Deposit-Driven Growth Strategy Risks Compressing Future Margins And Stalling Revenue

Key Takeaways

• Over-reliance on deposit growth relative to loans may lead to reduced net interest margins and negatively impact future earnings.
  
• Anticipated Federal Reserve rate cuts and high deposit costs could continue to pressure interest income and net margins.
  
• Strong local deposit growth and increased noninterest income from mortgage banking indicate resilience and potential for revenue and earnings boosts.

Catalysts

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

• Investors may perceive Mercantile Bank's growth strategy as being overly reliant on deposit growth outpacing loan growth, which could result in future net interest margin compression as the added deposits are likely to be invested at lower yields in securities. This might impact future earnings negatively.
  
• The bank's focus on reducing the loan-to-deposit ratio could lead to an increased proportion of lower-yield securities in the asset mix instead of higher-yielding loans, potentially impacting revenue growth prospects.
  
• Despite recent deposit growth, the shift towards higher-cost deposit products to manage the loan-to-deposit ratio could lead to compressed net interest margins, affecting future profitability.
  
• With the anticipation of further Federal Reserve rate cuts, there may be continued pressure on interest income from loans and securities, while competition may keep deposit costs elevated, negatively impacting net margins.
  
• The potential deceleration in commercial loan growth, coupled with strategies favoring deposit growth over loan expansion, might signal slower revenue growth going forward.

Mercantile Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Mercantile Bank's revenue will grow by 4.4% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 36.0% today to 28.5% in 3 years time.
• Analysts expect earnings to reach $72.0 million (and earnings per share of $4.39) by about November 2027, down from $80.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $80 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.5x on those 2027 earnings, up from 9.8x today. This future PE is greater than the current PE for the US Banks industry at 12.8x.
• Analysts expect the number of shares outstanding to grow by 0.54% 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 significant reduction in the loan-to-deposit ratio to 102% with a future target to reach the mid-90% range reflects a robust strategy to strengthen the bank's balance sheet and improve funding stability, potentially supporting stronger net margins.
  
• Strong local deposit growth at a 21% annualized rate and increased noninterest income, especially from mortgage banking where income grew 49%, demonstrate resilience and could boost revenue and earnings.
  
• Excellent asset quality with nonperforming assets only at 17 basis points of total assets indicates a low level of risk and potential for stable earnings.
  
• Increased net interest income, reflecting higher interest on loans and solid growth in mortgage loans, suggests a potential for improved future earnings as loan yield has increased despite a challenging rate environment.
  
• The bank's strong capital position and a focus on maintaining robust reserves provide a buffer against economic downturns, potentially leading to stronger financial health and stable net margins.

Valuation

• The analysts have a consensus price target of $49.88 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 2027, revenues will be $252.7 million, earnings will come to $72.0 million, and it would be trading on a PE ratio of 13.5x, assuming you use a discount rate of 6.7%.
• Given the current share price of $48.56, the analyst's price target of $49.88 is 2.6% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.