KBRA Affirms Ratings for Mercantile Bank Corporation

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Grand Rapids, Michigan-based Mercantile Bank Corporation (NASDAQ: MBWM) ("Mercantile" or "the company"). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for Mercantile Bank, the main subsidiary. The Outlook for all long-term ratings is Stable.

The ratings are supported by Mercantile’s durable business model, which has demonstrated the ability to reflect strong earnings performance throughout various interest rate environments (ROA has averaged 1.30% since 2018) due to its asset sensitive balance sheet and mortgage banking operations serving as natural hedges to one another. More recently, during this current rate hiking regime, MBWM’s ROA has reached record levels as its largely floating rate loan portfolio and lower-beta deposit base (average cost of 1.76% for 3Q23) has resulted in a significantly above peer NIM (4.03% for 9M23). While the margin has been on the decline since reaching peak levels in 4Q22 as deposit costs have accelerated in recent quarters and is projected to remain pressured in coming quarters, we believe that earnings capacity will remain at the higher end of the rating group prospectively. KBRA also favorably views the revenue diversity at the company, with noninterest income averaging 20% of revenues since 2018. However, we recognize that fee income has a tendency to be volatile given the concentration in mortgage banking, which is currently at relatively lower levels given the higher-rate environment impacting volume and GoS margins. Like many peers, Mercantile reflected some asset quality related challenges during the global financial crisis; however, the company’s favorable credit performance since that time has been supported by a more conservative stance with respect to borrower selection and loan concentrations, as well as tightened underwriting standards when necessary. In recent years, the NPA and NCO ratios have both consistently tracked below peer levels. With regard to the headwinds currently facing the banking industry, notably repricing risk for maturing fixed-rate CRE loans, as well as occupancy declines in the office sector, we believe that Mercantile is relatively insulated from both risk factors given its overall lower level of investor CRE (26% of loans or 228% of total risk-based capital as of 3Q23). Given the higher RWA levels (94% of assets) due to its more loaned up balance sheet and concentration in commercial lending, MBWM’s risk-based capital measures generally track below peer averages, though have been trending higher over the past year (CET1 ratio of 10.3% as of 3Q23). This is somewhat offset by a strong TCE ratio that is wholly reflective of unrealized losses from its securities book. The liquidity position, as measured by the loan-to-deposit ratio, has been managed more aggressively historically, though total liquidity available is considered adequate for its business model, which includes a higher level of uninsured deposits. However, these appear to be sturdy given that these are full-banking relationships that reflect a long history with Mercantile.

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