Mercantile Bank Corporation (NASDAQ:MBWM) Q4 2022 Earnings Conference Call January 17, 2023 10:00 AM ET

Company Participants

Julia Ward - IR, Lambert
Bob Kaminski - President & CEO
Ray Reitsma - COO & President of the Bank
Chuck Christmas - EVP & CFO

Conference Call Participants

Brendan Nosal - Piper Sandler
Daniel Tamayo - Raymond James
Erik Zwick - Hovde Group
Damon DelMonte - KBW

Operator

Good morning, and welcome to the Mercantile Bank Corporation Fourth Quarter 2022 Earnings Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.

I would now like to turn the conference over to Julia Ward, Lambert Investor Relations. Please go ahead.

Julia Ward

Good morning, everyone, and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the fourth quarter and full year of 2022.

Joining me today are members of Mercantile's management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, Chief Operating Officer and President of the Bank. We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open the call to questions.

Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings, and capital structure, as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to factors described in the company's latest Securities and Exchange Commission's filings. The company assumes no obligation to update any forward-looking statements made during the call.

If anyone does not already have a copy of the fourth quarter 2022 press release and presentation deck issued by Mercantile today, you can access it at the company's website at www.mercbank.com.

At this time, I would like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski.

Bob Kaminski

Thank you, Julia, and thanks to all of you for joining us on the conference call today.

Mercantile released its December 31st financial results this morning, which reported another strong quarter, finishing 2022 with continued success in numerous performance metrics.

Highlights for the fourth quarter include: continued increases in net interest margin rising to more normal ranges for Mercantile, which drove strong profitability in the quarter; solid growth in many fee income categories; continuation of our strong asset quality; disciplined control of overhead expenses; and while loan growth was dampened by some loan payoffs, customer relationship building by the sales staff continued to generate successes and pipelines remained strong.

For the fourth quarter, Mercantile produced earnings of $1.37 per share on revenues of $58.4 million. Full year 2022 earnings were $3.85 per share on revenues of $190.3 million. This morning, we also announced a cash dividend of $0.33 per share, payable on March 15, 2023. This represents a 3% increase over the fourth quarter dividend.

Ray will have more information on the loan portfolio, fee income and other operational topics, and Chuck will provide more detail on overall financial performance for the quarter and full year, as well as some guidance on our performance in 2023.

The Michigan economy continues to perform at a level we would describe as steady. Unemployment is only slightly higher at 4.3% in November compared to 4.1% at the end of the third quarter, but lower than what it was at January 01, 2022, when it was 5.1%.

Mercantile bankers and our clients continue to prepare and position for a potential economic downturn of some sort. Customers have been able to absorb higher interest costs thus far. This seems to reflect the strong balance sheets and robust performance coming out of the pandemic.

The real estate sector, most notably multifamily housing, has demonstrated some signs of reduced activity toward the end of 2022 as a result of higher borrowing costs and the level of new projects has slowed. Our overall pipeline, however, remains very healthy.

Our team continues to diligently monitor our client base and engage our borrowers, so that we understand their financial condition and any challenges they may be encountering. We remain very pleased with the performance of our customers and their ability to navigate in economic slowdown. Should difficulties arise, however, the deep customer knowledge of our bankers allows them to provide meaningful feedback and counsel to assist the borrowers and ultimately help manage risk for the bank. The loan portfolio, however, continues to be very strong.

While our senior management team is keenly focused on maneuvering through near-term economic conditions, we eagerly look forward to the future with much anticipation to craft strategies for long-term sustainability and success of our company. Our team ensures comprehensive plans are in place to create, develop and leverage opportunities for growth and excellence in performance in our existing markets as well as potential new markets.

An important key to future success is maintaining the steady pipeline of new talent entering our organization and the ongoing development and training of all employees so they can help us achieve our strategic initiatives. Relationship-focused banking allows us to understand the clients' immediate and long-term needs and design and implement products to fulfill those needs. Attainment of these objectives allows our company to provide best-in-class service to our customers, demonstrate peer-leading performance and provide attractive returns for our shareholders.

In closing my initial comments, I want to thank the Mercantile team for their excellent work in the fourth quarter and throughout 2022. Each day our staff members engage our clients and demonstrate the Mercantile way of relationship banking. Consumers and businesses have seemingly endless choices for their financial needs. For 25 years, customers and our markets have discovered the benefits of banking with Mercantile. As a result, Mercantile has grown consistently and profitably for its shareholders and proven to be a strong partner for the communities we serve.

Those are my prepared remarks, and I'll now turn the call over to Ray.

Ray Reitsma

Thanks, Bob. My comments will center around dynamics in the commercial and residential mortgage loan portfolios and noninterest income.

Core commercial loan growth for the year is 7% despite a contraction of 2% annualized in the fourth quarter. This contraction is attributable to payoffs of $39 million resulting from asset sales, $24 million from refinancing to the secondary market, and $39 million paid down from excess cash flow or cash reserves.

Our commercial backlog has grown sequentially over the last four year-ends and over each of the last four quarters, and currently resides at a four-year high. The pipeline for commercial construction commitments that we expect to fund over the next 12 to 18 months totals $197 million compared to $170 million last quarter.

Presently, line of credit utilization is 42% compared to 37% a year ago. However, bank commitments in aggregate have increased $385 million or 21% over the past year. The portfolio is well positioned for a rising rate environment, as 65% of the portfolio is comprised of floating rate loans, up from 50% at March 31, 2021, accomplished largely through our swap program.

Asset quality remained strong with nominal amounts of past due loans and non-performing assets of 16 basis points of total assets compared to 3 basis points last quarter. A single addition to non-accrual loans accounted for 90% of the increase to non-performing assets during the quarter. The deterioration of the C&I credit is attributable to an isolated management failure rather than stress in the industry or the general economy.

While we are proud of our outstanding asset quality metrics, we remain vigilant in our underwriting standards and monitoring efforts to identify any sign of deterioration in our loan portfolio. Our lenders are the first line of defense to recognize areas of emerging risk. Our risk rating process is robust with an emphasis on current borrower cash flow and our rating model, providing sensitivity to any challenges evolving within a borrower's finances.

All that said, our customers continue to report strong results to-date and have now begun to experience impacts of a potential recessionary environment. We continue to closely monitor concentration limits within our loan portfolio.

The mortgage business has slowed due to the rising rate environment, seasonality and lack of available housing inventory in the markets we serve. Higher rates have led to more demand for adjustable-rate mortgages, and the lack of inventory has led to more construction lending activity. We hold each of these types of loans on our balance sheet and, as a result, residential mortgages have increased 60% over the prior year.

Compared to a gain on sale event and immediate recognition of income, a portfolio loan takes about 24 months to generate an equal amount of income. We continue to pursue share in the purchase market with originations in the fourth quarter decreasing 36% compared to the fourth quarter last year due to the increase in mortgage rates since that time. Availability under residential construction loans is $72 million this quarter compared to $59 million one year ago. Refinance activity is just 13% of last year's comparable quarter.

Noninterest income for the fourth quarter is down 38% compared to the fourth quarter of 2021. The primary contributor to the overall reduction was the previously described decrease in mortgage banking income of 75%, which more than offset a 5% increase in service charges on accounts, a 23% increase in payroll services, a 7% increase in credit and debit card income and a 47% increase in swap income.

The optimization of our branch network is an ongoing endeavor that has yielded seven-figure annualized savings. Utilizing tools such as appointment banking, limited-service branches, live ATM machines and branch consolidations complemented by investments in our remaining facilities resulted in a nominal deposit attrition in the impacted markets. We have added commercial and mortgage lending talent in Saginaw and Traverse City markets, and plan to establish loan production offices in those markets in the near future.

That concludes my comments. I will now turn the call over to Chuck.

Chuck Christmas

Thanks, Ray.

As noted on Slide 10 of our presentation, this morning we announced net income of $21.8 million or $1.37 per diluted share for the fourth quarter of 2022 compared with net income of $11.6 million or $0.74 per diluted share for the respective prior year period. Net income for the full year 2022 totaled $61.1 million or $3.85 per diluted share compared to $59 million or $3.69 per diluted share during the full year 2021.

Higher net interest income, stemming from an improving net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and increases in treasury management fee income revenue streams, more than offset a significant decline in mortgage banking revenue, as industry-wide originations come off the record levels of 2020 and 2021, which were driven by low mortgage loan rates and resulting refinance activity. Our earnings performance in the 2021 periods also benefited from lower loan loss provisions, reflecting improved economic expectations.

Turning to Slide 11. Interest income on loans increased significantly during the 2022 periods compared to the prior year periods, reflecting an increase in interest rate environment and strong loan growth in core commercial and residential mortgage loans.

Our fourth quarter loan yield was 93 basis points higher than the third quarter and 142 basis points higher than the fourth quarter of 2021. The yield on loans during the full year 2022 was 44 basis points higher than the full year 2021, as the increase in interest rate environment impact didn't start in earnest until the second quarter of 2022, and the 2021 period was significantly impacted by PPP net loan fee accretion.

Interest income on securities also increased during the 2022 periods compared to the prior year periods, reflecting growth in the securities portfolio to deploy a portion of the excess liquid funds position and the higher interest rate environment.

Interest income on other earning assets, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, also increased during the 2022 periods compared to the prior year periods, generally reflecting the higher interest rate environment.

In total, interest income was $21.2 million and $38.3 million higher during the fourth quarter and full year 2022 when compared to the respective time periods in 2021.

We recorded increased interest expense on deposits during the fourth quarter of 2022 compared to the fourth quarter of 2021 in large part reflecting the increase in interest rate environment and enhanced competition for deposits. In comparing the full year 2022 to the full year 2021, we recorded an increase in interest expense on deposits, as deposit rates increased primarily during the latter part of 2022 and average interest-bearing deposit balances grew about 4%.

Interest expense on other borrowed money increased during the fourth quarter of 2022 compared to the fourth quarter of 2021 and grew during the full year 2022 compared to the full year 2021. The increases largely reflect interest costs associated with $90 million in subordinated notes issued between December of 2021 and January of 2022, and higher rates on our floating rate trust preferred securities.

In total, interest expense was $3.1 million and $4.2 million higher during the fourth quarter and full year 2022 when compared to the respective time periods in 2021.

Net interest income increased $18.1 million and $34.2 million during the fourth quarter and full year 2022, respectively, compared to the same time periods in 2021.

We recorded a credit loss provision expense of $3.1 million and $6.6 million during the fourth quarter and full year 2022, respectively, compared to a negative provision expense of $3.4 million and $4.3 million during the respective time periods in 2021.

The provision expense recorded during the 2022 periods was necessitated by the net increase in required reserve levels stemming from changes to several environmental factors that largely reflected enhanced inherent risk within the commercial loan and residential mortgage loan portfolios, as well as loan growth and increased specific reserve for certain distressed loan relationships. A higher reserve for residential mortgage loans reflecting slower principal prepayment rates and the resulting extended average life of the portfolio also impacted provision expense during 2022.

The negative provision expense recorded during the 2021 periods mainly reflected reduced allocations attributable to improvement in both current and forecasted economic conditions and net loan recoveries, which more than offset required reserve allocations necessitated by loan growth.

Overhead costs decreased $4.8 million during the fourth quarter of [2002] (ph) compared to the fourth quarter of 2021 and were down $2.9 million for the full year 2022 when compared to the full year 2021. Adjusting for charitable contributions to the Mercantile Bank Foundation, overhead costs decreased $1.8 million during the first quarter -- fourth quarter of 2022 compared to the fourth quarter of 2021 and were down slightly for the full year 2022 compared to the full year 2021.

Salary and benefit expenses declined during the 2022 periods, mainly from lower compensation related costs, in large part reflecting lower residential mortgage lender commissions, reduced stock-based compensation costs, and higher residential mortgage loan deferred costs. Regular salary costs, primarily reflecting annual merit pay increases and market adjustments, and bonus accruals were higher in the 2022 periods.

Continuing on Slide 14, our net interest margin was 4.30% during the fourth quarter of 2022, up 74 basis points from the third quarter of 2022 and up 156 basis points from the fourth quarter of 2021. The improved net interest margin is primarily a reflection of an increased yield on earning assets, in large part reflecting an increase in interest rate environment in 2022 as well as strong loan growth.

As I noted earlier, we recorded increased interest income on loans during the 2022 periods compared to the 2021 periods, which was achieved despite a significant reduction in PPP net loan fee accretion. During the full year 2022, PPP net loan fee accretion totaled $1.0 million compared to $10.8 million during the full year 2021.

Our average commercial loan rate increased 252 basis points during the full year 2022, a significant increase at a loan portfolio that averaged $3.1 billion during that time period. Given the asset sensitive nature of our balance sheet, which includes 65% of our commercial loan portfolio comprised of floating rate loans, any further increases in short-term interest rates will have a positive impact on our interest income.

After increasing only about 3 basis points per quarter over the past three quarters, our cost of funds increased 17 basis points during the fourth quarter of 2022. Despite the increase in interest rate environment, our deposit rates and those of our competitors were not meaningfully raised during the first nine months of 2022, which we believe reflected a relatively low level of competition for deposits given the excess liquidity positions of most financial institutions. However, as interest rates continue to rise and excess liquidity positions decline and end, deposit rates are now increasing and we believe deposit rate betas will ultimately return to historical levels.

We remain in a strong well-capitalized regulatory capital position. Our total risk-based capital ratio and all of our bank's regulatory capital ratios were augmented about a year ago with an aggregate $90 million in issuance of subordinated notes, of which a vast majority of the funds were downstreamed to the bank as a capital injection. As of year-end 2022, our bank's total risk-based capital ratio was 13.7% and was $166 million above the regulatory minimum threshold to be categorized as well-capitalized.

We did not repurchase shares during 2022. We have $6.8 million available in our current repurchase plan.

In regards to our thoughts on -- for 2023, on Slide Number 18, we share our latest assumptions on the interest rate environment and key performance metrics for 2023 with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on 25 basis point increases in the federal funds rate at the next two FOMC meetings and then unchanged for the remainder of 2023. This forecast also assumes no significant recessionary pressures.

We are projecting total loan growth in the range of 7% to 9%, with commercial loan growth itself of around 5%. While our commercial loan pipeline remains strong, we experienced a high level of payoffs and paydowns in 2022, especially in the latter part of the year.

We are forecasting our first quarter net interest margin to decline from the just-completed fourth quarter, as expected increases in our cost of funds more than offsets further increases in asset yields from the FOMC interest rate decisions. For the remainder of 2023, we project our net interest margin to further gradually decline as our asset yield remains stable, but our cost of funds continues to increase from competitive pressures and growth in interest-bearing liabilities to fund expected loan growth.

In closing, we are very pleased with our 2022 operating results and believe we remain well positioned to continue to successfully navigate through the myriad of challenges faced by all of us.

Those are my prepared remarks. I'll now turn the call back over to Bob.

Bob Kaminski

Thank you, Chuck. That concludes management's prepared remarks this morning, and we'll now open the call up for the question-and-answer period.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] And our first question here will come from Brendan Nosal with Piper Sandler. Please go ahead, sir.

Brendan Nosal

Hey, good morning, folks. How are you?

Bob Kaminski

Good morning.

Chuck Christmas

Good morning.

Brendan Nosal

Maybe just to start off on kind of the balance sheet side of things as you look ahead. Maybe just talk about your expectations for deposit flows as we move through 2023? And then, maybe tie that together with your ability to grow loans of that 7% to 9% clip [indiscernible] in the context of your loan to deposit ratio at 106% today?

Chuck Christmas

Yes, Brendan, this is Chuck. I'll take a swing at that one. So, clearly funding is back in vogue. Certainly, it was something that this company was very familiar with throughout its history up until the last couple of years, which obviously, virtually every financial institution saw itself with a strong level of excess liquidity.

We worked through that primarily through funding loan growth that we've had over the last couple of years. We did enhance our securities portfolio a little bit. And then, more recently, we are starting to see depositors use their funds. Although I will say in December of each year and this follows into January, we do typically see some meaningful reductions as our commercial customers pay taxes and tax payments as well as bonus payments.

But clearly, that's going to be -- one of our primary jobs as we get into 2023 here and likely beyond is getting back into the -- our ability to efficiently and effectively build our liabilities of the balance sheet instead of being able to rely on the asset side, primarily our funds at the Federal Reserve Bank of Chicago to fund any increases in our total assets.

So, we have -- even though we had all that excess liquidity over the last couple of years, we have never taken our foot off the -- we need to grow deposits [title] (ph). We knew that the excess liquidity was going to dry up at some point in time, it was just a matter of when. So, we have been enhancing our deposit relationships, bringing in new deposit relationships throughout this period, and that's something that, obviously, we'll continue to strive to do.

We also get meaningful deposit growth with our growth in our commercial loan portfolio, especially on the C&I credits when they bring over their operating accounts and, obviously, we try for ancillary business owner and management accounts as well.

I wish I had a silver bullet. I wish I think every CFO or management seem to wish to have a magic bullet when it comes to deposit growth. But a lot of it is just kind of, as I mentioned, keeping the foot on the gas pedal. It's a job for everybody, not just our branch and treasury management staff, but we expect every sales employee here at the bank to help us grow our deposit base.

We think there are some opportunities in some of the markets that we're in and some of the deposit products offerings that we have. So, we're in the process of enhancing some of our products, looking at some markets and types of depositors that maybe we didn't spend as much time on historically in an effort to fund any asset growth that we do have.

Brendan Nosal

All right. Awesome. Thank you, Chuck, for all the color. Maybe just one more for me. Just on the margin, perhaps more conceptually, I definitely appreciate the detailed guide here, I guess what would be better for the margin once the Fed has done raising rates? Would it be stability in short-term rates for a period of time? Or would it be better if they cut rates sooner?

Chuck Christmas

I think from a pure margin standpoint, it would be better if they hung on to rates for a while. Clearly, our margin has improved dramatically with the big increase in interest rates. Although I think it's important for us to remember that those rates came off incredibly low levels, which in fact had a pretty negative impact on bank net interest margins. Ours is -- I can vouch for over the last three to five years, pre-COVID days, and into the COVID period.

So, I think that it would seem that unless there's a significant recession coming, if the Fed does decide to start reducing rates, we don't think that they're going to get down to where they started from before. So, there would be some reduction in interest rates. It would have some negative impact on our company. But to the degree that the Fed holds rates steady or it has a slight decline in the future, that would be better on our net interest margin and certainly if they got very, very aggressive in cutting rates.

I think that being said, clearly one of the things that we keep an eye on, and Ray already kind of touched on a little bit, is what is the impact that the Fed is doing on the economy and more specifically to Mercantile, what does that doing to our commercial customers and our retail customers as well, and clearly their ability to pay existing debt and what type of impact that has on future decision making as that could impact loan growth opportunities as well.

So, clearly changes in interest rates have an impact on our net interest margin, but we certainly aren't going to take our eye off the fact that, that can also have a pretty big impact on our asset quality as well.

Brendan Nosal

Yes, got it. Okay. Thank you for taking the questions.

Bob Kaminski

Thank you.

Chuck Christmas

You're welcome.

Operator

And our next question will come from Daniel Tamayo with Raymond James. Please go ahead.

Daniel Tamayo

Good morning, guys. Thanks for taking my questions.

Bob Kaminski

Good morning.

Daniel Tamayo

Maybe just a follow-up on the balance sheet management question. So, given where -- as Brendan mentioned, you had at 106% on loan/deposit ratio. Do you -- I think last quarter you said 100% to 105% is kind of where you wanted to be. Does that mean you expect to see the balance sheet grow kind of in line with loan growth going forward?

And then, I guess, along with that, is there a breakeven point or how are you thinking about the ability to -- or your loan growth, given the ability to fund that -- I mean, if you're continuing to see net interest -- noninterest-bearing deposits come off and you've got to fund that with CDs or wholesale deposits, is there a breakeven point where you would perhaps take the foot off the gas on the loan growth side?

Chuck Christmas

Yes, I'll answer the first part, and let the guys chime in on the second part from an overall strategy standpoint. But you're right on. We desire to have our loan to deposit ratio somewhere between the 100% and 105%, which as you noted, we're pretty much there. So, our expectation is that if we do have additional growth on the asset side, which we certainly expect, is that a significant portion of that's going to have to be funded. On the liability side, and it's our druthers to certainly make sure that that's core deposits as much as we can, trying to stay away from wholesale funds to the degree that we can, but that's going to be based on the success of growing our deposit franchise.

So, we typically -- and I kind of mentioned it before in December, but we typically see deposits decline. It's seasonal for us. Because of our strong -- our large commercial focus and because of the payments that we see for taxes and bonuses come out at the end of the year and the early part of the first quarter of each year, we generally do see a deposit decline this time of year and then that builds up over time as well. So, we expect some of that natural seasonality to help us out a little bit as we go into 2023.

But clearly, that's -- as I mentioned before, that's going to be a big challenge of all banks, and I think that's what we're seeing now with deposit rates escalating. Definitely, there was some lag going on there and, a large part, deposit rates are maybe getting back to where maybe they should have been using historical betas in that type of analysis as well. But it's going to be a battle out there for deposits. And what we're going to strive to do is make sure that we can bring in those deposits when we need them, again as efficiently and as effectively as we can.

Bob Kaminski

Chuck gave some color as far as the annual cycle as to what our deposits do. But on a longer-term basis, Mercantile has been through these cycles previously where interest rates rising, interest rates falling, deposits being in high demand. And we've demonstrated an ability to cope with ideas and plans to be able to make sure that we don't need to take the foot off the gas pedal at all from a loan growth standpoint. That's been the nature of our company for a long, long time is commercial loan growth, overall asset growth.

And so, we do the things that we need to do to make sure that, that continues to be the case, and we have some ideas that we're working on to be able to come up with different flavors of deposits and things that are specific to certain markets or certain types customers that can help overall funding of that ongoing loan growth.

Daniel Tamayo

Okay. I appreciate that color. And then, switching gears here. Just on the fee income guidance, it seems like a decent drop. I know you talked about it a little bit in the prepared remarks, but from the fourth quarter level, the first quarter guidance is below kind of what I was expecting. Maybe you could talk a little bit more about what's driving that? And then, kind of as it goes throughout the year, what you may be looking for?

Chuck Christmas

Yes, I think there's two things going on there, Danny. One is just the seasonality of mortgage lending. You're in the Midwest. There's just not a lot of activity in January and February when it comes to buying and selling homes, and, of course, that's what we're relying on, certainly lot more than refinance. Although with rates -- with the long end of the curve doing what it's doing, it's going to be an interesting time when it comes to -- are there going to be some refinance opportunities from people that have gotten mortgage loans in 2022. So that's a big part of it.

The other thing that we're seeing is in service charge income. One of the big calculations in that is the earnings credit rate. And with interest rates going up, we have had the need more recently to go ahead and increase that earnings credit rate, which effectively brings our service charge income down. That earnings credit rate, which is kind of set right along with our deposit rates, while rates were increasing last year, it really wasn't until the fourth quarter that we had to increase the earnings credit rate and we've had to do that again just kind of like lock, stock and barrel with the deposit rates.

So, there's a little bit of -- it's still going to be strong. We're just not going to see the very strong loan -- fee income growth that we saw on service charge income.

Daniel Tamayo

Okay. But the increase in the swaps in the fourth quarter, is that -- are you still thinking that's going to be a similar number or that comes down to what we saw more in the middle of the year as well?

Chuck Christmas

Yes, that one's pretty hard to -- it's kind of like investment banking. It kind of comes and goes and it's hard to project on a quarter-by-quarter basis. I pretty much just straight line it in my budget, and just to let you know we've got about $200,000 budgeted each month. But again, that's -- there's a lot of volatility in that number, but we definitely see interest in that product. And I think that if medium- and long-term rates keep declining as they have, I think there'll be even more interest in that product. It's our desire of not offering fixed rates to larger commercial real estate products, and to put them into the swap product if in fact they want a fixed rate. So that's really driven by the borrower and their decision as to what type of rate structure they want to have.

Daniel Tamayo

Got it. Okay. Thanks for all the color. Thanks.

Chuck Christmas

You're welcome.

Bob Kaminski

Thank you.

Operator

Our next question will come from Erik Zwick with Hovde Group. Please go ahead.

Erik Zwick

Good morning, everyone.

Chuck Christmas

Hey, Erik. Good morning.

Bob Kaminski

Good morning.

Erik Zwick

First question for me. Just looking at the forecast for overhead costs in 2023, curious, one, does that include any charitable contributions?

Chuck Christmas

Nothing significant.

Erik Zwick

Okay. And then, just looking at 2022, you had contributions, I believe, in the second quarter and fourth quarter. Would you like spec something in those quarters? Or I guess, how do you guys determine the timing and magnitude of those contributions?

Chuck Christmas

Yes. Typically, Erik, what we look at is in the fourth quarter, when we see how the bank and the company has performed from an earnings perspective and, obviously, making sure that we're comfortable for asset quality and our capital levels, we typically make the decision in the fourth quarter. But we also -- if things happen during the year, if we have some maybe some non-core income come into the company, we may, at that point in time, go ahead and add additional contributions. But generally speaking, it will be a fourth quarter event, notwithstanding any one-time events during the year.

Erik Zwick

Makes sense. Thanks, Chuck, for the color there. And maybe I guess another one for you. Just looking at the forecasted range for those costs -- total overhead costs in the first quarter of '23, if I look at the run rate from the most recent quarter and back out that charitable contribution, it seems like you're forecasting kind of flat to maybe even potentially $1 million better on that run rate. So, just curious where that leverage is, or where you could see some improvement quarter-over-quarter?

Chuck Christmas

Yes. Most of that comes in our bonus accruals with the strong year that we had and, obviously, finished up with. We asked the -- executive management team asked the compensation committee to enhance our bank-wide bonus program. So, we had some -- which we doubled actually for non-senior management. And so, we had some catch-up accruals we needed to do in the fourth quarter associated with that doubling of the bank-wide bonus program.

Erik Zwick

Got it. Thank you. And then, switching gears towards credit. One, if you could remind me the industry of that larger kind of commercial NPA that you referenced that the management failure? And then, I guess, what's the remediation strategy and timing for a resolution on that credit as well?

Ray Reitsma

This is Ray. That was an automotive supplier. We're working with the company through a number of remediation steps. We expect that we'll have a pretty good resolution to this, I would say, within the next 90 to 120 days.

Erik Zwick

Okay. Thanks. And then, just thinking about the loan loss provision for 2023, let's, I guess, kind of assume that the Moody's forecast doesn't change materially and that there's not any material deterioration in the remaining credit in the portfolio. How -- given the outlook for 7% to 9% annualized loan growth and that mix being a mix of both commercial and residential, how are you providing for each dollar of new loan growth today?

Chuck Christmas

Yes. Everybody -- somebody had to bring up my CECL friend, but we have to provide a lot more on the residential side as a percentage of the loan balance than we do on the commercial side, primarily given the duration. Really kind of what we're looking at assuming no significant changes in the credit, obviously, no recession, a nominal level of net loan charge offs, we kind of expect that we'd be providing for maybe 1 basis point or 2 basis point of increase in the reserve coverage ratio as we worked our way throughout the year.

Erik Zwick

Okay. Thanks. That's helpful. That's all from me today. Thanks, guys.

Chuck Christmas

You're welcome.

Operator

[Operator Instructions] Our next question here will come from Damon DelMonte with KBW. Please go ahead.

Damon DelMonte

Hey, good morning, guys. Thanks for taking my question. Most of my questions have been asked and answered. But just to circle back on the LPO strategy, could you just kind of go back over the locations and the timing regarding those?

Bob Kaminski

Sure. We hired some talent in Saginaw, Michigan in the middle part of the year and have been seeking to establish a physical location. Those people are currently working out of their homes. So, we've begun to enjoy some asset growth in that market. Similarly in Traverse City, Michigan, where we've hired a commercial loan manager who we expect will grow a team out there. We do have a mortgage presence there, and are in the process of securing a physical location to go with the personnel. So, we have had a commercial loan presence in Traverse City for some time, and we're seeking to augment that.

So, we're both in each market in the early stages of growing out into a more physical presence from -- early presence that basically originated from people working out of their homes.

Damon DelMonte

Great. Thank you. And then, with respect to the lending opportunities that you're seeing, kind of tough to pinpoint the exact percentages here, but how would you characterize the opportunities coming from market disruption where you're taking market share from other customers from -- that have been associated with banks that have been acquired versus increased credit demand from current customers?

Ray Reitsma

I would characterize it that the majority -- trying to further -- think of the right adjective here. I'd say, if I just had to throw a fraction on it, somewhere in the two-thirds of new growth is coming from disruption in the market. Some of the larger players that we compete against are having trouble getting out of their own way and have, over the long haul, made it difficult for some pretty good customers to continue to bank with them. And we have been the beneficiary of that. And somewhere between a third-and-a-half is existing relationships that continue to grow and prosper, and, as a result, require more lending from us.

Bob Kaminski

And, Damon, those new client acquisitions take place over a period of time. In most cases, that the relationship is engaged and the lender or the salesperson works on building, enhancing the relationship. And it takes one more event that the incumbent bank does where they don't respond in a timely fashion or they mess something up with respect to someone's loan or account, and that's less strong, and then they look to flip the switch and move to Mercantile, which the relationship has already been developing in many cases for some time. So, it's a process, but as Ray said, we continue to benefit by the actions of -- or in actions of some of our competitors.

Damon DelMonte

Got it. Okay. That's great. That's all that I had. Thank you very much.

Bob Kaminski

Thanks, Damon.

Operator

And with no further questions, this will conclude our question-and-answer session. I'd like to turn the conference back over to Bob Kaminski for any closing remarks.

Bob Kaminski

Thank you very much for your interest in our company. We look forward to speaking with you next at the end of the first quarter in April, and this call has now ended. Thanks, again.

Operator

The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.