Earnings Call Transcript - MBWM Q4 2021

Operator, Operator

Good morning and welcome to the Mercantile Bank Corporation Fourth Quarter 2021 Earning Results Conference call. All participants will be in 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 Kate Croft, Lambert Investor Relations. Please go ahead.

Kate Croft, Investor Relations

Good morning, everyone and thank you for joining Mercantile Bank Corporation's conference call and webcast to discuss the company's financial results for the fourth quarter of 2021. Joining me today are members of Mercantile's management team including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, Chief Operating Officer and President of the bank. We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open the call up for questions. Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenues, earnings, and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to 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 fourth 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.

Robert Kaminski, CEO

Thank you, Kate. Good morning, everyone and thank you all for joining our call today. Our company's strong fourth quarter rounded out, it was an excellent year highlighted by steady operating performance, continued organic loan growth, and very sound asset quality metrics. Our results in 2021 were based on the solid foundation that we have built and driven by our relentless focus on serving our clients and communities at the highest level. We accomplished this by adding value as a trusted advisor to our customers. The Mercantile team is devoted to delivering exceptional service to our customers, building new relationships, and deepening the penetration of our markets. Our fourth quarter and full year 2021 performance reflects the continued success of that approach. We earned fourth quarter net income of $12.3 million, or $0.74 per share, for the full year 2021, net income totaled $59 million, a 33.7% increase over 2020, earnings per share were $3.69, an increase of more than 36.2% from the prior year. Excluding the year-end initial funding and formation of The Mercantile Bank Foundation, as a new vehicle for charitable giving and community investments, EPS would have grown to $0.94 per share in the fourth quarter and $3.89 for the full year 2021. We also announced today the declaration of a cash dividend of $0.31 per share for the first quarter of 2022. Chuck will provide you detailed comments on our full year 2021 and the fourth quarter performance including more color on revenue, expenses, and capital position. We believe a key differentiator for Mercantile is our level of sustained organic loan growth. Total loans of $3.45 billion are up 8% year-over-year as we continue to build out our new and existing markets by adding talented in-market lenders to maximize growth. Our organic commercial loan growth excluding Paycheck Protection Program loans is nothing short of stellar, up an annualized 27% in the fourth quarter, and 20% in 2021 compared to the prior year. Ray will provide you with a full update on the performance of the loan portfolio, but in short, based on the strength of our team, health of our customers' businesses, and the size of our loan pipelines, we expect to continue demonstrating strong organic commercial loan growth relative to peers. Accordingly, we took steps in the fourth quarter to bolster our capital position by issuing $75 million of subordinated notes that will provide support for the strong loan demand we are expecting. Importantly, organic growth is coming from all of our markets, led by the Grand Rapids in West Michigan region. We are confident in our ability to continue our success given the trends and outlook for our primary Michigan markets, where the economy and real estate conditions continue to be healthy. Our ongoing focus on proper underwriting and partnering with commercial borrowers with proven business acumen is reflected in our exceptional asset quality as we continue to report low levels of past due loans and non-performing assets. We also continue to see excellent results with our residential mortgage function. Our mortgage banking income totaled $6.9 million for the fourth quarter and $30 million for the full year. This success is possible because of our ongoing strategic initiatives to increase market share with the growing focus on purchase financing as opposed to the refinance market. Our team continues to build our robust pipeline and maintain strong volumes despite seasonality in the winter months. We continue to position ourselves for greater mortgage banking production in this extraordinary housing market as evidenced by our strategic hires of lenders and new office openings in Cincinnati, Ohio, and Midland and Petoskey, Michigan. While mortgage banking income is a large component of our non-interest income, we are pleased with the growth in all other key fee income categories during the year, including our commercial loan interest swap program introduced in late 2020. As I touched on earlier, our launch of The Mercantile Bank Foundation during the fourth quarter, impacted expenses for the quarter and the year ended December 31, 2021. Mercantile is strongly committed to sound environmental, social and governance practices, and our foundation will enable us to better support all communities in the markets we serve. It also enables us to more consistently distribute grants and other investments in the communities over time enabling the company to more efficiently and effectively allocate funding to the foundation. In closing, our operating performance in 2021 illustrates the effectiveness of our strategic initiatives, our entrepreneurial focus, and our culture. We have the right talent and strategies in place to continue to deliver high-level performance including steady profitability and a commitment to excellence. We are extremely proud of the efforts from our Mercantile team throughout the entire year and remain focused on continuing to deliver exceptional financial results, serving our existing and future clients, supporting our communities, and rewarding our shareholders. That concludes my introductory remarks and I'll now turn the call over to Ray.

Ray Reitsma, COO

Thanks, Bob. Today, my comments will center around three topics evident in the 2021 year-end results. Strong core commercial loan growth, strategic growth, sustainable non-interest income, and stability and operational efficiency. First, core commercial loan growth. For the fourth quarter, we are reporting core commercial loan growth of $184 million representing a 27% annualized growth rate. Full year core commercial loan growth is $482 million representing an increase of 20%. This growth has been possible due to the efforts of our commercial team and the focus on relationship building and the business community bank value proposition. The pandemic and the PPP program gave us an opportunity to prove in action what we have marketed in concept, namely that Mercantile has the capability and technology to serve them along with timely local decision-making and exceptional service. We paused our stock repurchase program in recognition of the fact that this strong level of growth requires robust capital support. Our backlog remains consistent with prior periods as we funded this impressive level of core growth. Secondly, strategic growth and sustainable non-interest income. During 2021, we reported non-interest income of $55.2 million, net of gain on a branch sale compared to $45.2 million last year, an increase of 22% or $10 million. How do we make the case that this is sustainable performance? Swap income accounted for $6 million of the growth, and the swap program allows us to meet customer demand for fixed rates without taking on the balance sheet risk of a conventional fixed rate, which is very important to margin sustainability in the present environment. Our term debt funding has been nearly 50% fixed over a long period of time, and we do not expect the mix to change meaningfully. Our mortgage banking income was relatively flat for the year, increasing $0.6 million, or 2% over the prior year as our team grew production from $864 million last year to $952 million this year. The case for sustainability in this business is supported by the fact that last year's volume represented a mix of 34% purchase activity to 66% refinance activity, while the present year mix is 52% to 48% split between purchase and refinance activity, and of course, purchase activity is far more sustainable than refinance activity. Lesser but important contributors to the non-interest income picture are the roles of service charges on accounts and credit and debit card income, which increased by 11% and 26% respectively for the year, reflecting growth in a number of relationships served as well as increased activity within the accounts as the economy recovers from the pandemic. In sum, non-interest income made up 28% of total revenue for fiscal 2021, up from 23% in the prior year, net income from swaps, debit and credit cards, and service charges overshadowed relatively flat income from mortgage activities compared to the prior year. Final topic of my comments relates to stability in operational efficiency in this inflationary environment. Year-to-date, we are reporting an efficiency ratio of 59.3%, when adjusted to exclude the impact of the foundation expense compared to 58.9% for the comparable period last year. Our consistent spending on technology over the years has served us well, allowing our customers to utilize numerous digital channels as alternatives to visiting a branch and providing the ability to reallocate resources toward further enhancements to an already up-to-date digital platform. It is worth noting that during this period of robust loan and non-interest income growth, our FTEs increased by only 6 from the prior year to a total of 627. That concludes my comments. Now I'll turn the call over to Chuck.

Charles Christmas, CFO

Thanks, Ray. As noted on slide 25, this morning, we announced net income of $11.6 million or $0.74 per diluted share for the fourth quarter of 2021 compared to $14.1 million, or $0.87 per diluted share for the respective prior year period. Net income for the full year 2021 totaled $59 million or $3.69 per diluted share compared to $44.1 million or $2.71 per diluted share for 2020. Costs related to the initial funding and formation of The Mercantile Bank Foundation decreased net income during the fourth quarter of 2021 and full year 2021 by approximately $3.2 million, or $0.20 per diluted share. Excluding these costs, diluted earnings per share increased $0.07, or 8%, for the fourth quarter of 2021 and $1.18 for over 43% for the full year 2021 compared to the respective 2020 periods. Turning to slide 26, interest income on loans during the three and 12 months 2021 period declined from the respective prior year periods, as lower PPP loan fee accretion and a lower interest rate environment offset growth in core commercial loans and residential mortgage loans. Interest income on securities in the fourth quarter of 2021 was 44% higher compared to the same period in 2020, in large part reflecting growth in the securities portfolio over the past 12 months to meet internal policy guidelines and deploy a portion of the excess liquid funds position. Securities interest income for the full year 2021 increased about 7% from 2020, if accelerated discount accretion on called U.S. Government agency bonds in 2020 is excluded. In total, interest income for the most recent quarter decreased $0.6 million from the fourth quarter of 2020 and was down $4.8 million for the full year 2021 as compared to the full year 2020. Interest expense declined or remained relatively unchanged in virtually all categories during 2021 periods compared to the prior year periods, with the reductions reflecting a low interest rate environment. In total, interest expense declined $1.3 million during the fourth quarter of 2021 compared to the fourth quarter of 2020 and was down $6.6 million between the full years of 2021 and 2020. Net interest income increased $0.7 million for the fourth quarter of 2021 compared to the fourth quarter of 2020 and was up $1.8 million for the full year of 2021 compared to the prior year. We recorded a negative provision expense of $3.4 million for the fourth quarter of 2021 compared to provision expense of $2.5 million for the prior year fourth quarter. For all of 2021, we recorded a negative provision expense of $4.3 million compared to provision expense of $14.1 million in 2020. The negative provision expense recorded during the 2021 periods mainly reflected reduced allocation associated with the economic and business conditions environmental factor depicting improvement in both current and forecasted economic conditions and the recording of net loan recoveries, which more than offset required reserve allocations necessitated by net growth in core commercial loans. The economic and business conditions environmental factor was upgraded during both the second and fourth quarters of 2021 resulting in an aggregate reserve balance reduction of approximately $7.3 million. Net loan recoveries totaled $1.3 million for the fourth quarter of 2021 at $1.7 million for the full year. The relatively large provision expense recorded during 2020 primarily reflected the stressed conditions related to the Coronavirus pandemic, which included two separate downgrades of the economic and business conditions environmental factor, the introduction of the COVID-19 pandemic environmental factor to address the unique challenges and uncertainties resulting from the pandemic and certain commercial loan downgrades. We elected to postpone the adoption of CECL until January 1, 2022. Based on preliminary results, the reserve balance and the CECL methodology will be about $5 million to $6 million lower than our reserve balance as of year-end 2021 as determined using the incurred loss methodology. The difference measured between $6.5 million and $7 million as of the previous two quarter ends. The primary difference between the two reserve models over the last few quarters has related to the economic forecast aspect of the calculation. Under CECL, the employed economic forecast has shown significant improvement. Under the incurred model, our view of economic and business conditions is generally positive and improving, but less so than what is reflected in market economic forecasts. Continuing on slide 28, as announced in late December and referenced earlier, our Bank made an initial $4 million contribution to the newly formed The Mercantile Bank Foundation. Excluding this contribution, overhead costs during the fourth quarter of 2021 increased $3.4 million when compared to the fourth quarter last year, while increasing $8.3 million for the full year 2021 compared to full year 2020. A significant portion of the increases will be recorded in the salaries and benefits line item. Salaries increased $2.4 million in all of 2021 compared to 2020, primarily reflecting annual merit and market adjustments along with promotions. In regard to the bonus programs, we expensed $4.5 million in 2021 compared to $3.2 million in 2020, reflecting a strong year of operating results. During the first three quarters of 2021, we had expensed $0.8 million each quarter based on a lower bonus payout rate. That accrual was increased to $2.1 million in the fourth quarter to reflect actual results and final bonus calculations as determined by the compensation committee. In regard to the stock-based compensation programs, we expect $3.8 million in 2021, compared to $2.3 million in 2020. During the first three quarters of 2021, we had expensed $0.6 million each quarter. That accrual was increased to $2 million in the fourth quarter to reflect right-sizing adjustments to the performance-based restricted stock awards, taking into account actual 2021 operating results and updated 2022 and 2023 forecasts. We recorded a $1.1 million increase in health insurance costs related to increased claims in 2021 compared to 2020, primarily reflecting services associated with the coronavirus. We also recorded an aggregate $0.9 million increase in liability and FDIC insurance costs. As far as 2022 overhead costs, we are currently projecting a quarterly run rate of between $26 million and $27 million. Continuing on slide 29, our net interest margin was 2.74% during the fourth quarter of 2021, up 3 basis points from the third quarter and within the range of 2.71% to 2.77% for the fourth quarters of 2021, but down from the 3% level recorded during the fourth quarter of 2020. Compared to the year-ago fourth quarter, the yield on earning assets decreased 43 basis points, while the cost of funds declined 17 basis points. Our yield on loans has been relatively consistent over the past six quarters, except during the fourth quarter of 2020 when we recorded larger than typical PPP fee income accretion. If we refer back to slide 24, net PPP fee income accretion of $2.3 million during the fourth quarter was down from a quarterly average of about $2.8 million during the first three quarters of 2021, and well below the $5.4 million recorded during the fourth quarter of 2020. As of year-end 2021, unrecognized net PPP fee income totaled $1 million, virtually all of which is related to PPP round number two fundings. Assuming PPP forgiveness trends remain unchanged, we expect a large majority of the remaining unrecognized net PPP fee income to be recorded as income during the first quarter of 2022. 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. The excess funds are a product of increased local deposits, which are primarily a product of the Federal government stimulus program as well as lower business and consumer investing and spending. Total local deposits and sweep balances increased $774 million or 22%, during 2021 and are up $1.6 billion or 60%, since year-end 2019. Almost one half of the growth in local deposits since year-end 2019 is comprised of increased non-interest bearing checking account balances. Overnight deposits averaged $738 million during the first quarter and $671 million during all of 2021, substantially higher than our typical average balance of around $75 million. This excess liquidity lowered our net interest margin during the fourth quarter and all of 2021 by about 40 basis points to 45 basis points. While we expect the level of excess overnight funds to decline in light of continued loan growth and wholesale fund maturities, we expect the level of overnight deposits to stay elevated well into the foreseeable future. Given the asset-sensitive nature of our balance sheet, any increases in short-term interest rates will have a positive impact on our net interest margin and net interest income. We remain in a strong and well-capitalized regulatory capital position. Our bank's Tier 1 leverage capital ratio continues to be impacted by the PPP loan portfolio and excess liquidity, although there is no similar impact on the total risk-based capital ratios as both components are assigned a zero percent risk-weighting. Both our Tier 1 leverage capital ratio and our total risk-based capital ratio have also been impacted by the strong core commercial loan growth over the past several quarters. Our total risk-based capital ratio and all of our bank's regulatory capital ratios were augmented in December with our $75 million issuance of subordinated notes, of which a vast majority of the funds were downstreamed to the bank as a capital injection. And as you might have seen last Friday, we closed on an add-on $15 million issuance, all of which was provided to the bank. As of year-end 2021, our total risk-based capital was 14% compared to 12.5% as of September 30, 2021. Our bank's total risk-based capital ratio was $147 million above the minimum threshold we categorize as well-capitalized at year end 2021. We repurchased about 47,000 shares for $1.6 million at a weighted average cost of $33.35 per share during the fourth quarter of 2021, bringing our year-to-date total up to about 683,000 shares for $21.4 million at a weighted average cost of $31.29 per share. The year-to-date weighted average cost equates to about 125% of average tangible book value. As of year-end 2021, we had $6.8 million available in our repurchase. However, given the recent stock price and prospects for additional solid loan growth, we do not plan to repurchase additional shares at least in the near term. In closing, we are very pleased with our operating results for all of 2021 and financial condition at the year end and believe we are well-positioned to continue to navigate through the unprecedented economic environment created by the Coronavirus pandemic and other events. Those are my prepared remarks, I'll now turn the call back over to Bob.

Robert Kaminski, CEO

Thank you, Chuck. That concludes management's presentation. We'll now turn the call to questions and answers.

Operator, Operator

We will now begin the question-and-answer session. Our first question will come from Brendan Nosal of Piper Sandler. Please go ahead.

Brendan Nosal, Analyst

Hey. Good morning, guys. How are you?

Robert Kaminski, CEO

Good morning, Brendan. Good, and you?

Brendan Nosal, Analyst

Good. Thanks. Maybe just to start off here on the expense side of things. I think, Chuck, kind of given the quarterly guide you provided that kind of implies roughly $106 million of full year cost at the midpoint of that range which I think will be pretty much flat with the core expense level you guys put up in 2021. So just given, I guess one, inflationary environment and two, what sounds like a pretty good revenue opportunity environment for you folks, how do you guys kind of keep a lid on costs in 2022 and hold it flat there?

Charles Christmas, CFO

Yeah. A couple of things going on, and I think you're right pressed on a little bit with our operating efficiency and our ability to continue to grow the company without corresponding growth in our operating environment, part of that is we have excess capacity that we're utilizing. And I think it's also a very important point and Ray also brought this up as we have always stayed very current on technology. So, while we definitely increase our technology spend every year. There is nothing outsized year-over-year in doing that approach, so pleased about that. I think another part of that is, we are expecting a reduction in mortgage banking. And with that will come a reduction in associated commission expense.

Brendan Nosal, Analyst

All right. That's helpful commentary. And then one more for me, just turning to loan growth. I mean typically I think of Mercantile as having upper-single digit growth on average. But obviously, this is a much different environment you're clearly seeing better opportunities as shown by 20% core loan growth this year. So, just help us size up, how you think about the potential for loan growth in 2022?

Ray Reitsma, COO

Yeah. This is Ray. I mean the potential is pretty robust as our backlogs have not fallen off appreciably as we funded all this growth. You always have to think about the caveat of asset sales and business sales by our customers which can offset their growth, but we are well positioned to continue to grow into the future and have a number of relationships that are moving from prospect status to customer status. Our customers are continuing to do well in their business and I also think that the inflationary environment will lead to our customers carrying higher levels of receivables and inventory, which will lead to higher funding needs from the bank. So, I think all those factors together make us fairly bullish on the growth level. And then net level depends a lot on which businesses sell or reduce loan balances from some of those non-controllable factors that we face every day of the year.

Robert Kaminski, CEO

I think Brendan, what reflects is the success of the relationship building that we've continued to do. Even during the pandemic, when there was a lot of distraction with focus being shifted to round one and round two of PPP and helping customers navigate through some of their challenges, but our team continued to prospect. There are a list of businesses and they wanted to bring on board Mercantile in some cases, we've talked about previously, we're able to help those prospects with their PPP loans and build further goodwill. And so, what you're seeing now with the pipelines, as Ray, said continuing to be replenished is just the effect of that, we've added some new lending talents to our team that is opening some new doors for us in terms of other opportunities in the community that we hadn't had previous exposure with. So, all that together really makes us feel very confident about the ability to continue robust loan growth in 2022.

Brendan Nosal, Analyst

All right. Great. Thank you for taking the questions.

Robert Kaminski, CEO

Thanks, Brendan.

Operator, Operator

Our question comes from Damon DelMonte of KBW. Please go ahead.

Damon DelMonte, Analyst

Hey. Good morning, guys. Hope everybody is doing well today.

Robert Kaminski, CEO

Doing well, Damon. Thank you.

Damon DelMonte, Analyst

Great. So, first question on just to kind of close the loop on the loan growth outlook. Are you confident that you can keep a double-digit pace? I know this year is 20% ex-PPP and Ray, as you said it's a very robust outlook, but are you thinking like something in the 10% to 12% range? Or do you think you could repeat something like you saw here this past year?

Charles Christmas, CFO

Hey, Damon. This is Chuck. I'll take a swing at it, as I didn't get a chance on the last one, but yeah. I think from a budget standpoint, we're in the pretty high-single digits. I think as Ray mentioned, the one wildcard is always out there is pay-offs for those that we encourage as part of our loan portfolio administration or as we definitely see from time-to-time the selling of the business, selling of the underlying collateral. That stuff, that's one that's always difficult to predict. Basically, it's impossible to predict with any degree of accuracy. The pipeline remains very strong and is certainly indicative of ongoing growth, but we also want to be at least from a budgetary standpoint, do want to take into account the unknown, but expected pay-offs.

Robert Kaminski, CEO

Part of the situation with the type of lending that we do that timing is everything. And while relationships may be loyal to the bank in terms of the funding of those opportunities may vary from quarter-to-quarter. You have a bunching of some funding's and some other quarters that there is a lag. So, I think overall, we feel really good about the ability to do those high-single digits in the way of growth as Chuck, just suggested, but we've seen from quarter-to-quarter there can be some choppiness, but in the end, over the long haul, I think the sustained growth is what we'll continue to demonstrate.

Damon DelMonte, Analyst

Yeah. I appreciate the color. And then, with regards to like kind of the core margin, Chuck, could you help kind of walk us through that? I know you mean for the dollar amount, I think and the PPP impact, but could you just go back through like the PPP impact on the margin as well as the drag from the excess liquidity?

Charles Christmas, CFO

Yeah. I think, from a margin that’s -- it’s a loaded question you got there, and obviously a lot of different tentacles to it. We provide the information about the PPP, we got $1 million remaining less than that. I expect the vast majority of the remaining PPP funds either to be paid off or the fee income to be fully accretive by the end of this quarter. So, we'll get $1 million out of that mostly in the first quarter. So that will be, I hope to this quarter this first quarter here. Excess liquidity, it's all about how fast we can utilize that excess liquidity. There is definitely we expect some deposit movements within there, we're definitely led in our wholesale funds run-off, although that's a measured approach gradual throughout the year, so that will take some time. We just talked about loan growth, certainly, we would love to use all of our excess liquidity for loan growth and we do think there'll be solid loan growth, but hard to tell exactly from that. So, I guess everybody can put their pencils to decrease what they want to say how far down our excess liquidity go by the end of the year. We think a majority of it will be gone by the end of the year, but it will be gradual given our matted approach to wholesale funding and our ongoing loan growth throughout the year. Obviously, it looks like the Federal Reserve is going to start raising short-term interest rates. We're definitely an asset-sensitive bank if nothing else and our $900 million in asset, but that will, that would of course the expectation was that would reprice as they change the rate on that if there was a change to the federal funds rate. From a commercial standpoint which of course dominates our balance sheets, just under $3 billion at the end of the year, about 55% of that is floating rate either tied to 30-day LIBOR or Wall Street Journal Prime of course now receives, as far as we go forward.

Brendan Nosal, Analyst

Okay. Great.

Damon DelMonte, Analyst

You seem to have realized better economic conditions and have seen improvement in portfolios. So along those lines, could you give us your thoughts about credit quality? Do you see evidence of signs of improvement?

Charles Christmas, CFO

Yeah, I'd say generally speaking, we have seen improvement across the spectrum. Certainly, the portfolio performance is demonstrating that you're seeing lower levels of charge-offs and delinquencies. Specific areas that are particularly strong are our commercial and industrial lines as well as our home equity lines. We've generally seen fewer delinquencies coming through, our watch list has also shrunk, and we've definitely seen improvement in the credit metrics that we have in place. Overall, I think our management process is extremely solid and we continue to monitor the environment closely, and we feel good about that.

Daniel Tamayo, Analyst

Good morning, guys.

Robert Kaminski, CEO

Good morning, Daniel.

Daniel Tamayo, Analyst

Maybe just to touch on the swap fees, again, I know you talked about it earlier in the prepared comments, but what -- in case I missed it. What are your expectations going forward? I know the number was a bit lower, obviously in the fourth quarter. But given, if we do end up in a rising rate environment, which seems likely, where do you see that kind of run rate for swap fees going forward? Thanks.

Charles Christmas, CFO

Yeah, Dan. This is Chuck. Another difficult one to answer, but I think one of the things that we do want to highlight is that 2021 this year very strong, income on swaps for us and basically, we introduced that just a little over a year ago. I think from a core standpoint, we feel really good about the fact that this is going to be an ongoing product for us. We're certainly going to want to push the product and those customers that want longer-term fixed rate financing and the lenders are doing a really good job of expressing that desire out on their calls in their calling efforts. So, kind of regard, I mean, certainly when rates change there'll be some impact on swap activity, but we do expect that this to be a core part of our offering on the commercial side.

Daniel Tamayo, Analyst

Okay. Great. Thank you. And then finally just on credit quality, reserves continue to come down. You've talked about the COVID environmental factor. How much of that is, I think you talked about it, but if you could just kind of remind me how much of the COVID environmental factor is remaining and maybe what kind of impact that may have on where reserves land as we get through kind of the end of our get back to normal phase here?

Charles Christmas, CFO

Yeah. Sure. So, we introduced the COVID factor back in 2020, I think all banks did in varying ways that they did it within their models. And we just simply added it as another environmental factor. It's included in our incurred model, and it's also included in our CECL model exactly the same way. So, the impact is the same, like all banks, because of the really strong asset quality since the great recession a significant portion of reserve balances are supported by environmental factors, and that's just because of the base loss rates are relatively low given the low level of charge-offs over the last decade or so. So, and you saw it in our fourth quarter, even our second quarter is when we do -- when we do change in environmental, it does have a relatively large impact on our reserve build. The COVID itself, it's a little over $6 million is the current impact to our reserve. We have never changed that rating, if you will, it's at its highest range. So, there is the ability and probably likelihood knock on wood that we're able to start reducing that. I don't think it will be an all or nothing. I think over time, we'll probably start like we did the economic conditions in 2021, my expectation is that we would start reducing that COVID number as we move forward on a quarter-by-quarter basis and slowly and hopefully moving that obviously we all want that environmental factor to go away. But I think it will be a gradual approach and not an overnight or one-quarter approach.

Robert Kaminski, CEO

Thanks, Dan.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Bob Kaminski for any closing remarks.

Robert Kaminski, CEO

Thank you very much for your interest in our company. We hope you and your families continue to stay healthy and safe. We look forward to speaking with you again in April, at the end of the first quarter. This call is adjourned. Thank you.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation and you may now disconnect.