Earnings Call Transcript
MERCANTILE BANK CORP (MBWM)
Earnings Call Transcript - MBWM Q4 2022
Operator, Operator
Good morning, and welcome to the Mercantile Bank Corporation Fourth Quarter 2022 Earnings Results Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Julia Ward, Lambert Investor Relations. Please go ahead.
Julia Ward, 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 and full year of 2022. Joining me today are members of Mercantile's management team, including Bob Kaminski, President and Chief Executive Officer; Chuck Christmas, Executive Vice President and Chief Financial Officer; and Ray Reitsma, Chief Operating Officer and President of the Bank. We will begin the call with management's prepared remarks and presentation to review the quarter's results, then open the call to questions. Before turning the call over to management, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings, and capital structure, as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to factors described in the company's latest Securities and Exchange Commission's filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the fourth quarter 2022 press release and presentation deck issued by Mercantile today, you can access it at the company's website at www.mercbank.com. At this time, I would like to turn the call over to Mercantile's President and Chief Executive Officer, Bob Kaminski.
Bob Kaminski, CEO
Thank you, Julia, and thanks to all of you for joining us on the conference call today. Mercantile released its December 31st financial results this morning, which reported another strong quarter, finishing 2022 with continued success in numerous performance metrics. Highlights for the fourth quarter include: continued increases in net interest margin rising to more normal ranges for Mercantile, which drove strong profitability in the quarter; solid growth in many fee income categories; continuation of our strong asset quality; disciplined control of overhead expenses; and while loan growth was dampened by some loan payoffs, customer relationship building by the sales staff continued to generate successes and pipelines remained strong. For the fourth quarter, Mercantile produced earnings of $1.37 per share on revenues of $58.4 million. Full year 2022 earnings were $3.85 per share on revenues of $190.3 million. This morning, we also announced a cash dividend of $0.33 per share, payable on March 15, 2023. This represents a 3% increase over the fourth quarter dividend. Ray will have more information on the loan portfolio, fee income and other operational topics, and Chuck will provide more detail on overall financial performance for the quarter and full year, as well as some guidance on our performance in 2023. The Michigan economy continues to perform at a level we would describe as steady. Unemployment is only slightly higher at 4.3% in November compared to 4.1% at the end of the third quarter, but lower than what it was at January 01, 2022, when it was 5.1%. Mercantile bankers and our clients continue to prepare and position for a potential economic downturn of some sort. Customers have been able to absorb higher interest costs thus far. This seems to reflect the strong balance sheets and robust performance coming out of the pandemic. The real estate sector, most notably multifamily housing, has demonstrated some signs of reduced activity toward the end of 2022 as a result of higher borrowing costs and the level of new projects has slowed. Our overall pipeline, however, remains very healthy. Our team continues to diligently monitor our client base and engage our borrowers, so that we understand their financial condition and any challenges they may be encountering. We remain very pleased with the performance of our customers and their ability to navigate through an economic slowdown. Should difficulties arise, however, the deep customer knowledge of our bankers allows them to provide meaningful feedback and counsel to assist the borrowers and ultimately help manage risk for the bank. The loan portfolio, however, continues to be very strong. While our senior management team is keenly focused on maneuvering through near-term economic conditions, we eagerly look forward to the future with much anticipation to craft strategies for long-term sustainability and success of our company. Our team ensures comprehensive plans are in place to create, develop and leverage opportunities for growth and excellence in performance in our existing markets as well as potential new markets. An important key to future success is maintaining the steady pipeline of new talent entering our organization and the ongoing development and training of all employees so they can help us achieve our strategic initiatives. Relationship-focused banking allows us to understand the clients' immediate and long-term needs and design and implement products to fulfill those needs. Attainment of these objectives allows our company to provide best-in-class service to our customers, demonstrate peer-leading performance and provide attractive returns for our shareholders. In closing my initial comments, I want to thank the Mercantile team for their excellent work in the fourth quarter and throughout 2022. Each day our staff members engage our clients and demonstrate the Mercantile way of relationship banking. Consumers and businesses have seemingly endless choices for their financial needs. For 25 years, customers and our markets have discovered the benefits of banking with Mercantile. As a result, Mercantile has grown consistently and profitably for its shareholders and proven to be a strong partner for the communities we serve. Those are my prepared remarks, and I'll now turn the call over to Ray.
Ray Reitsma, COO
Thanks, Bob. My comments will center around dynamics in the commercial and residential mortgage loan portfolios and noninterest income. Core commercial loan growth for the year is 7% despite a contraction of 2% annualized in the fourth quarter. This contraction is attributable to payoffs of $39 million resulting from asset sales, $24 million from refinancing to the secondary market, and $39 million paid down from excess cash flow or cash reserves. Our commercial backlog has grown sequentially over the last four year-ends and over each of the last four quarters, and currently resides at a four-year high. The pipeline for commercial construction commitments that we expect to fund over the next 12 to 18 months totals $197 million compared to $170 million last quarter. Presently, line of credit utilization is 42% compared to 37% a year ago. However, bank commitments in aggregate have increased $385 million or 21% over the past year. The portfolio is well positioned for a rising rate environment, as 65% of the portfolio is comprised of floating rate loans, up from 50% at March 31, 2021, accomplished largely through our swap program. Asset quality remained strong with nominal amounts of past due loans and non-performing assets of 16 basis points of total assets compared to 3 basis points last quarter. A single addition to non-accrual loans accounted for 90% of the increase to non-performing assets during the quarter. The deterioration of the C&I credit is attributable to an isolated management failure rather than stress in the industry or the general economy. While we are proud of our outstanding asset quality metrics, we remain vigilant in our underwriting standards and monitoring efforts to identify any sign of deterioration in our loan portfolio. Our lenders are the first line of defense to recognize areas of emerging risk. Our risk rating process is robust with an emphasis on current borrower cash flow and our rating model, providing sensitivity to any challenges evolving within a borrower's finances. All that said, our customers continue to report strong results to date and have now begun to experience impacts of a potential recessionary environment. We continue to closely monitor concentration limits within our loan portfolio. The mortgage business has slowed due to the rising rate environment, seasonality and lack of available housing inventory in the markets we serve. Higher rates have led to more demand for adjustable-rate mortgages, and the lack of inventory has led to more construction lending activity. We hold each of these types of loans on our balance sheet and, as a result, residential mortgages have increased 60% over the prior year. Compared to a gain on sale event and immediate recognition of income, a portfolio loan takes about 24 months to generate an equal amount of income. We continue to pursue share in the purchase market with originations in the fourth quarter decreasing 36% compared to the fourth quarter last year due to the increase in mortgage rates since that time. Availability under residential construction loans is $72 million this quarter compared to $59 million one year ago. Refinance activity is just 13% of last year's comparable quarter. Noninterest income for the fourth quarter is down 38% compared to the fourth quarter of 2021. The primary contributor to the overall reduction was the previously described decrease in mortgage banking income of 75%, which more than offset a 5% increase in service charges on accounts, a 23% increase in payroll services, a 7% increase in credit and debit card income and a 47% increase in swap income. The optimization of our branch network is an ongoing endeavor that has yielded seven-figure annualized savings. Utilizing tools such as appointment banking, limited-service branches, live ATM machines and branch consolidations complemented by investments in our remaining facilities resulted in a nominal deposit attrition in the impacted markets. We have added commercial and mortgage lending talent in Saginaw and Traverse City markets, and plan to establish loan production offices in those markets in the near future. That concludes my comments. I will now turn the call over to Chuck.
Chuck Christmas, CFO
Thanks, Ray. As noted on Slide 10 of our presentation, this morning we announced net income of $21.8 million or $1.37 per diluted share for the fourth quarter of 2022 compared with net income of $11.6 million or $0.74 per diluted share for the respective prior year period. Net income for the full year 2022 totaled $61.1 million or $3.85 per diluted share compared to $59 million or $3.69 per diluted share during the full year 2021. Higher net interest income, stemming from an improving net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and increases in treasury management fee income revenue streams, more than offset a significant decline in mortgage banking revenue, as industry-wide originations come off the record levels of 2020 and 2021, which were driven by low mortgage loan rates and resulting refinance activity. Our earnings performance in the 2021 periods also benefited from lower loan loss provisions, reflecting improved economic expectations. Turning to Slide 11. Interest income on loans increased significantly during the 2022 periods compared to the prior year periods, reflecting an increase in interest rate environment and strong loan growth in core commercial and residential mortgage loans. Our fourth quarter loan yield was 93 basis points higher than the third quarter and 142 basis points higher than the fourth quarter of 2021. The yield on loans during the full year 2022 was 44 basis points higher than the full year 2021, as the increase in interest rate environment impact didn't start in earnest until the second quarter of 2022, and the 2021 period was significantly impacted by PPP net loan fee accretion. Interest income on securities also increased during the 2022 periods compared to the prior year periods, reflecting growth in the securities portfolio to deploy a portion of the excess liquid funds position and the higher interest rate environment. Interest income on other earning assets, a vast majority of which is comprised of funds on deposit with the Federal Reserve Bank of Chicago, also increased during the 2022 periods compared to the prior year periods, generally reflecting the higher interest rate environment. In total, interest income was $21.2 million and $38.3 million higher during the fourth quarter and full year 2022 when compared to the respective time periods in 2021. We recorded increased interest expense on deposits during the fourth quarter of 2022 compared to the fourth quarter of 2021 in large part reflecting the increase in interest rate environment and enhanced competition for deposits. In comparing the full year 2022 to the full year 2021, we recorded an increase in interest expense on deposits, as deposit rates increased primarily during the latter part of 2022 and average interest-bearing deposit balances grew about 4%. Interest expense on other borrowed money increased during the fourth quarter of 2022 compared to the fourth quarter of 2021 and grew during the full year 2022 compared to the full year 2021. The increases largely reflect interest costs associated with $90 million in subordinated notes issued between December of 2021 and January of 2022, and higher rates on our floating rate trust preferred securities. In total, interest expense was $3.1 million and $4.2 million higher during the fourth quarter and full year 2022 when compared to the respective time periods in 2021. Net interest income increased $18.1 million and $34.2 million during the fourth quarter and full year 2022, respectively, compared to the same time periods in 2021. We recorded a credit loss provision expense of $3.1 million and $6.6 million during the fourth quarter and full year 2022, respectively, compared to a negative provision expense of $3.4 million and $4.3 million during the respective time periods in 2021. The provision expense recorded during the 2022 periods was necessitated by the net increase in required reserve levels stemming from changes to several environmental factors that largely reflected enhanced inherent risk within the commercial loan and residential mortgage loan portfolios, as well as loan growth and increased specific reserve for certain distressed loan relationships. A higher reserve for residential mortgage loans reflecting slower principal prepayment rates and the resulting extended average life of the portfolio also impacted provision expense during 2022. The negative provision expense recorded during the 2021 periods mainly reflected reduced allocations attributable to improvement in both current and forecasted economic conditions and net loan recoveries, which more than offset required reserve allocations necessitated by loan growth. Overhead costs decreased $4.8 million during the fourth quarter of 2022 compared to the fourth quarter of 2021 and were down $2.9 million for the full year 2022 when compared to the full year 2021. Adjusting for charitable contributions to the Mercantile Bank Foundation, overhead costs decreased $1.8 million during the fourth quarter of 2022 compared to the fourth quarter of 2021 and were down slightly for the full year 2022 compared to the full year 2021. Salary and benefit expenses declined during the 2022 periods, mainly from lower compensation-related costs, in large part reflecting lower residential mortgage lender commissions, reduced stock-based compensation costs, and higher residential mortgage loan deferred costs. Regular salary costs, primarily reflecting annual merit pay increases and market adjustments, and bonus accruals were higher in the 2022 periods. Continuing on Slide 14, our net interest margin was 4.30% during the fourth quarter of 2022, up 74 basis points from the third quarter of 2022 and up 156 basis points from the fourth quarter of 2021. The improved net interest margin is primarily a reflection of an increased yield on earning assets, in large part reflecting an increase in the interest rate environment in 2022 as well as strong loan growth. As I noted earlier, we recorded increased interest income on loans during the 2022 periods compared to the 2021 periods, which was achieved despite a significant reduction in PPP net loan fee accretion. During the full year 2022, PPP net loan fee accretion totaled $1.0 million compared to $10.8 million during the full year 2021. Our average commercial loan rate increased 252 basis points during the full year 2022, a significant increase at a loan portfolio that averaged $3.1 billion during that time period. Given the asset-sensitive nature of our balance sheet, which includes 65% of our commercial loan portfolio comprised of floating rate loans, any further increases in short-term interest rates will have a positive impact on our interest income. After increasing only about 3 basis points per quarter over the past three quarters, our cost of funds increased 17 basis points during the fourth quarter of 2022. Despite the increase in the interest rate environment, our deposit rates and those of our competitors were not meaningfully raised during the first nine months of 2022, which we believe reflected a relatively low level of competition for deposits given the excess liquidity positions of most financial institutions. However, as interest rates continue to rise and excess liquidity positions decline and end, deposit rates are now increasing and we believe deposit rate betas will ultimately return to historical levels. We remain in a strong well-capitalized regulatory capital position. Our total risk-based capital ratio and all of our bank's regulatory capital ratios were augmented about a year ago with an aggregate $90 million in issuance of subordinated notes, of which a vast majority of the funds were downstreamed to the bank as a capital injection. As of year-end 2022, our bank's total risk-based capital ratio was 13.7% and was $166 million above the regulatory minimum threshold to be categorized as well-capitalized. We did not repurchase shares during 2022. We have $6.8 million available in our current repurchase plan. In regards to our thoughts on 2023, on Slide Number 18, we share our latest assumptions on the interest rate environment and key performance metrics for 2023 with the caveat that market conditions remain volatile, making forecasting difficult. This forecast is predicated on 25 basis point increases in the federal funds rate at the next two FOMC meetings and then unchanged for the remainder of 2023. This forecast also assumes no significant recessionary pressures. We are projecting total loan growth in the range of 7% to 9%, with commercial loan growth itself of around 5%. While our commercial loan pipeline remains strong, we experienced a high level of payoffs and paydowns in 2022, especially in the latter part of the year. We are forecasting our first quarter net interest margin to decline from the just-completed fourth quarter, as expected increases in our cost of funds more than offsets further increases in asset yields from the FOMC interest rate decisions. For the remainder of 2023, we project our net interest margin to further gradually decline as our asset yield remains stable, but our cost of funds continues to increase from competitive pressures and growth in interest-bearing liabilities to fund expected loan growth. In closing, we are very pleased with our 2022 operating results and believe we remain well positioned to continue to successfully navigate through the myriad of challenges faced by all of us. Those are my prepared remarks. I'll now turn the call back over to Bob.
Bob Kaminski, CEO
Thank you, Chuck. That concludes management's prepared remarks this morning, and we'll now open the call up for the question-and-answer period.
Operator, Operator
We will now begin the question-and-answer session. Our first question will come from Brendan Nosal with Piper Sandler. Please go ahead.
Brendan Nosal, Analyst
Hey, good morning, folks. How are you?
Bob Kaminski, CEO
Good morning.
Chuck Christmas, CFO
Good morning.
Brendan Nosal, Analyst
Maybe just to start off on kind of the balance sheet side of things as you look ahead. Maybe just talk about your expectations for deposit flows as we move through 2023? And then, maybe tie that together with your ability to grow loans at that 7% to 9% clip under the context of your loan to deposit ratio at 106% today?
Chuck Christmas, CFO
Yes, Brendan, this is Chuck. I'll address that question. Clearly, funding has become a focus again. Our company has historically been well-acquainted with this until the past couple of years when most financial institutions experienced significant excess liquidity. We managed that mainly by funding our loan growth over the last couple of years and made some enhancements to our securities portfolio. Recently, we have begun to see depositors start using their funds. However, I do want to note that in December and into January, we typically see meaningful reductions as our commercial customers meet tax obligations and make bonus payments. Moving into 2023 and likely beyond, one of our key priorities will be to effectively and efficiently increase our liabilities on the balance sheet instead of relying solely on the asset side, particularly our holdings at the Federal Reserve Bank of Chicago, to support any growth in our total assets. Despite having excess liquidity, we have consistently aimed to grow deposits, knowing that this excess would eventually diminish; it was just a matter of timing. We have been strengthening our deposit relationships and bringing in new ones during this time, and this will remain a focus. Additionally, we see significant deposit growth linked to our expanding commercial loan portfolio, especially with C&I credits as they transfer their operating accounts. We also work towards attracting ancillary business owner and management accounts. While I can't offer a quick fix, I believe that maintaining our efforts is essential. Everyone here, not just our branch and treasury management teams, plays a role in growing our deposit base. We see opportunities in certain markets and deposit products, so we are enhancing our offerings and exploring markets and types of depositors that we may not have engaged with as much in the past, as part of our strategy to fund any asset growth.
Brendan Nosal, Analyst
All right. Awesome. Thank you, Chuck, for all the color. Maybe just one more for me. Just on the margin, perhaps more conceptually, I definitely appreciate the detailed guide here, I guess what would be better for the margin once the Fed has done raising rates? Would it be stability in short-term rates for a period of time? Or would it be better if they cut rates sooner?
Chuck Christmas, CFO
From a margin perspective, it would be advantageous if rates remained stable for some time. Our margin has significantly improved with the recent rise in interest rates, but we must keep in mind that those rates were previously at very low levels, which negatively affected bank net interest margins. In the past three to five years, especially before and during the COVID period, we experienced this firsthand. Unless a severe recession is on the horizon, if the Fed decides to lower rates, we don't expect them to drop back to the levels they were before. While there would be some decrease in interest rates, which could negatively affect our company, if the Fed maintains rates or only reduces them slightly, it would benefit our net interest margin. Conversely, aggressive rate cuts could be detrimental. Additionally, we need to monitor how the Fed's actions impact the economy and specifically how this affects our commercial and retail customers, including their ability to manage existing debt, as this could influence our future loan growth opportunities. Changes in interest rates certainly affect our net interest margin, but we must also consider their potential impact on our asset quality.
Brendan Nosal, Analyst
Yes, got it. Okay. Thank you for taking the questions.
Bob Kaminski, CEO
Thank you.
Chuck Christmas, CFO
You're welcome.
Operator, Operator
And our next question will come from Daniel Tamayo with Raymond James. Please go ahead.
Daniel Tamayo, Analyst
Good morning, guys. Thanks for taking my questions.
Bob Kaminski, CEO
Good morning.
Daniel Tamayo, Analyst
I'd like to follow up on the balance sheet management question. As Brendan mentioned, you had a loan/deposit ratio of 106%. Last quarter, you indicated that you wanted to maintain a ratio of 100% to 105%. Does this imply that you expect the balance sheet to grow in alignment with loan growth moving forward? Additionally, is there a breakeven point you are considering regarding your loan growth, especially given the need to fund that growth if noninterest-bearing deposits continue to decline and you have to rely on CDs or wholesale deposits? Would there be a point where you might slow down loan growth?
Chuck Christmas, CFO
Yes, I'll address the first part, and then the team can contribute to the second part regarding overall strategy. You are correct; we aim for our loan to deposit ratio to be between 100% and 105%, and we are nearly there. We anticipate that if we experience growth on the asset side, a significant portion will need to be funded through our liabilities, and we prefer to rely on core deposits as much as possible while avoiding wholesale funding when we can. This will depend on the success of expanding our deposit franchise. Typically, we see a decline in deposits during this time of year due to our large commercial focus and because of end-of-year tax and bonus payments, which affects the first quarter. We expect this seasonal pattern to assist us as we move into 2023. However, as I previously mentioned, this will be a considerable challenge for all banks, especially with rising deposit rates. We've noticed a delay in adjusting those rates, and they are aligning more closely with historical trends. Securing deposits will be competitive, and our goal is to attract the necessary deposits as efficiently and effectively as possible.
Bob Kaminski, CEO
Chuck gave some color as far as the annual cycle as to what our deposits do. But on a longer-term basis, Mercantile has been through these cycles previously where interest rates rising, interest rates falling, deposits being in high demand. And we've demonstrated an ability to cope with ideas and plans to be able to make sure that we don't need to take the foot off the gas pedal at all from a loan growth standpoint. That's been the nature of our company for a long, long time is commercial loan growth, overall asset growth. And so, we do the things that we need to do to make sure that, that continues to be the case, and we have some ideas that we're working on to be able to come up with different flavors of deposits and things that are specific to certain markets or certain types of customers that can help overall funding of that ongoing loan growth.
Daniel Tamayo, Analyst
Okay. I appreciate that color. And then, switching gears here. Just on the fee income guidance, it seems like a decent drop. I know you talked about it a little bit in the prepared remarks, but from the fourth quarter level, the first quarter guidance is below kind of what I was expecting. Maybe you could talk a little bit more about what's driving that? And then, kind of as it goes throughout the year, what you may be looking for?
Chuck Christmas, CFO
Yes, there are two factors influencing this situation. First, there's the seasonal pattern in mortgage lending, particularly in the Midwest where activity slows down in January and February due to fewer home buying and selling transactions. We're relying more on these transactions than on refinancing opportunities. However, as interest rates change, there might be refinancing chances for borrowers who took out loans in 2022, which is significant. Secondly, we’re also observing changes in service charge income. A key aspect of that is the earnings credit rate. With rising interest rates, we’ve recently had to increase this rate, which actually reduces our service charge income. This earnings credit rate is aligned with our deposit rates. Although rates were increasing last year, we only had to raise the earnings credit rate in the fourth quarter, and it has been adjusted significantly alongside deposit rates now. While our overall performance will remain strong, we won’t experience the same level of growth in loan fee income as we did in service charge income.
Daniel Tamayo, Analyst
Okay. Regarding the increase in the swaps in the fourth quarter, do you expect it to be a similar number or will it return to what we observed earlier in the year?
Chuck Christmas, CFO
Yes, that one's pretty challenging, similar to investment banking. It fluctuates and is difficult to predict on a quarterly basis. I generally just smooth it out in my budget, and just so you know, we have around $200,000 allocated each month. However, there is a lot of variability in that figure, but we definitely see interest in that product. I believe that if medium- and long-term rates continue to decline as they have, interest in that product will increase even more. Our goal is not to provide fixed rates for larger commercial real estate products and to transition them into the swap product if they desire a fixed rate. Ultimately, this is determined by the borrower and what type of rate structure they wish to choose.
Daniel Tamayo, Analyst
Got it. Okay. Thanks for all the color. Thanks.
Chuck Christmas, CFO
You're welcome.
Bob Kaminski, CEO
Thank you.
Operator, Operator
Our next question will come from Erik Zwick with Hovde Group. Please go ahead.
Erik Zwick, Analyst
Good morning, everyone.
Chuck Christmas, CFO
Hey, Erik. Good morning.
Bob Kaminski, CEO
Good morning.
Erik Zwick, Analyst
First question for me. Just looking at the forecast for overhead costs in 2023, curious, one, does that include any charitable contributions?
Chuck Christmas, CFO
Nothing significant.
Erik Zwick, Analyst
Okay. And then, just looking at 2022, you had contributions, I believe, in the second quarter and fourth quarter. Would you like to specify in those quarters? Or I guess, how do you guys determine the timing and magnitude of those contributions?
Chuck Christmas, CFO
Yes. Typically, we evaluate the performance of the bank and the company in the fourth quarter from an earnings perspective, ensuring we feel confident about asset quality and capital levels before making a decision. However, if unexpected events occur throughout the year, such as non-core income, we might decide to make additional contributions at that time. Generally, it will be a fourth quarter decision, unless there are any one-time events during the year.
Erik Zwick, Analyst
Thank you, Chuck, for the clarification. I have another question for you. Looking at the projected total overhead costs for the first quarter of '23, if I analyze the run rate from the most recent quarter and exclude the charitable contribution, it seems like you're anticipating that costs will be flat or possibly even $1 million lower on that run rate. I'm curious about where that potential leverage is or where you expect to see some improvement from one quarter to the next.
Chuck Christmas, CFO
Yes. Most of that comes from our bonus accruals due to the strong year we had. We asked the executive management team to enhance our bank-wide bonus program, which we actually doubled for non-senior management. As a result, we had some catch-up accruals to make in the fourth quarter linked to that doubling of the bank-wide bonus program.
Erik Zwick, Analyst
Got it. Thank you. And then, switching gears towards credit. One, if you could remind me the industry of that larger kind of commercial NPA that you referenced that the management failure? And then, I guess, what's the remediation strategy and timing for a resolution on that credit as well?
Ray Reitsma, COO
This is Ray. That was an automotive supplier. We're working with the company through a number of remediation steps. We expect that we'll have a pretty good resolution to this, I would say, within the next 90 to 120 days.
Erik Zwick, Analyst
Thanks. Considering the loan loss provision for 2023, if we assume that the Moody's forecast remains largely unchanged and there's no significant decline in the remaining credit within the portfolio, how are you accounting for each dollar of new loan growth given the expected annualized loan growth of 7% to 9% and that this includes both commercial and residential loans?
Chuck Christmas, CFO
Yes. We need to set aside a larger percentage of the loan balance for residential loans compared to commercial loans, mainly due to the duration. Assuming no significant changes in credit conditions, no recession, and a normal level of net loan charge-offs, we anticipate that we would need to increase our reserve coverage ratio by about 1 to 2 basis points as we progress through the year.
Erik Zwick, Analyst
Okay. Thanks. That's helpful. That's all from me today. Thanks, guys.
Chuck Christmas, CFO
You're welcome.
Operator, Operator
Our next question will come from Damon DelMonte with KBW. Please go ahead.
Damon DelMonte, Analyst
Hey, good morning, guys. Thanks for taking my question. Most of my questions have been asked and answered. But just to circle back on the LPO strategy, could you just kind of go back over the locations and the timing regarding those?
Bob Kaminski, CEO
Sure. We hired some talent in Saginaw, Michigan in the middle part of the year and have been seeking to establish a physical location. Those people are currently working out of their homes. So, we've begun to enjoy some asset growth in that market. Similarly in Traverse City, Michigan, where we've hired a commercial loan manager who we expect will grow a team out there. We do have a mortgage presence there, and are in the process of securing a physical location to go with the personnel. So, we have had a commercial loan presence in Traverse City for some time, and we're seeking to augment that. So, we're both in each market in the early stages of growing out into a more physical presence from an early presence that basically originated from people working out of their homes.
Damon DelMonte, Analyst
Thank you. Regarding the lending opportunities, it's difficult to specify exact percentages, but how would you describe the opportunities arising from market disruption where you're gaining market share from customers associated with acquired banks, compared to the increased credit demand from your current customers?
Ray Reitsma, COO
I would say that the majority of new growth is coming from disruption in the market. Many of the larger competitors we face are struggling to adapt, which has made it challenging for some strong customers to remain with them. As a result, we are benefiting from this situation. Additionally, between a third and a half of our growth is coming from existing relationships that continue to thrive, leading to increased lending needs from us.
Bob Kaminski, CEO
New client acquisitions occur gradually. Typically, the relationship is developed as lenders or salespeople engage with clients. It often requires a misstep from the incumbent bank, such as a delayed response or an error with a loan or account, which can weaken their standing. This opens the opportunity for clients to switch to Mercantile, a relationship that has often been built over time. While it is a process, our continued success is aided by the actions or inactions of some of our competitors.
Damon DelMonte, Analyst
Got it. Okay. That's great. That's all that I had. Thank you very much.
Bob Kaminski, CEO
Thanks, Damon.
Operator, Operator
And with no further questions, this will conclude our question-and-answer session. I'd like to turn the conference back over to Bob Kaminski for any closing remarks.
Bob Kaminski, CEO
Thank you very much for your interest in our company. We look forward to speaking with you next at the end of the first quarter in April, and this call has now ended. Thanks, again.
Operator, Operator
The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.