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.

Key Credit Considerations

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 1.3% since 2019; 1.4% during 9M24) due to its asset sensitive balance sheet and mortgage banking operations serving as a natural hedge to one another. More recently, during this higher interest rate environment, MBWM’s ROA has reached record levels as its largely floating rate loan portfolio and reasonably priced deposit base has resulted in a significantly above peer NIM. While the margin has been on the decline since reaching peak levels in 4Q22 as deposit costs have accelerated, and is projected to remain pressured in coming quarters due to the reduction in the Fed Funds target rate, we believe 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 necessitated. Regarding future potential headwinds for CRE segments, we believe MBWM is well-insulated given its lower concentration in investor CRE (236% of total risk-based capital as of 3Q24) and manageable office exposure (6% of loans). Additionally, the tenant mix for most office properties are largely service-oriented, mitigating concerns related to vacancies, while the company’s focus on suburban areas is largely in footprint. In recent years, the NPA and NCO ratios have both consistently tracked below peer levels. Given the higher RWA levels (92% 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. This is somewhat offset by a strong TCE ratio (9.1% as of 3Q24) 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, though liquidity is considered adequate for its business model, which includes a higher level of uninsured deposits. Moreover, management intends to reduce the loan-to-deposit ratio prospectively, and maintain a higher level of on-balance sheet liquidity.

Rating Sensitivities

A rating upgrade is not expected, though continued scaling within current markets and a higher level of fee income, while maintaining peer leading earnings and credit metrics would be viewed favorably. A rating downgrade is also unlikely, though any deterioration or slippage among key ratios, most notably credit, capital, or earnings, could potentially pressure ratings.

To access ratings and relevant documents, click here.

Methodologies