted on Slide 23, net fee income accretion totaled $0.8 million during the first quarter of 2022 compared to $2.8 million during the first quarter of 2021. A vast majority of the remaining unrecognized net PPP fee income of $0.2 million is expected to be recorded during the second quarter.

The cost of funds declined 7 basis points for the most recent quarter compared to the year ago quarter. The cost of deposits decreased 12 basis points which more than offset an increase in the cost of borrowed money associated with the issuance of the subordinated notes.

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 program -- programs as well as lower business and consumer investing and spending. Overnight deposits averaged $784 million during the first quarter of 2022 compared to $592 million during the first quarter of 2021 and $671 million during all of 2021, substantially higher than our typical average balance of around $75 million.

The excess liquidity lowered our net interest margin during the first quarter of 2022 and all of 2021 by about 40 to 45 basis points. While we expect the level of excess overnight deposits to decline in light of continued loan growth and wholesale fund maturities, we expect the level of overnight deposits to stay elevated well into the foreseeable future.

Given the asset-sensitive nature of our balance sheet, any further increases in short-term interest rates would have a positive impact on our net interest margin and net interest income. We remain in a strong, well-capitalized regulatory capital position. The Tier 1 leverage capital ratio continues to be impacted by excess liquidity, although there is no similar impact on the risk-based capital ratios as deposits maintained at the Federal Reserve Bank of Chicago are assigned a 0% risk weighting.

Both our Tier 1 leverage capital ratio and the total risk-based capital ratio have also been impacted by strong core commercial loan growth over the past several quarters. Our total risk-based capital ratio and all of our bank's regulatory capital ratios were augmented this past December and January with an aggregate $90 million issuance of subordinated notes, of which a mass majority of the funds were downstream to the bank as a capital injection. As of March 31, our total risk-based capital ratio was 14.1% compared to 12.5% as of September 30, 2021.

Our bank's total risk-based capital ratio was $157 million above the minimum threshold to be categorized as well capitalized at the end of the first quarter. We did not repurchased shares during the first quarter of 2022. Given the recent stock price and prospects for additional solid loan growth, we do not plan to purchase additional shares at least in the near term. We have $6.8 million available in our current repurchase plan.

On Slide 32, we share our latest assumptions on the interest rate environment and key performance metrics for the remainder of 2022, with the caveat that market conditions remain volatile, making forecasting difficult at best. As you can see, we are currently expecting fee income, overhead costs and our tax rates to remain relatively consistent for the remainder of the year. We are projecting the FOMC to increase the federal funds rate at each of the next 4 meetings, including a 50 basis point increase in early May. Based on this rate projection, along with the reduction of excess liquidity, we are forecasting our net interest margin to improve in each of the next 3 quarters.

For information regarding our floating rate loans and repricing opportunities, please refer to Slide 18. In closing, we are pleased with our operating results and financial condition as we begin the 2022 campaign and believe we remain well positioned to continue to successfully navigate through the myriad of challenges faced by all of us.

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

Thank you, Chuck. That concludes management's prepared comments. And we'll now open the call to the question-and-answer period.

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

How are you doing?

Good, Brendan.

Maybe just to start off on kind of the NII outlook you provided on Slide 32. I do get that part of the NIM expansion that you're forecasting is, one, a function of rates moving higher; and two, a function of some liquidity rolling off the balance sheet. I'm sure that I could do the math myself. I'm just kind of curious how much of that margin improvement do you think is really a function of rates moving higher?

I think most of the expected increase is from the rates, but we are expecting a reduction in some of that excess liquidity. Although as I mentioned, we still think it's going to be relatively elevated even by the end of this year. I think if you look on Page 32 with the average earning assets, we expect loan growth to be somewhat similar for the remainder of this year as to what it was in the first quarter. But you can see that average earning assets are trending downward at least for the next couple of quarters before it flattens out. And of course, what that is, is really a net of the loan growth less the expected runoff of some of our excess liquidity.

Yes, that makes perfect sense. Okay. Good. Maybe one more for me just on the expense outlook. So costs obviously fell quite a bit from the first quarter as top accruals reset, which is certainly nice to see. So I guess just going forward in that the outlook you provide for expenses, is it safe to assume that, that includes accruals for what is appearing to be a good NII outlook given rate increases?

Yes. Yes. That takes into account what we think the rates are going to do for the rest of this year and the associated impact on our overhead costs for the remainder of the year.

And the next question will come from Daniel Tamayo with Raymond James.

Maybe just starting on the loan growth. You just talked about that guidance kind of remaining similar to what we saw in the first quarter, which is great. First quarter had a little more 1:4 family growth than I was expecting. Can you just talk about what the type of mix of growth you're expecting going forward? And if there was anything unusual in the first quarter?

Yes. I think in regards to the residential mortgage area, we continue to kind of go along with what we had structured for the last several years, and that is to sell a vast majority of our fixed rate loans, but then the book or ARMs, which are primarily 5/1 and 7/1 ARMs. We are looking into potentially finding some investors for the ARM products as we go forward as we have seen the ARM product become more popular with our client base.

Quite frankly, we would like to see a little bit less ARM balance sheet growth with our residential mortgage loan portfolio. But clearly, we want to make sure that our mortgage operation stays very strong and that we're providing the products that our customers are asking for. So it's kind of more of a balance there. But definitely, the trend is there for additional growth, and we're looking for ways to maybe mitigate that.

I'd supplement that point with the fact that construct mortgages have become more popular, roughly twice as high as the previous quarter, and that has the impact of staying on the balance sheet during the construction period and reducing the amount of loans that are sold while we wait for those to complete construction.

Okay. Great. And then switching gears here to the fee income and I appreciate you guys putting guidance on that last slide. That's very helpful. Within the fee income, Obviously, mortgage banking took a big hit in the quarter, and you talked about the refi versus purchase dynamics a little bit. Was there -- can you give what the gain on sale rate was in the quarter and what the change was from last year or the fourth quarter? And if there was any MSR change in that number as well?

I think on the gain rate, we're going to probably have to get back to you, Danny. We're looking at each other. I don't think either of us have that. As far as the MSRs, we haven't seen a huge impact. We do lower cost to market, so there's no fair value adjusting going on there. We certainly continue to see some acceleration from some refinance activity. Clearly, we see a decline in refinance activity. So accelerated amortization of mortgage servicing rights is slowing down. And we would expect that to continue to slow down, which, of course, would be a tailwind for mortgage banking income as we go forward. But clearly, the production and especially the volume of sold versus portfolio is going to be a bigger player on that number.

And just kind of bigger picture, the number came -- the run rate, if you will, I guess, came way down in the quarter. You've talked about the focus on growing the purchase side. If you -- is this the new run rate that you're still expecting that, that would come down as refi volumes decline from that $3.3 million number? And how are you thinking about where you might end up in a normalized environment in terms of volumes at least?

I'll give you a general answer, and I'll let Chuck follow up with the specifics. But seasonally here in Michigan, we do expect a pickup in activity as we move from the first quarter into the second, and the second quarter and the third are seasonally strong for us here in the lovely state of Michigan. It's weather-driven, school-driven like it is everywhere else. So we would expect to see some recovery there from a seasonal pattern that's an evidence every year.

I think as we also mentioned, another factor into the mix is the limited supply of homes that are available for sale. And as I mentioned in my comments, Danny, many customers who were interested in buy an existing home are frustrated by the lack of availability. So they're opting for a construction process, which, with some of the challenges that we've outlined, it takes us a little bit longer, too. So as Ray hit on that number, we've seen a significant increase in our construction commitments here in the first quarter.

And I think as long as the current housing inventory remains low, I think you'll see customers exploring that as a possibility because they desire a new home and there's just nothing available from an existing home standpoint. So they're looking at all options, but a lot of dynamics in the market right now are affecting consumer decisions.

Yes. I think, Danny, if -- Chuck again, if I could add to that is when you look at our fee income performance for the first quarter, apart from the mortgage banking, we think that the trends that you saw in the first quarter will continue for the rest of the year. And as Ray mentioned, we had solid growth in some of our more ongoing and core fee income, especially on the treasury management side of things. The big wildcard as we're talking here and trying to answer your questions as best we can, is mortgage banking, and there's just so many moving parts to it that it becomes somewhat difficult to try to narrow that down.

We're very, very pleased with our mortgage operation. Clearly, us and the industry certainly enjoyed very, very strong refinance activity over the last calendar -- 2 calendar years and other attributes as well included pretty high gain rates in the marketplace. But with the increase in mortgage rates, the refi area is drying up pretty significantly and reliance on purchase is going to become a bigger and bigger issue.

And all along as we go out and hire additional commercial mortgage lenders, we make sure that they have the ability to be high performers in kind of a purchase-only market that we seem to be entering into. So clearly, we're not going to make -- and I think I can speak for the industry, we're not going to make the lofty numbers that we had the last couple of years. But I think as Ray mentioned, we saw really solid growth in the purchase volume that we've got. And think we're doing a good job, and our lenders are doing a really good job of being out on the streets and getting a higher volume. And I would dare to say that we believe that we've increased our market penetration and it's just in a different market.

One other tidbit I throw on there, Daniel, is that all the numbers that we've referenced so far have related to closed volume. If you move a step further and look at the applications, they show a continuation of that trend. The applications that we have for purchases and construction are higher by a similar percentage as the closed volume. So they're like 25% over what they were last year at this time. And similarly, the apps for refinance are down in that 60% range. So if you move from what's closed to what we anticipate closing, based on applications in process, yes, the trend will continue.

I think looking at our mortgage production for the first quarter, those numbers are pretty much on track with what we were expecting for the first quarter. The main difference is the percentage of loans that we're selling and the mix of the type of loans that we're generating leaning towards construction. So I think in the end, it will all wash out and end up as we have projected. Just there are variables along the way that are certainly affecting what's falling into that mortgage production income -- mortgage banking income in any 1 quarter.

That's terrific. I appreciate that, particularly as it relates to the impact on loan growth...

And the next question will be from Damon DelMonte with KBW.

How's everybody doing today?

Damon, how are you?

So first question, I just wanted to talk a little bit about loan growth. You guys sound pretty optimistic on the commercial side of things. Do you think that kind of keeping the commercial growth rate at that high single, low double-digit range is doable for the remainder of the year? Or do you think it kind of comes back to the more the mid- to upper single-digit range?

I would say that based on all the information we have right now, we'd expect to continue along the pace that we demonstrated in the first quarter. As we look at our backlogs, opportunities and all the surrounding information, it appears that the immediate future looks a lot like the past.

Yes. I would add, the unknown that we have, and of course, we had some in the first quarter, is the payoffs. And so when we look at our pipelines and all the trends, we definitely see a lot of momentum there and believe we'll hit on that. But it's just a matter of the payoffs that come in as borrowers sell their projects or the underlying assets. That's the unknown trying to factor in commercial loan growth.

Got it. And is there any particular region of your footprint or area of your footprint that is showing better opportunity than others?

Not particularly. Grand Rapids is always a strong market for us. We're very represented here by our commercial loan team and a long history of participating in that market. But they're all fairly robust.

Got it. Okay. All right. That's great. And then on the credit side. You guys finally adopted CECL as of 1/1 in 2022. You had a modest adjustment to your reserve level. Chuck, can you help us just think a little bit about what the outlook would be for provision expense, especially with the strong outlook for loan growth? Like should we start to see a more normalized level of provisioning?

This is the new normal.

You're going to maybe talk about CECL. But clearly, the loan growth necessitates additional reserves. And while we don't like making provisions, we certainly want to make sure we keep our reserve adequate, which is reflective of that loan growth. And of course, we're very proud of our very strong credit metrics, which if you look at just so it makes it difficult to increase reserve of any notable size, which means that you're heavily relying on your qualitative measurements and those factors.

So really, I think while the growth is certainly going to be there or we think it's going to be there and that's going to result in some reserve increases like it did in the first quarter, it's kind of more of a -- to answer your question in a very long-winded way, it's more about what happens with those qualitative factors. The big one, of course, which is pretty much out of our control is the economic forecast as we use a third party and look to market for that.

When you look at expected GDP growth, unemployment rates, those types of things over the next couple of years, those are still pretty strong and pretty frothy, which doesn't add a lot to your reserve calculation. As a matter of fact, as of the end of the year and at the end of March is actually a small negative to our reserve calculation on the economic factors. So we would expect that probably as we move along that quarter-over-quarter, maybe the economic forecast isn't as strong and maybe we'll see the need to add to our reserves as we move along. I would say that's just not Mercantile, I would say that, that impacts any bank that's adopted CECL.

But I would also say, we've got other factors in there. We have quite a bit of money in our reserve associated with COVID, not just the disease itself, but all the impacts that it has, supply chains and all those things that we know about. There's quite a bit of money in the reserve for that factor. Hopefully, over time, we can start peeling some of that away, definitely look forward to that. And then, of course, we'll just keep an eye on all the other normal regulatory factors that we have.

So I can't give you a solid answer. I think that right now, what we saw in the first quarter seems to be what I would expect at least in the next couple of quarters, but that makes the assumption that there's no significant change in economic forecasting.

I will add that just pure commercial loan growth in and of itself, does not contribute a whole lot to the reserves under CECL because of the duration of those commercial loans is on the short side compared to longer-term residential mortgage loans. So just by growing the commercial portfolio, absent the other factors that Chuck talked about with qualitative and asset quality, the growth itself does not require the addition of a whole lot of reserves as much as you might think based on the incurred loss model, which we just came off of.

Yes. It's -- and that's one of the reasons why we delayed CECL as long as we could because we know it to be a duration based model. We're obviously a commercial bank with a duration of barely over 2 years. And so when you look at it, when we book a $1 of mortgage loans and $1 of commercial loans, the mortgage loan takes twice as much reserve as what the commercial loan does. We don't agree with that. That's the way that the framework works, so we have to deal with that. But then, therefore, you have a lot more reliance on environmental factors on the commercial side to support some higher reserve dollars.

Got it. Okay. That's great color and very helpful. And then just one final question on expenses. I apologize if this was said either in response to a question or in your prepared remarks, but the guidance is obviously a step up from where we were this quarter. Did you say that salary -- or would you say that salary and benefits and like data processing are the 2 main drivers of the step-up going forward versus this past quarter?

Yes, that's correct. I think Bob mentioned in his opening remarks, we did a pay raise for all of our hourly people towards the end of the first quarter. So there's the ongoing costs associated with that. But -- so as always, when you look at the makeup of our overhead, as salaries and benefits and as data processing costs that are the big numbers and changes in those are going to be the primary drivers of any changes in our overhead costs.

And the next question will be from Bryce Rowe from Hovde Group.

How are you?

Well.

I wanted to -- I appreciate all the kind of the detail and the discussion around CECL. I understand it's a moving target, so to speak. Maybe one question on the margin and the margin outlook that was provided there in the deck. What level of deposit beta are you kind of assuming with these rate hikes? And are you thinking about each subsequent rate hike any differently from a deposit beta perspective?

Yes, Bryce, it's a great question because of all the things that we talked about, mortgage bank and some others that's difficult to forecast, deposits are just there. Obviously, all the banks including Mercantile have seen significant deposit growth over the last couple of years. We don't think it's all going to stay. We think a fair amount of it's going to stay. But when the money starts actually -- when the balances start leaving, they're starting to be invested, starting to be spent or whatnot. That, of course, has a play into the margin calculation and excess funding and all that type of thing. So we have to have some expectations for that.

And I would say so far, we've seen very little in the way of deposit withdrawals. As a matter of fact, -- we generally have -- we have some seasonality here at this bank where we generally lose about $100 million in primarily checking account balances in January as our customers pay bonuses and taxes and stuff like that. That did happen this year. It's seasonal for us. But if you exclude the one withdrawal from the large depositor that made large deposit at the end of last year, we actually saw a net deposit growth here in the first quarter.

So in a quarter in that we generally see a reduction in deposits, we actually saw more growth. So we love deposits. We know at some point in time down the road, we're going to want more deposits, but we clearly have many now. But what we don't see is a lot of money changing banks. The rates are still quite low, and there's really not much of an incentive from a rate perspective for people to start moving money from bank to bank. There's just not a lot of competition out there for deposits given a vast majority of the banks out there have plenty of excess deposits on hand.

I bring that up because that certainly impacts deposit rates. As we know, deposit rates are impacted primarily by 2 things. One is the overall interest rate environment, which obviously is increasing and additional increases are expected but also the demand for the deposits has a big play as well. And so what we have seen, at least so far, and we only have one increase so far, of course, is that deposit rates in our markets changed very little, at least after the first Fed increase.

Rates are -- we're surmising here, but rates are very, very low. And I think a lot of depositors are somewhat indifferent because of those low rates. However, we think that is going to change as it's in the market, it's in the news that the Fed is getting more aggressive with rates. Obviously, folks see what's going on with mortgage rates. They'll probably become more attentive to what's being paid on deposits. And perhaps that will put some pressure on us as a market, as an industry, to have to raise deposit rates as we move forward.

But to the degree that they're going to move going forward is kind of really anybody's guess. In my -- on the assumptions that I provided on our forecast, ideas and thoughts that I provided, we kind of use more of our historical betas, which are probably more aggressive. Clearly, we want to be somewhat conservative in putting out our expectations. So they're relatively aggressive because we're using historical numbers. I use those consistently throughout the rest of the year, but I think it's probably more likely that the betas will be relatively low and slow at the beginning and will probably speed up as we move on and we get more increases from the Fed.

So that's kind of our thoughts is that we'll probably eventually come out at an average of betas. But -- and so we budgeted or forecasted at an average level, but it will probably be a little less at the beginning and a little more beta at the end.

(Operator Instructions) The next question will be from John Rodis from Janney.

Chuck, a question for you on the securities portfolio. Just given your outlook for average earning assets, should we sort of assume securities are flat to down going forward given the outlook for loan growth?

Yes. I think I have a little bit of an increase in that portfolio, John, but I don't think -- it's nothing material. So what you see in the average earning assets is that security is staying relatively stable, the growth in loans, as we've talked about, and then the net is the reduction in excess funding.

Okay. Okay. Just one more question, and hopefully, you didn't already answer this. Just in the prepared remarks, I think you talked about the payoffs in the quarter. You said 1/3 of the payoffs had were experiencing some financial difficulties. Could you maybe just give some more details on those difficulties?

They were performance difficulties, largely related to the industry they were in relative to the pandemic environment. And I believe one was hospitality and one was an entertainment venue obviously impacted by the environment. And so the performance during that particular time was depressed.

Okay. And Ray, do you see more exposure there? Or as it relates to those industries and stuff that would give you a pause?

Not at this point. We feel pretty good about our remaining portfolio. Our watch list is at a low point historically. And most of those types of credits have performed quite well of late.

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

Well, thank you very much for your interest in our company. We look forward to speaking with you next at the end of the second quarter. This call is concluded.

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