Prepared remarks
Good morning. And welcome to the Mercantile Bank Corporation 2026 second quarter earnings results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Nichole Kladder, Chief Marketing Officer of Mercantile Bank. Please go ahead.
Hello, and thank you for joining us. Today, we will cover the company's financial results for the second quarter of 2026. The team members joining me this morning include Raymond E. Reitsma, President and Chief Executive Officer, as well as Chuck Christmas, Executive Vice President and Chief Financial Officer. Our agenda will begin with prepared remarks by both Raymond and Chuck, and will include references to our presentation covering this quarter's results. You can access a copy of the presentation as well as the press release sent earlier today by visiting mercbank.com. After our prepared remarks, we will then open the call to your questions. Before we begin, 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 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. Let's begin. Raymond?
Thank you, Nichole. Our results for the second quarter of 2026 continue to build on the theme of commercial expertise generating a strong profile. The consummation of the purchase of Eastern Michigan on 12/31/2025 represents execution of our strategic objectives around deposit growth, loan growth, and margin stability paired with strong asset quality and overall financial performance. We continue to demonstrate top quartile ROA performance to our peers, built around the following traits. A strong and durable net interest margin. Over the last five quarters, the SOFR 90-day average rate has dropped 71 basis points while our margin increased by 11 basis points to 3.59%. This illustrates effective execution of our strategic objective to maintain a steady margin via match funding of our assets and liabilities and refutes the notion that we have an asset-sensitive balance sheet despite the relatively large portion of floating rate assets. Very strong asset quality. Nonperforming assets to total assets remain at the low levels typical of our company, at 9 basis points of total assets as of 06/30/2026. Nonperforming loans to total loans over the last 6.5 years averaged 12 basis points. The allowance for credit losses stands at 1.13% of total loans as of 06/30/2026, and on a dollar volume basis was nearly 10 times the level of nonperforming loans, providing a very strong coverage relative to past due nonperforming loan levels. These numbers demonstrate our long-standing commitment to excellence in loan underwriting and administration. Improved on-balance-sheet liquidity and loan-to-deposit ratio. At the end of the second quarter of 2026, our loan-to-deposit ratio stood at 93% compared to 100% on 06/30/2025, 91% on 12/31/2025, 98% on 12/31/2024, and 110% on 12/31/2023. As of 06/30/2026, our deposit mix included 27% noninterest-bearing deposits and 24% lower-cost deposits, up from 25% and 20% respectively at the end of the second quarter of 2025, which has contributed to the stability of our net margin. Net interest margin. Our acquisition of Eastern Michigan contributed positively to these measures. Deposit growth during the 12 months ended 06/30/2026 was 12.4% with growth in the noninterest-bearing accounts outpacing the growth in interest-bearing accounts during that period. Our recent focus on deposit growth is not new to our bank. In fact, the last five year-end periods demonstrate a deposit compounded annual growth rate of 9.2%. Strong commercial loan growth. Commercial loan growth in the second quarter of 2026 was $115 million, an annualized growth rate of 11.7%. As foreshadowed in the prior quarter's commentary, loan payoffs did moderate from the prior four quarters' experience, reducing $60 million compared to the prior quarter. As of 06/30/2026, commitments to make new loans totaled $224 million and commitments to fund existing commercial and residential construction loans totaled $283 million, with each amount at or near five-quarter highs. We expect that loan growth for 2026 will fall within the range of previously defined expectations of mid-single-digit percentages. Continued strong growth in key fee income categories. Growth in commercial deposit relationships has supported growth in treasury management services resulting in a 35% increase in service charges on accounts during the second quarter of 2026 compared to the second quarter of 2025. Our credit and debit card offerings reported growth of 21% in the first six months of 2026 compared to the respective 2025 period. Well-managed expenses. Net revenue, defined as net interest income plus noninterest income, grew 15.3% to $130 million during the first six months of 2026 from $118 million in the respective 2025 period. Occupancy costs plus data processing costs were virtually unchanged as a percentage of net revenue, and salaries and benefits increased from 34% to 35% of net revenue, primarily reflecting our investment in the Southeast Michigan market. In sum, these traits have allowed us to report quarter-over-quarter EPS growth of 10% in the second quarter of 2026 compared to the prior-year second quarter, a 1.52% return on average assets and a 14% return on average equity in the second quarter of 2026, and an annualized 11.6% increase in the tangible book value per share in the current year second quarter compared to the first quarter of 2026. Additionally, our five-year tangible book value per share compounded annual growth rate of 9% and five-year earnings per share compounded annual growth rate of 15.1% historically places us in the top tier of our proxy group. We remain excited about the recently completed combination with Eastern Michigan. The integration of operations is well underway and the cultures have meshed very well. That concludes my remarks. I will now turn the call over to Chuck.
Thanks, Raymond. This morning, we announced net income of $25.9 million, or $1.50 per diluted share, for the second quarter of 2026 compared with net income of $22.6 million, or $1.39 per diluted share, for the second quarter of 2025. Net income during the first six months of 2026 totaled $48.6 million, or $2.82 per diluted share, compared to $42.2 million, or $2.60 per diluted share, during the first six months of 2025. Growth in net income during both time frames primarily reflected increased net interest income and lower provision expense that more than offset higher noninterest expense costs and federal income tax expense. Excluding nonrecurring costs associated with the year-end 2025 acquisition of Eastern Michigan and the previously announced core and digital banking system conversion, adjusted net income was $26.4 million, or $1.53 per diluted share, for the second quarter of 2026, and $51.7 million, or $2.99 per diluted share, for the first six months of 2026. Adjusted diluted earnings per share increased 14 cents, or approximately 10%, in the second quarter of 2026 compared to the second quarter of 2025, and increased 39 cents per diluted share, or approximately 15%, during the first six months of 2026 compared to the first six months of 2025. We believe using these non-GAAP measurements reflects our core earnings performance and provides for more accurate current-period versus prior-period comparisons. Interest income on loans was relatively unchanged during the second quarter and first six months of 2026 compared to the prior year periods, reflecting loan growth that was offset by a lower yield on loans. Average loans totaled $4.89 billion during the second quarter of 2026, compared to $4.7 billion during the second quarter of 2025, an increase of $197 million. Mercantile Bank's robust commercial loan fundings of $535 million during the last 12 months were largely mitigated by significant levels of payoffs and partial paydowns on certain larger commercial loans during those periods, which aggregated $459 million. Our yield on loans during the second quarter of 2026 was 28 basis points lower than the second quarter of 2025, primarily reflecting the 75-basis-point aggregate decline in the federal funds rate during the last four months of 2025. Interest income on securities increased during the second quarter and first six months of 2026 compared to the prior year periods, reflecting growth in the securities portfolio and a higher yield. The growth and higher yield reflect the acquisition of Eastern Michigan along with ongoing portfolio growth and reinvestment of matured lower-yielding investments at Mercantile Bank. Average balances were up $325 million and the average yield increased 54 basis points quarter-over-quarter. Interest income on other earning assets, a large portion of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, increased during the second quarter and first six months of 2026 compared to the prior year periods, reflecting a higher average balance that more than offset a lower average yield. The average balance was up $178 million while the average yield declined 87 basis points quarter-over-quarter, the latter of which largely depicts the aggregate 75-basis-point decrease in the federal funds rate during the last four months of 2025. In total, interest income was $4.7 million and $9.8 million higher during the second quarter and first six months of 2026 compared to the respective prior year periods. Interest expense on deposits decreased during the second quarter and first six months of 2026 compared to the prior year periods, reflecting a lower cost of deposits that more than offset interest-bearing deposit growth. The growth in interest-bearing deposit balances and the lower cost of these funds reflect the acquisition of Eastern Michigan along with growth and lower deposit costs at Mercantile Bank. Costs of interest-bearing deposits at both banks were positively impacted by the aforementioned decline in the federal funds rate in late 2025. Average interest-bearing deposits totaled $3.96 billion during the second quarter of 2026, compared to $3.46 billion during the second quarter of 2025, an increase of $493 million. The cost of all deposits was down 50 basis points during the second quarter of 2026 compared to the second quarter of 2025. Interest expense on Federal Home Loan Bank of Indianapolis advances decreased during the second quarter and first six months of 2026 compared to the prior year periods, largely reflecting a lower average balance. Interest expense on other borrowed funds increased during the second quarter and first six months of 2026 compared to the prior year periods, largely reflecting the impact of a term loan we obtained in late 2025 to assist in the cash portion of the Eastern Michigan acquisition. In total, interest expense was $3 million and $5.3 million lower during the second quarter and first six months of 2026 compared to the prior year periods. Net interest income increased $7.8 million and $15.1 million during the second quarter and first six months of 2026, respectively, compared to the prior year periods, primarily reflecting growth in earning assets and a higher net interest margin. Average earning assets totaled $6.43 billion during the second quarter of 2026 compared to $5.73 billion during the second quarter of 2025, an increase of $699 million that largely reflects the acquisition of Eastern Michigan at year-end 2025, along with the securities and overnight funds growth at Mercantile Bank. The net interest margin was 3.59% during the second quarter of 2026 compared to 3.48% during the second quarter of 2025. The improvement is largely due to the Eastern Michigan acquisition. The yield on earning assets declined 33 basis points while the cost of funds declined 44 basis points during the second quarter of 2026 compared to the prior year second quarter. Impacting our net interest margin over the past couple of years was our strategic initiative to lower the loan-to-deposit ratio, which generally entailed deposit growth exceeding loan growth and using additional monies to purchase securities. A large portion of deposit growth was in higher-costing money market and time deposit products, while the purchased securities provided a lower yield than loan products. Despite that strategic initiative and declines in the federal funds rate during late 2024 and 2025, our quarterly net interest margin has remained relatively stable. Over the past eight quarters, our net interest margin has averaged 3.49% with a high of 3.59% and a low of 3.41%. We remain committed to managing our balance sheet in a manner that minimizes the impact of changes in the interest rate environment on our net interest margin. Basic funds management practices such as match funding combined with scheduled maturities of lower-yielding fixed-rate commercial loans and securities and higher-rate time deposits, along with scheduled rate adjustments on residential mortgage loans, should provide for a relatively stable net interest margin in future periods. We recorded provisions for credit losses of negative $1.8 million and negative $3.6 million during the second quarter and first six months of 2026, respectively. The second quarter negative provision expense mainly reflected the elimination of a $2.7 million specific allocation associated with the resolution of a nonperforming commercial construction loan, which was partially offset by changes in the economic forecast general allocations necessitated by net loan growth and an increase in certain qualitative factor allocations. The reserve balance decreased $1.3 million during the second quarter of 2026 reflecting the negative $1.8 million provision expense and net loan recoveries of $500 thousand. The reserve balance equaled 1.13% of total loans at 06/30/2026. Our sustained strength in loan quality metrics continues to be impactful to our loan loss reserve calculations. The baseline allowance largely determined from historical net loan charge-off activity represents only one-third of our current reserve balance, reflecting a low level of net loan charge-off activity during our look-back period beginning in 2011 through the end of the second quarter of 2026. Specific reserve allocations on nonperforming loans totaled just $900 thousand or about 2% of the reserve balance at the end of the second quarter. Noninterest expenses were $6 million and $17 million higher during the second quarter and first six months of 2026, respectively, compared to the prior year periods. Excluding one-time costs associated with the ongoing core and digital banking system conversion and the year-end 2025 acquisition of Eastern Michigan that aggregated $600 thousand and $3.9 million during the second quarter and first six months of 2026, respectively, noninterest expenses increased $5.4 million and $13.1 million compared to the prior-year periods. Eastern Michigan Bank's noninterest expenses totaled $4 million and $8 million during the second quarter and first six months of 2026, respectively. The increase in core operating costs largely reflects higher salary and benefit costs with the remaining growth generally depicting the impacts of inflation and a larger balance sheet. In addition, we recorded a $1.4 million decrease in the reserve for unfunded loan commitments primarily reflecting a lower level of commercial loan commitments largely stemming from the high level of commercial loan fundings that took place during the second quarter. Federal income tax was $1.9 million and $2 million higher during the second quarter and first six months of 2026, respectively, compared to the prior year periods, largely reflecting a higher level of pretax net income and a lower level of net benefits from transferable energy tax credits. The effective tax rate was 16.9% during the second quarter and first six months of 2026 compared to 12.9% and 15.7% during the respective time periods in 2025. The 2025 periods had higher levels of transferable energy tax credit activity given carryback opportunities. Additional acquisitions of transferable energy credits may be made from time to time, subject to our investment policy, tax credit availability, and tax credits derived from our low-income housing and historical tax credit activities. Both Mercantile Bank and Eastern Michigan Bank have strong and well-capitalized regulatory capital positions. Mercantile Bank's total risk-based capital ratio was 13.5% as of 06/30/2026, $205 million above the minimum threshold to be categorized as well capitalized. Eastern Michigan Bank's total risk-based capital ratio was 23.1% as of 06/30/2026, $36 million above the minimum threshold to be categorized as well capitalized. We did not repurchase shares during the second quarter of 2026. We have $6.8 million available in our current repurchase plan. Thoughts on the remainder of 2026. On Slide 23 in the investor presentation, we share our assumptions on the interest rate environment and key performance metrics for the remainder of 2026 with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on no changes in the federal funds rate during the remainder of 2026. Although we believe our net interest margin will remain relatively stable in a changing interest rate environment as it has over the past eight quarters, we are projecting loan growth in a range of 5% to 7% annualized during each quarter which encompasses a strong commercial loan pipeline as well as expected fewer commercial loan payoffs during the remainder of the year. We are forecasting a higher net interest margin during the last six months of 2026 compared to the first six months of 2026 as we benefit from commercial loan growth, lower levels of monies at the Federal Reserve Bank of Chicago, and maturing low-yielding fixed-rate commercial real estate loans and investments. We are projecting a federal income tax rate of 17% which encompasses continued growth in net benefits from our low-income housing and historical tax credit activities along with additional transferable energy tax credit investments. Expected quarterly results for noninterest income and noninterest expense are also provided for your reference. Noninterest expense projections reflect personnel investments that were made in the latter part of 2025 and the first six months of 2026 and expected during the remainder of 2026 to support expansion in Southeast Michigan, as well as to support operational areas as we switch core and digital banking providers to enhance the durability, efficiency, and experience for our customers and employees. Costs associated with the core and digital banking system conversion are not included. In closing, we are very pleased with our operating results during the second quarter and first six months of 2026 and our continued strong financial condition, and believe we remain well positioned to successfully navigate through the myriad of challenges and uncertainties faced by all financial institutions. That concludes my prepared remarks. I will now turn the call back over to Raymond.
Thank you, Chuck. That concludes the prepared remarks from management. We will now move to the question-and-answer portion of the call.
Questions and answers
We will now begin the question-and-answer session. To ask a question, you may press * then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * then 1. At this time, we will pause momentarily to assemble our roster. The first question comes from Daniel Tamayo with Raymond James. Your line is now open.
Alright. Thanks, guys. Morning. Maybe we can start on the expense increase in the guidance there. I heard what you were saying, Chuck, about increased personnel investments and the expansion in Michigan. Could you parse out what is related to the hirings in Southeast Michigan and what is related to the core conversion? As much as you could help us find the settling point after the costs come out post-core conversion, that would be helpful. Thanks.
Yeah. Good morning, Danny. Glad to answer your questions. There is definitely a lot going on that impacts our overhead costs. The cost associated with our core conversion is significant; we wanted to make sure the effort is properly staffed. We made the determination early on to be more than fully staffed in certain operational areas to help not only with the core conversion but especially the training. There will be a time period where we have to make sure that all of our employees are trained on the respective areas of the new core and the new digital system, and we have been aggressive in hiring in those areas to make sure we are fully staffed. We are very excited about our expansion into Southeast Michigan. It started quite a few years ago, but within the last 12 months has really taken off. We have hired exceptional personnel both on the commercial side as well as the treasury side in that market, and we continue to talk to additional folks to join our team. Southeast Michigan is one-third of Michigan, and we are a very small presence there today. Given the size of that market and where we are at now, we have made huge strides over the last 12 months. If you look at our net loan growth, Southeast Michigan does not have many payoffs, and their growth roughly equals our net growth. We have had a lot of payoffs here notwithstanding the strong fundings. I cannot give you a specific number regarding Southeast Michigan going forward, but we think it is a strong market and we expect to continue to build that market as we have over the last 12 months. Most of the additional expense is coming from hiring to support growth in that market and to ensure our operations are fully staffed for the core conversion and related training. We will continue to build our company in all of our markets as opportunities present themselves. We are very pleased with all our markets; loan growth is showing across the board and we want to support that with additional people at all levels throughout the company.
Thanks, Chuck. And then just in terms of post-core conversion, are the savings still on pace for what you discussed before? Maybe remind us what types of expenses you expect to recoup.
Danny, the savings are really going to start in the second quarter of next year when we flip the switch in February, get through all the tests and validations, and exit our current providers. It's hard to put a specific number on the savings because there are many moving parts, including growth in volume that has impacts. We are switching providers on both digital and core, which are different platforms, and as we look to our teams and set up our frameworks to best fit the new platforms, we have been making changes. We do know that the contract savings on the core itself are significant, but there are many variables, so it will be a while before we can say with precision what our ongoing costs will be.
Okay. Fair enough. On the credit side, sounds like you're getting down towards the end of specific reserves or they are more modest at this point, and you still have net recoveries. If you have any thoughts on where reserves could stabilize or when the loan loss provision might turn positive, any guidance on that number would be helpful.
We certainly enjoy negative provisions, especially when they result from recoveries and the resolution of loan situations. We did have provision expense in prior periods associated with building up specific reserves when appropriate. The relatively low level of specific reserves on nonperforming loans right now reflects two things: first, the gross dollars of nonperforming loans are not very much, and second, our underwriting and collateral coverage and guarantees minimize the specific reserves needed. Overall, we simply do not have many nonperforming loans, and that has been the case for quite a while across our look-back period. As a result, we rely on qualitative factors to support an adequate level of the loan loss reserve. We are at 1.13%. Historically, we have been between this level and probably the low 1.20s, and I would expect, absent a significant economic change, that we would stay somewhere within that range. The economy has the biggest impact on our portfolio quality. If we entered a period of stress, reserves across banks would increase, resulting in larger provision expenses. Overall, we feel solid about the quality of our loan portfolio and expect stability in the near term. We do not have many charge-offs, and while accounting may eliminate a charge-off, the borrower still owes money, and we will work through all available channels to maximize recoveries.
Alright. Terrific. Thanks for the color, Chuck. Appreciate it.
The next question comes from Brendan Nosal with Hovde Group. Your line is now open.
Hey. Good morning, guys. Hope you are doing well.
Brendan. Good morning.
Let me start on funding and the environment. Can you update us on the competitive landscape for core funding and how that has evolved across your footprint over the past couple of months?
I would say it's been pretty consistent; we have not seen much in the way of deposit rates changing. We do manage credit union competition, especially on the CD side, but our CD portfolio has stayed steady. We grew very significantly on a net basis during the first quarter. We did see some deposit reductions in the second quarter locally, but that was mainly seasonality, especially on the public unit side as well as April 15 tax payments. The third quarter is usually pretty good because public units start collecting property taxes here in Michigan, so we expect solid local deposit growth in the third quarter. We have also seen significant growth in our checking account products, especially noninterest-bearing accounts, which directly reflects our strong commercial and industrial (C&I) loan growth so far this year. One of the advantages of C&I lending is the deposit balances that come with it and the associated treasury management products. The improvement in service charges reflects growth in treasury management income, driven by commercial loan growth and expanded product use among existing customers. Deposit growth, along with bringing Eastern Michigan on board, is allowing us to get out of the brokered CD market. We had significant brokered CD maturities in the second quarter and are down to about $20 million left, two CDs that both mature in December. We are hopeful to be out of the brokered CD market by the end of this year, driven by the local deposit growth we are experiencing and expect to continue to experience.
Okay. Thanks for the color, Chuck. One more from me: turning to capital, ratios continue to build nicely this quarter even with more robust loan growth. Is there a point at which capital build becomes something you want to more actively manage, and how would you think about using capital, including share repurchases, if ratios continue to build?
We appreciate the recognition of our capital ratios. We are pleased to be able to grow assets while also growing capital ratios. Strong capital positions allow us to take advantage of opportunities such as acquisitions, loan growth, and market expansion. From a buyback standpoint, it has been some time since we repurchased shares. We have a plan in place and the board has been supportive of management's recommendations. A big part of buybacks is the stock price. We are pleased with the recent run and feel we are getting closer to fair valuation after being below our benchmarks for some time. We also want to ensure we have capital to take advantage of opportunities. We have subordinated notes that flip to a floating rate and become callable in January; that is on our radar but no decisions have been made. We would prefer to earn our way out of that position, and current spreads are favorable if we did consider refinancing. From a capital ratio perspective, the subordinated notes' conversion would have some impact — roughly a 30 basis point haircut each year on the total risk-based capital ratio if you lost 20% of the balance, so we evaluate that in our quarterly and annual capital stack reviews. Our approach is to continue augmenting capital with strong net income, pay a competitive and growing cash dividend, and maintain ample capital to support growth opportunities and additional net income generation.
Awesome. Thanks for taking my questions, Chuck. Welcome.
The next question comes from Nathan Race with Piper Sandler. Your line is now open.
Hey, guys. Good morning. Thanks for taking the questions.
You bet. Good morning.
I was wondering if you can unpack some of the specific margin drivers for the expansion you alluded to over the next couple of quarters, specifically around what amount of loans you have repricing upward that are currently fixed. Also, in terms of securities cash flow coming off, what does that reinvestment repricing look like assuming reinvestment?
One of the slides in the deck, Slide 9, shows fixed-rate commercial real estate (CRE) volumes as well as agency bonds that are scheduled to mature the rest of this year and into 2027, which creates opportunity for yield enhancement. Another important driver that started having a bigger impact in the back half of the second quarter was the reduction in our deposits at the Federal Reserve, which reflects net loan growth. Historically we have had excess funds at the Fed earning 3.65%, and as those funds are used to fund loans yielding in the mid-to-high sixes, that transition supports margin improvement. So the main drivers are loan repricing on maturing fixed-rate loans, reinvestment of maturing securities, and declines in balances at the Federal Reserve as loans fund.
Sure.
Could you help us in terms of what that upward repricing looks like on the roughly $100 million of loans expected to mature in the back half of this year? Are we talking something north of 6% as a blended rate on new loans coming onto the portfolio, or any thoughts on blended new production yields?
We would expect about a 200-basis-point improvement, give or take, on the existing average loan rate of about 4.6%, suggesting a reprice into the mid-6% range on average. We also have about $38 million in agency bonds at just over 1% and based on current strategy and yields, reinvestment would be at a little over 4%, which would pick up about 300 basis points on those dollars for the rest of the year.
Got it. And then one more on deposit growth expectations going forward. I appreciate the commentary on seasonality in Q2 related to tax payments. Any visibility into the core deposit gathering pipeline? I know you have excess liquidity you can use to fund loan growth, but how do you see deposit gathering trending over the next few quarters?
We will see seasonality by quarter. June 30 is normally a low point for public unit balances in Michigan, which pick up in July, August, and September as property taxes are collected, so we expect higher average public unit balances in upcoming quarters from that seasonality. We continue to see strong core local deposit growth, especially in noninterest-bearing checking driven by our commercial activities and C&I lending. Borrowers often use deposits to fund a portion of loans, so those deposit balances help cost of funds and create cross-sell opportunities for treasury management products, which in turn helps fee income. We are also effective at bringing in deposit-only customers and believe we have a competitive product suite. There is no secret sauce—basic relationship banking, comprehensive product offerings, and strong execution are the drivers of continued deposit growth.
Got it. I appreciate all the color. Thank you.
The next question comes from Damon Del Monte with KBW. Your line is now open.
Good morning, guys. Hope everybody's doing well today. Most of my questions have been asked and answered, but just a few quick ones here. Chuck, appreciate the color and the outlook for the margin. If we were to see a rate hike in 2027, how would you expect the margin to respond?
Overall, we work to be agnostic to changes in interest rates by managing the structure of our balance sheet. When rates go up, yields go up and costs go up; when rates go down, the opposite occurs. Match funding, portfolio structure, and using investments to bridge repricing gaps help stabilize margin. If rate moves are modest, such as 25 or 50 basis points, our modeling supports a relatively stable net interest margin. If rate changes are very aggressive, we would see more movement until things catch up across assets and liabilities, but our balance sheet management is designed to minimize those impacts.
Got it. That is helpful. On the loan loss reserve outlook, you said in the last couple of years you have been kind of in the 1.20s or down to 1.13. Would you expect some builds toward 1.20, or is mid-1 teens acceptable?
Given our portfolio mix, reserve factors for commercial loans are a bit under 1% while on residential mortgage loans are a bit over 2%, reflecting duration differences. CECL is a duration-based model and we are primarily a commercial lender; commercial loans are generally shorter term, and we must account for prepayments on mortgages which increases duration. We cannot assume renewals of lines of credit when they mature, which limits reserve buildup under CECL. The biggest driver of reserve changes will be the economy. If the independent third-party economic forecast shows deterioration, that would drive a reserve build. If we see stress impacting specific customers and increased nonaccruals, that would also lead to increased reserves. All things equal with a steady economy and stable nonperforming loan levels, I would expect coverage in the mid-teens on a ratio basis, which aligns with your question about mid-teens being acceptable.
Got it. Thanks for that color. Last one: when you think about the investments you made in Southeast Michigan and the outlook for growth, is that becoming a more central driver of portfolio growth or are you still seeing good activity in Grand Rapids and the rest of your footprint?
The answer is all of the above. The outlook in Southeast Michigan is good; we have a strong team there and they are early in their time frame with us, bringing over many customers and being very successful. It is a huge market with lots of potential. Markets like Grand Rapids and the rest of West Central Michigan and Northern Michigan are more mature for us but still have plenty of opportunity. Originations are fairly well spread out across our footprint on an even basis.
Okay. That is all I had. Thanks a lot, guys. Appreciate it.
The next question comes from Matthew Breese with Stephens Inc. Your line is now open.
Hey. Good morning.
Good morning, Matthew. How can we help?
Curious, what was the spot cost of deposits and spot NIM at the end of the quarter? And how do you feel about your ability to either maintain or further lower deposit costs from here?
When you look at our yields for the quarter, they reflect where our deposit rates were; we did not change deposit rates during the quarter. There may be some opportunity for modest repricing on the CD side, but it's not a huge component and not overly significant. So the yields for the quarter are generally reflective of where our rates are today.
Okay. And on commercial real estate, you mentioned you expect slowdown in payoff and prepayment activity. What gives you that confidence and what is the expectation for CRE growth in the coming quarters?
The confidence comes from communication with our borrowers. We stay in close contact, and in the prior spate of payoffs over the previous four quarters, borrowers told us what was coming and largely delivered on that. They are telling us those payoffs should slow. Of course, they can change their minds, but current communication supports moderation in payoffs.
Got it. And you have spoken a couple of times about the mix shift out of cash into loans and how that is accretive to NIM. From where we sit today at about 5% cash to assets, how much of that do you think is excess cash?
If you look at our balance sheet and interest-earning assets, the excess funds are somewhere between $100 million and $125 million.
And what is the time frame expectation to shift that mix?
We would like to do it by the end of this year. Net commercial loan growth will drive that based on our fundings and any payoffs. If not by year-end, we expect to achieve it by early next year.
Okay. Great. I will leave it there. I appreciate all the answers.
This concludes our question-and-answer session. I would like to turn the conference back over to Raymond for today's call and for your interest in Mercantile Bank Corporation.
Thank you for joining today's call and for your interest in Mercantile Bank Corporation. That concludes today's call.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.