Mercantile Bank Corporation (NASDAQ:MBWM) Q2 2022 Earnings Conference Call July 19, 2022 10:00 AM ET
Company Representatives
Bob Kaminski – President, Chief Executive Officer
Chuck Christmas – Executive Vice President, Chief Financial Officer
Ray Reitsma – Chief Operating Officer, President of the Bank
Jeff Tryka – Lambert Investor Relations
Conference Call Participants
Brendan Nosal – Piper Sandler
Daniel Tamayo – Raymond James
Damon DelMonte – KBW
Operator
Good morning and welcome to the Mercantile Bank Corporation, Second Quarter 2022 Earnings Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded.
I would now like to turn the conference over to Jeff Tryka, Lambert Investor Relations. Please go ahead.
Jeff Tryka
Thank you, Ted. 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 second quarter 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, and then open it up for – 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 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 second 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.
Bob Kaminski
Thank you, Jeff, and thanks to all of you for joining us on the conference call today. This morning Mercantile released its second quarter financial results which portrayed another solid quarter earnings and grow as we reach the midpoint of 2022, and positioned us well for a strong second half of the year.
Our second quarter earnings were $0.74 per share, on total revenues of $42.1 million. Earnings when a loss on disposition of the bank properties is excluded or $0.76 per share. The preemptive efforts of our team, along with the strong foundation we have built, have prepared us to be in an excellent position should we see a downturn in the economy, but we’ll touch on that more later. Today we also announced a cash dividend of $0.32 per share payable on September 14.
During management’s comments this morning, we will outline the excellent work of the Mercantile teams to successfully deliver positive results for our shareholders, and provide best in class products and services to our commercial and retail clients. Execution of our short term and long term strategic initiatives continues to provide for us a balanced framework to successfully navigate the challenges and leverage the opportunities in this dynamic operating environment.
Highlights for the second quarter and first half of the 2022 include expansion of net interest margin as it starts to increase to a more normally expected level, robust growth in the loan portfolio with the commercial pipeline remaining at high levels, continuation of outstanding asset quality, diligent management of overhead expenses, and growth in several non-mortgage fee income categories. Chuck and Ray will provide more specifics on each of these topics shortly in their comments.
We remained very pleased with the performance of our team as we continually engage with our clients through the strong relationships we have built to understand their needs and provide solutions to help them raise their financial objectives. The ability to nimbly adjust to the evolving economic and environmental conditions has been a key factor of our organizations success, including the production of consistent organic loan and deposit growth and the expansion of many non-interest income categories.
As it was expected this year, rising mortgage rates have significantly dampened the production volumes experienced over the last two years. Refinance activity has slowed to a trickle and the focus of our team as we have emphasized throughout 2021 in the first half of 2022 is purchase financing opportunities. Tight inventories of available housing for sale in most of our markets have further challenged prospective purchasers’ ability to secure a new home.
Management continues to focus on hiring proven commission based mortgage lenders to complement our lending teams in our mature markets, as well as seeking opportunities to bolster account levels and new markets. Our leadership team also continues to work with their relentless focus on further development of our digital channels to enhance our customers’ experiences and ensure the most efficient deployment of our company’s resources.
Within the next few quarters for example, we plan on introducing a new business banking product offering that will allow some commercial clients to digitally engage with Mercantile end-to-end for their lending needs. Additionally, our data analytics team is constantly working to utilize the vast array of customer information available at our disposal to better understand and be able to more quickly anticipate customer needs.
The economies in the markets served by Mercantile continue to performance in a steady fashion. The unemployment rate in Michigan is 4.3%, down from 6.2% a year ago. However, most of the metro markets which contain most of our significant concentrations of assets and business opportunities, it remains below 4%.
With this low unemployment rate, the ability to staff at required levels is among the most significant issues for companies, both – as both hiring new staff and replacing existing staff, while managing payroll costs continue to challenge management teams. Our energy costs, our higher borrowing costs with rising interest rates and supply chain issues are also factors requiring much focus for clients at the present time.
Mercantile lending teams continue to stay closely engaged with clients to identify any signals of stress in the portfolio that may be emerging with these conditions. Just as they did during the last two plus years with the COVID-19 pandemic, the Mercantile client base continues to directly manage their business and personal finances and maintain a steady performance.
As the FOMC acts to slow the rate of inflation in the U.S. economy, we believe we’re well positioned to continue delivering solid results for our shareholders, as we continually work to leverage opportunities and mitigate risks. While our markets and our customers remains strong, we vigilantly look on the horizon to assess the possibility of a recession as the Fed works to attempt to thread the needle to reduce inflation with a soft landing.
Mercantile balance sheet will allow us to make gains in a rising rate environment, yet we also fully understand and work to anticipate potential strains on the loan portfolio as a result of increased borrowing costs and the impact of a potentially slowing economy on our client base. We firmly believe however, that our consistent credit underwriting and loan administration will continue to serve us well.
Finally, I want to acknowledge the dedication and hard work from the Mercantile team for the continuation of their stellar performance in the second quarter. Their efforts to develop new relationships and enhance existing relationships, which is the foundation of our culture, has positioned Mercantile for success for the rest of ‘22 and beyond.
Those are my prepared remarks. I’ll now turn the call over to Ray.
Ray Reitsma
Thank you, Bob. My comments will center around dynamics in the following areas: The commercial and mortgage loan portfolios, net interest income and branch optimization activities.
We reported annualized core commercial loan growth of 10% for the second quarter and 11% for the first six months of 2022. This growth was achieved despite payouts relates to asset or business sales of $124 million year-to-date and has been possible due to the efforts of our commercial team and their focus on relationship building and the community bank value proposition.
Our commercial backlog remains consistent with prior periods as we fund this impressive level of growth. Availability under construction commitments that we expect to fund over the next 12 to 18 months totals a $175 million. Presently line of credit usage is 34% compared with 30% a year ago; however, bank commitments in aggregate have increased $438 million over the past year. The portfolio is also well positioned for an increasing rate environment as 63% of the portfolio is floating rate loans, up from 50% at March 31, 2021, accomplished largely through our SWOT program.
Asset quality is pristine with non-performing assets of 3.5 basis points of total assets and nominal amount of past due loans. Parts of those credits are 29% lower than year ago levels. While we are proud of our asset quality numbers, we are vigilant in monitoring efforts relative to a potential recession.
Our lenders are the first line of defense as they seek to identify areas of emerging risks. Our risk rating process is robust with an emphasis on current borrower cash flow in our rating model, providing sensitivity to any emerging challenges in the borrowers’ finances. All that said, our customers have reported strong results to-date and a recessionary environment is more anticipation than actual experience. We also closely monitor exposures in the automotive industry and commercial real estate concentration we well.
The mortgage business is slow due to the rising rate environment and lack of available housing inventory in the markets that 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 52% over the prior year.
Compared to a gain on sale event and immediate recognition of income, a portfolio only takes about 24 months to generate an equal amount of income. We continue to increase share in the purchase market with originations of 9% over last year’s comparable quarter. Availability under residential construction loans of $85 million compared to $48 million one year ago. Refinance activity is 36% of last year’s comparable quarter.
Non-interest income for the second quarter is down 43% compared to the second quarter of 2021, when adjusted for a gain on the sale of a branch in 2021. The primary contributor, to the overall reduction was the previously described decrease in mortgage banking income of 75% and a reduction in swap income of 71%.
Positive contributors were a 24% increase in service charges on accounts, a 15% increase in payroll services and an 11% increase in credit and debit card income. The optimization of our branch network is an ongoing endeavor that has yielded seven figure savings, utilizing tools such as appointment banking, limited service branches, live ATM machines and branch consolidations, complemented by investments in our remaining facilities have resulted in nominal deposit attrition of less than 1% in the impacted markets.
That concludes my comments. I will now turn the call over to Chuck.
Charles Christmas
Thank you, Ray. As noted on slide 10, this morning we announced net income of $11.7 million or $0.74 per diluted share for the second quarter of 2022, compared with net income of $18.1 million or $1.12 per diluted share for the respective prior year period. Net income during the first six months of 2022 total $23.2 million or $1.47 per diluted share, compared to $32.3 million or $2 per diluted share during the first six months of 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 several key fee income revenue streams, in large part mitigated a significant decline in mortgage banking income revenue as industry wide originations come off the record levels of 2020 and 2021, which were driven by low mortgage loan rates and result in refinance activity. Our earnings performance in the 2021 period is also benefited from large negative loan loss provisions reflecting improved economic conditions and expectations.
Turning to slide, 11, interest income on loans increased during the 2022 period compared to the prior year periods, reflecting growth in core commercial and residential mortgage loans. The yield on loans during the 2022 periods was relatively similar to that of the 2021 period, as an increased interest rate environment during the first six months of 2022 mitigated the significantly higher level of PPP, net loan fee accretion recorded during the 2021 period.
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 Fed Reserve Bank of Chicago increases well during the 2022 periods compared to the prior year periods, generally reflecting higher average balances and the higher interest rate environment.
In total, interest income was $3.8 million and $4.9 million higher during the second quarter and first six months of 2022 when compared to the respective time periods in 2021. Interest expense on deposits declined during the 2022 periods, compared to the prior year periods, as lower deposit rates more than offset increased interest bearing deposit balance.
Interest expense on other borrowed money increased during the 2022 periods compared to the prior year period, reflecting interest costs associated with the $90 million in subordinated notes issued between December 2021 and January 2022. In total, interest expense was $0.3 million and $0.1 million higher during the second quarter and first six months of 2022, when compared to the respective time periods in 2021.
Net interest income increased $3.5 million and $4.8 million during the second quarter in the first six months of 2022 respectively, compared to the respective time periods in 2021. We’ve recorded a credit loss provision of $0.5 million and $0.6 million during the second quarter and first six months of 2022 respectively, compared to a negative provision expense of $3.1 million and $2.8 million during the respective time periods in 2021.
The provision expense recorded during the second quarter of 2022 mainly reflected allocations necessitated by net commercial and residential mortgage loan growth, increased specific reserves on certain commercial loans, and a higher reserve on residential mortgage loans study from a projected increase average life of the portfolio, which in total were not fully mitigated by the combined impact of the reduced COVID-19 environmental allocation, net loan recoveries and continued strong asset quality metrics.
The negative provision expense recorded during the second quarter of 2021 was mainly comprised of a reduced allocation associated with the economic and business conditions environmental factor.
Continue on slide 13, excluding a $0.5 million contribution to the Mercantile Bank Foundation, overhead costs were relatively unchanged during the 2022 periods compared to the prior year periods. Overhead costs increased to $0.2 million during the second quarter of 2022, compared to the second quarter of 2021 and were up $0.9 million during the first six months of 2022, when compared to the same time period in 2021.
We recorded a loss of $0.4 million on the sale of our Lansing facility during the second quarter of 2022. The sale of our facility is part of our relocation efforts to a lease facility that better aligned our operations in the greater Lansing area and provides for lower operating costs.
Continuing on slide 14, our net interest margin was 2.88% during the second quarter of 2021, up 31 basis points from the first quarter of 2022 and up 12 basis points from the second quarter of 2021. The improved net interest margin is primarily a reflection of the increased yield on earning assets, in large part reflecting the increase in interest rate environment thus far in 2022.
As I noted earlier, we recorded increased interest income on loans during the 2022 periods compared to the 2021 period, which was achieved despite a significant reduction in PPP loan fee accretion. During the first six months of 2022 PPP net loan fee accretion totaled $1.0 million compared to $5.7 million during the same time period in 2021. Our average commercial loan rate increased 61 basis points from year end 2021 to June 30, a significant increase on our loan portfolio that averaged just under $3 billion during that time period.
Our net interest margin continues to be negatively impacted by excess liquidity; however, the impact declined during the second quarter due to a lower volume of excess liquidity reflecting balances used to fund loan growth and deposit withdrawals. The negative impact on our net interest margin from excess liquidity equaled 23 basis points during the second quarter of 2022 compared to 40 basis points during the first quarter of 2022.
We expect the trend to continue to decline as excess monies are used to fund future loan growth and FHLB advance maturities. Given the asset sensitive nature of our balance sheet, which includes 63% of our commercial loan portfolio comprised of floating rate loans, any further increases in short term interest rates would have a positive impact on our net interest margin and net interest income.
We remain in a strong and well capitalized regulatory capital position. The Tier 1 leverage capital ratio continues to be impacted by excess liquidity, although there is no similar impact on the risk based capital ratios as deposits maintained at the Federal Reserve Bank of Chicago are assigned a 0% risk weighting.
Both our Tier 1 leverage capital ratio and total risk based capital ratio have also been impacted by strong commercial loan growth over the past several quarters. Our total risk based capital ratio and all of our banks regulatory capital ratios were augmented this past December and January with an aggregate $90 million issuance of subordinated note, of which a vast majority of the funds were down streamed to the bank as a capital injection.
As of June 30, our banks’ total risk based capital ratio was 13.4%, and was $149 million above the minimum threshold to be categorized as well capitalized at the end of the second quarter. We did not repurchase shares during the first six months of 2022. We have $6.8 million available in our current repurchase plan.
On slide 18 we provided some thoughts regarding the remainder of 2022. As we share our latest assumptions on the interest rate environment and key performance metrics for the remainder of the year, with the caveat that market conditions remain volatile making forecasting difficult.
We are forecasting an improved net interest margin due to loan growth and the interest rate environment over the next two quarters with fee income, overhead costs, and our tax rates remain relatively consistent. This forecast is predicated on several additional increases in the federal funds rate, including a 75 basis point increase next week and a 50 basis point increase in September.
In closing, we are pleased with our operating results and financial conditions through the midway point of 2022, and believe we remain well positioned to continue to successfully navigate through the myriad of challenges faced by others.
Those are my prepared remarks. I’ll now turn the call back over to Bob.
Bob Kaminski
Thank you, Chuck, and that concludes the management’s prepared comments, and we’ll now open the call up for the question-and-answer period.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions]. And the first question will be from Brendan Nosal with Piper Sandler. Please go ahead.
Brendan Nosal
Hey! Good morning guys! How are you?
Bob Kaminski
Good morning, Brendan!
Brendan Nosal
Good. Maybe just to start out on the margin health you provided, and first thanks for offering the detail again on your rate expectations there. So I guess kind of looking at year end, 380 to 390 margin, assuming another 150 bips of that fund increase. Can you just help us understand how much of that improvement is due to the continued rotation of liquidity into loans and then what underlying deposit data assumption you are using in that model?
Charles Christmas
Yeah, sure. Brendan, this is Chuck. In regards to the excess liquidity, we think we’ll be down to an excess of probably somewhere between $50 million and $100 million by the end of this year. Again, most of that being funded loan growth, as well as we have about $50 million, $54 million in Federal Home and bank advances. But at this point in time, as long as we have that excess liquidity we do not plan to replace, so that gets our balances down. Look, you know certainly a lot closer to normal than they certainly have been over the last couple of years.
That assumption also assumes that we do not have any material changes in deposit balances. Excluding the transactions by one larger customer, our deposit balances overall, local deposit balances overall have been quite steady, and so we just went ahead and stuck with that for the rest of this year. We do know that there’s still a lot of stimulus sitting in the deposit accounts of our customers, but at least today we haven’t seen any significant movement.
Definitely on an overall basis we certainly have seen movements within every customer, but any customers that we’ve had some rather relatively significant withdrawals, you know we continue to grow our deposit base in large part because of the ongoing growth in the commercial loan portfolio, as those borrowers bring your rather significant deposit balances with that. So that’s kind of the overall assumption that goes into our margin expectations.
Brendan Nosal
Got it. And I may not have caught it, but did you mention kind of what deposit betas you’re using? I heard the balance part.
Charles Christmas
Yeah, you know the deposit rate is by – you know besides the provision expense, the deposit rates are probably the two biggest items that could potentially have the biggest impact on our forecast. To-date we haven’t – we’ve – our any increases in deposit rates have been quite limited. That’s not only us, but that’s all the banks in our market area, and I talked to CFO’s outside of our market area that’s been pretty common as well.
As the Fed continues to raise interest rates and I think on an overall basis, the system sees less excess liquidity. We do think that we’ll start seeing additional pressures to raise deposit rates as we go forward. So that is in our assumptions and we basically had used our historical beta assumptions for the rest of this year, which ranged generally 40% to 60% of the Fed increases.
Brendan Nosal
Got it, that’s super helpful. Maybe one more for me, I guess to ask you guys about the other big hard-to-know piece of the outlook. I guess just conceptually on kind of the reserve level and the provision, you know now that you’re running on CECL, I mean what does it take kind of in that CECL model to start building reserves given the expectation for a downturn at some point in the not too distant future. I mean is it simply upward movement in the stated unemployment rate or is there something a little more forward looking in that model that could potentially drive that.
Charles Christmas
Yes, this is Chuck again. I think you know you said it spot on. It’s all about that economic forecast, which we use a third party forecast and we compare that to other third parties to make sure that the particular one that we use is in the same area as forecasts tend to get all over the place on occasion. I think that will be the case as we round up the rest of this year and go into next year.
I think when we look at our model and how it’s reacted thus far, it would appear that the unemployment rate and probably the GDP rate has probably the biggest impact on the outcome of our CECL calculation in regards to the economic forecast, and as we look at our particular forecast that we use, as well as that of the others, we just really don’t have to-date. We just have not seen any significant impact on the unemployment rate, and the GDP while they are coming down, they are still rel – on a bigger scale they are relatively unchanged.
So I think those are the two driving factors the unemployment will [run by] [ph] by for sure when it comes into these, you know how these models work.
Brendan Nosal
Yeah, understood. Thank you for taking the questions.
Charles Christmas
You’re welcome.
Operator
The next question will be from Daniel Tamayo from Raymond James. Please go ahead.
Daniel Tamayo
Hey! Good morning, everyone!
A – Bob Kaminski
Good morning, Danny!
Daniel Tamayo
If I can – I can just start, just a follow up on the NIM conversation. The 390 is a big number, especially relative to where you were last year. Last quarter obviously there’s been a lot of rate hikes since then. But you know assuming that the year plays out as your assuming in your guidance, how would you think about, and I guess the excess liquidity gets to where you would expect – you mentioned and gets to $50 million to $100 million by the end of the year. How would you assume future or additional rate hikes if we get them in 2023 with an impact you know NII at that point or the margin?
A – Bob Kaminski
Yeah, I think on an overall basis it’s our belief that any further increases from the federal reserve will result in a positive impact on the net interest income and on the net interest margin. You know who knows what they are going to be doing next year, but they certainly seem like they are going to stay aggressive for the remainder of this year and that’s our expectation.
I will you know – again, the big question is those deposit betas and what happens with those. Again, it’s not only the increase in interest rate environment that will have pressure on deposit rates, but as I mentioned, I think there’s less liquidity in the system and the banks, you know it’s certainly what we’ve seen so far and us included, we’ve seen some really good loan growth. I think we’re going to start seeing demand for deposit growth pick up and I think that would likely have – you know for sure that would have an impact on deposit rates. It’s just very difficult to know to what degree.
I would say going forward and assuming we don’t get too many 75 and 50 basis point increases from the Fed next year, I would venture a guess that our margin, at least for the first part of 2023 will stay relatively consistent with our projection for the fourth quarter of this year.
Daniel Tamayo
Okay, alright thank you. And you know on the loan pipeline you talked about that remaining strong, but you know even with all these, are you seeing any impact from the rate hikes on demand now and how – what’s your overarching thought going forward as we continue to see higher rates, how that may impact loan demand?
Bob Kaminski
Yeah, this is Ray. Today the rate increases have not really impacted loan demand in a material way. I’d expect that future increases would start to dampen some of the loan requests related to commercial real estate projects in particular. That would be mitigated by the fact that housing is in such short supply, so that particular slice will probably have more resiliency than other types of projects. But I would suspect that that would be the first place that we see that demand soften, but I would emphasize that to this point that hasn’t occurred.
Daniel Tamayo
Okay, okay, terrific! And then last one for me, you know you mentioned the capital levels, you know it’s still strong, but you obviously have taken a bit of a hit here with the AOCI impacts. Just if you could give your thoughts on kind of how comfortable you are with TCE levels in the mid-seven’s or if that’s something you’re just not considering too much if you’re more focused on the regulatory side.
Charles Christmas
Yeah, I think we’re – you know we’re focused on both sides. You know it depends on who we’re talking to. You know if you were the FDIC asking me the question, I might answer it a little bit differently, but you know they are both important to different groups, and I think when we look at the tangible and we see that under 8%, we know a big chunk of that reason why we’re under 8% is the interest rate environment and over time that will take care of itself and then we’ll end up having a positive impact long term on that capital ratio. And all things being equal, with that taking place, as well as we expect to continue to remain profitable, we’ll get that ratio back above 8%. It’s always been our long term goal to be somewhere around 8.25%, 8.50% and that’s what we’ll continue to look forward to over time.
Daniel Tamayo
Is there a level of any one of the capital ratios that if rates do spike again from here, that would give you pause in terms of continuing to invest in loan growth or you know think about raising capital?
Charles Christmas
Yeah, I think that we’re pretty far away from having to raise additional capital. You know certainly we supplemented our base with the subordinated notes barely six months ago. So you know I think we’ve got – we have built quite a question where we are as of today, so I think it would take a pretty significant hit to our capital ratios and more on our earnings basis versus you know an interest rate basis for us to be making significant looks at raising additional capital, but you know clearly that something as a management team we are always thinking about both short term, long term and certainly what the potential, some recessionary pressures coming down the road here.
Bob Kaminski
Yeah, this is Bob. I’ll follow up on that. In summary we are really comfortable with our capital levels and as Chuck said, we are looking at that all the time, looking at it every quarter with our board. We feel very comfortable with the fact that our capital base will continue to allow us to have the ability to grow the loan portfolio as we have and to continue to maintain the trajectory that we witnessed and experienced for the last couple of years.
Daniel Tamayo
Okay, great! I appreciate all that color. Thanks guys.
Bob Kaminski
Thank you.
Charles Christmas
Welcome Danny!
Operator
[Operator Instructions] The next question is from Damon DelMonte with KBW. Please go ahead.
Damon DelMonte
Hey! Good morning guys! Hope everybody is doing well today. Just, I wanted to start off on.
Bob Kaminski
Good morning, Damon!
Damon DelMonte
Good morning! Just wanted to start off on the loan growth side of things. Another quarter of – a decent amount of profiling of mortgage loans for you guys, just wondering you know, is that 17% of total loans, you know up from 12% or 13% in the first half of last year, kind of where do you see that heading directionally and what are some of the characteristics of those mortgages? Are they 5/1 ARM, 7/1 ARM, are they 15 year fixed, 30 year fixed. What kind of product are you putting in the portfolio?
Bob Kaminski
Stop you right there.
Chuck Christmas
Stop you right there. A very significant portion of the loans that we put, the mortgage loans that we put in our books are adjustable rate. They are predominantly 7/1 and 10/1 ARMs. Coming in at third place will probably be a 5/1 ARM. We tried very hard not to put any fixed rate loans on our books and if we do, it’s usually around the 10 and 15 year mark on that.
As far as the trajectory, certainly and you pointed it out, the percent of residential mortgage loans has been increasing, and has – really it increased really in the last six months, maybe nine months are we’ve seen market rates go up. And so those, many customers are now looking to the adjustable rate product versus the fixed rate product, but we continue to sell all the fixed rates, certainly that we can and then again repeating myself here, but if we put them on the balance sheet, a vast, vast majority are adjustable rate, you know down the road at some point in time.
It seems to me that as far as mortgage loans, that trend would likely continue. You know if anything, in the back half of the second quarter we saw mortgage rates go up even more than they were at the beginning of the year and certainly even at the beginning of the second quarter. Clearly volume and production is going to have a big say on that. We know that that will remain under pressure, especially given the significant decline in refinance. But I think as Ray mentioned, you know on the purpose side we actually saw an increase and so we’re very pleased to see that.
So we certainly expect some level of production, but it’s hard to. That’s one of those things that’s pretty hard to predict, but we don’t really see a change in keeping floating adjustables and selling fixed.
Also as a percent of total loans again, the big part there would of course be the commercial loan growth, and we did see – and we have seen throughout this year, but especially in the second quarter, a fairly large dollar amount of pay offs, and as we mentioned, most of that comes from selling the businesses or selling the underlying assets, and we do know if that activity continues.
Last year when we grew commercial loans 20%, the volume of pay offs was quite a bit lower, and I think this year maybe a little bit higher than average, but closer to average this year and our overall growth of you know how you want to slice and dice it, 9% to 11%, it’s kind of more of – i ‘s actually above our historical norm of closer to 7% or 8%, but we think that that 10%, 11% on the commercial side is something that we’ll continue to enjoy for the remainder of this year, but again Payoffs is always going to be the big question.
So long winded answer to your relatively short question. I would expect that given what we saw in the second quarter and assuming that there’s not going to be a lot of change going forward in the rest of this year, is that we would expect some increase in residential mortgage loans as a percent of total loans, but I don’t think it’s going to be anything that substantial.
Bob Kaminski
This if Bob. I’ll add that, and point out that as Ray mentioned in his comments, we have seen good increases in construction lending in our residential portfolio, because a lot of people that are wanting to buy a house can’t find an existing house to buy, so they are resorting to constructing new houses and so our construction portfolio is up quite significantly over what it was in the last couple of years. So that will give us certainly a tailwind over the next 12 to 18 months of those construction long funds.
Ray Reitsma
I think a third component would be the fact that as the 41% increase in the money supply works its way into our customer’s receivables and inventories, that will drive our commercial line of credit usage upward and that will be somewhat of a balance on a proportional basis to the increase that we see in the residential portfolio as well.
Damon DelMonte
Got it. And Ray, you had mentioned that the line utilization was 34% this quarter, and what was that versus – was it either last quarter or the year ago quarter. I missed that number.
Ray Reitsma
It was 30% a year ago compared to 34% today.
Damon DelMonte
Got it, okay. That’s helpful, alright great. And then I guess as we look at the margin, which is a pretty sizeable jump from this quarter to what you’re projecting for the back half of the year. It sounds like a lot of that is going to be kind of the remixing of earning assets and liquidity going out the door. What was the access “access liquidity” for this quarter as a starting point.
Chuck Christmas
On the margin I think it was 23 basis points.
Damon DelMonte
Okay, and you expect that to be flushed out basically Chuck by the end of the year.
Chuck Christmas
Yeah, at the very end of the year. I mean, we’ll still have some of that through in the fourth quarter itself. So my answer prior was, talking about right at year end. I think there’ll still be some pressures in the fourth quarter, but I think the third will be less than the second quarter and the fourth will be less of an impact than the third quarter.
Damon DelMonte
Okay. And then just kind of directionally here, if you look at the $0.74 you guys reported this quarter and you kind of take the midpoint of your guidance, obviously not including the impact of a provision, which shouldn’t be too much. You know you are still looking at like anywhere from a 35% to a 45% increase of off second quarter earnings. Does that seem reasonable, is that kind what your expectation is?
Chuck Christmas
Yeah, I think based on your comment about provision expense. You are going to guarantee that right.
Bob Kaminski
So you are going to let the economists know that forecast is going to continue to be very rosy and that there won’t be any impact on the reserve. But having said all that Damon, I think that that makes sense. We are going to – we are standing here prepared and hopefully we’ll see a very significant increase in our margin, both from increase in interest rates, which will help net interest income; we’ll see growth in the commercial loan portfolio. We’ll see an healthier margin, decline impact on access liquidity. All that adds up to some notable increase in overall earnings performance, but again those deposit rates and provision, you now definitely are two big question marks out there.
Damon DelMonte
Got it. Okay, that’s all that I had. Thanks a lot. I appreciate the color.
Bob Kaminski
Thanks Damon.
Operator
Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Bob Kaminski for any closing remarks.
Bob Kaminski
Yeah, thanks Chad and thank you all for your interest in our company. We look forward to speaking with you next at the end of the third quarter. This call has ended.
Operator
Thank you, sir. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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