Earnings Call Transcript - MBWM Q1 2021

Operator, 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. After today’s presentation, there will be an opportunity to ask questions. 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, Investor Relations

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.

Bob Kaminski, CEO

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 outlined in our release this morning, Mercantile had an extremely strong quarter to start 2021, thanks to the wonderful work of our team across all fronts throughout 2020 and during the first quarter. This positions us well for success for the rest of this year and beyond. Despite the recent surges of COVID experienced 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 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. We also announced 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.

Ray Reitsma, President of Mercantile Bank, Michigan

Thanks, Bob. Our total loan portfolio increased by $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 at 14% on an annualized basis. Generally, our C&I loan funding net of PPP activity remains similar to pre-pandemic levels, as we continue to add targeted new commercial relationships around our PPP activity and also service 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 to 18 months. Accruing commercial past 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 0.08% 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. The 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 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.

Chuck Christmas, CFO

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 by $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 in 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 the interest rate environment. In total, interest expense declined by $2.4 million during the first quarter of 2021 compared to the first quarter of 2020. Net interest income decreased by $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 by $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 31 as determined using the incurred loss methodology. The primary difference between the two reserve models as of March 31 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. Continuing on slide 22, overhead costs increased by $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 funds for the bonus programs during the first quarter of last year, given the onset of the Coronavirus pandemic. Continuing 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 by 29 basis points, while the cost of funds declined by 6 basis points during the first three months of 2021 compared to the fourth quarter. The yield on loans declined by 31 basis points largely 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 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 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 31. 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 can offer key considerations that should be factored into any earnings forecast for 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 at the quarter's 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, CEO

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

Operator, Operator

Our first question will come from Brendan Nosal with Piper Sandler. Please go ahead.

Brendan Nosal, Analyst

Hey. Good morning, everybody. How are you?

Bob Kaminski, CEO

Hi, Brendan. How are you?

Brendan Nosal, Analyst

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, CFO

Yeah. Brendan, this is Chuck. I will tackle that one, and the short answer is, yes. We definitely have considered that and we 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 are about 2.06. There are 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. It’s rather common that we do 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 lending operations. 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 match-pointing those longer-term fixed-rate loans. And so if we do prepay the FHLB advances, it’s something we look at pretty regularly. We do need to be cautious, knowing that we are potentially exposing at least part of our balance sheet to an increase in interest rate environment when, of course, the idea of inflationary pressures is out there every day regarding what’s going on in our economy and whether there are inflationary pressures that will result in higher interest rates as we move forward. So that is something we are carefully considering, doing lots of calculations, and analysis, and we will see where we go from here, but it is something on our radar.

Brendan Nosal, Analyst

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, President of Mercantile Bank, Michigan

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 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 economy 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, Analyst

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

Ray Reitsma, President of Mercantile Bank, Michigan

You bet.

Operator, Operator

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

Damon DelMonte, Analyst

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, CEO

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 provide you the components of that calculation.

Damon DelMonte, Analyst

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

Bob Kaminski, CEO

Okay.

Damon DelMonte, Analyst

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, CEO

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

Damon DelMonte, Analyst

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

Bob Kaminski, CEO

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, Analyst

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 has your outlook changed for the remainder of the year? Do you think you could kind of outperform the broader mortgage index?

Ray Reitsma, President of Mercantile Bank, Michigan

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, Analyst

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

Bob Kaminski, CEO

Thanks, Damon.

Operator, Operator

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

David Long, Analyst

Good morning, everyone.

Bob Kaminski, CEO

Good morning.

Chuck Christmas, CFO

Good morning.

David Long, Analyst

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, CEO

Yeah. This is Bob. I will start off and then hand 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 situation. 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, but many of those measures aren’t mandates. I think many segments of the economy are doing very well. The industries that you mentioned, the hospitality and the entertainment, certainly continue 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. It’s kind of an unusual situation that while the cases are very high, 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 a large portion of 2020, those cases had dropped quite substantially down to one of the strongest performances in the country. The dynamics of why the cases are increasing is open for debate. Overall, the economy continues to do pretty well given all those complicating factors and it is a complicated situation.

David Long, Analyst

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, CFO

Yeah. This is Chuck. I will take the 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 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, 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’m not really sure what’s going on. There’s a lot 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 were 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 continues to be those over $2 million. Again, those are the ones that get extra scrutiny, 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 see 45 out there. A vast majority of those 45 have completed applications for quite some time. One of the guidelines 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 quite a few loans that are well in excess of the 90 days. So with regard to Round One, it’s just kind of a drip, drip, drip. Regarding 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 and 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 since then, and like I said, it’s very slow now. In regards to forgiveness, not a lot of guidance out there, but assuming we go through the same process or a 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. 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, Analyst

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, President of Mercantile Bank, Michigan

Yeah. This is Ray. We certainly have been able to leverage that, and it boils down to speed and responsiveness within the process, and strong communication as the parameters of the program evolve. 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. 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, Analyst

Excellent. Thanks for taking my questions.

Bob Kaminski, CEO

Thanks, David.

Operator, Operator

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

Bryce Rowe, Analyst

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, CFO

Yeah. That is a good observation. It is something that we have been doing and we continue to do so. We have been buying the same type of bonds we always have; we are just buying more of them. We have kind of led with U.S. Government agency bonds, generally callable bonds, usually of maturities of three years to ten 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. We have also been adding to the municipal bond portfolio, both tax-exempt 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 while also doing our part in assisting our communities with their financing needs. We tend to do the same idea with the maturity; we ladder those out. So we have been buying some mortgage backs that primarily are CRA qualified that we can pick up from time to time. It’s nice to help our CRA efforts, but it’s also nice with the rate environment that they are not so pricey; instead of paying yields of 105, 107 like it had been over quite a few years, the prices are down to 101 or so. So that helps manage 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, Analyst

Okay. That’s helpful. Thanks, Chuck. And then 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, CEO

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 they are currently in. 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, Analyst

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 two in terms of the reservable level. So just curious how you, I mean, how you might be able to see 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, CFO

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, and it’s an important factor from a number of basis points we have put through, as our incurred model. What we have not done on the incurred model is we haven’t changed that economic factor yet. To put it a matter of perspective, which varies a little bit by portfolio, but on average we put 35, right now the way 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 of 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. We went to 10 factors in the second quarter of last year. We call that the COVID-19 factor, which is just kind of -- there’s just a big unknown about what’s going to happen with COVID-19. Obviously, it’s unprecedented. At that point in time we were directionless quite frankly and didn’t have a vaccine or anything like that. That’s definitely a one-time 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 and 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. The long answer to your question is I think, over time, probably in the next few quarters based on the current trends and expectation, as we get closer to the end of this year and the adoption of CECL, when we start modifying those two factors alone, we think that the incurred model and the CECL model will be closer, just like they were before COVID hit.

Bryce Rowe, Analyst

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, CEO

Bryce, I think I would respond to that similar to how 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. You are seeing good core loan growth now because of the way we do business. 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, I believe it’s something we have certainly been interested in. If the cultures do not match, it’s something we will be less interested in.

Bryce Rowe, Analyst

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

Chuck Christmas, CFO

Thanks, Bryce.

Operator, 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, CEO

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

Operator, Operator

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