Mercantile Bank Corporation (NASDAQ:MBWM) Q1 2021 Earnings Conference Call April 20, 2021 10:00 AM ET

Company Participants

Tyler Deur - Lambert, Investor Relations
Bob Kaminski - President and CEO
Chuck Christmas - Executive Vice President and CFO
Ray Reitsma - President, Mercantile Bank, Michigan

Conference Call Participants

Brendan Nosal - Piper Sandler
Damon DelMonte - KBW
David Long - Raymond James
Bryce Rowe - Hovde Group
John Rodis - Janney

Operator

Good morning. And welcome to the Mercantile Bank Corporation First Quarter 2021 Earnings Results Call and Webcast. 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 this event is being recorded. I would now like to turn the conference over to Tyler Deur from Lambert, Mercantile’s Investor Relations firm. Please go ahead.

Tyler Deur

Thanks, Matt. 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 first quarter 2021. I am Tyler Deur with Lambert IR, Mercantile’s Investor Relations firm and joining me today are members of their management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, President of Mercantile Bank, Michigan.

We will begin the call with management’s prepared remarks and presentation to review the quarter’s results then open the call up to questions. However, before we begin today’s call, 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 different materially from any forward-looking statements made today due to the factors described in the company’s latest Securities and Exchange Commission 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 first quarter 2021 press release and presentation deck issued by Mercantile today, you can access it at the company’s website 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?

Bob Kaminski

Thank you, Tyler, and good morning, everyone. On the call this morning, we will provide you with detailed information on the company’s performance in the first quarter, as well as updates on the current operating environment, which continues to be impacted by the COVID-19 pandemic.

As has been outlined in our release this morning, Mercantile had an extremely strong quarter to start 2021, the wonderful work of our team across all fronts throughout 2020 and during the first quarter position as well for success and the rest of this year and beyond.

Despite the recent surges of COVID experience throughout the country and specifically in the State of Michigan, we remain optimistic due to the increasing pace of vaccinations. We continue to closely monitor pandemic-related developments, while prioritizing the health and safety of our customers and employees, and are constantly finding ways to seamlessly transition as needed to navigate these new and changing environments. Our full timeline of pandemic-related activities can be found on slide 10 of our deck.

The Mercantile team once again demonstrated resiliency and adaptability during the first quarter, delivering another solid financial performance. We achieved net income of $14.2 million and per share earnings of $0.87 per share.

We also announced this morning the declaration of a cash dividend in the amount of $0.29 per share payable on June 16th. Later in this call Chuck will dive deeper into the details of our financial statements as of March 31st, which includes the ongoing strength in mortgage banking income, sound asset quality, solid growth in core commercial loans and managed overhead costs.

In addition to our commercial lending teams continued efforts on the forgiveness phase of round one PPP in the first quarter, we also work to assist to pass a new loan recipient clients the second round PPP funding requests.

These new opportunities for relationship building speak to not only the dedicated and efficient efforts of our lending group, but also the adaptability and perseverance of the local economies and businesses throughout our communities.

We are fully engaged to meet the evolving needs of our customers, as we understand their challenges related to the pandemic. We also continue to evaluate new products and service opportunities to further strengthen our relationships within these markets in support of our communities as they transition to a recovery from the pandemic and a more robust economic growth.

While our dedication to the needs of our new and existing customers requires a significant amount of time and effort, we remain committed to growing our customer relationships. This work is demonstrated by our solid and sustained new business pipelines. Ray will provide you with an update on our growth and ongoing new business development later in this call.

The ongoing success of strategic initiatives in mortgage banking that we designed to boost market share and increase revenue was especially evident in the first quarter. Our mortgage team including those at our new lending offices exceeded expectations and continued to leverage opportunities to produce solid loan production numbers.

Their work has allowed us to position ourselves extremely well to leverage the strong demand and capitalize on this market to deliver robust mortgage banking income. Additionally, higher levels of refinance activity remain persistent through the first quarter in light of the historically low interest rate environment.

Once again, the relationship based approach of Mercantile will provide us the ability to generate consistently solid mortgage production in times when interest rate and market conditions are favorable such as we currently enjoy, but also at times when conditions aren’t as accommodating. Ray will share more details on this in his comments.

Turning to operations. We are constantly evaluating our processes across the Board to ensure adaptation of industry best practices, while leveraging available data to capture efficiencies, customized unique client interactions and optimize our internal systems.

We remain focused on expanding our non-interest income revenue streams and continuing to identify opportunities to build on the strength of this income as we have over the past five years. While non-interest income growth has been strongly driven by our robust mortgage banking production, we have also implemented ongoing initiatives with a strategic focus on enhancing the customer experience through digital delivery and the development of advancing technology.

For years Mercantile has focused on investments in the evolution of banking and this change in the manner in which banks do business has been -- has only been accelerated in the current environment.

This investment and new ways of banking has enabled the recent branch consolidations, while ensuring the efficient optimization of each of our relationship centers. This allows our staff to fully engage clients so we can meet their new banking needs while more routine and repetitive transactions can be serviced at their convenience through our digital channels. Mercantile’s current footprint can be viewed on slide three of the deck.

All of our initiatives illustrate our resolute focus on our people, which continues to heighten our commitment to pursuing best practices in environmental, social additional governance with particular emphasis on the social component, as we work to meet the needs of our shareholders, customers and communities.

In the first quarter, we improve -- we approved a supplier diversity program and diversity equity and inclusion policies, while our entire DEI team has been continuously providing access to enriched learning and growth opportunities for the Mercantile staff through a wide variety of methods. These include live virtual speaking engagements, videos, books, articles, group discussions, training and creating safe spaces for employees to ask questions and engage in conversations.

All of our supervisors have been provided with best practice overviews, resources and other tools to engage their teams in DEI work and are strongly encouraged to collaborate with other supervisors to share ideas across the organization.

Thanks Diversity Council, comprised of a wide cross-section of employees and departments is also actively working to implement additional supportive DEI strategies and constantly developing new ideas.

We remain committed to providing enhanced knowledge and growth opportunities for all of our team members to ensure that diversity equity inclusion are not reactive measures but a natural part of our workspace culture where everyone is equipped to be a leader in their specific roles.

As I close my comments I want to re-emphasize our optimism for the year ahead across all of our markets and business lines as our team has proven their leadership capabilities well beyond traditional banking.

We remain focused on building on these foundational efforts throughout our company, capitalize on sustained strategies for future success of all of our customers, employees, communities and shareholders.

Those are my prepared remarks. I will now turn the call over to Ray.

Ray Reitsma

Thanks, Bob. Our total loan portfolio increased $171 million during the quarter, comprised of $89 million in growth of PPP loans and $84 million in growth of core commercial loan categories, $49 million of which related to C&I categories. Core commercial loan growth is 14% on an annualized basis.

In general, our C&I loan funding net off PPP activity remains similar to pre-pandemic levels as we continue to add targeted new commercial relationships around our PPP activity and also serve existing relationships.

Additionally, our construction pipeline remains solid with $135 million of commitments in commercial construction and development loans, which we expect to fund over the next 12 months to 18 months.

Accruing commercial pass due loans at quarter end are nominal in dollar terms, totaling $1.2 million representing four borrowers. Our overall past due information can be found on slides 17 and 18.

Asset quality remains strong as non-performing loans totaled just $2.8 million or 0.8%, I am sorry, 0.08% of total loans at March 31, 2021. This breakdown can be found in the financial portion of our presentation on slides 25 and 26.

The following recaps are provisioning activities during the COVID-19 impacted time periods. In the second quarter of 2020 provision expense of $7.6 million was generated entirely through increases to environmental factors. The third quarter of 2020 provision expense of $3.2 million was driven by risk rating adjustments to 159 specific credits, eight of which moved to the watchlist.

Fourth quarter 2020 provision expense of $2.5 million was driven by a $3.9 million increase in qualitative and environmental factors. Our loan loss provision expense for the current quarter totaled $300,000, primarily driven by loan growth. These actions bring the allowance for losses to total loans to 1.33% net of PPP loans, up 55% from 86 basis points at March 31, 2020.

Payment deferrals at the peak of the program in mid-July impacted 738 borrowers and represented $719 million of exposure. Presently as of March 31 extensions are in place beyond that date for 12 borrowers, representing $2.6 million of exposure as seen on slide 11.

The current modest deferral numbers when combined with our expectations for a limited future requests and our strong past due performance are positive indicators. The risk grading process depicts a portfolio with solid characteristics reflecting strength similar to that of the pre-crisis economy as seen in slide 16.

Maintaining accurate risk ratings will remain a key focus in the upcoming quarters as our borrowers continue to report results impacted by the pandemic. We continue to monitor the financial condition and performance of credits particularly in the following segments, hotels and lodging, assisted living, restaurants and entertainment. None of these individual segments account for more than 4.8% of commercial loans and the composition of these segments can be seen in -- are on slide 13.

We recorded non-interest income during the first quarter of $13.5 million, up $6.9 million or 106% from the prior year first quarter. As can be seen on slide 21, this improved level of non-interest income was largely driven by 235% quarter-over-quarter increase in mortgage banking income, reflecting the success of our ongoing strategic initiatives designed to increase market share, a higher level of refinance activity stemming from historically low rates and increased share in the purchase market and an increased percentage of loans sold.

For the first quarter of 2021, purchase mortgage loans originated were up 75% over the comparable quarter in the prior year, while refinance activity increased by 90% as can be seen on slide 24.

April applications and backlogs suggest that refinance opportunities will exist into the near future and purchase applications are at seasonally higher levels. Continuing to enhance mortgage banking income through increased market share including expanding share in the purchase market remains a priority and we will continue to hire a proven mortgage loan originators as we are able as in the case of our new mortgage office in the Cincinnati area, which opened during the fourth quarter of 2020 in the Petoskey, Michigan loan production office, which opened during the second quarter of 2021.

Non-interest income from payroll services decreased 3.5% due to higher levels of unemployment during the quarter relative to the prior year comparable quarter. Services charges on accounts for the year decreased 5.5% due primarily to larger balances offsetting charges.

Credit and debit card income increased by approximately 23% on a quarter-over-quarter basis, as activity within the accounts recovered from reduced activity during the pandemic and the base of activity grew as new relationships came to the bank and existing relationships were more fully developed.

Finally, we reported $653,000 of swap income reflecting interest rate risk management products put into place for clients during the quarter.

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

Chuck Christmas

Thanks, Ray, and good morning to everybody. As noted on slide 19, this morning we announced net income of $14.2 million or $0.87 per diluted share for the first quarter of 2021, compared with net income of $10.7 million or $0.65 per diluted share for the first quarter of 2020. Generally speaking, increased mortgage banking income more than offset a lower level of net interest income and higher overhead costs during the quarter.

Turning to slide 20, interest income on loans declined in the first quarter of 2021 compared to the first three months of 2020, primarily due to the FOMC rate cuts totaling 150 basis points during March of 2020.

Interest income on securities during the first quarter of 2020 benefited from accelerated discount accretion and called U.S. Government agency bonds totaling $1.8 million. In total, interest income declined $3.1 million during the first quarter of 2021 compared to the first quarter of 2020, primarily reflecting a lower interest rate environment that could not be fully offset with growth and earning assets.

Interest expense declined in all categories during the first quarter of 2020 compared to the first three months of 2020, reflecting the decline in interest rate environment. In total, interest expense declined $2.4 million during the first quarter of 2021 compared to the first quarter of 2020.

Net interest income decreased $0.8 million during the first quarter of 2021 compared to the first three months of 2020.

The provision expense recorded during the first quarter of 2021 totaled $0.3 million, compared to $0.7 million during the first three months of last year. Combined with net loan recoveries of $0.4 million, the loan loss reserve increased $0.7 million during the first quarter of this year.

We have elected to postpone the adoption of CECL until January 1, 2022. However, we continue to run our CECL model concurrently with our incurred loss model. Based on preliminary results the reserve balance under the CECL methodology is about $5 million lower than our reserve balance as of March 31st as determined using the incurred loss methodology.

The primary difference between the two reserve models as of March 31st is with the economic forecast aspect of the calculation. Under CECL the employed economic forecast has shown significant improvement over the past couple of quarters.

Under our incurred model we have not modified our economic qualitative factor rating as we believe it is premature to do so given the spike in COVID cases in Michigan over the past several weeks and the ongoing state mandated restrictions.

Continue on slide 22, overhead cost increased $2.2 million during the first quarter of 2021 compared to the first three months of 2020, primarily reflecting high salary and benefit costs, as well as $0.5 million in one-time costs associated with two of our branch facilities.

Salary and benefit costs were up $1.6 million during the first quarter of 2021 compared to the prior year first quarter, mainly reflecting increased mortgage banking-related compensation costs and employee merit pay increases.

In addition, we accrued for our bonus programs during the first quarter of 2021. We did not accrue any moneys for the bonus programs during the first quarter of last year, given the onset of the Coronavirus pandemic.

Continue on slide 23, our net interest margin was 2.77% during the first quarter of 2021, down 23 basis points from the fourth quarter of 2020 and down 86 basis points when compared to the first quarter of 2020.

The yield on earning assets decreased 29 basis points, while the cost of funds declined 6 basis points during the first three months of 2021, when compared to the fourth quarter. The yield on loans declined 31 basis points in large part reflecting a lower level of PPP net fee income accretion, which had spiked during the fourth quarter due to forgiveness activity.

As seen on slide 12, net fee income accretion totaled $2.8 million during the first three months of 2021, compared to $5.4 million during the fourth quarter of 2020. The yield on loans during the first quarter of 2021 was equal to the yield on loans during the third quarter of 2020. The level of PPP net fee income accretion was similar during these two periods. As of quarter end, unrecognized PPP net fee income totaled $8.2 million, a majority of which is related to PPP Round Number Two fundings made during the first quarter.

Our net interest margin continues to be negatively impacted by a significant volume of excess on balance sheet liquidity depicted by low yielding deposits with the Federal Reserve Bank of Chicago and a correspondent bank.

The excess funds are a product of increased local deposits, which are primarily a product of federal government stimulus programs, as well as lower business and consumer investing and spending.

Overnight deposits averaged $587 million during the first quarter of 2021, up from the $560 million during the -- average during the fourth quarter of 2020 and substantially higher than our typical average balance of $50 million to $75 million.

The excess liquidity lowered our net interest margin during the fourth quarter -- first quarter of 2021 by about 37 basis points. We expect the level of overnight deposits to stay elevated well into the foreseeable future.

The cost of funds has also been on a declining trend, primarily reflecting the falling interest rate environment and we expect that trend to continue throughout 2021 as time deposits originated in the higher interest rate environment in prior periods mature.

As shown on slide 27, we remain in a strong and well-capitalized regulatory capital position. The Tier 1 leverage capital ratio was 9.7% and the total risk based capital ratio was 13.5% as of March 31st. The Tier 1 leverage capital ratio continues to be impacted by the PPP loan portfolio and excess liquidity, with no similar impact on risk based capital ratios as both components are assigned a zero percent risk weighting. The total risk based capital ratio was $124 million above the minimum threshold to be categorized as well capitalized.

We repurchased about 118,000 shares for $3.5 million at a weighted average cost of $29.91 per share during the first quarter of 2021. As of quarter end, we had $6.3 million available in our repurchase plan.

On slide 28 and to conclude my prepared remarks, we have some comments on the 2021 forecast. Due to the high degree of uncertainty that currently exists, we will again not be providing earnings performance guidance. However, we are able to offer key considerations that should be factored into any earnings forecast and our company. Clearly economic conditions, asset quality, PPP forgiveness activity and mortgage banking operations are expected to have the most impact on our operating results for this year.

In closing, we are pleased with our first quarter of 2021 operating results and financial condition as the quarter end, and believe we are well-positioned to continue to navigate through the unprecedented environment created by the Coronavirus pandemic and other events.

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

Bob Kaminski

Thank you, Chuck. That concludes management’s prepared comments and we will now open the call for the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Brendan Nosal with Piper Sandler. Please go ahead.

Brendan Nosal

Hey. Good morning, everybody. How are you?

Bob Kaminski

Hi, Brendan. How are you?

Brendan Nosal

Well. Thanks. Just want to start off here on the excess liquidity that you folks mentioned and I appreciate your comments that it’s probably going to stick around for quite some time. Who is wondering if you guys have considered using those excess funds to pay down some of the wholesale borrowings that you do have on the sheet to try and find a way to support the margin?

Chuck Christmas

Yeah. Brendan, this is Chuck. I will tackle that one and the short answer is, yes. We definitely have considered that and we can continue to consider that. The brokered deposits are about $30 million and we don’t have the capacity to prepay them. But they are scheduled to mature over the next 12 months or so 12 months to 15 months. So those will take care of themselves.

Most of our wholesale funding is in federal home bank advances. We have -- the average rates about 2.06. There’s some advances in there that are well below 1% that were taken out earlier in 2020 and there are some other advances that are over 3%, which were taken out in higher rate environments, and of course, some in between.

I think it’s important to remember that the reason why we got those FHLB advances is to manage interest rate risk and while we don’t match fund on a loan-by-loan basis we certainly match one on a portfolio-by-portfolio basis.

And it’s rather common that we do a five-year fixed rate balloon notes, especially on commercial real estate loans and occasionally we will do some seven-year stuff and those advances were obtained when we needed the liquidity, but also in reflection of our fixed rate and lending operations.

So we did it to protect our margin in the event of an increase in interest rate environment and it’s important to note that a vast majority of those loans are still out there. So the portfolio at least based on the original intent is still doing its job. It is matchpoint mean those longer term fixed rate loans.

And so if we do prepay the FHLB advances and again it’s something that we look at pretty regularly, we do need to do that knowing that we are exposing --potentially exposing at least part of our balance sheet to an increase in interest rate environment when of course the idea of an inflationary pressures is out there every day in regards to what’s going on in our economy and whether there’s inflation to be out there that will result in higher interest rates as we move forward.

So that is something that we again we are carefully considering, doing lots of calculations, lots of analysis and we will just see where we go from here, but it is something on our radar.

Brendan Nosal

Yeah. That’s fantastic, Chuck. Thank you so much for those thoughts. That’s helpful. And then one more for me and then I will step back. It looks like outside of all the PPP noise, loan growth was quite strong this quarter, which makes for two pretty healthy quarters in a row, which is just not something that many community banks are seeing these days. So does it nice to see strong trends there. Just help us understand kind of where the commercial growth is coming from, what your commercial customer sentiment is today and how you guys think about loan growth through the remainder of year?

Ray Reitsma

Yeah. This is Ray. I’d be happy to tackle that one. The funding that we see in the very near future that we can point to some specificity is similar to what you pointed out in the last couple of quarters.

And much of that comes from new relationships. This environment that we have all been through has really differentiated our approach as a bank and that differentiation approach has led to more and more opportunities to pick up relationships that we had been calling into for a number of years and so that has provided a nice bit of momentum.

Also the academy is fairly decent here in West Michigan and the trend toward the shortage of labor has led to greater investments in equipment than we have seen in the past. So that’s been somewhat of a trend fueling our balance sheet. And of late we have seen increased usage in our line of credit facilities not in a big major way but in a subtle way that’s been big enough to increase the overall trends in our balance sheet.

Brendan Nosal

Got it. That’s very helpful. Thank you for taking the questions.

Ray Reitsma

You bet.

Operator

Our next question will come from Damon DelMonte with KBW. Please go ahead.

Damon DelMonte

Hey. Good morning, guys. Hope everybody is doing well today. First question just wanted to circle back on the margin, Chuck. So the reported was 2.77%, I think you said there was 37 basis points of a drag from the liquidity. What was the impact from PPP?

Bob Kaminski

I don’t have that in basis points, but we did record about $2.8 million in PPP fee income, and of course, we have the 1% on top of that. Our average balance was $433 million during the first quarter. So, sorry, I can’t give you a specific number, but I can give you the components of that calculation.

Damon DelMonte

That’s fine. I could -- yeah, I can back into that. Yeah. That’s fine.

Bob Kaminski

Okay.

Damon DelMonte

And then, I guess, just with regard to the outlook for loan growth, are you seeing any benefit from the market disruption that may be going on from the TCF deal that was announced with HBAN or has that not really started yet?

Bob Kaminski

No. That’s definitely been an opportunity for us and there is disruption from that announcement.

Damon DelMonte

And are you seeing that in the way of new lending relationships or possibly hiring of commercial bankers?

Bob Kaminski

Both of those are opportunities. The obtaining of relationships comes a little bit faster than the people. But they are definitely both opportunities.

Damon DelMonte

Okay. Great. And then, I guess, just on the fee income side, I think, Ray, your commentary was pretty positive for mortgage banking that things continue to trend well, pipelines are strong, housing market remains healthy. You had a much stronger quarter in the first quarter than we had -- we were expecting and it seems to be better than what the broader index may have been forecasting for the year. How is your outlook change for the remainder of the year, do you think you could kind of outperform the broader mortgage index?

Ray Reitsma

Yeah. I think that is possible. I think we are well positioned relative to both arms of the market, the refi and the purchase. We have seen some shifting toward the purchase market as being more active as the rates have begun to tick up a little bit and we have put focus on that particular portion of the market, the purchase market over a number of years and took the refinancing activity as the rates offered it, but the real work is to get a bigger and bigger share of the purchase market. And given that we have focused on that for some period of time, I think that’s where we are distancing ourselves from those around us.

Damon DelMonte

Got it. Okay. That’s all that I had. I appreciate the color guys. Thanks.

Bob Kaminski

Thanks, Damon.

Operator

Our next question will come from David Long with Raymond James. Please go ahead.

David Long

Good morning, everyone.

Bob Kaminski

Good morning.

Chuck Christmas

Good morning

David Long

Looking at the backdrop, obviously, the economic outlook continues to improve. Can you talk a little bit about some of your risky areas especially with the State of Michigan now going back to at least some type of modified shutdowns here, thinking specifically about your hotel portfolio and the restaurant portfolios and how they are performing here?

Bob Kaminski

Yeah. This is Bob. I will start off and then head off to the other guys for further commentary amplification. While the case load in Michigan has certainly surged, the state government of Michigan has not implemented new restrictive measures as they had done during a great portion of 2020 and it’s a complicated star and there’s a lot going on there behind the scenes.

But I think the state government is content with the pace of vaccinations and looking to address the rising cases that way. We will continue to emphasize the restrictive measures that are still on the books and still being recommended by lot of those measures aren’t mandates. And I think because of it I think many segments of the economy are doing very well.

The industries that you mentioned, the hospitality, the entertainment, that certainly continues to be challenged in the State of Michigan. But there are some signs of life there in terms of the activities that people are able to do within the current environment given the guidelines and the restrictions that continue to remain in place.

So it’s kind of an unusual situation that while the cases are very high and I think we are getting national attention for the way that the cases have increased here and that’s certainly the case. As you saw during the large portion of 2020, those cases had dropped quite substantially down to one of the strongest performances in the country and the dynamics of why the cases are increasing is open for debate. But I think overall the economy continues to do pretty darn well given all those complicating factors and it is a pretty complicated situation.

David Long

Got it. Okay. I appreciate that color. Thank you. And then separately looking at the first round, and now the second round of the PPP, thanks for giving us the amount of fees that are still left, but as far as timing and forgiveness, what are you expecting with the remaining Round One forgiveness and then what about your expectations for timing on Round Two and how that plays out?

Chuck Christmas

Yeah. This is Chuck. I will take a first swing at that. The forgiveness activity has been quite frustrating, not only for us and myself, trying to put numbers together, but for the borrowers as well.

Especially over the last four weeks to six weeks the level of forgiveness, payments, transactions however you want to term it, from the SBA have been incredibly slow. There are many days, I would say probably two days out of the week that we don’t get any payments and the days that we do we are getting like four or five.

So it’s been painfully slow. I am not really sure what’s going on. I -- there’s lots to work -- lots of guesses out there as to what’s going on and certainly it’s a tremendous amount of volume that the SBA has to go through. We are kind of hoping that coming out of spring break, it would speed up, but based on what we have seen late last week and so far at least yesterday, nothing’s really changed there.

From an overall numbers perspective, the slowest part or slowest segment, it continues to be those over $2 million. Again, those are the ones who get extra scrutiny I guess if you want to call it that and there’s lots of additional questions and additional information that has been provided. We did 50 of those loans and only five so far have been forgiven. So we saw 45 out there. A vast majority of those 45 have -- had completed applications for quite some time.

One of the guidelines that was from the original program was that within 90 days of receiving a full application, the SBA was supposed to make a determination. We and my understanding is all banks have very -- quite a few loans that are well in excess of the 90 days.

So with regards to Round One, it’s just kind of a drip, drip, drip. In regards to getting those payments through, a large percentage of the dollar amount again is wrapped up in those loans that are over $2 million.

In regards to PPP Round Number two, we are still making loans under that program, but we are maybe doing one to three loans a day. We were very active, very busy at the end of January and I would say at least half of February in making those loans. But it’s been relatively slow sense, and like I said, it’s very slow now.

In regards to forgiveness, not a lot of guidance out there in regards to that, but assuming we go through the same process or similar process that we did in Round One, perhaps during the third quarter -- later on in the third quarter, we might start seeing some forgiveness activity come through and my expectation would be that the fourth quarter is probably going to be the busiest quarter in regards to forgiveness activity under Round Two loans.

David Long

Excellent. No. I appreciate the call. I know you don’t have a lot of guidance there on Round Two. And then lastly with the PPP program overall, how have you guys been able to leverage that to bring in prospects and have you been able to add new clients from the PPP both Round One and now with Round Two?

Ray Reitsma

Yeah. This is Ray. We certainly have been able to leverage that and it’s a kind of boils down to speed and responsiveness within the process, strong communication as the parameters of the program evolve shall we say. And those types of things demonstrate what a relationship with us looks like and there has been some frustration with some of our competitors around those points.

And since we have had dialogues with these prospects for a lengthy period of time, a number of years this has been a great platform to kind of prove what we say about how we do business is actually how we do business and that’s been a nice contributor to the growth -- some of the growth that you have seen in our numbers over the past few quarters.

David Long

Excellent. Thanks for taking my questions.

Bob Kaminski

Thanks, David.

Operator

Our next question will come from Bryce Rowe with Hovde Group. Please go ahead.

Bryce Rowe

Thanks. Good morning. Just a few questions here. One, Chuck, I wanted to ask kind of again around the excess liquidity, we have seen you all build up the bond portfolio methodically over the last several quarters and was curious if you thought that could continue as we move throughout 2021?

Chuck Christmas

Yeah. That is a good observation. It is something that we have been doing and we continue to do so. Been -- buying the same type of bonds we always have, we are just buying more of them. We have kind of lead with U.S. Government agency bonds, generally callable bonds, usually of state of maturities of three years to 10 years and just building out a ladder as part of that portfolio. Just not wanting to go too long, but knowing that of course the longer you go a little bit better rate you get.

Also been adding to the municipal bond portfolio, tax exemption, as well as taxable, we continue to stay within the State of Michigan and generally within our markets. There’s usually enough product out there that we can build the portfolio and help the excess liquidity, but also do our part in assisting our communities as well with their financing needs.

We tend to do -- the same idea with the maturity is we ladder those out. So and we have been buying some mortgage backs that primarily are CRA qualified that we can pick up from time-to-time. It’s nice though to help our CRA efforts, but it’s also nice with the rate environment that they are not so pricey instead of paying yield 105, 107 like it had been over quite a few years. The prices are down to 101 or so. So that helps you on the prepayment risk there. Yeah, I think, what you have been seeing, I think, we will continue to see at least for the next couple of quarters.

Bryce Rowe

Okay. That’s helpful. Thanks Chuck. And then kind of I wanted to follow up on the mortgage question, obviously good volume coming in here and certainly appreciate the focus on purchase versus refinance markets. So I was curious if you could kind of breakout the newer markets that you have added and how much they might account for some of the volume and then any appetite you might have to further expand the mortgage offices whether it would be in some of the Michigan markets or even outside of Michigan like the Cincinnati effort?

Bob Kaminski

Well, yeah, we certainly will be on the lookout for more talent and add where that’s available. The markets are of interest, but of more interest is getting the right people to add to the team. We feel like we have been successful in the case of Cincinnati and the new group up in Petoskey that we did add people who fit in with the way we do business and the Cincinnati office has provided very close to what we expected. The Petoskey office is just lifting off but we expect to have that add maybe depending on the environment between $75 million and $125 million over a year coming up.

We are in discussions with teams in a number of markets right now and very early. But the interest is certainly there. Our team on the production side has a very good reputation. That’s one of the hot points with producers that they are unable to get the volume that they produce through the system that they are in currently.

So that has been an attractive element and as they talk to their colleagues who have moved over here, they hear good things about our team. So, we expect to continue to add them as the opportunity arises. That’s extraordinarily difficult to quantify, but it’s a definite opportunity.

Bryce Rowe

Okay. That’s great. Maybe one or two more for me, it’s interesting to hear that the CECL commentary relative to the incurred loss model and obviously the discrepancy between those twos and -- those two in terms of the reservable level. So just curious how you, I mean, how you might be able to seek that dynamic or manage the dynamic, is there something that you just thought about to align those reserve levels up more appropriately maybe with a special coded bucket or something along those lines, just trying to kind of understand how you think about that as you approach CECL adoption?

Chuck Christmas

Yeah. This is Chuck. I will pick that one. Up until December, our CECL calculation and our incurred loss calculation was pretty similar. What ended up -- what’s happened is that it really started in September, but certainly with December and now what we see in March, is the economic forecasts are improving on the CECL, which course is very important on CECL.

We also have an economic factor. It’s an important factor from a number of basis points we have put through it and are incurred. And what we have not done on the incurred as we haven’t changed that economic factor yet. And to put it a matter of perspective and it varies a little bit by portfolio, but on average we put 35, right now the way that we have the economic factor rated, which is very low is 35 basis points applied to almost every loan on average. I think that’s a good number to have.

So when we feel comfortable -- and I think we are definitely in the right direction when we feel more comfortable with the economic situation, which of course is driven by COVID, we will definitely start improving that rating which will bring that 35 basis points down.

Over time it will just have to analyze that at the end of each quarter and see where we are at and see what the levels and direction and magnitude and how our borrowers are doing and put that into our calculations and our thought processes.

We just saw, as I mentioned in my prepared remarks, it was just a little bit premature, especially what we already talked about this morning just what’s going on in Michigan with the cases and the surge and all that.

The other big part of our incurred calculation is a new factor. So we went to 10 factors in the second quarter of last year. We call the COVID-19 factor, which is just kind of -- there’s just a big unknown what’s going to happen with COVID-19. Obviously, it’s unprecedented. At that point in time we are directionless quite frankly and had didn’t have a vaccine or anything like that. That’s a definitely a onetime type factor. Right now that’s 20 basis points applied to all loans.

We would expect over time as hopefully sooner than later COVID gets in our rearview mirror and ultimately over time we will start dropping that, the ratings on that which would improve the ratings on that which will drop the basis points along the way and then at some point we will drop that factor altogether.

So it’s really those two factors that we haven’t changed since the second quarter. So I think the long answer to your question is I think over time probably the next few quarters based on the current trends and expectation is that as we get closer to the end of this year and the adoption of CECL when we start modifying those two factors alone, we would think that the incurred model and the CECL model will be closer just like they were before COVID hit.

Bryce Rowe

That’s great detail. Chuck, I appreciate that. Maybe one more for me, for Bob, Bob just curious if there’s any appetite for M&A. I know you all haven’t been super acquisitive in your history but with the, I guess, the environment seemingly heating up from an acquisition perspective, any opportunities on the horizon and you maybe speak to Mercantile’s appetite.

Bob Kaminski

Bryce, I think, I would respond to that similar to as we have responded in the past that we are certainly open to M&A. We have an appetite for M&A. The big question for us is the culture of another organization and how that culture lines up with the Mercantile culture.

It was touched on by the guys within the framework of this call, I think it was related to the mortgage area and going to some new markets, hiring additional lenders. It’s about the culture of the people and how those people fit into the way we do business because that has been -- it’s been a very successful recipe for Mercantile and leads to the performance that you see quarter-after-quarter with solid performance and you are seeing good core loan growth now because the way we do business.

And so really the M&A question for us keeps going back to the culture and if we find potential M&A partners that culture is a good match for ours and I believe it’s something we have certainly been interested in and if the cultures do not match something we will be less interested in.

Bryce Rowe

All right. That’s great. Appreciate all the answers. Have a good day.

Chuck Christmas

Thanks, Bryce.

Operator

[Operator Instructions] Our next question will come from John Rodis with Janney. Please go ahead.

John Rodis

Good morning, guys.

Bob Kaminski

Good morning, John.

John Rodis

Chuck, just a question on expenses, you highlighted the $500,000, I guess, some branch write-down. So excluding the $500,000 is sort of that $24.6 million. Is that a pretty good area sort of run rate going forward?

Chuck Christmas

Yeah. I think the big caveat would be of course the mortgage banking with the commission -- vast majority of our lenders are commission based. So we need to correlate that expense with the volume that that’s out there. But aside from that adjustment, matching that up with our -- with mortgage income excluding those two branch write-downs, yeah, I think, that’s a good run rate.

John Rodis

Okay. Thank you.

Chuck Christmas

Welcome.

Operator

This concludes 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, Matt. And we thank you all for your continued interest in our company and hope that you and your families stay healthy and safe. And we look forward to speaking with you again at the conclusion of the second quarter. This conference call has now concluded. Thank you.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.