Form 10-Q
Table of Contents

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

Commission File No. 000-26719

 

 

MERCANTILE BANK CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Michigan   38-3360865

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

310 Leonard Street, NW, Grand Rapids, MI 49504

(Address of principal executive offices) (Zip Code)

(616) 406-3000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At November 12, 2013, there were 8,707,534 shares of common stock outstanding.

 

 

 


Table of Contents

MERCANTILE BANK CORPORATION

INDEX

 

         Page No.  

PART I.

  Financial Information   
  Item 1. Financial Statements   
  Condensed Consolidated Balance Sheets - September 30, 2013 (Unaudited) and December 31, 2012      1   
  Condensed Consolidated Statements of Income - Three and Nine Months Ended September 30, 2013 (Unaudited) and September 30, 2012 (Unaudited)      2   
  Condensed Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2013 (Unaudited) and September 30, 2012 (Unaudited)      4   
  Condensed Consolidated Statements of Changes in Shareholders’ Equity - Nine Months Ended September 30, 2013 (Unaudited) and September 30, 2012 (Unaudited)      5   
  Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2013 (Unaudited) and September 30, 2012 (Unaudited)      7   
  Notes to Condensed Consolidated Financial Statements (Unaudited)      9   
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations      50   
  Item 3. Quantitative and Qualitative Disclosures About Market Risk      77   
  Item 4. Controls and Procedures      80   

PART II.

  Other Information   
  Item 1. Legal Proceedings      81   
  Item 1A. Risk Factors      81   
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds      81   
  Item 3. Defaults Upon Senior Securities      81   
  Item 4. Mine Safety Disclosures      81   
  Item 5. Other Information      81   
  Item 6. Exhibits      82   
  Signatures      83   


Table of Contents

MERCANTILE BANK CORPORATION

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     September 30,
2013
    December 31,
2012
 
     (Unaudited)     (Audited)  

ASSETS

    

Cash and due from banks

   $ 33,207,000      $ 20,302,000   

Interest-bearing deposit balances

     6,428,000        10,822,000   

Federal funds sold

     86,283,000        104,879,000   
  

 

 

   

 

 

 

Total cash and cash equivalents

     125,918,000        136,003,000   

Securities available for sale

     123,793,000        138,314,000   

Federal Home Loan Bank stock

     11,961,000        11,961,000   

Loans

     1,075,487,000        1,041,189,000   

Allowance for loan losses

     (25,195,000     (28,677,000
  

 

 

   

 

 

 

Loans, net

     1,050,292,000        1,012,512,000   

Premises and equipment, net

     25,159,000        25,919,000   

Bank owned life insurance

     51,073,000        50,048,000   

Accrued interest receivable

     3,777,000        3,874,000   

Other real estate owned and repossessed assets

     3,549,000        6,970,000   

Net deferred tax asset

     19,771,000        22,015,000   

Other assets

     6,710,000        15,310,000   
  

 

 

   

 

 

 

Total assets

   $ 1,422,003,000      $ 1,422,926,000   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Deposits

    

Noninterest-bearing

   $ 216,055,000      $ 190,241,000   

Interest-bearing

     905,454,000        944,963,000   
  

 

 

   

 

 

 

Total deposits

     1,121,509,000        1,135,204,000   

Securities sold under agreements to repurchase

     65,680,000        64,765,000   

Federal Home Loan Bank advances

     45,000,000        35,000,000   

Subordinated debentures

     32,990,000        32,990,000   

Accrued interest and other liabilities

     6,990,000        8,377,000   
  

 

 

   

 

 

 

Total liabilities

     1,272,169,000        1,276,336,000   

Shareholders’ equity

    

Preferred stock, no par value; 1,000,000 shares authorized; none issued

     0        0   

Common stock, no par value; 20,000,000 shares authorized; 8,707,534 shares outstanding at September 30, 2013 and 8,706,251 shares outstanding at December 31, 2012

     163,629,000        166,074,000   

Retained earnings (deficit)

     (9,264,000     (21,134,000

Accumulated other comprehensive income (loss)

     (4,531,000     1,650,000   
  

 

 

   

 

 

 

Total shareholders’ equity

     149,834,000        146,590,000   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 1,422,003,000      $ 1,422,926,000   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

1.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Three Months     Three Months     Nine Months     Nine Months  
     Ended     Ended     Ended     Ended  
     Sept 30, 2013     Sept 30, 2012     Sept 30, 2013     Sept 30, 2012  
     (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)  

Interest income

        

Loans, including fees

   $ 13,411,000      $ 13,386,000      $ 38,944,000      $ 40,653,000   

Securities, taxable

     1,003,000        1,009,000        3,017,000        3,351,000   

Securities, tax-exempt

     211,000        319,000        763,000        1,109,000   

Federal funds sold

     38,000        46,000        127,000        116,000   

Interest-bearing deposit balances

     4,000        8,000        17,000        22,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     14,667,000        14,768,000        42,868,000        45,251,000   

Interest expense

        

Deposits

     2,190,000        2,728,000        6,733,000        8,581,000   

Short-term borrowings

     19,000        39,000        57,000        130,000   

Federal Home Loan Bank advances

     141,000        183,000        379,000        871,000   

Other borrowings

     323,000        234,000        938,000        705,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     2,673,000        3,184,000        8,107,000        10,287,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     11,994,000        11,584,000        34,761,000        34,964,000   

Provision for loan losses

     (1,700,000     (400,000     (4,700,000     (3,400,000
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     13,694,000        11,984,000        39,461,000        38,364,000   

Noninterest income

        

Services charges on accounts

     397,000        378,000        1,155,000        1,142,000   

Earnings on bank owned life insurance

     337,000        378,000        1,025,000        1,170,000   

Mortgage banking activities

     194,000        447,000        671,000        1,021,000   

Rental income from other real estate owned

     99,000        270,000        454,000        806,000   

Other income

     656,000        584,000        1,976,000        1,792,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     1,683,000        2,057,000        5,281,000        5,931,000   

Noninterest expense

        

Salaries and benefits

     5,256,000        4,849,000        15,094,000        14,394,000   

Occupancy

     639,000        598,000        1,921,000        1,947,000   

Furniture and equipment depreciation, rent and maintenance

     242,000        282,000        754,000        888,000   

Problem asset costs

     373,000        1,576,000        783,000        4,931,000   

FDIC insurance costs

     184,000        294,000        604,000        894,000   

Merger-related costs

     719,000        0        779,000        0   

Other expense

     2,509,000        2,586,000        7,383,000        7,389,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expenses

     9,922,000        10,185,000        27,318,000        30,443,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before federal income tax expense

     5,455,000        3,856,000        17,424,000        13,852,000   

Federal income tax expense

     2,002,000        1,240,000        5,554,000        4,365,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     3,453,000        2,616,000        11,870,000        9,487,000   

Preferred stock dividends and accretion

     0        0        0        1,030,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to common shares

   $ 3,453,000      $ 2,616,000      $ 11,870,000      $ 8,457,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

2.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Continued)

(Unaudited)

 

     Three Months      Three Months      Nine Months      Nine Months  
     Ended      Ended      Ended      Ended  
     Sept 30, 2013      Sept 30, 2012      Sept 30, 2013      Sept 30, 2012  
     (Unaudited)      (Unaudited)      (Unaudited)      (Unaudited)  

Basic earnings per share

   $ 0.40       $ 0.30       $ 1.36       $ 0.98   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per share

   $ 0.40       $ 0.30       $ 1.36       $ 0.95   
  

 

 

    

 

 

    

 

 

    

 

 

 

Cash dividends per share

   $ 0.12       $ 0.00       $ 0.33       $ 0.00   
  

 

 

    

 

 

    

 

 

    

 

 

 

Average basic shares outstanding

     8,707,038         8,622,719         8,706,133         8,612,831   
  

 

 

    

 

 

    

 

 

    

 

 

 

Average diluted shares outstanding

     8,725,268         8,653,751         8,719,956         8,896,728   
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

3.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     Three Months
Ended
Sept 30, 2013
    Three Months
Ended
Sept 30, 2012
    Nine Months
Ended
Sept 30, 2013
    Nine Months
Ended
Sept 30, 2012
 
     (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)  

Net income

   $ 3,453,000      $ 2,616,000      $ 11,870,000      $ 9,487,000   

Other comprehensive income (loss):

        

Unrealized holding gains (losses) on securities available for sale

     (5,376,000     (188,000     (10,165,000     (917,000

Fair value of interest rate swap

     (79,000     (459,000     718,000        (1,106,000
  

 

 

   

 

 

   

 

 

   

 

 

 
     (5,455,000     (647,000     (9,447,000     (2,023,000
  

 

 

   

 

 

   

 

 

   

 

 

 

Tax effect of unrealized holding gains (losses) on securities available for sale

     1,841,000        64,000        3,517,000        321,000   

Tax effect of fair value of interest rate swap

     (25,000     161,000        (251,000     387,000   
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,816,000        225,000        3,266,000        708,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax effect

     (3,639,000     (422,000     (6,181,000     (1,315,000
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (186,000   $ 2,194,000      $ 5,689,000      $ 8,172,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

4.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 

($ in thousands)    Preferred
Stock
     Common
Stock
    Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 

Balances, January 1, 2013

   $ 0       $ 166,074      $ (21,134   $ 1,650      $ 146,590   

Employee stock purchase plan (1,098 shares)

        19            19   

Dividend reinvestment plan (1,954 shares)

        33            33   

Stock option exercises (2,950 shares)

        52            52   

Stock tendered for stock option exercises (2,419 shares)

        (52         (52

Stock-based compensation expense

        354            354   

Cash dividends ($0.33 per common share)

        (2,851         (2,851

Net income for the nine months ended September 30, 2013

          11,870          11,870   

Change in net unrealized holding gain on securities available for sale, net of tax effect

            (6,648     (6,648

Change in fair value of interest rate swap, net of tax effect

            467        467   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balances, September 30, 2013

   $ 0       $ 163,629      $ (9,264   $ (4,531   $ 149,834   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

5.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

 

($ in thousands)    Preferred
Stock
    Common
Stock
    Common
Stock
Warrant
    Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income
    Total
Shareholders’
Equity
 

Balances, January 1, 2012

   $ 20,331      $ 172,841      $ 1,138      $ (32,639   $ 3,328      $ 164,999   

Repurchase of preferred stock

     (21,000             (21,000

Preferred stock dividends

           (362       (362

Accretion of preferred stock

     669            (669       0   

Repurchase of common stock warrant

       (6,327     (1,138         (7,465

Employee stock purchase plan (1,743 shares)

       29              29   

Stock option exercises (47,007 shares)

       488              488   

Stock tendered for stock option exercises (18,718 shares)

       (317           (317

Stock-based compensation expense

       14              14   

Net income for the nine months ended September 30, 2012

           9,487          9,487   

Change in net unrealized holding gain on securities available for sale, net of tax effect

             (596     (596

Change in fair value of interest rate swap, net of tax effect

             (719     (719
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, September 30, 2012

   $ 0      $ 166,728      $ 0      $ (24,183   $ 2,013      $ 144,558   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

6.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Nine Months
Ended
Sept 30, 2013
    Nine Months
Ended
Sept 30, 2012
 

Cash flows from operating activities

    

Net income

   $ 11,870,000      $ 9,487,000   

Adjustments to reconcile net income to net cash from operating activities

    

Depreciation and amortization

     1,629,000        1,669,000   

Provision for loan losses

     (4,700,000     (3,400,000

Stock-based compensation expense

     354,000        14,000   

Proceeds from sales of mortgage loans held for sale

     43,789,000        57,233,000   

Origination of mortgage loans held for sale

     (41,147,000     (62,347,000

Net gain from sales of mortgage loans held for sale

     (550,000     (853,000

Net (gain) loss from sale and valuation write-down of foreclosed assets

     (1,024,000     1,817,000   

Earnings on bank owned life insurance

     (1,025,000     (1,170,000

Net change in:

    

Accrued interest receivable

     97,000        464,000   

Other assets

     13,451,000        2,638,000   

Accrued expenses and other liabilities

     (776,000     1,652,000   
  

 

 

   

 

 

 

Net cash from operating activities

     21,968,000        7,204,000   

Cash flows from investing activities

    

Loan originations and payments, net

     (37,232,000     27,283,000   

Purchases of securities available for sale

     (37,492,000     (45,973,000

Proceeds from maturities, calls and repayments of securities available for sale

     31,578,000        82,580,000   

Proceeds from sales of securities available for sale

     10,310,000        0   

Proceeds from sales of foreclosed assets

     6,505,000        12,753,000   

Purchases of premises and equipment

     (250,000     (415,000
  

 

 

   

 

 

 

Net cash from (for) investing activities

     (26,581,000     76,228,000   

Cash flows from financing activities

    

Net decrease in time deposits

     (13,871,000     (43,811,000

Net increase in all other deposits

     176,000        39,302,000   

Net increase (decrease) in securities sold under agreements to repurchase

     915,000        (12,538,000

Proceeds from Federal Home Loan Bank advances

     10,000,000        20,000,000   

Maturities of Federal Home Loan Bank advances

     0        (30,000,000

Net increase (decrease) in other borrowed money

     107,000        (1,000

Repurchase of preferred stock

     0        (21,000,000

Repurchase of common stock warrant

     0        (7,465,000

Proceeds from stock option exercises, net of cashless exercises

     0        171,000   

Employee stock purchase plan

     19,000        29,000   

Dividend reinvestment plan

     33,000        0   

Payment of cash dividends on preferred stock

     0        (496,000

Payment of cash dividends to common shareholders

     (2,851,000     0   
  

 

 

   

 

 

 

Net cash for financing activities

     (5,472,000     (55,809,000
  

 

 

   

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

7.


Table of Contents

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

 

     Nine Months
Ended
Sept 30, 2013
    Nine Months
Ended
Sept 30, 2012
 

Net change in cash and cash equivalents

     (10,085,000     27,623,000   

Cash and cash equivalents at beginning of period

     136,003,000        76,372,000   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 125,918,000      $ 103,995,000   
  

 

 

   

 

 

 

Supplemental disclosures of cash flows information

    

Cash paid during the period for:

    

Interest

   $ 8,779,000      $ 11,157,000   

Federal income tax

     0        0   

Noncash financing and investing activities:

    

Transfers from loans to foreclosed assets

     2,060,000        10,448,000   

See accompanying notes to condensed consolidated financial statements.

 

8.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation: The unaudited financial statements for the three and nine months ended September 30, 2013 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank of Michigan (“our bank”) and our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance center”). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended September 30, 2013 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2012.

We formed a business trust, Mercantile Bank Capital Trust I (“the trust”), in 2004 to issue trust preferred securities. We issued subordinated debentures to the trust in return for the proceeds raised from the issuance of the trust preferred securities. The trust is not consolidated, but instead we report the subordinated debentures issued to the trust as a liability.

Earnings Per Share: Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans and our common stock warrant granted to the U.S. Department of Treasury that we repurchased on July 3, 2012, and are determined using the treasury stock method. Our unvested restricted shares, which contain non-forfeitable rights to dividends whether paid or accrued (i.e., participating securities), are included in the number of shares outstanding for both basic and diluted earnings per share calculations. In the event of a net loss, our unvested restricted shares are excluded from the calculation of both basic and diluted earnings per share.

Approximately 64,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2013. In addition, stock options for approximately 54,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2013. Stock options for approximately 94,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2013.

Approximately 38,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2012. In addition, stock options for approximately 26,000 and 21,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2012, respectively. Also, our stock warrant for approximately 616,000 shares of common stock was included in determining diluted earnings per share for the three and nine months ended September 30, 2012 taking into account our full repurchase of said stock warrant on July 3, 2012. Stock options for approximately 137,000 and 142,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September, 30, 2012, respectively.

 

(Continued)

9.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans: Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

Interest income on commercial loans and mortgage loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than when they are 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal and interest is considered doubtful.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses: The allowance for loan losses (“allowance”) is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when we believe the uncollectability of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. We estimate the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of delay, the reasons for delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.

 

(Continued)

10.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Troubled Debt Restructurings: A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans. Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described above under “Allowance for Loan Losses.” Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have historically consisted of interest rate swap agreements that qualified for hedge accounting. In February 2012, we entered into an interest rate swap agreement that qualifies for hedge accounting. However, in June 2011, we simultaneously purchased and sold an interest rate cap, a structure commonly referred to as a “cap corridor”, which does not qualify for hedge accounting. The current outstanding interest rate swap and cap corridor are discussed in more detail in Note 9. We do not use derivatives for trading purposes.

Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various loans and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.

 

(Continued)

11.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

If designated as a hedge, we formally document the relationship between derivatives as hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet. If designated as a hedge, we also formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in cash flows of the hedged items. Ineffective hedge gains and losses are recognized immediately in current earnings as noninterest income or expense. We discontinue hedge accounting when we determine the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or terminates, or treatment of the derivative as a hedge is no longer appropriate or intended.

Adoption of New Accounting Standards: In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement. We adopted this ASU in the first quarter of 2013.

 

(Continued)

12.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2. SECURITIES

The amortized cost and fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) are as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

September 30, 2013

          

U.S. Government agency debt obligations

   $ 97,460,000       $ 376,000       $ (8,542,000   $ 89,294,000   

Mortgage-backed securities

     13,382,000         1,129,000         0        14,511,000   

Michigan Strategic Fund bonds

     0         0         0        0   

Municipal general obligation bonds

     17,275,000         432,000         (1,000     17,706,000   

Municipal revenue bonds

     877,000         40,000         0        917,000   

Mutual funds

     1,376,000         0         (11,000     1,365,000   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 130,370,000       $ 1,977,000       $ (8,554,000   $ 123,793,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2012

          

U.S. Government agency debt obligations

   $ 78,447,000       $ 1,039,000       $ (388,000   $ 79,098,000   

Mortgage-backed securities

     20,182,000         1,814,000         0        21,996,000   

Michigan Strategic Fund bonds

     11,255,000         0         0        11,255,000   

Municipal general obligation bonds

     21,700,000         1,043,000         0        22,743,000   

Municipal revenue bonds

     1,726,000         91,000         0        1,817,000   

Mutual funds

     1,354,000         51,000         0        1,405,000   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 134,664,000       $ 4,038,000       $ (388,000   $ 138,314,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(Continued)

13.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2. SECURITIES (Continued)

 

Securities with unrealized losses at September 30, 2013 and December 31, 2012, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

 

     Less than 12 Months     12 Months or More     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

September 30, 2013

               

U.S. Government agency debt obligations

   $ 70,142,000       $ (7,691,000   $ 6,134,000       $ (851,000   $ 76,276,000       $ (8,542,000

Mortgage-backed securities

     0         0        0         0        0         0   

Michigan Strategic Fund bonds

     0         0        0         0        0         0   

Municipal general obligation bonds

     394,000         (1,000     0         0        394,000         (1,000

Municipal revenue bonds

     0         0        0         0        0         0   

Mutual funds

     1,365,000         (11,000     0         0        1,365,000         (11,000
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 71,901,000       $ (7,703,000   $ 6,134,000       $ (851,000   $ 78,035,000       $ (8,554,000
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2012

               

U.S. Government agency debt obligations

   $ 33,555,000       $ (388,000   $ 0       $ 0      $ 33,555,000       $ (388,000

Mortgage-backed securities

     0         0        0         0        0         0   

Michigan Strategic Fund bonds

     0         0        0         0        0         0   

Municipal general obligation bonds

     0         0        0         0        0         0   

Municipal revenue bonds

     0         0        0         0        0         0   

Mutual funds

     0         0        0         0        0         0   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 33,555,000       $ (388,000   $ 0       $ 0      $ 33,555,000       $ (388,000
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(Continued)

14.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2. SECURITIES (Continued)

 

We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.

At September 30, 2013, 59 debt securities and one mutual fund with fair values totaling $78.0 million have unrealized losses aggregating $8.6 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.

The amortized cost and fair values of debt securities at September 30, 2013, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

 

     Weighted
Average
Yield
    Amortized
Cost
     Fair
Value
 

Due in 2013

     6.94   $ 355,000       $ 355,000   

Due in 2014 through 2018

     4.99        4,651,000         4,751,000   

Due in 2019 through 2023

     3.17        31,126,000         29,918,000   

Due in 2024 and beyond

     3.64        79,480,000         72,893,000   

Mortgage-backed securities

     5.19        13,382,000         14,511,000   

Mutual funds

     2.09        1,376,000         1,365,000   
    

 

 

    

 

 

 
     3.74   $ 130,370,000       $ 123,793,000   
    

 

 

    

 

 

 

 

(Continued)

15.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2. SECURITIES (Continued)

 

The amortized cost of securities issued by the State of Michigan and all its political subdivisions totaled $18.2 million and $23.4 million at September 30, 2013 and December 31, 2012, respectively, with estimated market values of $18.6 million and $24.6 million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies, did not exceed 10% of shareholders’ equity.

The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $85.2 million and $83.8 million at September 30, 2013 and December 31, 2012, respectively. In addition, substantially all of our municipal bonds have been pledged to the Discount Window of the Federal Reserve Bank of Chicago. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES

Our total loans at September 30, 2013 were $1.08 billion compared to $1.04 billion at December 31, 2012, an increase of $34.3 million, or 3.3%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at September 30, 2013 and December 31, 2012, and the percentage change in loans from the end of 2012 to the end of the third quarter of 2013, are as follows:

 

                               Percent  
     September 30, 2013     December 31, 2012     Increase  
     Balance      %     Balance      %     (Decrease)  

Commercial:

            

Commercial and industrial

   $ 286,887,000         26.7   $ 285,322,000         27.4     0.5

Vacant land, land development, and residential construction

     40,741,000         3.8        48,099,000         4.6        (15.3

Real estate – owner occupied

     258,656,000         24.1        259,277,000         24.9        (0.2

Real estate – non-owner occupied

     368,301,000         34.2        324,886,000         31.2        13.4   

Real estate – multi-family and residential rental

     53,178,000         4.9        50,922,000         4.9        4.4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total commercial

     1,007,763,000         93.7        968,506,000         93.0        4.1   

Retail:

            

Home equity and other

     36,575,000         3.4        38,917,000         3.7        (6.0

1-4 family mortgages

     31,149,000         2.9        33,766,000         3.3        (7.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total retail

     67,724,000         6.3        72,683,000         7.0        (6.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total loans

   $ 1,075,487,000         100.0   $ 1,041,189,000         100.0     3.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

(Continued)

16.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Nonperforming loans as of September 30, 2013 and December 31, 2012 were as follows:

 

     September 30,
2013
     December 31,
2012
 

Loans past due 90 days or more still accruing interest

   $ 0       $ 0   

Nonaccrual loans

     10,526,000         18,970,000   
  

 

 

    

 

 

 

Total nonperforming loans

   $ 10,526,000       $ 18,970,000   
  

 

 

    

 

 

 

The recorded principal balance of nonaccrual loans was as follows:

 

     September 30,
2013
     December 31,
2012
 

Commercial:

     

Commercial and industrial

   $ 1,581,000       $ 1,677,000   

Vacant land, land development, and residential construction

     922,000         2,194,000   

Real estate – owner occupied

     570,000         2,087,000   

Real estate – non-owner occupied

     4,642,000         9,010,000   

Real estate – multi-family and residential rental

     764,000         2,021,000   
  

 

 

    

 

 

 

Total commercial

     8,479,000         16,989,000   

Retail:

     

Home equity and other

     805,000         889,000   

1-4 family mortgages

     1,242,000         1,092,000   
  

 

 

    

 

 

 

Total retail

     2,047,000         1,981,000   
  

 

 

    

 

 

 

Total nonaccrual loans

   $ 10,526,000       $ 18,970,000   
  

 

 

    

 

 

 

 

(Continued)

17.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

An age analysis of past due loans is as follows as of September 30, 2013:

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     Greater
Than 89
Days
Past Due
     Total
Past Due
     Current      Total
Loans
     Recorded
Balance > 89
Days and
Accruing
 

Commercial:

                    

Commercial and industrial

   $ 22,000       $ 0       $ 631,000       $ 653,000       $ 286,234,000       $ 286,887,000       $ 0   

Vacant land, land development, and residential construction

     0         0         85,000         85,000         40,656,000         40,741,000         0   

Real estate – owner occupied

     0         0         53,000         53,000         258,603,000         258,656,000         0   

Real estate – non-owner occupied

     0         0         1,860,000         1,860,000         366,441,000         368,301,000         0   

Real estate – multi-family and residential rental

     0         0         264,000         264,000         52,914,000         53,178,000         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     22,000         0         2,893,000         2,915,000         1,004,848,000         1,007,763,000         0   

Retail:

                    

Home equity and other

     0         0         0         0         36,575,000         36,575,000         0   

1-4 family mortgages

     25,000         0         463,000         488,000         30,661,000         31,149,000         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total retail

     25,000         0         463,000         488,000         67,236,000         67,724,000         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due loans

   $ 47,000       $ 0       $ 3,356,000       $ 3,403,000       $ 1,072,084,000       $ 1,075,487,000       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(Continued)

18.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

An age analysis of past due loans is as follows as of December 31, 2012:

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     Greater
Than 89
Days
Past Due
     Total
Past Due
     Current      Total
Loans
     Recorded
Balance > 89
Days and
Accruing
 

Commercial:

                    

Commercial and industrial

   $ 80,000       $ 0       $ 871,000       $ 951,000       $ 284,371,000       $ 285,322,000       $ 0   

Vacant land, land development, and residential construction

     289,000         0         614,000         903,000         47,196,000         48,099,000         0   

Real estate – owner occupied

     199,000         0         1,337,000         1,536,000         257,741,000         259,277,000         0   

Real estate – non-owner occupied

     303,000         0         1,123,000         1,426,000         323,460,000         324,886,000         0   

Real estate – multi-family and residential rental

     0         0         613,000         613,000         50,309,000         50,922,000         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     871,000         0         4,558,000         5,429,000         963,077,000         968,506,000         0   

Retail:

                    

Home equity and other

     1,000         0         13,000         14,000         38,903,000         38,917,000         0   

1-4 family mortgages

     47,000         190,000         437,000         674,000         33,092,000         33,766,000         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total retail

     48,000         190,000         450,000         688,000         71,995,000         72,683,000         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due loans

   $ 919,000       $ 190,000       $ 5,008,000       $ 6,117,000       $ 1,035,072,000       $ 1,041,189,000       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(Continued)

19.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Impaired loans as of September 30, 2013, and average impaired loans for the three and nine months ended September 30, 2013, were as follows:

 

     Unpaid
Contractual
Principal
Balance
     Recorded
Principal
Balance
     Related
Allowance
   Third Quarter
Average
Recorded
Principal
Balance
     Year-To-Date
Average
Recorded
Principal
Balance
 

With no related allowance recorded:

              

Commercial:

              

Commercial and industrial

   $ 2,632,000       $ 1,063,000          $ 1,170,000       $ 1,378,000   

Vacant land, land development and residential construction

     1,200,000         804,000            907,000         1,148,000   

Real estate – owner occupied

     575,000         347,000            865,000         1,159,000   

Real estate – non-owner occupied

     5,135,000         4,108,000            4,651,000         4,878,000   

Real estate – multi-family and residential rental

     1,008,000         337,000            425,000         487,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total commercial

     10,550,000         6,659,000            8,018,000         9,050,000   

Retail:

              

Home equity and other

     508,000         464,000            466,000         474,000   

1-4 family mortgages

     1,398,000         754,000            715,000         746,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total retail

     1,906,000         1,218,000            1,181,000         1,220,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total with no related allowance recorded

   $ 12,456,000       $ 7,877,000          $ 9,199,000       $ 10,270,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

 

(Continued)

20.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

     Unpaid
Contractual
Principal
Balance
     Recorded
Principal
Balance
     Related
Allowance
     Third Quarter
Average
Recorded
Principal
Balance
     Year-To-Date
Average
Recorded
Principal
Balance
 

With an allowance recorded:

              

Commercial:

              

Commercial and industrial

   $ 2,002,000       $ 1,941,000       $ 1,035,000       $ 1,764,000       $ 1,990,000   

Vacant land, land development and residential construction

     4,557,000         4,418,000         1,216,000         4,466,000         3,158,000   

Real estate – owner occupied

     2,368,000         2,310,000         901,000         2,330,000         2,810,000   

Real estate – non-owner occupied

     28,358,000         28,346,000         9,785,000         28,789,000         30,216,000   

Real estate – multi-family and residential rental

     2,820,000         2,752,000         923,000         2,639,000         2,973,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     40,105,000         39,767,000         13,860,000         39,988,000         41,147,000   

Retail:

              

Home equity and other

     322,000         293,000         102,000         309,000         339,000   

1-4 family mortgages

     2,370,000         2,340,000         1,101,000         2,480,000         1,477,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total retail

     2,692,000         2,633,000         1,203,000         2,789,000         1,816,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with an allowance recorded

   $ 42,797,000       $ 42,400,000       $ 15,063,000       $ 42,777,000       $ 42,963,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans:

              

Commercial

   $ 50,655,000       $ 46,426,000       $ 13,860,000       $ 48,006,000       $ 50,197,000   

Retail

     4,598,000         3,851,000         1,203,000         3,970,000         3,036,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 55,253,000       $ 50,277,000       $ 15,063,000       $ 51,976,000       $ 53,233,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income of $0.7 million and $2.2 million was recognized on impaired loans during the third quarter and first nine months of 2013, respectively.

 

(Continued)

21.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Impaired loans as of December 31, 2012, and average impaired loans for the three and nine months ended September 30, 2012, were as follows:

 

     Unpaid
Contractual
Principal
Balance
     Recorded
Principal
Balance
     Related
Allowance
   Third Quarter
Average
Recorded
Principal
Balance
     Year-To-Date
Average
Recorded
Principal
Balance
 

With no related allowance recorded:

              

Commercial:

              

Commercial and industrial

   $ 1,926,000       $ 1,617,000          $ 3,209,000       $ 3,521,000   

Vacant land, land development and residential construction

     2,356,000         1,401,000            1,480,000         1,959,000   

Real estate – owner occupied

     2,368,000         1,557,000            3,391,000         3,535,000   

Real estate – non-owner occupied

     9,984,000         5,492,000            5,832,000         6,850,000   

Real estate – multi-family and residential rental

     1,188,000         413,000            918,000         841,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total commercial

     17,822,000         10,480,000            14,830,000         16,706,000   

Retail:

              

Home equity and other

     580,000         483,000            482,000         603,000   

1-4 family mortgages

     1,636,000         789,000            715,000         715,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total retail

     2,216,000         1,272,000            1,197,000         1,318,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total with no related allowance recorded

   $ 20,038,000       $ 11,752,000          $ 16,027,000       $ 18,024,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

 

(Continued)

22.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

 

     Unpaid
Contractual
Principal
Balance
     Recorded
Principal
Balance
     Related
Allowance
     Third Quarter
Average
Recorded
Principal
Balance
     Year-To-Date
Average
Recorded
Principal
Balance
 

With an allowance recorded:

              

Commercial:

              

Commercial and industrial

   $ 3,221,000       $ 1,926,000       $ 924,000       $ 3,528,000       $ 3,406,000   

Vacant land, land development and residential construction

     2,333,000         2,219,000         1,367,000         2,981,000         3,529,000   

Real estate – owner occupied

     4,307,000         3,626,000         1,388,000         4,120,000         5,235,000   

Real estate – non-owner occupied

     33,818,000         32,964,000         11,773,000         25,220,000         23,085,000   

Real estate – multi-family and residential rental

     4,471,000         3,923,000         1,408,000         4,748,000         8,306,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     48,150,000         44,658,000         16,860,000         40,597,000         43,561,000   

Retail:

              

Home equity and other

     423,000         394,000         204,000         291,000         259,000   

1-4 family mortgages

     555,000         475,000         125,000         503,000         484,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total retail

     978,000         869,000         329,000         794,000         743,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total with an allowance recorded

   $ 49,128,000       $ 45,527,000       $ 17,189,000       $ 41,391,000       $ 44,304,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans:

              

Commercial

   $ 65,972,000       $ 55,138,000       $ 16,860,000       $ 55,427,000       $ 60,267,000   

Retail

     3,194,000         2,141,000         329,000         1,991,000         2,061,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 69,166,000       $ 57,279,000       $ 17,189,000       $ 57,418,000       $ 62,328,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest income of $0.4 million and $1.1 million was recognized on impaired loans during the third quarter and first nine months of 2012, respectively.

 

(Continued)

23.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Credit Quality Indicators. We utilize a comprehensive grading system for our commercial loans. All commercial loans are graded on a ten grade rating system. The rating system utilizes standardized grade paradigms that analyze several critical factors such as cash flow, operating performance, financial condition, collateral, industry condition and management. All commercial loans are graded at inception and reviewed and, if appropriate, re-graded at various intervals thereafter. The risk assessment for retail loans is primarily based on the type of collateral and payment activity.

Loans by credit quality indicators were as follows as of September 30, 2013:

Commercial credit exposure – credit risk profiled by internal credit risk grades:

 

     Commercial and
Industrial
     Commercial
Vacant Land,
Land Development,
and Residential
Construction
     Commercial
Real Estate -
Owner Occupied
     Commercial
Real Estate -
Non-Owner
Occupied
     Commercial
Real Estate -
Multi-Family
and Residential
Rental
 

Internal credit risk grade groupings:

              

Grades 1 – 4

   $ 208,750,000       $ 8,089,000       $ 157,824,000       $ 205,586,000       $ 31,755,000   

Grades 5 – 7

     75,339,000         27,022,000         97,819,000         130,040,000         18,230,000   

Grades 8 – 9

     2,798,000         5,630,000         3,013,000         32,675,000         3,193,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

   $ 286,887,000       $ 40,741,000       $ 258,656,000       $ 368,301,000       $ 53,178,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Retail credit exposure – credit risk profiled by collateral type:

 

     Retail
Home Equity
and Other
     Retail
1-4 Family
Mortgages
 

Total retail

   $ 36,575,000       $ 31,149,000   
  

 

 

    

 

 

 

 

(Continued)

24.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Loans by credit quality indicators were as follows as of December 31, 2012:

Commercial credit exposure – credit risk profiled by internal credit risk grades:

 

     Commercial and
Industrial
     Commercial
Vacant Land,
Land Development,
and Residential
Construction
     Commercial
Real Estate -
Owner Occupied
     Commercial
Real Estate -
Non-Owner
Occupied
     Commercial
Real Estate -
Multi-Family
and Residential
Rental
 

Internal credit risk grade groupings:

              

Grades 1 – 4

   $ 180,314,000       $ 6,526,000       $ 150,467,000       $ 154,127,000       $ 24,015,000   

Grades 5 – 7

     101,832,000         37,697,000         102,988,000         128,041,000         22,082,000   

Grades 8 – 9

     3,176,000         3,876,000         5,822,000         42,718,000         4,825,000   

Total commercial

   $ 285,322,000       $ 48,099,000       $ 259,277,000       $ 324,886,000       $ 50,922,000   

Retail credit exposure – credit risk profiled by collateral type:

 

     Retail Home
Equity and
Other
     Retail 1-4
Family
Mortgages
 

Total retail

   $ 38,917,000       $ 33,766,000   
  

 

 

    

 

 

 

 

(Continued)

25.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

All commercial loans are graded using the following criteria:

 

  Grade 1. Excellent credit rating that contain very little, if any, risk of loss.

 

  Grade 2. Strong sources of repayment and have low repayment risk.

 

  Grade 3. Good sources of repayment and have limited repayment risk.

 

  Grade 4. Adequate sources of repayment and acceptable repayment risk; however, characteristics are present that render the credit more vulnerable to a negative event.

 

  Grade 5. Marginally acceptable sources of repayment and exhibit defined weaknesses and negative characteristics.

 

  Grade 6. Well defined weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if the credit does not stabilize or if further deterioration is observed in the near term, the loan will likely be downgraded and placed on the Watch List (i.e., list of lending relationships that receive increased scrutiny and review by the Board of Directors and senior management).

 

  Grade 7. Defined weaknesses or negative trends that merit close monitoring through Watch List status.

 

  Grade 8. Inadequately protected by current sound net worth, paying capacity of the obligor, or pledged collateral, resulting in a distinct possibility of loss requiring close monitoring through Watch List status.

 

  Grade 9. Vital weaknesses exist where collection of principal is highly questionable.

 

  Grade 10. Considered uncollectable and of such little value that continuance as an asset is not warranted.

The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditor’s rights in order to preserve our collateral position.

 

(Continued)

26.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity in the allowance for loan losses and the recorded investments in loans as of and during the three and nine months ended September 30, 2013 are as follows:

 

     Commercial
Loans
    Retail
Loans
    Unallocated     Total  

Allowance for loan losses:

        

Balance at June 30, 2013

   $ 22,382,000      $ 2,559,000      $ 6,000      $ 24,947,000   

Provision for loan losses

     (1,730,000     (7,000     37,000        (1,700,000

Charge-offs

     0        (85,000     0        (85,000

Recoveries

     2,002,000        31,000        0        2,033,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 22,654,000      $ 2,498,000      $ 43,000      $ 25,195,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses:

        

Balance at December 31, 2012

   $ 26,043,000      $ 2,645,000      $ (11,000   $ 28,677,000   

Provision for loan losses

     (4,375,000     (379,000     54,000        (4,700,000

Charge-offs

     (2,774,000     (107,000     0        (2,881,000

Recoveries

     3,760,000        339,000        0        4,099,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 22,654,000      $ 2,498,000      $ 43,000      $ 25,195,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 13,860,000      $ 1,203,000      $ 0      $ 15,063,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 8,794,000      $ 1,295,000      $ 43,000      $ 10,132,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans:

        

Ending balance

   $ 1,007,763,000      $ 67,724,000        $ 1,075,487,000   
  

 

 

   

 

 

     

 

 

 

Ending balance: individually evaluated for impairment

   $ 46,426,000      $ 3,851,000        $ 50,277,000   
  

 

 

   

 

 

     

 

 

 

Ending balance: collectively evaluated for impairment

   $ 961,337,000      $ 63,873,000        $ 1,025,210,000   
  

 

 

   

 

 

     

 

 

 

 

(Continued)

27.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity in the allowance for loan losses and the recorded investments in loans as of and during the three and nine months ended September 30, 2012 are as follows:

 

     Commercial
Loans
    Retail Loans     Unallocated     Total  

Allowance for loan losses:

        

Balance at June 30, 2012

   $ 26,471,000      $ 3,167,000      $ 51,000      $ 29,689,000   

Provision for loan losses

     (355,000     (35,000     (10,000     (400,000

Charge-offs

     (1,548,000     (343,000     0        (1,891,000

Recoveries

     326,000        38,000        0        364,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 24,894,000      $ 2,827,000      $ 41,000      $ 27,762,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses:

        

Balance at December 31, 2011

   $ 33,431,000      $ 3,019,000      $ 82,000      $ 36,532,000   

Provision for loan losses

     (3,480,000     121,000        (41,000     (3,400,000

Charge-offs

     (10,662,000     (513,000     0        (11,175,000

Recoveries

     5,605,000        200,000        0        5,805,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 24,894,000      $ 2,827,000      $ 41,000      $ 27,762,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 15,498,000      $ 305,000      $ 0      $ 15,803,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 9,396,000      $ 2,522,000      $ 41,000      $ 11,959,000   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans:

        

Ending balance

   $ 957,411,000      $ 77,877,000        $ 1,035,288,000   
  

 

 

   

 

 

     

 

 

 

Ending balance: individually evaluated for impairment

   $ 61,378,000      $ 1,836,000        $ 63,214,000   
  

 

 

   

 

 

     

 

 

 

Ending balance: collectively evaluated for impairment

   $ 896,033,000      $ 76,041,000        $ 972,074,000   
  

 

 

   

 

 

     

 

 

 

 

(Continued)

28.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Loans modified as troubled debt restructurings during the three months ended September 30, 2013 were as follows:

 

     Number of
Contracts
     Pre-
Modification
Recorded
Principal
Balance
     Post-
Modification
Recorded
Principal
Balance
 

Commercial:

        

Commercial and industrial

     1       $ 553,000       $ 553,000   

Vacant land, land development and residential construction

     0         0         0   

Real estate – owner occupied

     0         0         0   

Real estate – non-owner occupied

     2         171,000         171,000   

Real estate – multi-family and residential rental

     2         346,000         346,000   
  

 

 

    

 

 

    

 

 

 

Total commercial

     5         1,070,000         1,070,000   

Retail:

        

Home equity and other

     0         0         0   

1-4 family mortgages

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total retail

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total

     5       $ 1,070,000       $ 1,070,000   
  

 

 

    

 

 

    

 

 

 

Loans modified as troubled debt restructurings during the nine months ended September 30, 2013 were as follows:

 

     Number of
Contracts
     Pre-
Modification
Recorded
Principal
Balance
     Post-
Modification
Recorded
Principal
Balance
 

Commercial:

        

Commercial and industrial

     2       $ 613,000       $ 613,000   

Vacant land, land development and residential construction

     2         3,247,000         3,247,000   

Real estate – owner occupied

     3         909,000         909,000   

Real estate – non-owner occupied

     4         2,239,000         2,239,000   

Real estate – multi-family and residential rental

     2         346,000         346,000   
  

 

 

    

 

 

    

 

 

 

Total commercial

     13         7,354,000         7,354,000   

Retail:

        

Home equity and other

     0         0         0   

1-4 family mortgages

     1         1,879,000         1,879,000   
  

 

 

    

 

 

    

 

 

 

Total retail

     1         1,879,000         1,879,000   
  

 

 

    

 

 

    

 

 

 

Total

     14       $ 9,233,000       $ 9,233,000   
  

 

 

    

 

 

    

 

 

 

 

(Continued)

29.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Loans modified as troubled debt restructurings during the three months ended September 30, 2012 were as follows:

 

     Number of
Contracts
     Pre-
Modification
Recorded
Principal
Balance
     Post-
Modification
Recorded
Principal
Balance
 

Commercial:

        

Commercial and industrial

     1       $ 133,000       $ 128,000   

Vacant land, land development and residential construction

     0         0         0   

Real estate – owner occupied

     0         0         0   

Real estate – non-owner occupied

     5         18,042,000         18,042,000   

Real estate – multi-family and residential rental

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total commercial

     6         18,175,000         18,170,000   

Retail:

        

Home equity and other

     0         0         0   

1-4 family mortgages

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total retail

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total

     6       $ 18,175,000       $ 18,170,000   
  

 

 

    

 

 

    

 

 

 

Loans modified as troubled debt restructurings during the nine months ended September 30, 2012 were as follows:

 

     Number of
Contracts
     Pre-
Modification
Recorded
Principal
Balance
     Post-
Modification
Recorded
Principal
Balance
 

Commercial:

        

Commercial and industrial

     6       $ 850,000       $ 843,000   

Vacant land, land development and residential construction

     0         0         0   

Real estate – owner occupied

     5         1,588,000         1,587,000   

Real estate – non-owner occupied

     6         22,433,000         22,433,000   

Real estate – multi-family and residential rental

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total commercial

     17         24,871,000         24,863,000   

Retail:

        

Home equity and other

     0         0         0   

1-4 family mortgages

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total retail

     0         0         0   
  

 

 

    

 

 

    

 

 

 

Total

     17       $ 24,871,000       $ 24,863,000   
  

 

 

    

 

 

    

 

 

 

 

(Continued)

30.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended September 30, 2013 (amounts as of period end):

 

     Number of
Contracts
     Recorded
Principal
Balance
 

Commercial:

     

Commercial and industrial

     0       $ 0   

Vacant land, land development and residential construction

     0         0   

Real estate – owner occupied

     0         0   

Real estate – non-owner occupied

     0         0   

Real estate – multi-family and residential rental

     0         0   
  

 

 

    

 

 

 

Total commercial

     0         0   

Retail:

     

Home equity and other

     0         0   

1-4 family mortgages

     0         0   
  

 

 

    

 

 

 

Total retail

     0         0   
  

 

 

    

 

 

 

Total

     0       $ 0   
  

 

 

    

 

 

 

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the nine months ended September 30, 2013 (amounts as of period end):

 

     Number of
Contracts
     Recorded
Principal
Balance
 

Commercial:

     

Commercial and industrial

     0       $ 0   

Vacant land, land development and residential construction

     0         0   

Real estate – owner occupied

     0         0   

Real estate – non-owner occupied

     0         0   

Real estate – multi-family and residential rental

     0         0   
  

 

 

    

 

 

 

Total commercial

     0         0   

Retail:

     

Home equity and other

     0         0   

1-4 family mortgages

     0         0   
  

 

 

    

 

 

 

Total retail

     0         0   
  

 

 

    

 

 

 

Total

     0       $ 0   
  

 

 

    

 

 

 

 

(Continued)

31.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended September 30, 2012 (amounts as of period end):

 

     Number of
Contracts
     Recorded
Principal
Balance
 

Commercial:

     

Commercial and industrial

     0       $ 0   

Vacant land, land development and residential construction

     0         0   

Real estate – owner occupied

     0         0   

Real estate – non-owner occupied

     0         0   

Real estate – multi-family and residential rental

     0         0   
  

 

 

    

 

 

 

Total commercial

     0         0   

Retail:

     

Home equity and other

     0         0   

1-4 family mortgages

     0         0   
  

 

 

    

 

 

 

Total retail

     0         0   
  

 

 

    

 

 

 

Total

     0       $ 0   
  

 

 

    

 

 

 

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the nine months ended September 30, 2012 (amounts as of period end):

 

     Number of
Contracts
     Recorded
Principal
Balance
 

Commercial:

     

Commercial and industrial

     0       $ 0   

Vacant land, land development and residential construction

     0         0   

Real estate – owner occupied

     0         0   

Real estate – non-owner occupied

     0         0   

Real estate – multi-family and residential rental

     0         0   
  

 

 

    

 

 

 

Total commercial

     0         0   

Retail:

     

Home equity and other

     0         0   

1-4 family mortgages

     0         0   
  

 

 

    

 

 

 

Total retail

     0         0   
  

 

 

    

 

 

 

Total

     0       $ 0   
  

 

 

    

 

 

 

 

(Continued)

32.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2013 is as follows:

 

     Commercial
and
Industrial
    Commercial
Vacant Land,
Land Development,
and Residential
Construction
    Commercial
Real Estate -
Owner
Occupied
    Commercial
Real Estate -
Non-Owner
Occupied
    Commercial
Real Estate -
Multi-Family
and Residential
Rental
 

Commercial Loan Portfolio:

          

Beginning Balance

   $ 2,266,000      $ 5,440,000      $ 3,580,000      $ 34,424,000      $ 2,775,000   

Charge-Offs

     0        0        0        0        0   

Payments

     (324,000     (303,000     (271,000     (1,690,000     (295,000

Transfers to ORE

     0        0        0        (350,000     0   

Net Additions/Deletions

     466,000        0        (652,000     68,000        343,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 2,408,000      $ 5,137,000      $ 2,657,000      $ 32,452,000      $ 2,823,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Retail
Home Equity
and Other
    Retail
1-4 Family
Mortgages
 

Retail Loan Portfolio:

    

Beginning Balance

   $ 2,029,000      $ 0   

Charge-Offs

     0        0   

Payments

     (16,000     0   

Transfers to ORE

     0        0   

Net Additions/Deletions

     0        0   
  

 

 

   

 

 

 

Ending Balance

   $ 2,013,000      $ 0   
  

 

 

   

 

 

 

 

(Continued)

33.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for loans categorized as troubled debt restructurings during the nine months ended September 30, 2013 is as follows:

 

     Commercial
and
Industrial
    Commercial
Vacant Land,
Land Development,
and Residential
Construction
    Commercial
Real Estate -
Owner
Occupied
    Commercial
Real Estate -
Non-Owner
Occupied
    Commercial
Real Estate -
Multi-Family
and Residential
Rental
 

Commercial Loan Portfolio:

          

Beginning Balance

   $ 2,721,000      $ 3,071,000      $ 4,116,000      $ 37,672,000      $ 3,026,000   

Charge-Offs

     (35,000     (725,000     (70,000     (716,000     (15,000

Payments

     (1,902,000     (456,000     (1,310,000     (5,475,000     (530,000

Transfers to ORE

     (74,000     0        (363,000     (1,153,000     0   

Net Additions/Deletions

     1,698,000        3,247,000        284,000        2,124,000        342,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 2,408,000      $ 5,137,000      $ 2,657,000      $ 32,452,000      $ 2,823,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Retail Home
Equity and
Other
    Retail
1-4 Family
Mortgages
 

Retail Loan Portfolio:

    

Beginning Balance

   $ 155,000      $ 0   

Charge-Offs

     0        0   

Payments

     (21,000     0   

Transfers to ORE

     0        0   

Net Additions/Deletions

     1,879,000        0   
  

 

 

   

 

 

 

Ending Balance

   $ 2,013,000      $ 0   
  

 

 

   

 

 

 

 

(Continued)

34.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2012 is as follows:

 

     Commercial
and
Industrial
    Commercial
Vacant Land,
Land Development,
and Residential
Construction
    Commercial
Real Estate -
Owner
Occupied
    Commercial
Real Estate -
Non-Owner
Occupied
    Commercial
Real Estate -
Multi-Family
and Residential
Rental
 

Commercial Loan Portfolio:

          

Beginning Balance

   $ 4,665,000      $ 3,250,000      $ 6,809,000      $ 16,881,000      $ 4,985,000   

Charge-Offs

     (60,000     0        (12,000     (474,000     0   

Payments

     (268,000     (55,000     (2,750,000     (178,000     (263,000

Transfers to ORE

     (45,000     0        0        (579,000     0   

Net Additions/Deletions

     123,000        0        105,000        18,043,000        0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 4,415,000      $ 3,195,000      $ 4,152,000      $ 33,693,000      $ 4,722,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Retail
Home Equity
and Other
    Retail 1-4
Family
Mortgages
 

Retail Loan Portfolio:

    

Beginning Balance

   $ 159,000      $ 0   

Charge-Offs

     0        0   

Payments

     (2,000     0   

Transfers to ORE

     0        0   

Net Additions/Deletions

     0        0   
  

 

 

   

 

 

 

Ending Balance

   $ 157,000      $ 0   
  

 

 

   

 

 

 

 

(Continued)

35.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for loans categorized as troubled debt restructurings during the nine months ended September 30, 2012 is as follows:

 

     Commercial
and
Industrial
    Commercial
Vacant Land,
Land Development,
and Residential
Construction
    Commercial
Real Estate -
Owner
Occupied
    Commercial
Real Estate -
Non-Owner
Occupied
    Commercial
Real Estate -
Multi-Family
and Residential
Rental
 

Commercial Loan Portfolio:

          

Beginning Balance

   $ 4,553,000      $ 5,100,000      $ 6,183,000      $ 12,037,000      $ 12,626,000   

Charge-Offs

     (172,000     0        (426,000     (499,000     (2,180,000

Payments

     (763,000     (1,952,000     (3,317,000     (689,000     (5,914,000

Transfers to ORE

     (96,000     (351,000     0        (579,000     0   

Net Additions/Deletions

     893,000        398,000        1,712,000        23,423,000        190,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 4,415,000      $ 3,195,000      $ 4,152,000      $ 33,693,000      $ 4,722,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Retail
Home Equity
and Other
    Retail
1-4 Family
Mortgages
 

Retail Loan Portfolio:

    

Beginning Balance

   $ 164,000      $ 0   

Charge-Offs

     0        0   

Payments

     (7,000     0   

Transfers to ORE

     0        0   

Net Additions/Deletions

     0        0   
  

 

 

   

 

 

 

Ending Balance

   $ 157,000      $ 0   
  

 

 

   

 

 

 

 

(Continued)

36.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The allowance related to loans categorized as troubled debt restructurings was as follows:

 

     September 30,      December 31,  
     2013      2012  

Commercial:

     

Commercial and industrial

   $ 619,000       $ 772,000   

Vacant land, land development, and residential construction

     1,208,000         713,000   

Real estate – owner occupied

     893,000         1,116,000   

Real estate – non-owner occupied

     9,639,000         9,751,000   

Real estate – multi-family and residential rental

     885,000         745,000   
  

 

 

    

 

 

 

Total commercial

     13,244,000         13,097,000   

Retail:

     

Home equity and other

     0         0   

1-4 family mortgages

     920,000         0   
  

 

 

    

 

 

 

Total retail

     920,000         0   
  

 

 

    

 

 

 

Total related allowance

   $ 14,164,000       $ 13,097,000   
  

 

 

    

 

 

 

In general, our policy dictates that a renewal or modification of an 8- or 9-rated loan meets the criteria of a troubled debt restructuring, although we review and consider all renewed and modified loans as part of our troubled debt restructuring assessment procedures. Loan relationships rated 8 contain significant financial weaknesses, resulting in a distinct possibility of loss, while relationships rated 9 reflect vital financial weaknesses, resulting in a highly questionable ability on our part to collect principal; we believe borrowers warranting such ratings would have difficulty obtaining financing from other market participants. Thus, due to the lack of comparable market rates for loans with similar risk characteristics, we believe 8- or 9-rated loans renewed or modified were done so at below market rates. Loans that are identified as troubled debt restructurings are considered impaired and are individually evaluated for impairment when assessing these credits in our allowance for loan losses calculation.

 

(Continued)

37.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

4. PREMISES AND EQUIPMENT, NET

Premises and equipment are comprised of the following:

 

     September 30,
2013
     December 31,
2012
 

Land and improvements

   $ 8,556,000       $ 8,556,000   

Buildings

     24,727,000         24,564,000   

Furniture and equipment

     12,647,000         12,861,000   
  

 

 

    

 

 

 
     45,930,000         45,981,000   

Less: accumulated depreciation

     20,771,000         20,062,000   
  

 

 

    

 

 

 

Premises and equipment, net

   $ 25,159,000       $ 25,919,000   
  

 

 

    

 

 

 

Depreciation expense totaled $0.3 million during the third quarter of 2013 and 2012. Depreciation expense totaled $1.0 million during the first nine months of 2013, compared to $1.1 million during the first nine months of 2012.

 

5. DEPOSITS

Our total deposits at September 30, 2013 totaled $1.12 billion compared to $1.14 billion at December 31, 2012, a decrease of $13.7 million, or 1.2%. The components of our outstanding balances at September 30, 2013 and December 31, 2012, and percentage change in deposits from the end of 2012 to the end of the third quarter of 2013, are as follows:

 

                               Percent  
     September 30, 2013     December 31, 2012     Increase  
     Balance      %     Balance      %     (Decrease)  

Noninterest-bearing demand

   $ 216,055,000         19.3   $ 190,241,000         16.8     13.6

Interest-bearing checking

     195,964,000         17.5        188,057,000         16.5        4.2   

Money market

     136,363,000         12.1        144,479,000         12.7        (5.6

Savings

     52,993,000         4.7        56,454,000         5.0        (6.1

Time, under $100,000

     45,146,000         4.0        51,730,000         4.6        (12.7

Time, $100,000 and over

     257,651,000         23.0        234,430,000         20.6        9.9   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
     904,172,000         80.6        865,391,000         76.2        4.5   

Out-of-area interest-bearing checking

     0         0.0        21,967,000         1.9        NM   

Out-of-area time, under $100,000

     4,672,000         0.4        7,706,000         0.7        (39.4

Out-of-area time, $100,000 and over

     212,665,000         19.0        240,140,000         21.2        (11.4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
     217,337,000         19.4        269,813,000         23.8        (19.4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total deposits

   $ 1,121,509,000         100.0   $ 1,135,204,000         100.0     (1.2 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

(Continued)

38.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchase (“repurchase agreements”) are offered principally to certain large deposit customers. Information relating to our repurchase agreements follows:

 

     Nine Months Ended
September 30, 2013
    Twelve Months Ended
December 31, 2012
 

Outstanding balance at end of period

   $ 65,680,000      $ 64,765,000   

Average interest rate at end of period

     0.13     0.13

Average daily balance during the period

   $ 64,309,000      $ 61,930,000   

Average interest rate during the period

     0.12     0.25

Maximum daily balance during the period

   $ 76,979,000      $ 81,980,000   

Repurchase agreements generally have original maturities of less than one year. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank. Repurchase agreements are secured by securities with an aggregate market value equal to the aggregate outstanding balance.

 

7. FEDERAL HOME LOAN BANK ADVANCES

Our Federal Home Loan Bank advances totaled $45.0 million at September 30, 2013 and mature at varying dates from March 2017 through September 2017, with fixed rates of interest from 1.22% to 1.51% and averaging 1.34%. At December 31, 2012, our Federal Home Loan Bank advances totaled $35.0 million and mature at varying dates from March 2017 through September 2017, with fixed rates of interest from 1.22% to 1.51% and averaging 1.35%. Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit as of September 30, 2013 totaled about $150.0 million, with availability approximating $94.0 million.

Maturities of currently outstanding FHLB advances are as follows:

 

2013

   $ 0   

2014

     0   

2015

     0   

2016

     0   

2017

     45,000,000   

 

(Continued)

39.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

8. COMMITMENTS AND OFF-BALANCE SHEET RISK

Our bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by our bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on our credit assessment of the borrower. If required, estimated loss exposure resulting from these instruments is expensed and is generally recorded as a liability. There was no reserve or liability balance for these instruments as of September 30, 2013 and December 31, 2012.

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at September 30, 2013 and December 31, 2012 follows:

 

     September 30,
2013
     December 31,
2012
 

Commercial unused lines of credit

   $ 225,732,000       $ 222,237,000   

Unused lines of credit secured by 1 – 4 familyresidential properties

     23,430,000         24,250,000   

Credit card unused lines of credit

     8,555,000         8,512,000   

Other consumer unused lines of credit

     6,379,000         4,613,000   

Commitments to extend credit

     92,382,000         64,565,000   

Standby letters of credit

     20,657,000         10,591,000   
  

 

 

    

 

 

 
   $ 377,135,000       $ 334,768,000   
  

 

 

    

 

 

 

 

(Continued)

40.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

8. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)

 

Certain of our commercial loan customers have entered into interest rate swap agreements directly with our correspondent banks. To assist our commercial loan customers in these transactions, and to encourage our correspondent banks to enter into the interest rate swap transactions with minimal credit underwriting analyses on their part, we have entered into risk participation agreements with the correspondent banks whereby we agree to make payments to the correspondent banks owed by our commercial loan customers under the interest rate swap agreement in the event that our commercial loan customers do not make the payments. We are not a party to the interest rate swap agreements under these arrangements. As of September 30, 2013, the total notional amount of the underlying interest rate swap agreements was $18.1 million, with a net fair value from our commercial loan customers’ perspective of negative $2.7 million. These risk participation agreements are considered financial guarantees in accordance with applicable accounting guidance and are therefore recorded as liabilities at fair value, generally equal to the fees collected at the time of their execution. These liabilities are accreted into income during the term of the interest rate swap agreements, generally ranging from four to fifteen years.

 

9. HEDGING ACTIVITIES

Our interest rate risk policy includes guidelines for measuring and monitoring interest rate risk. Within these guidelines, parameters have been established for maximum fluctuations in net interest income. Possible fluctuations are measured and monitored using net interest income simulation. Our policy provides for the use of certain derivative instruments and hedging activities to aid in managing interest rate risk to within the policy parameters. To help mitigate the negative impact to our net interest income in an increasing interest rate environment resulting from our cost of funds likely increasing at a higher rate than the yield on our assets, we may periodically enter into derivative financial instruments.

In June 2011, we simultaneously purchased and sold an interest rate cap with a correspondent bank, a structure commonly referred to as a “cap corridor.” The cap corridor, which does not qualify for hedge accounting, consisted of us purchasing a $100 million interest rate cap with a strike rate in close proximity to the then-current 30-Day Libor rate and selling a $100 million interest rate cap with a strike rate that is 125 basis points higher than the purchased interest rate cap strike rate. On the settlement date, the present value of the purchased interest rate cap was recorded as an asset, while the present value of the sold interest rate cap was recorded as a liability. At each month end, the recorded balances of the purchased and sold interest rate caps are adjusted to reflect the current present values, with the offsetting entry being recorded to interest income on commercial loans. We recorded a nominal decrease during the first nine months of 2013 to interest income on commercial loans to reflect the net change in present values. Payments made or received under the purchased and sold interest rate cap contracts, if any, are also recorded to interest income on commercial loans. No such payments were made or received during the first nine months of 2013. The cap corridor matured in June 2013.

 

(Continued)

41.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

9. HEDGING ACTIVITIES (Continued)

 

In February 2012, we entered into an interest rate swap agreement with a correspondent bank to hedge the floating rate on our subordinated debentures. Our $32.0 million of subordinated debentures have a rate equal to the 90-Day Libor Rate plus a fixed spread of 218 basis points, and are subject to repricing quarterly. The interest rate swap agreement provides for us to pay our correspondent bank a fixed rate, while our correspondent bank will pay us the 90-Day Libor Rate on a $32.0 million notional amount. The quarterly re-set dates for the floating rate on the interest rate swap agreement are the same as the re-set dates for the floating rate on the subordinated debentures. While the trade date of the interest rate swap agreement was in February 2012, the effective date was in January 2013, with a maturity date of January 2018. The interest rate swap agreement does qualify for hedge accounting; therefore, monthly fluctuations in the present value of the interest rate swap agreement, net of tax effect, are recorded to other comprehensive income. As of September 30, 2013 and December 31, 2012, the present value of the interest rate swap agreement was recorded as a liability in the amount of $0.4 million and $1.1 million, respectively.

 

10. FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of September 30, 2013 and December 31, 2012 (dollars in thousands):

 

     Level in   September 30, 2013      December 31, 2012  
     Fair Value
Hierarchy
  Carrying
Values
     Fair
Values
     Carrying
Values
     Fair
Values
 

Financial assets:

             

Cash

   Level 1   $ 1,995       $ 1,995       $ 1,576       $ 1,576   

Cash equivalents

   Level 2     123,923         123,923         134,427         134,427   

Securities available for sale

   (1)     123,793         123,793         138,314         138,314   

FHLB stock

   (2)     11,961         11,961         11,961         11,961   

Loans, net

   Level 3     1,050,292         1,047,313         1,012,512         1,004,541   

Bank owned life insurance

   Level 2     51,073         51,073         50,048         50,048   

Accrued interest receivable

   Level 2     3,777         3,777         3,874         3,874   

Financial liabilities:

             

Deposits

   Level 2     1,121,509         1,123,304         1,135,204         1,135,614   

Repurchase agreements

   Level 2     65,680         65,680         64,765         64,765   

FHLB advances

   Level 2     45,000         45,139         35,000         35,000   

Subordinated debentures

   Level 2     32,990         32,974         32,990         32,943   

Accrued interest payable

   Level 2     1,643         1,643         2,314         2,314   

Interest rate swap

   (1)     394         394         1,113         1,113   

 

(1) See Note 11 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities.
(2) It is not practical to determine the fair value of FHLB stock due to transferability restrictions.

 

(Continued)

42.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

10. FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

 

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, bank owned life insurance, demand deposits, repurchase agreements, and variable rate loans and deposits that reprice frequently and fully. For fixed rate loans and deposits and for variable rate loans and deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of subordinated debentures and Federal Home Loan Bank advances is based on current rates for similar financing. Fair value of the interest rate swap is determined primarily utilizing market-consensus forecasted yield curves. Fair value of off-balance sheet items is estimated to be nominal.

 

11. FAIR VALUES

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

We are required to use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources, or unobservable, meaning those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.

 

(Continued)

43.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

11. FAIR VALUES (Continued)

 

Level 3: Significant unobservable inputs that reflect our own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities that are recorded at fair value on a recurring or nonrecurring basis:

Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies, municipal general obligation and revenue bonds, Michigan Strategic Fund bonds and mutual funds. We have no Level 1 or 3 securities.

Derivatives. The interest rate swap is measured at fair value on a recurring basis. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves, and accordingly, the interest rate swap agreement is classified as Level 2.

Mortgage loans held for sale. Mortgage loans held for sale are carried at the lower of aggregate cost or fair value measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics. As of September 30, 2013 and December 31, 2012, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $1.4 million and $3.5 million, respectively.

Loans. We do not record loans at fair value on a recurring basis. However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge-off.

Foreclosed Assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed and repossessed assets, establishing a new cost basis. We subsequently adjust estimated fair value of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates.

 

(Continued)

44.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

11. FAIR VALUES (Continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2013 are as follows:

 

           Quoted               
           Prices in               
           Active      Significant        
           Markets for      Other     Significant  
           Identical      Observable     Unobservable  
           Assets      Inputs     Inputs  
     Total     (Level 1)      (Level 2)     (Level 3)  

Available for sale securities

         

U.S. Government agency debt obligations

   $ 89,294,000      $ 0       $ 89,294,000      $ 0   

Mortgage-backed securities

     14,511,000        0         14,511,000        0   

Municipal general obligation bonds

     17,706,000        0         17,706,000        0   

Municipal revenue bonds

     917,000        0         917,000        0   

Mutual funds

     1,365,000        0         1,365,000        0   

Derivatives

         

Interest rate swap agreement

     (394,000     0         (394,000     0   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 123,399,000      $ 0       $ 123,399,000      $ 0   
  

 

 

   

 

 

    

 

 

   

 

 

 

There were no transfers in or out of Level 1, Level 2 or Level 3 during the first nine months of 2013.

 

(Continued)

45.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

11. FAIR VALUES (Continued)

 

The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 are as follows:

 

           Quoted               
           Prices in               
           Active      Significant        
           Markets for      Other     Significant  
           Identical      Observable     Unobservable  
           Assets      Inputs     Inputs  
     Total     (Level 1)      (Level 2)     (Level 3)  

Available for sale securities

         

U.S. Government agency debt obligations

   $ 79,098,000      $ 0       $ 79,098,000      $ 0   

Mortgage-backed securities

     21,996,000        0         21,996,000        0   

Michigan Strategic Fund bonds

     11,255,000        0         11,255,000        0   

Municipal general obligation bonds

     22,743,000        0         22,743,000        0   

Municipal revenue bonds

     1,817,000        0         1,817,000        0   

Mutual funds

     1,405,000        0         1,405,000        0   

Derivatives

         

Interest rate swap agreement

     (1,113,000     0         (1,113,000     0   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 137,201,000      $ 0       $ 137,201,000      $ 0   
  

 

 

   

 

 

    

 

 

   

 

 

 

There were no transfers in or out of Level 1, Level 2 or Level 3 during 2012.

Assets Measured at Fair Value on a Nonrecurring Basis

The balances of assets measured at fair value on a nonrecurring basis as of September 30, 2013 are as follows:

 

            Quoted                
            Prices in                
            Active      Significant         
            Markets for      Other      Significant  
            Identical      Observable      Unobservable  
            Assets      Inputs      Inputs  
     Total      (Level 1)      (Level 2)      (Level 3)  

Impaired loans (1)

   $ 31,205,000       $ 0       $ 0       $ 31,205,000   

Foreclosed assets (1)

     3,549,000         0         0         3,549,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 34,754,000       $ 0       $ 0       $ 34,754,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(Continued)

46.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

11. FAIR VALUES (Continued)

 

The balances of assets measured at fair value on a nonrecurring basis as of December 31, 2012 are as follows:

 

            Quoted                
            Prices in                
            Active      Significant         
            Markets for      Other      Significant  
            Identical      Observable      Unobservable  
            Assets      Inputs      Inputs  
     Total      (Level 1)      (Level 2)      (Level 3)  

Impaired loans (1)

   $ 34,406,000       $ 0       $ 0       $ 34,406,000   

Foreclosed assets (1)

     6,970,000         0         0         6,970,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 41,376,000       $ 0       $ 0       $ 41,376,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents carrying value and related write-downs for which adjustments are based on the estimated value of the property or other assets.

 

12. REGULATORY MATTERS

We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if, after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator. At September 30, 2013 and December 31, 2012, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since September 30, 2013 that we believe have changed our bank’s categorization.

 

(Continued)

47.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

12. REGULATORY MATTERS (Continued)

 

Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:

 

     Actual     Minimum Required
for Capital
Adequacy Purposes
    Minimum Required
to be Well
Capitalized Under
Prompt Corrective
Action Regulations
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

September 30, 2013

               

Total capital (to risk weighted assets)

               

Consolidated

   $ 186,699         15.3   $ 97,366         8.0   $ NA         NA   

Bank

     186,020         15.3        97,317         8.0        121,646         10.0

Tier 1 capital (to risk weighted assets)

               

Consolidated

     171,362         14.1        48,683         4.0        NA         NA   

Bank

     170,691         14.0        48,659         4.0        73,025         6.0   

Tier 1 capital (to average assets)

               

Consolidated

     171,362         12.6        54,537         4.0        NA         NA   

Bank

     170,691         12.5        54,510         4.0        68,171         5.0   

December 31, 2012

               

Total capital (to risk weighted assets)

               

Consolidated

   $ 173,323         14.6   $ 94,738         8.0   $ NA         NA   

Bank

     173,828         14.7        94,629         8.0        118,286         10.0

Tier 1 capital (to risk weighted assets)

               

Consolidated

     158,349         13.4        47,369         4.0        NA         NA   

Bank

     158,871         13.4        47,315         4.0        70,972         6.0   

Tier 1 capital (to average assets)

               

Consolidated

     158,349         11.3        55,995         4.0        NA         NA   

Bank

     158,871         11.4        55,937         4.0        69,922         5.0   

 

(Continued)

48.


Table of Contents

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

12. REGULATORY MATTERS (Continued)

 

Our consolidated capital levels as of September 30, 2013 and December 31, 2012 include $32.0 million of trust preferred securities issued by the trust in September 2004 and December 2004 subject to certain limitations. Under applicable Federal Reserve guidelines, the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate amount of restricted core elements that may be included in our Tier 1 capital must not exceed 25% of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Our ability to include the trust preferred securities in Tier 1 capital in accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated assets as of December 31, 2009 were less than $15.0 billion. As of September 30, 2013 and December 31, 2012, all $32.0 million of the trust preferred securities were included in our consolidated Tier 1 capital.

Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On October 11, 2012, our Board of Directors declared a cash dividend on our common stock in the amount of $0.09 per share that was paid on December 10, 2012 to shareholders of record as of November 9, 2012. This represented our first common stock cash dividend since the first quarter of 2010, as in April 2010 we had suspended payments of cash dividends on our common stock. On January 10, 2013, our Board of Directors declared a cash dividend on our common stock in the amount of $0.10 per share that was paid on March 8, 2013 to shareholders of record as of February 8, 2013. On April 11, 2013, our Board of Directors declared a cash dividend on our common stock in the amount of $0.11 per share that was paid on June 10, 2013 to shareholders of record as of May 10, 2013. On July 11, 2013, our Board of Directors declared a cash dividend on our common stock in the amount of $0.12 per share that was paid on September 10, 2013 to shareholders of record as of August 9, 2013. On October 10, 2013, our Board of Directors declared a cash dividend on our common stock in the amount of $0.12 per share that will be paid on December 10, 2013 to shareholders of record as of November 8, 2013.

 

49.


Table of Contents

MERCANTILE BANK CORPORATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “projects,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward looking-statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.

Future Factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; changes in the national and local economies; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2012 or in this report. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.

Introduction

The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, Mercantile Bank of Michigan (“our bank”), our bank’s two subsidiaries, Mercantile Bank Real Estate Co., LLC (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance company”), at September 30, 2013 and December 31, 2012 and the results of operations for the three and nine months ended September 30, 2013 and September 30, 2012. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.

Critical Accounting Policies

Accounting principles generally accepted in the United States of America are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting policies, see Note 1 of the Notes to our Consolidated Financial Statements included on pages F-48 through F-54 in our Form 10-K for the fiscal year ended December 31, 2012 (Commission file number 000-26719). Our allowance for loan losses policy and accounting for income taxes are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements, and actual results may differ from those estimates. We have reviewed the application of these policies with the Audit Committee of our Board of Directors.

 

50.


Table of Contents

MERCANTILE BANK CORPORATION

 

Allowance for Loan Losses: The allowance for loan losses (“allowance”) is maintained at a level we believe is adequate to absorb probable incurred losses identified and inherent in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Loan losses are charged against the allowance when we believe the uncollectability of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results.

The allowance is increased through a provision charged to operating expense. Uncollectable loans are charged-off through the allowance. Recoveries of loans previously charged-off are added to the allowance. A loan is considered impaired when it is probable that contractual interest and principal payments will not be collected either for the amounts or by the dates as scheduled in the loan agreement. Impairment is evaluated in aggregate for smaller-balance loans of similar nature such as residential mortgage, consumer and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. The timing of obtaining outside appraisals varies, generally depending on the nature and complexity of the property being evaluated, general breadth of activity within the marketplace and the age of the most recent appraisal. For collateral dependent impaired loans, in most cases we obtain and use the “as is” value as indicated in the appraisal report, adjusting for any expected selling costs. In certain circumstances, we may internally update outside appraisals based on recent information impacting a particular or similar property, or due to identifiable trends (e.g., recent sales of similar properties) within our markets. The expected future cash flows exclude potential cash flows from certain guarantors. To the extent these guarantors provide repayments, a recovery would be recorded upon receipt. Loans are evaluated for impairment when payments are delayed, typically 30 days or more, or when serious deficiencies are identified within the credit relationship. Our policy for recognizing income on impaired loans is to accrue interest unless a loan is placed on nonaccrual status. We put loans into nonaccrual status when the full collection of principal and interest is not expected.

Income Tax Accounting: Current income tax liabilities or assets are established for the amount of taxes payable or refundable for the current year. In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws for which the outcome may be uncertain. We periodically review and evaluate the status of our tax positions and make adjustments as necessary. Deferred income tax liabilities and assets are also established for the future tax consequences of events that have been recognized in our financial statements or tax returns. A deferred income tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences that can be carried forward (used) in future years. The valuation of our net deferred income tax asset is considered critical as it requires us to make estimates based on provisions of the enacted tax laws. The assessment of the realizability of the net deferred income tax asset involves the use of estimates, assumptions, interpretations and judgments concerning accounting pronouncements, federal and state tax codes and the extent of future taxable income. There can be no assurance that future events, such as court decisions, positions of federal and state tax authorities, and the extent of future taxable income will not differ from our current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.

 

51.


Table of Contents

MERCANTILE BANK CORPORATION

 

Accounting guidance requires that we assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors which may impact future operating results. Significant weight is given to evidence that can be objectively verified. During 2011, we returned to pre-tax profitability for four consecutive quarters. Additionally, we experienced lower provision expense, continued declines in nonperforming assets and problem asset administration costs, a higher net interest margin, a further strengthening of our regulatory capital ratios and additional reductions in wholesale funding. This positive evidence allowed us to conclude that, as of December 31, 2011, it was more likely than not that we returned to sustainable profitability in amounts sufficient to allow for realization of our deferred tax assets in future years. Consequently, we reversed the valuation allowance that we had previously determined necessary to carry against our entire net deferred tax asset starting on December 31, 2009.

Merger Agreement

On August 14, 2013, Mercantile Bank Corporation (“Mercantile”) and Firstbank Corporation (“Firstbank”), a Michigan corporation, entered into an Agreement and Plan of Merger (the “merger agreement”). Under the terms of the merger agreement, Firstbank will be merged with and into Mercantile, with Mercantile as the surviving corporation.

Upon completion of the merger, Firstbank shareholders will receive one share of Mercantile common stock for each share of Firstbank common stock that they own. Each right of any kind to receive Firstbank common stock or benefits measured by the value of a number of shares of Firstbank common stock granted under the Firstbank stock plans will be converted into an award with respect to a number of shares of Mercantile common stock equal to the aggregate number of shares of Firstbank common stock subject to such award. Firstbank restricted stock and unvested stock options will become fully vested as of the effective time of the merger. The exchange ratio is fixed and will not be adjusted to reflect stock price changes prior to the effective time of the merger. Based on the closing price of Mercantile common stock on the Nasdaq Stock Market on August 14, 2013, the last trading day before public announcement of the merger agreement, the exchange ratio represented approximately $18.77 in value for each share of Firstbank common stock. Mercantile shareholders will continue to own their existing Mercantile shares.

Based on the estimated number of shares of Mercantile and Firstbank common stock that will be outstanding immediately prior to the effective time of the merger, we estimate that, upon the closing, former Mercantile shareholders will own approximately 52% of the combined company following the merger and former Firstbank shareholders will own approximately 48% of the combined company following the merger.

As part of the merger, Mercantile’s Board of Directors expects to declare and pay a special cash dividend of $2.00 per share to Mercantile shareholders prior to the effective time of the merger, subject to the satisfaction of the closing conditions set forth in the merger agreement.

 

52.


Table of Contents

MERCANTILE BANK CORPORATION

 

Immediately following the effective time of the merger, the board of directors of the combined company will consist of six members, including (i) the President and Chief Executive Officer of Mercantile plus two members of Mercantile’s Board of Directors as of the date of the merger agreement who are independent for purposes of the rules of Nasdaq selected by Mercantile’s Board of Directors and (ii) the President and Chief Executive Officer of Firstbank plus two members of Firstbank’s Board of Directors who are independent for purposes of the rules of Nasdaq selected by Firstbank’s Board of Directors. Mercantile’s Board of Directors has made a non-binding determination to select David Cassard and Calvin Murdock to serve as directors of the combined company. Firstbank’s Board of Directors has selected Edward Grant and Jeff Gardner to serve as directors of the combined company. The fees and/or other remuneration to be provided to the non-employee directors of the combined company have not been determined.

The merger agreement provides that, upon completion of the merger, Thomas R. Sullivan will serve as Mercantile’s Chairman of the Board, Michael H. Price will continue to serve as Mercantile’s President and Chief Executive Officer, Robert B. Kaminski, Jr. will continue to serve as an Executive Vice President and Chief Operating Officer of Mercantile, Charles E. Christmas will continue to serve as Mercantile’s Senior Vice President and Chief Financial Officer, and Samuel G. Stone will serve as an Executive Vice President of Mercantile.

Approval of the Board of Governors of the Federal Reserve System (“FRB”) is required to complete the merger. An application was filed with the FRB on September 17, 2013. Approval has not yet been obtained. Mercantile and Firstbank have each agreed to take actions in order to obtain regulatory clearance required to consummate the merger.

The obligations of Mercantile and Firstbank to complete the merger are subject to the satisfaction of the following conditions, among others: (i) the approval of the merger agreement by the holders of a majority of the outstanding shares of Mercantile common stock; (ii) the approval of the merger agreement by the holders of a majority of the outstanding shares of Firstbank common stock; (iii) the approval of the issuance of shares of Mercantile common stock to Firstbank shareholders in connection with the merger by the affirmative vote of holders of a majority of the shares present in person or represented by proxy and entitled to vote at the Mercantile special meeting, assuming a quorum; (iv) the consents, authorizations, approvals, or exemptions required under the Bank Holding Company Act, the FDI Act, and the Michigan Banking Code; (v) the absence of any injunction, decree, order, statute, rule or regulation by a court of other governmental entity that makes unlawful or prohibits the consummation of the merger; (vi) the effectiveness of the registration statement and the absence of a stop order or proceedings threatened or initiated by the SEC for that purpose; and (vii) the authorization for the listing on Nasdaq of the shares of Mercantile common stock to be issued in connection with the merger and upon conversion of the Firstbank restricted stock and the shares of Mercantile common stock reserved for issuance pursuant to Mercantile stock options, subject to official notice of issuance.

Mercantile and Firstbank have each made customary representations, warranties and covenants in the merger agreement, including, among others, covenants to conduct their business in the ordinary course between the execution of the merger agreement and the completion of the merger, and covenants not to engage in certain kinds of transactions during that period.

 

53.


Table of Contents

MERCANTILE BANK CORPORATION

 

The merger agreement generally precludes Mercantile and Firstbank from soliciting or engaging in discussions or negotiations with a third party with respect to an acquisition proposal. However, if Mercantile or Firstbank receives an unsolicited acquisition proposal from a third party and Mercantile’s or Firstbank’s Board of Directors, as applicable, among other things, determines in good faith (after consultation with its legal and financial advisors) that such unsolicited proposal is a superior proposal, then Mercantile or Firstbank, as applicable, may furnish non-public information to and enter into discussions with, and only with, that third party regarding such acquisition proposal.

Mercantile and Firstbank may mutually agree to terminate the merger agreement at any time, notwithstanding approval of the merger agreement by shareholders. Either company may also terminate the merger agreement if the merger is not consummated by March 31, 2014, subject to certain exceptions. In addition, either company may terminate the agreement to enter into a definitive agreement with respect to a superior proposal, subject to certain conditions and the payment of a termination fee.

Generally, all fees and expenses incurred in connection with the merger agreement and the transactions contemplated by the merger agreement will be paid by the party incurring those expenses. Subject to specific exceptions, Mercantile or Firstbank may be required to pay a termination fee of $7.9 million and/or expense reimbursement up to $2.0 million.

The merger will be accounted for using the acquisition method of accounting. Mercantile will be treated as the acquirer for accounting purposes.

Mercantile and Firstbank currently expect the effective time of the merger to be on or about January 1, 2014. However, the merger is subject to various regulatory clearances and the satisfaction or waiver of other conditions as described in the merger agreement, some of which may be outside the control of Mercantile and Firstbank, and the merger could be completed at an earlier time, a later time or not at all.

The merger agreement has been filed as an exhibit to this Form 10-Q to provide security holders with information regarding its terms. It is not intended to provide any other factual information about Mercantile, Firstbank or their respective subsidiaries and affiliates. The merger agreement contains representations and warranties by each of the parties to the merger agreement. These representations and warranties were made solely for the benefit of the other party to the merger agreement and (i) are not intended to be treated as categorical statements of fact, but rather as a way of allocating risk to one of the parties if those statements prove to be inaccurate, (ii) may have been qualified in the merger agreement by confidential disclosure schedules that were delivered to the other party in connection with the signing of the merger agreement, which disclosure schedules may contain information that modifies, qualifies and creates exceptions to the representations, warranties and covenants set forth in the merger agreement, (iii) may be subject to standards of materiality applicable to the parties that differ from what might be viewed as material to investors, (iv) were made only as of the date of the merger agreement or such other date or dates as may be specified in the merger agreement. Moreover, information concerning the subject matter of the representations, warranties and covenants may change after the date of the merger agreement, which subsequent information may or may not be fully reflected in public disclosures by Mercantile or Firstbank. Accordingly, the representations, warranties and covenants or any descriptions should not be relied upon as characterizations of the actual state of facts or condition of Mercantile or Firstbank.

Mercantile’s Board of Directors has approved, subject to Mercantile shareholder approval, an amendment to the Mercantile articles of incorporation which increases the number of authorized shares of common stock from 20 million to 40 million. The approval of the amendment by the Mercantile shareholders is not a condition precedent to the closing of the merger. In the event this proposal is approved by Mercantile shareholders, but the merger is not completed, the amendment will not become effective.

 

54.


Table of Contents

MERCANTILE BANK CORPORATION

 

Financial Overview

Our operating performance and financial condition continued to improve through the first nine months of 2013. In prior years, especially during the period of 2008 through 2010, our earnings performance was negatively impacted by substantial provisions to the allowance and problem asset administration costs. During that period, ongoing state, regional and national economic struggles negatively impacted some of our borrowers’ cash flows and underlying collateral values, leading to increased nonperforming assets, higher loan charge-offs and increased overall credit risk within our loan portfolio. We have worked with our borrowers to develop constructive dialogue to strengthen our relationships and enhance our ability to resolve complex issues. As a result of those efforts and modestly improved economic conditions, we have experienced significant improvement in our asset quality since the early stages of 2011, resulting in substantially lower provisions to the allowance and problem asset administration costs. Although improving, conditions remain stressed in some sectors, most notably certain non-owner occupied commercial real estate markets. While we have increased our sales efforts to grow the commercial loan portfolio, we remain vigilant as to the administration and quality of our loan portfolio.

We recorded a net profit for the third quarter of 2013, our eleventh consecutive quarterly net profit after over two years of quarterly losses. Significantly improved asset quality has resulted in lower provision expense and problem asset administration costs. In addition, our improved earnings performance reflects the many positive steps we have taken over the past five years to not only partially mitigate the impact of asset quality-related costs in the near term, but to establish an improved foundation for our longer-term performance as well. First, our net interest margin has improved as we have lowered local deposit rates and have replaced maturing high-rate deposits and borrowed funds with lower-costing funds, which has more than offset a decline in asset yields primarily due to a lower interest rate environment. Our commercial loan pricing initiatives have significantly mitigated the negative impact of a higher level of nonaccrual loans. In addition, we have increased our local deposit balances, primarily reflecting the successful implementation of various initiatives, campaigns and product enhancements. The local deposit growth, combined with the reduction of loans outstanding, have provided for a substantial reduction of, and reliance on, wholesale funds and a reduction in our cost of funds. Lastly, our regulatory capital position remains strong.

Our asset quality metrics remain on an improving trend, and we are optimistic that the positive trend will continue. In aggregate dollar amounts, nonperforming asset levels have declined almost 90% since the peak level at March 31, 2010, and at September 30, 2013, were at the lowest level since year-end 2006. Progress in the stabilization of economic and real estate market conditions has resulted in numerous loan rating upgrades and significantly lower volumes of loan rating downgrades, which when combined with increasing recoveries of prior loan charge-offs, have provided for a substantially lower provision expense.

Financial Condition

Our total assets were virtually unchanged during the first nine months of 2013, declining $0.9 million, and totaled $1.42 billion as of September 30, 2013. During this time period, total loans increased $34.3 million, while federal funds sold decreased $18.6 million and securities available for sale declined $14.5 million. Total deposits declined $13.7 million during the first nine months of 2013, while Federal Home Loan Bank (“FHLB”) advances increased $10.0 million.

 

55.


Table of Contents

MERCANTILE BANK CORPORATION

 

Our loan portfolio is primarily comprised of commercial loans. Commercial loans increased $39.3 million during the first nine months of 2013, and at September 30, 2013 totaled $1.01 billion, or 93.7% of the loan portfolio. Non-owner occupied commercial real estate (“CRE”) loans increased $43.4 million, commercial and industrial loans were up $1.6 million and multi-family and residential rental real estate loans grew $2.3 million, while owner occupied CRE loans decreased $0.6 million and vacant land, land development and residential construction loans were down $7.4 million. We are pleased to see the net increase in the commercial loan segment of our loan portfolio. We had experienced a decline in commercial loans during 2012, although a much smaller reduction than what we experienced during the previous three years. During the period of 2009 through 2011, we had made a concerted effort to reduce our non-owner occupied CRE and construction lending segments, and the sluggishness of business activity in our markets resulted in fewer opportunities to make quality loans. We employed a systematic approach to reduce our exposure to certain non-owner occupied CRE and construction businesses given the nature of that type of lending and depressed economic conditions. We believed that such a reduction was in our best interest when taking into account the increased inherent risk and nominal deposit balances associated with the targeted borrowing relationships.

Starting in early 2012, with a pruned commercial loan portfolio, an improved earnings performance and financial condition, and stabilized economic conditions, we significantly enhanced our commercial loan sales efforts. During the first nine months of 2013, we funded approximately $200 million in new commercial loans, expanding the trend that started during 2012 when we funded about $176 million in new commercial loans, a majority of which occurred during the latter half of the year. However, we continue to experience significant commercial loan principal paydowns and payoffs. A majority of these principal paydowns and payoffs were welcomed, such as on stressed loan relationships. We have also experienced some instances where well-performing relationships have been refinanced at other financial institutions and other situations where the borrower has sold the underlying asset, paying off the loan. In many of those cases where the loans were refinanced elsewhere, we believed the terms and conditions of the new lending arrangements were too aggressive, generally reflecting the very competitive banking environment in our markets. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship. In addition, we continue to receive accelerated principal paydowns from certain borrowers who have elevated deposit balances generally resulting from profitable operations and an apparent unwillingness to expand their businesses and/or replace equipment primarily due to economic- and tax-related uncertainties. Usage of existing commercial lines of credit remains relatively steady.

The commercial loan portfolio represents loans to businesses generally located within our markets. Approximately 72% of the commercial loan portfolio is primarily secured by real estate properties, with the remaining generally secured by other business assets such as accounts receivable, inventory and equipment. The continued concentration of the loan portfolio in commercial loans is consistent with our strategy of focusing a substantial amount of our efforts on commercial banking. Corporate and business lending is an area of expertise for our senior management team, and our commercial lenders have extensive commercial lending experience, with most having at least ten years’ experience. Of each of the loan categories that we originate, commercial loans are most efficiently originated and managed, thus limiting overhead costs by necessitating the attention of fewer employees. Our commercial lending business generates the largest portion of local deposits and is our primary source of demand deposits.

 

56.


Table of Contents

MERCANTILE BANK CORPORATION

 

The following table summarizes our loan portfolio:

 

     9/30/13      6/30/13      3/31/13      12/31/12      9/30/12  

Commercial:

              

Commercial & Industrial

   $ 286,887,000       $ 279,300,000       $ 272,890,000       $ 285,322,000       $ 271,814,000   

Land Development & Construction

     40,741,000         42,170,000         45,174,000         48,099,000         56,622,000   

Owner Occupied Commercial RE

     258,656,000         253,172,000         253,089,000         259,277,000         276,185,000   

Non-Owner Occupied Commercial RE

     368,301,000         357,452,000         327,776,000         324,886,000         299,356,000   

Multi-Family & Residential Rental

     53,178,000         53,522,000         50,035,000         50,922,000         53,434,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Commercial

     1,007,763,000         985,616,000         948,964,000         968,506,000         957,411,000   

Retail:

              

1-4 Family Mortgages

     36,575,000         35,709,000         35,735,000         33,766,000         38,454,000   

Home Equity & Other Consumer Loans

     31,149,000         37,337,000         38,257,000         38,917,000         39,423,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Retail

     67,724,000         73,046,000         73,992,000         72,683,000         77,877,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,075,487,000       $ 1,058,662,000       $ 1,022,956,000       $ 1,041,189,000       $ 1,035,288,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential mortgage loans and consumer loans decreased in aggregate $5.0 million during the first nine months of 2013, and at September 30, 2013, totaled $67.7 million, or 6.3% of total loans. Although the residential mortgage loan and consumer loan portfolios may increase in future periods, we expect the commercial sector of the lending efforts and resultant assets to remain the dominant loan portfolio category.

Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to provide appropriate loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur quickly because of changing economic conditions. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on an internal watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on impaired loans, as well as on foreclosed and repossessed assets, are reviewed periodically; however, we have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions.

 

57.


Table of Contents

MERCANTILE BANK CORPORATION

 

Our asset quality continued to improve significantly during the first nine months of 2013, and has now been on an improving trend for over three years. Nonperforming assets, comprised of nonaccrual loans and foreclosed properties, totaled $12.2 million as of September 30, 2013, compared to $25.9 million as of December 31, 2012. The volume of nonperforming assets has generally been on a declining trend since the peak of $117.6 million on March 31, 2010, and is currently at its lowest level since year-end 2006. The level of nonperforming assets began to increase during 2007, with ongoing and significant increases during 2008 and 2009. The increases primarily reflected the impact of poor economic conditions and the resulting negative impact on many of our commercial borrowers’ operating results and financial condition, but were also indicative of our aggressive posture and conservative loan administration practices in regards to measuring borrower financial strength and assigning loan grades on the entire commercial loan portfolio, and developing workout strategies for financially-troubled borrowers. Since 2009, the level of additions to the nonperforming asset category has declined significantly, while the level of interest in, and sales of, foreclosed properties and assets securing nonperforming loans has increased substantially. The resulting impact of our loan administration strategies, combined with a stabilization of economic conditions, have provided for significant improvement in our asset quality and have given us optimism that the momentum will continue in future periods.

The substantial and rapid collapse of the residential real estate market that began in 2007 had a significant negative impact on the residential real estate development lending portion of our business. The resulting decline in real estate prices and slowdown in sales stretched the cash flow of our local developers and eroded the value of our underlying collateral, which caused elevated levels of nonperforming assets and net loan charge-offs. From the period of 2007 through most of 2011, we witnessed stressed economic conditions in Michigan and throughout the country. The resulting decline in business revenue negatively impacted the cash flows of many of our borrowers, some to the point where loan payments became past due. In addition, real estate prices had fallen significantly, thereby exposing us to larger-than-typical losses in those instances where the sale of collateral was the primary source of repayment. Also during that time, we saw deterioration in guarantors’ financial capacities to fund deficient cash flows and reduce or eliminate collateral deficiencies.

Throughout 2008, we experienced a rapid deterioration in a number of commercial loan relationships which previously had been performing satisfactorily. Analysis of certain commercial borrowers revealed a reduced capability to make required payments as indicated by factors such as delinquent loan payments, diminished cash flow, deteriorating financial performance, or past due property taxes, and in the case of commercial and residential development projects slow absorption or sales trends. In addition, commercial real estate is the primary source of collateral for many of these borrowing relationships and updated evaluations and appraisals in many cases reflected significant declines from the original estimated values.

Throughout 2009, 2010 and 2011, we saw a continuation of the stresses caused by the poor economic conditions, especially in the non-owner occupied CRE markets. High vacancy rates or slow absorption resulted in inadequate cash flow generated from some real estate projects we financed and required guarantors to provide personal funds to make full contractual loan payments and pay other operating costs. In some cases, the guarantors’ cash and other liquid reserves became seriously diminished. In other cases, sale of the collateral, either by the borrower or us, was our primary source of repayment.

 

58.


Table of Contents

MERCANTILE BANK CORPORATION

 

As of September 30, 2013, nonperforming assets totaled $12.2 million, or 0.9% of total assets, compared to $25.9 million (1.8% of total assets) and $35.9 million (2.6% of total assets) as of December 31, 2012 and September 30, 2012, respectively. The reductions primarily reflect principal payments and charge-offs on nonaccrual loans, as well as sales proceeds and valuation write-downs on foreclosed properties. The $13.7 million reduction during the first nine months of 2013 and the $23.7 million decline during the twelve-month period ended September 30, 2013, equate to declines of 53.1% and 66.2%, respectively. As of September 30, 2013, nonperforming loans and foreclosed properties consisting of non-owner occupied CRE totaled $5.5 million, reflecting reductions of $7.7 million and $12.1 million during the past nine and twelve months, respectively. Nonperforming loans and foreclosed properties consisting of owner occupied CRE totaled $1.2 million as of September 30, 2013, reflecting reductions of $2.3 million and $5.2 million during the past nine and twelve months, respectively. Nonperforming loans secured by, and foreclosed properties consisting of, owner occupied and rental residential properties totaled $3.1 million at September 30, 2013, reflecting reductions of $1.7 million and $2.3 million during the past nine and twelve months, respectively.

The following tables provide a breakdown of nonperforming assets by collateral type:

NONPERFORMING LOANS

 

     9/30/13      6/30/13      3/31/13      12/31/12      9/30/12  

Residential Real Estate:

              

Land Development

   $ 43,000       $ 317,000       $ 471,000       $ 1,188,000       $ 1,820,000   

Construction

     0         0         316,000         319,000         321,000   

Owner Occupied / Rental

     2,859,000         3,201,000         3,298,000         4,321,000         4,952,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,902,000         3,518,000         4,085,000         5,828,000         7,093,000   

Commercial Real Estate:

              

Land Development

     627,000         650,000         704,000         737,000         817,000   

Construction

     0         0         0         0         0   

Owner Occupied

     718,000         960,000         1,747,000         2,577,000         4,238,000   

Non-Owner Occupied

     3,251,000         4,642,000         4,988,000         9,093,000         11,247,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     4,596,000         6,252,000         7,439,000         12,407,000         16,302,000   

Non-Real Estate:

              

Commercial Assets

     1,111,000         755,000         869,000         734,000         1,386,000   

Consumer Assets

     0         1,000         1,000         1,000         1,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,111,000         756,000         870,000         735,000         1,387,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 8,609,000       $ 10,526,000       $ 12,394,000       $ 18,970,000       $ 24,782,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

59.


Table of Contents

MERCANTILE BANK CORPORATION

 

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

 

     9/30/13      6/30/13      3/31/13      12/31/12      9/30/12  

Residential Real Estate:

              

Land Development

   $ 495,000       $ 619,000       $ 899,000       $ 1,174,000       $ 1,498,000   

Construction

     89,000         89,000         132,000         157,000         324,000   

Owner Occupied / Rental

     219,000         315,000         729,000         491,000         474,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     803,000         1,023,000         1,760,000         1,822,000         2,296,000   

Commercial Real Estate:

              

Land Development

     6,000         31,000         51,000         52,000         341,000   

Construction

     0         0         0         0         0   

Owner Occupied

     501,000         606,000         961,000         957,000         2,157,000   

Non-Owner Occupied

     2,239,000         2,256,000         3,734,000         4,139,000         6,366,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,746,000         2,893,000         4,746,000         5,148,000         8,864,000   

Non-Real Estate:

              

Commercial Assets

     0         0         0         0         0   

Consumer Assets

     0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,549,000       $ 3,916,000       $ 6,506,000       $ 6,970,000       $ 11,160,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following tables provide a reconciliation of nonperforming assets:

NONPERFORMING LOANS RECONCILIATION

 

     3rd Qtr     2nd Qtr     1st Qtr     4th Qtr     3rd Qtr  
     2013     2013     2013     2012     2012  

Beginning balance

   $ 10,526,000      $ 12,395,000      $ 18,970,000      $ 24,782,000      $ 28,524,000   

Additions, net of transfers to ORE

     502,000        438,000        (948,000     2,387,000        (1,494,000

Returns to performing status

     0        0        0        (37,000     0   

Principal payments

     (2,363,000     (1,988,000     (3,511,000     (6,960,000     (1,245,000

Loan charge-offs

     (56,000     (319,000     (2,116,000     (1,202,000     (1,003,000
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 8,609,000      $ 10,526,000      $ 12,395,000      $ 18,970,000      $ 24,782,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

60.


Table of Contents

MERCANTILE BANK CORPORATION

 

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION

 

     3rd Qtr     2nd Qtr     1st Qtr     4th Qtr     3rd Qtr  
     2013     2013     2013     2012     2012  

Beginning balance

   $ 3,916,000      $ 6,505,000      $ 6,969,000      $ 11,160,000      $ 11,545,000   

Additions

     350,000        57,000        1,640,000        1,303,000        1,652,000   

Sale proceeds

     (527,000     (2,374,000     (1,887,000     (4,858,000     (1,190,000

Valuation write-downs

     (190,000     (272,000     (217,000     (636,000     (847,000
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 3,549,000      $ 3,916,000      $ 6,505,000      $ 6,969,000      $ 11,160,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Through the first nine months of 2013, the level of loan charge-offs continued to significantly decline, especially in comparison to the levels during 2010 and 2009. The reduction primarily reflects a decline in nonperforming loans and an overall improvement in the quality of the loan portfolio. During the first nine months of 2013, we recorded net recoveries of prior period charge-offs totaling $1.2 million, or an annualized negative 0.2% of average total loans. For comparative purposes, net loan charge-offs equaled 0.5%, 1.4%, 2.4% and 2.2% of average loans during 2012, 2011, 2010 and 2009, respectively. Recoveries of previously charged-off loans totaled $4.1 million during the first nine months of 2013. For comparative purposes, recoveries of previously charged-off loans totaled $7.9 million, $4.2 million, $2.8 million and $1.4 million in 2012, 2011, 2010 and 2009, respectively.

The following table provides a breakdown of net loan charge-offs (recoveries) by collateral type:

 

     3rd Qtr     2nd Qtr     1st Qtr     4th Qtr     3rd Qtr  
     2013     2013     2013     2012     2012  

Residential Real Estate:

          

Land Development

   $ (387,000   $ (119,000   $ 690,000      $ (119,000   $ 77,000   

Construction

     0        0        0        0        0   

Owner Occupied / Rental

     (105,000     (301,000     479,000        16,000        166,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (492,000     (420,000