Mercantile Bank (NASDAQ:MBWM) held its second-quarter earnings conference call on Tuesday. Below is the complete transcript from the call.
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Summary
Mercantile Bank reported strong asset quality, with nonperforming assets at 9 basis points and nonperforming loans averaging 12 basis points over the past six years.
The loan-to-deposit ratio improved to 93% in Q2 2026 from 100% a year prior, aided by a 12.4% increase in deposits.
Commercial loan growth was robust, with $115 million added in Q2 2026, and commitments for new loans and construction loans reached five-quarter highs.
Key fee income categories, like treasury management services, saw a 35% increase in service charges, while credit and debit card offerings grew by 21% in H1 2026.
Net revenue increased by 15.3% in H1 2026, with a 10% EPS growth in Q2 2026 year-over-year and a 14% return on average equity.
The integration with Eastern Michigan is proceeding well, contributing positively to financial metrics such as net interest income.
The company expects loan growth in the mid-single-digit percentages for 2026 and projects a stable net interest margin amidst a volatile interest rate environment.
Net income for Q2 2026 was $25.9 million, up from $22.6 million in Q2 2025, driven by increased net interest income and lower provision expenses.
Mercantile Bank maintains strong capital positions, with a total risk-based capital ratio of 13.5% as of June 30, 2026.
Future guidance includes a 5% to 7% annualized loan growth and stable net interest margins, with anticipated benefits from maturing low-yield investments.
Full Transcript
Ray Reitsma, President & Chief Executive Officer
Floating-rate assets. Very strong asset quality. Nonperforming assets to total assets remain at the low levels typical of our company at 9 basis points of total assets as of June 30, 2026. Nonperforming loans to total loans over the last six and a half years average 12 basis points. The allowance for credit losses stands at 1.13% of total loans as of June 30, 2026, and on a dollar volume basis was nearly 10 times the level of nonperforming loans, providing a very strong coverage relative to past due nonperforming loan levels.
These numbers demonstrate our longstanding commitment to excellence in loan underwriting and administration. Improved on-balance-sheet liquidity and loan-to-deposit ratio. At the end of the second quarter of 2026 our loan-to-deposit ratio stood at 93% compared to 100% at June 30, 2025, and 91% on December 31, 2025, 98% on December 31, 2024, and 110% on December 31, 2023. As of June 30, 2026, our deposit mix included 27% noninterest-bearing deposits and 24% lower-cost deposits, up from 25% and 20%, respectively, at the end of the second quarter of 2025, which has contributed to the stability of our net margin.
Net interest margin. Our acquisition of Eastern Michigan contributed positively to these measures. Deposit growth during the 12 months ended June 30, 2026 was 12.4%, with growth in the noninterest-bearing accounts outpacing the growth in interest-bearing accounts during that period. Our recent focus on deposit growth is not new to our bank. In fact, the last five year-end periods demonstrate a deposit compounded annual growth rate of 9.2%. Strong commercial loan growth.
Commercial loan growth in the second quarter of 2026 was $115 million, an annualized growth rate of 11.7%. As foreshadowed in the prior quarter's commentary, loan payoffs did moderate from the prior four quarters' experience, reducing by $60 million compared to the prior quarter. As of June 30, 2026, commitments to make new commercial loans total $224 million and commitments to fund existing commercial and residential construction loans total $283 million, with each amount at or near five-quarter highs.
We expect that loan growth for 2026 will fall within the range of previously defined expectations of mid-single-digit percentages. Continued strong growth in key fee income categories. Growth in commercial deposit relationships has supported growth in treasury management services, resulting in a 35% increase in service charges on accounts during the second quarter of 2026 compared to the second quarter of 2025. Our credit and debit card offerings report growth of 21% in the first six months of 2026 compared to the respective 2025 period.
Well-managed expenses. Net revenue, defined as net interest income plus noninterest income, grew 15.3% to $136.3 million during the first six months of 2026 from $118.2 million in the respective 2025 period. Occupancy costs plus data processing costs were virtually unchanged as a percentage of net revenue, and salaries and benefits increased from 34% to 35% of net revenue, primarily reflecting our investment in the Southeast Michigan market. In sum, these traits have allowed us to report a quarter-over-quarter EPS growth of 10% in the second quarter of 2026 compared to the prior-year second quarter, a 1.52% return on average assets and a 14% return on average equity in the second quarter of 2026, and an annualized 11.6% increase in the tangible book value per share in the current-year second quarter compared to the first quarter of 2026. Additionally, our five-year tangible book value per share compounded annual growth rate of 9% and five-year earnings per share compounded annual growth rate of 15.1% historically place us in the top tier of our proxy group. We remain excited about the recently completed combination with Eastern Michigan.
The integration of operations is well underway, and the cultures have meshed very well. That concludes my remarks. I'll now turn the call over to Chuck.
Chuck, Chief Financial Officer
Thanks, Ray. This morning we announced net income of $25.9 million, or $1.50 per diluted share, for the second quarter of 2026, compared with net income of $22.6 million, or $1.39 per diluted share, for the second quarter of 2025. Net income during the first six months of 2026 totaled $48.6 million, or $2.82 per diluted share, compared to $42.2 million, or $2.60 per diluted share, during the first six months of 2025. Growth in net income during both time frames primarily reflected increased net interest income and lower provision expense that more than offset higher noninterest expense and federal income tax expense, excluding nonrecurring costs associated with the year-end 2025 acquisition of Eastern Michigan and the previously announced core and digital banking system conversion. Adjusted net income was $26.4 million, or $1.53 per diluted share, for the second quarter of 2026 and $51.7 million, or $2.99 per diluted share, for the first six months of 2026. Adjusted diluted earnings per share increased $0.14, or approximately 10%, in the second quarter of 2026 compared to the second quarter of 2025, and increased $0.39 per diluted share, or approximately 15%, during the first six months of 2026 compared to the first six months of 2025.
We believe using these non-GAAP measurements reflects our core earnings performance and provides for more accurate current-period versus prior-period comparisons. Interest income on loans was relatively unchanged during the second quarter and first six months of 2026 compared to the prior-year periods, reflecting loan growth that was offset by a lower yield on loans. Average loans totaled $4.89 billion during the second quarter of 2026 compared to $4.70 billion during the second quarter of 2025, an increase of $197 million.
Mercantile Bank's robust commercial loan fundings of $535 million during the last 12 months were largely mitigated by significant levels of payoffs and partial paydowns on certain larger commercial loans during those periods, which aggregated $459 million. Our yield on loans during the second quarter of 2026 was 28 basis points lower than the second quarter of 2025, primarily reflecting the 75 basis point aggregate decline in the federal funds rate during the last four months of 2025.
Interest income on securities increased during the second quarter and first six months of 2026 compared to the prior-year periods, reflecting growth in the securities portfolio and a higher yield. The growth and higher yield reflect the acquisition of Eastern Michigan along with ongoing portfolio growth and reinvestment of maturing lower-yielding investments at Mercantile Bank. Average balances were at $325 million and the average yield increased 54 basis points quarter over quarter.
Interest income on other earning assets, a large portion of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, increased during the second quarter and first six months of 2026 compared to the prior-year periods, reflecting a higher average balance that more than offset a lower average yield. The average balance was up $178 million while the average yield declined 87 basis points quarter over quarter, which largely depicts the aggregate 75 basis point decrease in the federal funds rate during the last four months of 2025.
In total, interest income was $4.7 million and $9.8 million higher during the second quarter and first six months of 2026 compared to the respective prior-year periods. Interest expense on deposits decreased during the second quarter and first six months of 2026 compared to the prior-year periods, reflecting a lower cost of deposits that more than offset interest-bearing deposit growth. The growth in interest-bearing deposit balances and the lower costs of these funds reflect the acquisition of Eastern Michigan along with growth and lower deposit costs at Mercantile Bank.
Costs of interest-bearing deposits at both banks were positively impacted by the aforementioned decline in the fed funds rate in the latter part of 2025. Average interest-bearing deposits totaled $3.96 billion during the second quarter of 2026 compared to $3.46 billion during the second quarter of 2025, an increase of $493 million. The cost of all deposits was down 50 basis points during the second quarter of 2026 compared to the second quarter of 2025.
Interest expense on Federal Home Loan Bank of Indianapolis advances declined during the second quarter and first six months of 2026 compared to the prior-year periods, largely reflecting a lower average balance. Interest expense on other borrowed funds increased during the second quarter and first six months of 2026 compared to the prior-year periods, largely reflecting the impact of a term loan we obtained in late 2025 to assist in the cash portion of the Eastern Michigan acquisition.
In total, interest expense was $3.0 million and $5.3 million lower during the second quarter and first six months of 2026 compared to the prior-year periods. Net interest income increased $7.8 million and 15 point during the second quarter and first six months of 2026, respectively, compared to the prior-year periods, primarily reflecting growth in earning assets and a higher net interest margin. Average earning assets totaled $6.43 billion during the second quarter of 2026 compared to $5.73 billion during the second quarter of 2025, an increase of $699 million that largely reflects the acquisition of Eastern Michigan at year-end 2025 along with the securities and overnight funds growth at Mercantile Bank. The net interest margin was 3.59% during the second quarter of 2026 compared to 3.48% during the second quarter of 2025. The improvement is largely due to the Eastern Michigan acquisition. The yield on earning assets declined 33 basis points while the cost of funds declined 44 basis points during the second quarter of 2026 compared to the prior-year second quarter. Impacting our net interest margin over the past couple of years was our strategic initiative to lower the loan-to-deposit ratio, which generally entailed deposit growth exceeding loan growth and using additional monies to purchase securities. A large portion of deposit growth was in higher-costing money market and time deposit products, while the purchased securities provided a lower yield than loan products. Despite that strategic initiative and declines in the federal funds rate during the latter parts of 2025 and 2024, our quarterly net interest margin has remained relatively stable. Over the past eight quarters, our net interest margin has averaged 3.49%, with a high of 3.59% and a low of 3.41%.
We remain committed to managing our balance sheet in a manner that minimizes the impact of changing interest rate environments on our net interest margin. Basic funds management practices such as match funding, combined with scheduled maturities of lower-yielding fixed-rate commercial loans and securities and higher-rate time deposits, along with scheduled rate adjustments on residential mortgage loans, should provide for a relatively stable net interest margin in future periods.
We recorded provisions for credit losses of negative $1.8 million and negative $3.6 million during the second quarter and first six months of 2026, respectively. The second quarter negative provision expense mainly reflected the elimination of a $2.7 million specific allocation associated with the resolution of a nonperforming commercial construction loan, which was partially offset by changes in the economic forecast, general allocations necessitated by net loan growth, and an increase in certain qualitative factor allocations.
The reserve balance decreased $1.3 million during the second quarter of 2026, reflecting the negative $1.8 million provision expense and net loan recoveries of $0.5 million. The reserve balance equals 1.13% of total loans at June 30, 2026. Our sustained strength of loan quality metrics continues to be impactful to our loan loss reserve calculations. The baseline allowance, largely determined from historical net loan charge-off activity, represents only one third of our current reserve balance, reflecting a low level of net loan charge-off activity during our lookback period.
From the beginning of 2011 through the end of the second quarter of 2026, specific reserve allocations on nonperforming loans totaled just $0.9 million, or about 2% of the reserve balance at the end of the second quarter. Noninterest expenses were $6.0 million and $17.0 million higher during the second quarter and first six months of 2026, respectively, compared to the prior-year periods. Excluding one-time costs associated with the ongoing core and digital banking system conversion and the year-end 2025 acquisition of Eastern Michigan that aggregated $0.6 million and $3.9 million during the second quarter and first six months of 2026, respectively, noninterest expenses increased $5.4 million and $13.1 million compared to the prior-year periods. Eastern Michigan Bank's noninterest expenses totaled $4.0 million and $8.0 million during the second quarter and first six months of 2026, respectively. The increase in core operating costs largely reflects higher salary and benefit costs, with the remaining growth generally depicting the impacts of inflation and a larger balance sheet. In addition, we recorded a $1.4 million decrease in allocations to the reserve for unfunded loan commitments, primarily reflecting a lower level of commercial loan commitments largely stemming from the high level of commercial loan fundings that took place during the second quarter. Federal income tax was $1.9 million and $2.0 million higher during the second quarter and first six months of 2026, respectively, compared to the prior-year periods, largely reflecting a higher level of pretax net income and a lower level of net benefits from transferable energy tax credits. The effective tax rate was 16.9% during the second quarter and first six months of 2026 compared to 12.9% and 15.7% during the respective time periods in 2025.
The 2025 periods had higher levels of transferable energy tax credit activity. Given carryback opportunities, additional acquisitions of transferable energy tax credits may be made from time to time subject to our investment policy, tax credit availability, and tax credits derived from our low-income housing and historical tax credit activities. Both Mercantile Bank and Eastern Michigan Bank have strong and well-capitalized regulatory capital positions.
Mercantile Bank's total risk-based capital ratio was 13.5% as of June 30, 2026, $205 million above the minimum threshold to be categorized as well capitalized. Eastern Michigan Bank's total risk-based capital ratio was 23.1% as of June 30, 2026, $36 million above the minimum threshold to be categorized as well capitalized. We did not repurchase shares during the second quarter of 2026. We have $6.8 million available in our current repurchase plan.
Thoughts on the remainder of 2026: On slide number 23 in the investor presentation we share our assumptions on the interest rate environment and key performance metrics for the remainder of 2026 with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on no changes in the federal funds rate during the remainder of 2026, although we believe our net interest margin will remain relatively stable in a changing interest rate environment as it has over the past eight quarters.
We are projecting loan growth in a range of 5% to 7% annualized during each quarter, which encompasses a strong commercial loan pipeline as well as expected fewer commercial loan payoffs during the remainder of the year. We are forecasting a higher net interest margin during the last six months of 2026 compared to the first six months of 2026 as we benefit from commercial loan growth, lower levels of monies at the Federal Reserve Bank of Chicago, and maturing low-yielding fixed-rate commercial real estate loans and investments.
We are projecting a federal income tax rate of 17%, which encompasses continued growth in net benefits from our low-income housing and historical tax credit activities along with additional transferable energy tax credit investments. Expected quarterly results for noninterest income and noninterest expense are also provided for your reference. Noninterest expense projections reflect personnel investments that were made in the latter part of 2025 and first six months of 2026 and expected during the remainder of 2026 to support expansion in Southeast Michigan, as well as to support operational areas as we switch core and digital banking providers to enhance the durability, efficiency, and experience for our customers and employees. Costs associated with the core and digital banking system conversion are not included. In closing, we are very pleased with our operating results during the second quarter and first six months of 2026 and continued strong financial condition, and believe we remain well positioned to successfully navigate through the myriad of challenges and uncertainties faced by all financial institutions.
That concludes my prepared remarks. I'll now turn the call back over to Ray.
OPERATOR (Moderator)
Thank you, Chuck. That concludes the prepared remarks from management and we will now move to the question and answer portion of the call. We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then one. At this time, we will pause momentarily to assemble our roster.
The first question comes from Daniel Tamayo with Raymond James. Your line is now open.
Daniel Tamayo, Analyst at Raymond James
All right, thanks, guys. Morning. Maybe we can just start on the expense increase in the guidance there. I hear what you were saying there, Chuck, in the commentary about the increased personnel investments and the expansion in Michigan. Maybe you could just parse out what's related to the hirings in Southeast Michigan and what's related to the core conversion. And, as much as you could, help us find the settling point after the costs come out post core conversion.
That would be helpful.
Chuck, Chief Financial Officer
Thanks. Yeah. Good morning, Danny. This is Chuck. I'm glad to answer your questions. You know, there's definitely a lot going on that impacts our overhead costs, the costs associated with our core conversion. You know, we want to make sure that it's a big lift for our team, and we want to make sure that we do it effectively and accurately. So we made the determination early on to make sure that we are, I would say, more than fully staffed, especially in certain operational areas, to help with not only the core conversion, but especially the training.
Clearly, there's going to be a time period where we have to make sure that all of our employees are trained on their respective areas of the new system, both the core and the digital system. And so we have been very aggressive in hiring in those areas to make sure that we're fully staffed at least. We're very excited about our expansion into Southeast Michigan. That started quite a few years ago, but really within the last, I would say, 12 months has really taken off.
We've hired exceptional personnel, both on the commercial side as well as the treasury side in that market, and we continue to talk to additional folks to join our team. And, you know, we expect, as Ray has said on several occasions, Southeast Michigan is one third of Michigan, and we are but a tiny, tiny blip there. Given the size of that market and where we're at now, we've made huge strides already over the last 12 months. If you look at our net loan growth, obviously Southeast Michigan doesn't have much in the way of payoffs, but when you look at their growth, that equals about our net growth.
Obviously, we've had a lot of payoffs here, notwithstanding the strong fundings we've had in this market. So I can't give you a number specifically as we go forward in regards to the Southeast Michigan market. We think it's a strong market for us, and we expect to continue to build that market out as we have over the last 12 months in the future period. So that's where most of that additional expense is coming from. Obviously, we want to continue to build out our company in all of our markets as the opportunities present themselves.
We're very pleased with the markets. I think when we look at the loan growth, all of our markets are showing growth, and we want to continue to support that with additional people at all levels and all positions throughout the company.
Daniel Tamayo, Analyst at Raymond James
Thanks, Chuck. And then just in terms of, like, post core conversion, the savings still kind of on pace for what you guys were talking about before? Maybe just remind us what type of expenses you expect to recoup.
Chuck, Chief Financial Officer
Yeah, Danny, the expenses are... The savings are really going to start in the second quarter of next year. You know, when we do flip the switch in February and we get through all the testing and validations and exit our current providers in both those areas, it's kind of hard to put a specific number on the savings. I mean, we can look at different contracts, but obviously there's growth in volume that has impacts, and we are switching providers on both digital and core, which are different platforms.
And as we look to our teams and make sure that we are set up and our framework is designed to best fit that new framework, we've been making changes there as well. We do know that the savings on the core itself just on the contract is pretty significant, but there's a lot of moving parts that make it very difficult to say this is going to be our cost going forward, and it will be a while before we get to that point.
Daniel Tamayo, Analyst at Raymond James
Okay, fair enough. On the credit side, so obviously really nice story. You talked about kind of the puts and takes within the reserves, and it sounds like you're getting down towards the end of the specific reserves, or at least those are much more modest at this point, but you still have net recoveries. I guess if you have any thoughts on where you think reserves could stabilize, or if, you know, when you think the loan loss provision might turn positive, any guidance on that number would be helpful.
Chuck, Chief Financial Officer
Yeah, I mean, certainly we enjoy negative provisions, especially when they're because of recoveries and the resolution of loan situations that, you know, as we like to remind everybody, we did have provision expense associated with building up those specific reserves as we felt appropriate. I think the relatively low level of specific reserves on nonperforming loans that we have right now is really a reflection of two things. One and foremost is not very much at all in just gross dollars of nonperforming loans that we have on the books.
But I think it's also reflective of the way that we underwrite loans: there's always a risk of loss, but when we have a loan go sideways and we go into collection mode, we've got quite a bit of collateral. We've got guarantees that we can rely on, which obviously then minimize the specific reserves that we need to establish. But overall, you know, it's a reflection of the fact that we just don't have a lot of loans on nonperforming, and we haven't had for quite a while now, certainly past most of our lookback period.
Which basically means that we have to rely on the qualitative factors to support what we believe is an adequate level of the loan loss reserve. You know, we're at 1.13%. I think if you look at us, we've kind of been between where we are now and probably the low 1.20s for quite some time now. And I would expect, notwithstanding any significant change in the economy, that we would stay somewhere within that range. Clearly the economy has the biggest impact on the overall quality of our loan portfolio at any given time.
So if we did enter into a period of stress, our reserve, like all banks' reserves, are designed to reflect that with increased reserve level requirements, which would lead to, you know, obviously potential sizable positive provision expenses. So overall, we feel very solid, feel very good about the quality of our loan portfolio. It's been very consistent at its relative current level now, and we don't see anything in the near term, at least, that is going to change that.
You know, we don't have a lot of charge-offs, so we generally don't have a lot of recoveries. But we do try to recover every dollar that we do charge off and have expectations that while on the accounting side we've had to eliminate it, the borrower still owes us money, and we're going to work through any channels that we have available to us to maximize those recoveries.
Daniel Tamayo, Analyst at Raymond James
All right, terrific. Well, thanks for the color, Chuck.
Chuck, Chief Financial Officer
Appreciate it. You're welcome, Danny.
OPERATOR (Moderator)
The next question comes from Brendan Nozzle with HOVD Group. Your line is now open.
Brendan Nozzle, Analyst at Hovde Group
Hey, good morning, guys. Hope you're doing well.
Chuck, Chief Financial Officer
Hey, Brendan.
Brendan Nozzle, Analyst at Hovde Group
All right, let me just start off here on kind of funding and the environment. Can you just update us on the competitive landscape for core funding and how that has evolved across your footprint over the past couple of months?
Chuck, Chief Financial Officer
Yeah, I would say that—this is Chuck again—I would say it's been pretty consistent. We really haven't seen much in the way of deposit rates changing. We always have the credit union issue to deal with, especially on the CD side of things. But our CD portfolio has stayed pretty steady. We've had really solid growth. We grew very significantly on a net basis during the first quarter, and I think we did see some deposit reductions in the second quarter on a local basis, but that was really seasonality, especially on the public unit side, as well as obviously April 15 with tax payments being due with primarily our business, but also some consumer customers as well. The third quarter is usually pretty good, mostly because of the public units when they start getting their taxes in on the property tax side of things here in Michigan. So we do expect some very solid local deposit growth here in the third quarter from that. But we've also seen very significant growth—and Ray kind of touched on some of the numbers—on our checking account products, especially our noninterest bearing, which is really a direct reflection of the very strong C&I loan growth that we've experienced so far this year.
There's lots of reasons why we like C&I, but certainly one of them is the deposit balances that they bring and then the myriad of different cash management, treasury management products that we have. And you can see from the improvement, or the growth I should say, on service charges where that treasury management income gets recorded on our income statement. The solid growth there is really a reflection of the growth on the commercial side with those loan balances coming over with the associated deposits, but also the expanded use as we continue to market our ever-growing suite of products to our existing customers as well.
So on an overall basis, the deposits are growth. We're very pleased about that. I think that deposit growth, along with bringing Eastern Michigan on board, is letting us get out of the brokered CD market. We had significant levels of maturities here in the second quarter to the degree that we're down to only about $20 million left. There's two CDs there that both mature in December. So we're hopeful that we will be out of the brokered CD market by the end of this year.
And again, that's really strongly attributed to the local deposit growth that we've been experiencing and expect to continue to have.
Brendan Nozzle, Analyst at Hovde Group
Okay. All right. Thanks for the color, Chuck. One more from me. Just turning to capital. Ratios continue to build nicely this quarter, even with kind of returning to more robust loan growth. Is there a point at which the capital build becomes something you want to more actively manage and talk about the path through which you would do that, and whether share repurchase is something you would be interested in if we continue to see ratios build?
Chuck, Chief Financial Officer
Yeah, appreciate you noticing our capital ratios. Obviously we're very pleased with that. Notwithstanding the strong growth that we do have on the asset side, we're able to grow our overall capital ratios and, you know, makes us feel good to have strong capital ratios. You never know what's going to happen from an economic standpoint, but it allows you to take advantage of the opportunities that come, whether it's acquisitions, loan growth, you know, expansions in the markets, all those things.
You know, a position of strong capital gives you the ability to take care of the, or to take advantage of those opportunities as they come about. I think from a, you know, from a buyback standpoint, clearly, you know, it's been quite a while since we bought back any shares. We do have a plan in place. Our board has always been supportive of management's recommendations with its buyback plans. I think, you know, a big part of that clearly is our stock price and, you know, we're very pleased with the run that we've had, where we think that we're finally getting close to where we think we should be valued.
We've been frustratingly low below some of the benchmarks that we look at, so we're obviously pleased with what we've seen over the last few months there. I think the other thing that we're looking at, making sure we have capital to take advantage of those opportunities again. We do have our subordinated notes that do flip to a floating rate and become callable in January. We're obviously looking at that, that is on our radar. We've made no decisions whatsoever in regards to that.
Quite frankly, we would love to earn our way out of that position that we've got there. And I think we're definitely going in the right direction from that potential opportunity there. I think the other thing that, you know, we've got, we had very favorable pricing. While we're not going to keep the 3.25% fixed rate that we have come January, our spread over 90-day LIBOR, I'll say, is only 212 basis points, which, if you did the math today, that's a rate that's still under 6%, which I think is very favorable compared to if you wanted to refinance that with a new sub note.
Not saying we will or won't, we're not at that point yet. But if we do start looking at the capital haircut, you know, doing some calculations, that's about 30 basis every year, losing 20% of the balance, that's about 30 basis points off our total risk-based capital ratio. So looking at those numbers, looking at the environment today, you know, all the forecasting that we're doing, we're comfortable with at least one year of letting that float, if not even a year after that, or who knows more, as we look at our capital stack each quarter end and certainly at each year end.
So that's kind of our thoughts on capital is obviously we want to continue to augment it with a strong net income, pay a competitive and growing cash dividend, making sure that we've got lots and lots of capital to take advantage of the opportunities and continue to grow the company, which obviously is the foundation for additional net income growth.
OPERATOR (Moderator)
The next question comes from Nathan Race with Piper Sandler. Your line is now open.
Nathan Race, Analyst at Piper Sandler
Hey guys, good morning. Thanks for taking the questions. Chuck, I was wondering if you can unpack some of the specific margin drivers for the expansion that you alluded to over the next couple of quarters, you know, specifically around what amount of loans you have repricing upwards that are currently fixed and also just in terms of securities cash flow coming off and kind of what that repricing looks like as well, assuming that's reinvested.
Chuck, Chief Financial Officer
Yeah, I know I gave one of the slides in there, has the amount—oh, it's on slide nine. So yeah, there's definitely a few things that are going on that are having a positive impact on our net interest margin. On slide nine, we give the volume of fixed-rate CRE as well as our agency bonds that are scheduled not only to mature the rest of this year, but also in 2027. So a lot of opportunity for continued yield enhancement from that activity. The other thing that happened—it started really having a bigger impact in the back half of the second quarter than the first half of the second quarter—was our level of deposits at the Federal Reserve coming down. And that's really a strong reflection of the net loan growth. So, you know, obviously we've been dealing with some pretty sizable payoffs. Quite frankly, we had some sizable payoffs again in the second quarter, especially with some line paydowns that came in with borrowers having excess cash in their operations. But as we continue to grow our loan portfolio, especially on the commercial side, we'll be able to use our existing excess funds that we've got at the Federal Reserve to fund that.
So going from, you know, a 3.65% that we get on our funds at the Federal Reserve to something probably in the sixes somewhere on the loan side. So as we continue to forecast that transition happening, that certainly buoys the net interest margin along with the repricing that we talked about. I would say those are the main drivers for the expected improvement in the margin.
Nathan Race, Analyst at Piper Sandler
And Chucky, could you just help us in terms of kind of what that upward repricing looks like on the 100 million or so of loans that are expected to mature in the back half of this year? Are we talking about like something north of 6%, kind of where the blended rate on new loans are coming on the portfolio at? Or just any thoughts on kind of what the blended rate of new loan production is these days?
Chuck, Chief Financial Officer
Yeah, I’d say we would probably be looking at about a 200 basis point, give or take obviously, improvement on the existing average rate of about 4.6%. So somewhere in the mid-sixes is where we would think that we would reprice on an average basis. And then we've got $38 million in agency notes, agency bonds, at just a little over 1%. And based on our strategy right now, buying that yield is a little over 4%. So we'll pick up about 300 basis points on those dollars for the rest of the year.
Nathan Race, Analyst at Piper Sandler
Gotcha. And then if I could just ask one more on kind of deposit growth expectations going forward. And I appreciate the commentary earlier on some of the seasonality that impacted 2Q around tax payments and so forth, but, you know, any visibility into kind of the core deposit calendar pipeline? And I know you guys have some, you know, excess liquidity you can use to fund loan growth, but just, you know, any thoughts on kind of how deposit gathering can trend over the next few quarters as well?
Chuck, Chief Financial Officer
Yeah, like I mentioned, we'll definitely see some seasonality, as we did in the second quarter. You know, when you get to the end of the second quarter, you know, public—and I'm speaking for all banks, basically—you know, the public funds, especially here in Michigan, public units in Michigan collect most of their taxes during the summertime, July and August and September. So you kind of get to the end of June, it's kind of at the low point with deposit balances.
And then you kind of get to September and it's kind of the high point. And then obviously, you know, it goes up and down from there. I would say, you know, on a core basis, on an average basis, if you will—like I said, June 30th is a low point—so we would expect higher average balances from our public unit customers in the future quarters just from the seasonality. You know, again we continue to get very strong corporate local deposit growth, certainly especially on the noninterest-bearing checking.
That's coming from our commercial activities, our commercial lending activities, especially on the C&I side. And as we talked about, that was really the leader of the growth on the commercial lending side. So looking at borrowers paying anywhere from funding 10% to 20% of their own loans with their deposit balances. So getting those obviously helps the cost of deposits but also, again, allows us to cross-sell the treasury management products that we have, which helps the fee income side as well.
We're also doing a really good job of just bringing in—finding—deposit-only customers and making sure that we've got, as we believe we do, a complete suite of products that is attractive to those types of customers as well. So a lot of it is just, you know, blocking and tackling, you know, doing what Mercantile Bank does, what a community bank does every day, is out there selling our products and services and our values, driving relationships. We are a relationship bank on everything that we do. And so, you know, when we have a customer we want the whole ball of wax and, you know, deposits has to be a big part of that. And so that's—you know, that's—we don't have any secret sauce, magic bullets, or anything like that. We just do basic banking and make sure we're getting the entire relationship and, when the customers come in, making sure that we're taking really good care of them.
Nathan Race, Analyst at Piper Sandler
Got it. I appreciate the color. Thank you.
OPERATOR (Moderator)
The next question comes from Damon Del Monte with KBW. Your line is now open.
Damon Del Monte, Analyst at KBW
Hey, good morning guys. Hope everybody's doing well today. So most of my questions have been asked and answered, but just a few quick ones here. Chuck, appreciate the color and the outlook there for the margin. If we were to see a rate hike in 2027, how would you expect the margin to respond to that?
Chuck, Chief Financial Officer
I think overall we think that we're pretty well stable on our net interest margin. We work very hard to make ourselves agnostic—we use that term all the time—to interest rate changes. We specifically manage the structure of our balance sheet that when rates go up, we see yields go up, we see costs go up. When rates go down, we see the opposite happening. And it's, again, basic banking. It's match funding and looking at the structure of your loan portfolio, looking at your deposit base, and then using your investment portfolio to kind of bridge any gaps you might have in there from a repricing perspective.
I think if we have super aggressive cuts or increases, you know, there'll be a little more change there, just as some things have to catch up. But if we're looking at, you know, 25 basis points a quarter, 50 basis points a quarter, my expectation—our modeling supports the fact—that we would expect our margin to stay relatively stable.
Damon Del Monte, Analyst at KBW
Okay, that's helpful, thanks. And then in your commentary around the, kind of like, the loan loss reserve outlook going forward, did you say that, you know, in the last couple years you've been kind of in the 120 basis point range or down to 113, so you'd expect it to kind of stay in that range? So, I mean, would we expect a little bit of builds towards the 120, or do you think kind of in the mid–one-teens is probably acceptable?
Chuck, Chief Financial Officer
I would say that, you know, given the factors that we have on commercial loan growth compared to our mortgage factors, you know, our reserve factors for commercial loans is a little bit under 1%, while on residential mortgage loans is lower 2%, which really reflects, well, a lot of things. But one of the things that definitely reflects is duration. I won't get on my soapbox this morning, but you know, CECL's a duration-based model and we're a commercial lender and commercial loans are short term and we're not allowed—while we have to take into account prepayments, and we definitely do that on the mortgage side—we're not allowed to look at ourselves as a relationship bank and make the assumption that we're gonna renew loans, you know, we're gonna renew lines of credit when they mature in a year, we're not allowed to do that. So that's the biggest hindrance that we have when we're trying to build a reserve under the CECL framework is this duration expectation. And when your biggest asset has a duration of maybe two years, it's difficult to build a reserve. But we do. We’ve got the different allocations and different environmental things that we can work off of.
I would say any significant growth in the reserve—because I'm not expecting the allocations and our calculations to differ much going forward—the biggest thing is going to be the economy. So, you know, if we get our independent third-party economic forecasts that show deterioration, that would drive, you know, a reserve build. And certainly if any of that downplay in the economy starts impacting specific customers and we have to start, you know, putting, you know, having some loans go out, you know, a higher volume of nonaccruals and starting to do specific reserves, things like that, you know, would obviously result in a reserve build as well. I think all things being equal with a steady economy, our nonperforming staying, you know, relatively stable, which they have, I would expect, you know, using your question, probably mid-teens on a coverage ratio.
Ray Reitsma, President & Chief Executive Officer
The answer is all of the above. The outlook in southeast Michigan is good. We have a really strong team there and they're early in their timeframe with us, so bringing over lots of customers and they've been very successful at it. It's a huge market with lots of potential. And yet in markets like Grand Rapids and the rest of west Michigan, central Michigan, northern Michigan, we're more mature in those markets. But there's plenty of opportunity there.
So, you know, the originations are fairly well spread out across our footprint on an even basis.
OPERATOR (Moderator)
Reminder, if you have a question, please press star then one to be added to the queue. That's star then one. If you have a question, our next question comes from Matthew Brees with Stephens Inc. Your line is now open.
Matthew Brees, Analyst at Stephens Inc.
Hey, good morning. Morning. Curious what was the spot cost of deposits and the spot NIM at the end of the quarter and just curious how you feel about your ability to either maintain or further lower deposit—further lower deposit costs from here.
Chuck, Chief Financial Officer
You know, Matt, I would say that when you look at our yields for the quarter, I think that's really reflective of our deposit rates. We didn't change deposit rates, I don't think at all during the quarter. You know, there's some opportunity for some repricing on the CD side, but it's not a huge component and I don't think the repricing is overly significant. So I think if you look at the yields on our deposits for the quarter, I think that's reflective of where our rates are even today.
Matthew Brees, Analyst at Stephens Inc.
Okay. And then on commercial real estate, you'd mentioned, you know, you expect some slowdown in payoff, prepayment activity. What gives you that confidence and, you know, what is expectations for commercial real estate growth in the coming quarters?
Ray Reitsma, President & Chief Executive Officer
The confidence comes from communication with our borrowers and, you know, we stay in close contact. And in the prior spate of payoffs that we had over the previous four quarters, they told us what was coming and largely delivered on that. They're telling us that, you know, those will slow. Of course they reserve the right to change their minds. So, you know, who knows exactly what the future will bring. But the communication has been that those should continue to moderate.
Matthew Brees, Analyst at Stephens Inc.
Okay. And then just last one, you've spoken a couple of times about kind of the mix shift out of cash into loans and how that's accretive to the NIM. Just curious what your definition is of excess cash. It tends to move around a little bit with seasonal deposits. But, you know, from where we sit today at about 5% cash to assets, how much of that do you think is excess?
Chuck, Chief Financial Officer
Yeah, if you looked at our balance sheet I have right in front of me, I think if you looked at interest-earning assets that we have that we mark on our balance sheet, that number will be somewhere between $100 and $125 million.
Matthew Brees, Analyst at Stephens Inc.
What's the timeframe to kind of mix shift that?
Chuck, Chief Financial Officer
You know, we'd love to be able to do it by the end of this year. Of course that's really, you know, net-net net commercial loan growth is going to drive that based on our fundings and any payoffs that we do get. But I would think that by early next year we would be able to get there, if not by the end of this year.
Matthew Brees, Analyst at Stephens Inc.
Okay, great. I'll leave it there. I appreciate all the answers.
Chuck, Chief Financial Officer
You betcha.
OPERATOR (Moderator)
This concludes our question and answer session. I would like to turn the conference back over to Ray for any closing remarks.
Ray Reitsma, President & Chief Executive Officer
Just want to thank you for your participation in today's call and for your interest in Mercantile Bank Corporation. And that concludes today's call.
OPERATOR (Moderator)
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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