2023-10-18 00:14:49 ET
Summary
- Mercantile Bank's trading day ends with a +7.38% increase after releasing positive Q3 2023 results.
- Net interest income and net interest margin improved from Q3 2022. Growth in commercial loans continues, up 4 percent.
- Concerns about the unrealized losses on the securities portfolio.
Mercantile Bank's ( MBWM ) trading day ends with +7.38% after it released its Q3 2023 results . Contrary to expectations, the bank released quite positive results and is proving to be more resilient than expected despite the uncertain macroeconomic environment.
Q3 2023 highlights
The most important aspect that drove up the price per share was better-than-expected profitability.
There were many concerns about the increase in the cost of liabilities resulting in reduced profitability, but Mercantile Bank reported an improvement in both net interest income and net interest margin. Specifically, net interest income improved by $6.58 million over Q3 2022 and by $37.31 million over the January-September 2022 period. This was driven by commercial loans, which grew by 4 percent (annualized).
As for the net interest margin there was a 40 basis point improvement over Q3 2022 but it is still not at the levels of the previous three quarters. In any case, 4% represents a positive margin considering that the average for banks with assets between $1-$4.9 billion is only 3.17% . Favoring the higher margins are the prevalence of variable-rate loans, 69 percent, and the prevalence of commercial loans over retail loans, 78 percent versus 22 percent. While better profitability is a positive aspect, the risks of such an approach need to be analyzed. As we will see later, there was a slight increase in NPLs this quarter. In addition, the yield on loans continues to increase: from 6.19% to 6.37%.
Mercantile Bank Corporation Q3 2023
Finally, regarding Q4 2023 guidance, management expects loan growth to continue despite very high interest rates; the net interest margin is expected to decline slightly, 3.85%-3.95%, but would remain higher than the average of peers.
Focus on loans
The composition of loans is still skewed toward commercial rather than retail loans. In particular, commercial real estate non-owner occupied still have a significant weight, 24 percent of total loans. The latter provides better returns but also bring higher risks as they are subject to business cycle trends. When economic growth slows being overexposed could be problematic.
Be that as it may, to date Mercantile Bank's loan quality remains high, but the increase in NPLs of 9 basis points from the previous quarter jumps out. What this slight increase was due to was explained by COO Raymond Reitsma during the conference call:
So that single credit was one that was under some pressure from a margin standpoint in a particular industry that it serves. Management made some, in hindsight, poor decisions about how to manage their business. And the owner supported it for a while with cash injections, made the decision not to continue to do that and shut the doors. And so as we compare that particular company to others that we serve in the same industry, we've tentatively drawn the conclusion that it was a company-specific, rather than an industry-specific malaise that struck this particular company. And we've begun collection efforts and expect to get full resolution to this within a quarter or two.
In short, this was a single credit given to a company that made a series of poor operational choices. In any case, it would appear that others belonging to the same sector are not in the same situation. No more specific information was given on this.
Personally, I do not think there is cause for concern as it was a single company in trouble, however, I think it is worth monitoring the situation closely in the coming quarters. Should NPLs continue to increase Mercantile Bank's management may have underestimated the risk. As seen above, loan yields continue to rise and this may put more pressure on borrowers.
In 12 months, $2 billion worth of variable-rate commercial loans will mature, and borrowers could refinance the debt at a higher rate. This scenario is even more plausible if the Fed were to - surprisingly - raise interest rates further.
Finally, we can see that Mercantile Bank has a CRE concentration ratio below the 300% threshold despite the large amount of commercial loans: its regulatory capital manages to support this exposure. Reducing this ratio further in the coming months could be a good way to hedge against an unexpected increase in NPLs.
Unrealized losses
Unrealized losses within the securities portfolio is the scourge of all banks in this 2023, including of course Mercantile Bank.
Huge amounts of fixed-rate government bonds have been purchased in previous years, and with the rise in the Fed Funds Rate, a sharp devaluation of these was inevitable. The problem is that the Fed has repeatedly announced the "higher for longer" scenario, which assumes that such unrealized losses will be part of Mercantile Bank's balance sheet for a while longer.
Compared to 9 months ago, these unrealized losses have increased and have now reached $93 million, almost twice the net interest income for Q3 2023. The duration of the portfolio is 5 years and represents about 13% of total assets, so it will be a while before this weight can be downsized within the balance sheet. There is good news, however: according to the words of CFO Charles Christmas , there will be a large volume of maturity of securities held this quarter. This means that from the coming quarters the bank will be able to take advantage of attractive repricing opportunities and replace securities with low yields with securities with significantly higher yields given current money market rates.
Finally, Mercantile Bank meets the capital requirements imposed by the Basel Committee despite substantial unrealized losses. Should the Fed reverse monetary policy sooner than expected, these capital requirements could experience a major and rapid improvement.
Conclusion
The market assessed this quarterly report of Mercantile Bank very positively, mainly due to an increase in both net interest income and net interest margin. Despite the adverse macroeconomic environment, the bank manages to make new commercial loans at a high rate. However, much of it is at floating rates, and when the Fed Funds Rate comes back down, the net interest margin may suffer a decline.
As of today, issues remain regarding unrealized losses on portfolio securities, but new repricing opportunities open up beginning this quarter. In general, it would seem that the pessimism that has surrounded the banking sector since SVB's failure is now behind us. The market sees the future more positively but I personally keep my guard up, especially if NPLs continue to rise. After all, high interest rates often create problems for borrowers.
For further details see:
Mercantile Bank: Market Reacts Well To Q3 2023 Earnings