Broadening Deposit Base And Mortgage Sales Will Secure Future Stability

Key Takeaways

• Broadening the deposit base and improving asset quality enhance liquidity, support net margins, and reduce credit loss provisions.
  
• Restructuring the mortgage portfolio and a robust loan pipeline could boost non-interest income and future revenue growth.
  
• Economic uncertainty and increased expenses may pressure earnings, while competition and reliance on costly deposits could impact revenue and profitability.

Catalysts

Operates as the bank holding company for Mercantile Bank that provides commercial and retail banking services to small- to medium-sized businesses and individuals in the United States.

• Mercantile Bank has focused on broadening its deposit base, resulting in a significant increase in business deposits by 24% and personal deposits by 9%, which should improve their net interest margin by enhancing the bank's liquidity position.
  
• By restructuring their mortgage portfolio to sell more originations on the secondary market, Mercantile has increased its mortgage banking income by 13% year over year, potentially boosting non-interest income and overall earnings.
  
• The bank has a robust commercial loan pipeline of $234 million, and even though commitments have decreased, discussions are at an all-time high, suggesting potential future revenue growth if these discussions convert into accepted commitments.
  
• Strengthening of asset quality with nonperforming assets at only 9 basis points of total assets along with strong risk management may result in lower provisions for credit losses, improving net margins.
  
• With a focus on maintaining a durable net interest margin through managing the cost of funds and strategically growing the securities portfolio, Mercantile is in a position to withstand interest rate volatility, positively impacting future earnings stability.

Mercantile Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Mercantile Bank's revenue will grow by 8.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 34.9% today to 30.7% in 3 years time.
• Analysts expect earnings to reach $85.9 million (and earnings per share of $5.27) by about May 2028, up from $77.6 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.3x on those 2028 earnings, up from 9.0x today. This future PE is greater than the current PE for the US Banks industry at 11.0x.
• Analysts expect the number of shares outstanding to grow by 0.71% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.72%, as per the Simply Wall St company report.

Mercantile Bank Future Earnings Per Share Growth

Risks

• The uncertainty in the economic environment may slow commercial loan demand and impact future loan growth, affecting revenue.
  
• The bank's reliance on higher-cost money market and time deposit products for deposit growth could pressure net interest margins, affecting earnings.
  
• Increased noninterest expenses, particularly from higher salary and benefits costs, may pressure net margins if not offset by revenue growth.
  
• Provision expenses could rise due to economic uncertainty, as indicated by the inclusion of adverse economic scenarios, impacting net income.
  
• Intense competition and potential spread tightening in loan yields may limit net interest income growth, affecting overall profitability.

Valuation

• The analysts have a consensus price target of $50.125 for Mercantile Bank based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $279.9 million, earnings will come to $85.9 million, and it would be trading on a PE ratio of 11.3x, assuming you use a discount rate of 6.7%.
• Given the current share price of $42.97, the analyst price target of $50.12 is 14.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.