Expanding Securities Portfolio Will Provide Stable Interest Income In High-Rate Environment

Key Takeaways

• Mercantile Bank aims to lower loan-to-deposit ratios by focusing on business deposits and retail growth, enhancing net interest margins.
  
• Strong mortgage income growth and maintained asset quality are poised to support consistent earnings and revenue growth.
  
• Deposit growth outpacing loan growth and declining net interest margins could suppress future profitability amid costs, risks in commercial real estate, and volatile interest rates.

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.

• Mercantile Bank's strategy to broaden their focus on business deposits, expand in the governmental and public realm, and grow the retail customer base aims to sustainably lower their loan-to-deposit ratio, potentially enhancing future net interest margins by reducing reliance on more expensive wholesale funding.
  
• The bank's strong mortgage banking income growth, driven by successful adaptation to selling a greater portion of originations in the secondary market, is expected to continue contributing positively to noninterest income, supporting future revenue growth.
  
• By maintaining high asset quality with low nonperforming assets and vigilant risk management, Mercantile Bank is positioned to minimize loan losses, which could enhance net margins and contribute to consistent earnings growth.
  
• The strategic increase in the securities portfolio, using surplus deposits, provides stable interest income in a higher rate environment, potentially supporting steady revenue growth despite fluctuations in loan demand.
  
• Expected loan growth of 5% to 7% alongside strategic deposit initiatives sets the stage for solid earnings growth, allowing for potential reinvestment into capital expansion initiatives or shareholder returns, thereby impacting future EPS positively.

Mercantile Bank Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Mercantile Bank's revenue will grow by 6.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 35.5% today to 30.8% in 3 years time.
• Analysts expect earnings to reach $82.2 million (and earnings per share of $5.04) by about March 2028, up from $79.6 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 12.6x on those 2028 earnings, up from 9.1x today. This future PE is greater than the current PE for the US Banks industry at 11.2x.
• Analysts expect the number of shares outstanding to grow by 0.68% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.88%, as per the Simply Wall St company report.

Mercantile Bank Future Earnings Per Share Growth

Risks

• The bank experienced deposit growth that outpaced loan growth, leading to a lower loan-to-deposit ratio, which can negatively impact net interest income and profit margins as higher-cost deposits may reduce overall earnings.
  
• Declining net interest margins, driven by rising costs of funds and lower yields on earning assets, could suppress future profitability and earnings.
  
• The potential over-concentration in commercial real estate loans poses a risk if the market conditions for commercial real estate weaken, which could impact asset quality and increase provision expenses.
  
• Significant exposure to floating-rate loans tied to federal funds rates could present vulnerability in a volatile interest rate environment, affecting revenue consistency.
  
• Increased noninterest expenses, including higher salary and benefit costs, could outweigh revenue improvements, negatively impacting net income and net margins.

Valuation

• The analysts have a consensus price target of $53.0 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 $266.7 million, earnings will come to $82.2 million, and it would be trading on a PE ratio of 12.6x, assuming you use a discount rate of 6.9%.
• Given the current share price of $44.48, the analyst price target of $53.0 is 16.1% 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.