mbwm20140630_10q.htm 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 June 30, 2014

 

[  ] 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 

 

 

 

(IRS Employer Identification No.)

incorporation or organization)        

 

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 August 8, 2014, there were 16,851,320 shares of common stock outstanding.

 

 
 

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

INDEX

 


  

PART I.

Financial Information  

Page No.
     
 

Item 1.       Financial Statements

 
     
 

Condensed Consolidated Balance Sheets - June 30, 2014 (Unaudited) and December 31, 2013

  1
 

 

 
 

Condensed Consolidated Statements of Income - Three and Six Months Ended June 30, 2014 (Unaudited) and June 30, 2013 (Unaudited)

2

     
 

Condensed Consolidated Statements of Comprehensive Income - Three and Six Months Ended June 30, 2014 (Unaudited) and June 30, 2013 (Unaudited)

3

 

 

 
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity - Six Months Ended June 30, 2014 (Unaudited) and June 30, 2013 (Unaudited)

4

 

 

 
 

Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2014 (Unaudited) and June 30, 2013 (Unaudited)

6

     
 

Notes to Condensed Consolidated Financial Statements (Unaudited)  

  8
     
 

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

  65
     
 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

  83
     
 

Item 4.   Controls and Procedures

  86
     

PART II.

Other Information

 
     
 

Item 1.        Legal Proceedings

  87
     
 

Item 1A.     Risk Factors

  87
     
 

Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds

  87
     
 

Item 3.        Defaults Upon Senior Securities

  87
     
 

Item 4.        Mine Safety Disclosures

  87
     
 

Item 5.        Other Information  

  87
     
 

Item 6.        Exhibits

  88
     
 

Signatures

  89

  

 
 

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

PART I --- FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

 


 

   

June 30,

   

December 31,

 
   

2014

    2013  
   

(Unaudited)

    (Audited)  

ASSETS

               

Cash and due from banks

  $ 58,730,000     $ 17,149,000  

Interest-bearing deposits

    48,150,000       6,389,000  

Federal funds sold

    11,973,000       123,427,000  

Total cash and cash equivalents

    118,853,000       146,965,000  
                 

Securities available for sale

    475,275,000       131,178,000  

Federal Home Loan Bank stock

    19,226,000       11,961,000  
                 

Loans

    2,073,482,000       1,053,243,000  

Allowance for loan losses

    (20,856,000 )     (22,821,000 )

Loans, net

    2,052,626,000       1,030,422,000  
                 

Premises and equipment, net

    49,003,000       24,898,000  

Bank owned life insurance

    55,693,000       51,377,000  

Goodwill

    50,870,000       0  

Core deposit intangible

    17,213,000       0  

Net deferred tax asset

    9,238,000       17,754,000  

Accrued interest receivable

    7,711,000       3,649,000  

Other real estate owned and repossessed assets

    2,878,000       2,851,000  

Other assets

    20,696,000       5,911,000  
                 

Total assets

  $ 2,879,282,000     $ 1,426,966,000  
                 

LIABILITIES AND SHAREHOLDERS' EQUITY

               

Deposits

               

Noninterest-bearing

  $ 515,646,000     $ 224,580,000  

Interest-bearing

    1,787,615,000       894,331,000  

Total deposits

    2,303,261,000       1,118,911,000  
                 

Securities sold under agreements to repurchase

    124,108,000       69,305,000  

Federal Home Loan Bank advances

    57,044,000       45,000,000  

Subordinated debentures

    54,131,000       32,990,000  

Other borrowed money

    14,348,000       1,620,000  

Accrued interest and other liabilities

    10,252,000       5,815,000  

Total liabilities

    2,563,144,000       1,273,641,000  
                 

Shareholders' equity

               

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

    0       0  

Common stock, no par value; 40,000,000 shares authorized; 16,839,175 shares outstanding at June 30, 2014 and 8,739,108 shares outstanding at December 31, 2013

    318,452,000       162,999,000  

Retained earnings (deficit)

    673,000       (4,101,000 )

Accumulated other comprehensive income (loss)

    (2,987,000 )     (5,573,000 )

Total shareholders’ equity

    316,138,000       153,325,000  
                 

Total liabilities and shareholders’ equity

  $ 2,879,282,000     $ 1,426,966,000  

 

 


 

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

   

Six Months

   

Six Months

 
   

Ended

   

Ended

   

Ended

    Ended  
   

June 30, 2014

   

June 30, 2013

   

June 30, 2014

    June 30, 2013  
   

(Unaudited)

   

(Unaudited)

   

(Unaudited)

    (Unaudited)  

Interest income

                               

Loans, including fees

  $ 16,657,000     $ 12,687,000     $ 28,756,000     $ 25,533,000  

Securities, taxable

    1,393,000       1,007,000       2,627,000       2,014,000  

Securities, tax-exempt

    374,000       257,000       557,000       552,000  

Federal funds sold

    41,000       35,000       109,000       89,000  

Interest-bearing deposits

    17,000       6,000       21,000       13,000  

Total interest income

    18,482,000       13,992,000       32,070,000       28,201,000  
                                 

Interest expense

                               

Deposits

    2,272,000       2,223,000       4,307,000       4,543,000  

Short-term borrowings

    27,000       19,000       49,000       39,000  

Federal Home Loan Bank advances

    156,000       119,000       306,000       238,000  

Other borrowings

    474,000       319,000       791,000       615,000  

Total interest expense

    2,929,000       2,680,000       5,453,000       5,435,000  
                                 

Net interest income

    15,553,000       11,312,000       26,617,000       22,766,000  
                                 

Provision for loan losses

    (700,000 )     (1,500,000 )     (2,600,000 )     (3,000,000 )
                                 

Net interest income after provision for loan losses

    16,253,000       12,812,000       29,217,000       25,766,000  
                                 

Noninterest income

                               

Services charges on accounts

    522,000       384,000       887,000       758,000  

Earnings on bank owned life insurance

    282,000       350,000       581,000       688,000  

Mortgage banking activities

    349,000       225,000       412,000       477,000  

Rental income from other real estate owned

    43,000       156,000       99,000       355,000  

Other income

    1,092,000       657,000       1,815,000       1,321,000  

Total noninterest income

    2,288,000       1,772,000       3,794,000       3,599,000  
                                 

Noninterest expense

                               

Salaries and benefits

    7,037,000       4,981,000       12,267,000       9,838,000  

Occupancy

    914,000       624,000       1,626,000       1,282,000  

Furniture and equipment

    368,000       256,000       615,000       512,000  

FDIC insurance costs

    224,000       175,000       401,000       420,000  

Problem asset costs

    (36,000 )     279,000       (56,000 )     410,000  

Merger-related costs

    3,453,000       46,000       3,830,000       60,000  

Other expense

    4,106,000       2,452,000       6,590,000       4,875,000  

Total noninterest expenses

    16,066,000       8,813,000       25,273,000       17,397,000  
                                 

Income before federal income tax expense

    2,475,000       5,771,000       7,738,000       11,968,000  
                                 

Federal income tax expense

    966,000       1,755,000       2,649,000       3,552,000  
                                 

Net income

  $ 1,509,000     $ 4,016,000     $ 5,089,000     $ 8,416,000  
                                 

Basic earnings per share

  $ 0.13     $ 0.46     $ 0.50     $ 0.97  

Diluted earnings per share

  $ 0.13     $ 0.46     $ 0.50     $ 0.97  

Cash dividends per share

  $ 2.12     $ 0.11     $ 2.24     $ 0.21  
                                 

Average basic shares outstanding

  $ 11,406,908     $ 8,705,667     $ 10,080,242     $ 8,705,673  

Average diluted shares outstanding

  $ 11,435,867     $ 8,718,649     $ 10,094,725     $ 8,718,627  

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 
2.

Table Of Contents
 

  

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 


 

   

Three Months

   

Three Months

   

Six Months

   

Six Months

 
   

Ended

   

Ended

   

Ended

    Ended  
   

June 30, 2014

   

June 30, 2013

   

June 30, 2014

    June 30, 2013  
   

(Unaudited)

   

(Unaudited)

   

(Unaudited)

    (Unaudited)  
                                 

Net income

  $ 1,509,000     $ 4,016,000     $ 5,089,000     $ 8,416,000  
                                 

Other comprehensive income (loss):

                               

Unrealized holding gains (losses) on securities available for sale

    1,537,000       (3,787,000 )     4,148,000       (4,789,000 )

Fair value of interest rate swap

    (140,000 )     763,000       (126,000 )     797,000  
      1,397,000       (3,024,000 )     4,022,000       (3,992,000 )
                                 

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

    (568,000 )     1,325,000       (1,481,000 )     1,676,000  

Tax effect of fair value of interest rate swap

    49,000       (266,000 )     45,000       (226,000 )
      (519,000 )     1,059,000       (1,436,000 )     1,450,000  
                                 

Other comprehensive income (loss), net of tax

    878,000       (1,965,000 )     2,586,000       (2,542,000 )
                                 

Comprehensive income

  $ 2,387,000     $ 2,051,000     $ 7,675,000     $ 5,874,000  

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 
3.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

 


 

                            Accumulated          
                    Retained     Other     Total  

($ in thousands)

 

Preferred

   

Common

   

Earnings

   

Comprehensive

   

Shareholders’

 
   

Stock

   

Stock

   

(Deficit)

   

Income (Loss)

    Equity  
                                         

Balances, January 1, 2014

  $ 0     $ 162,999     $ (4,101 )   $ (5,573 )   $ 153,325  
                                         

Stock option exercises (5,920 shares)

            75                       75  
                                         

Stock grants to directors for retainer fees (7,375 shares)

            155                       155  
                                         

Stock-based compensation expense

            351                       351  
                                         

Cash dividends ($2.24 per common share)

            (20,102 )     (315 )             (20,417 )
                                         

Common stock issued in connection with Firstbank merger (8,087,272 shares)

            173,310                       173,310  
                                         

Stock options issued to replace existing Firstbank options at merger date

            1,664                       1,664  
                                         

Net income for the six months ended June 30, 2014

                    5,089               5,089  
                                         

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

                            2,667       2,667  
                                         

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

                            (81     (81 )
                                         

Balances, June 30, 2014

  $ 0     $ 318,452     $ 673     $ (2,987 )   $ 316,138  

 

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 
4.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION 

CONDENSED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

 


 

                            Accumulated          
                    Retained     Other     Total  

($ in thousands)

 

Preferred

   

Common

   

Earnings

   

Comprehensive

   

Shareholders’

 
   

Stock

   

Stock

   

(Deficit)

   

Income (Loss)

    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-based compensation expense

            236                       236  
                                         

Cash dividends ($0.21 per common share)

            (1,814 )                     (1,814 )
                                         

Net income for the six months ended June 30, 2013

                    8,416               8,416  
                                         

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

                            (3,113 )     (3,113 )
                                         

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

                            571       571  
                                         

Balances, June 30, 2013

  $ 0     $ 164,548     $ (12,718 )   $ (892 )   $ 150,938  

 

 


 

See accompanying notes to condensed consolidated financial statements.

  

 
5.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 


 

   

Six Months

   

Six Months

 
   

Ended

    Ended  
   

June 30, 2014

    June 30, 2013  

Cash flows from operating activities

               

Net income

  $ 5,089,000     $ 8,416,000  

Adjustments to reconcile net income to net cash from operating activities

               

Depreciation and amortization

    1,967,000       1,086,000  

Accretion of acquired loans

    (512,000 )     0  

Provision for loan losses

    (2,600,000 )     (3,000,000 )

Stock-based compensation expense

    351,000       236,000  

Proceeds from sales of mortgage loans held for sale

    16,958,000       29,298,000  

Origination of mortgage loans held for sale

    (16,525,000 )     (28,383,000 )

Net gain from sales of mortgage loans held for sale

    (383,000 )     (395,000 )

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

    (605,000 )     (895,000 )

Earnings on bank owned life insurance

    (581,000 )     (688,000 )

Net change in:

               

Accrued interest receivable

    312,000       214,000  

Other assets

    (1,678,000 )     11,930,000  

Accrued interest and other liabilities

    (5,844,000 )     (1,368,000 )

Net cash from (for) operating activities

    (4,051,000 )     16,451,000  
                 

Cash flows from investing activities

               

Cash received in merger

    91,806,000       0  

Loan originations and payments, net

    (75,655,000 )     (20,433,000 )

Purchases of securities available for sale

    (11,679,000 )     (28,973,000 )

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

    22,800,000       28,538,000  

Proceeds from sales of securities available for sale

    0       3,905,000  

Proceeds from sales of foreclosed assets

    1,940,000       5,659,000  

Purchases of premises and equipment

    (874,000 )     (134,000 )

Net cash from (for) investing activities

    28,338,000       (11,438,000 )
                 

Cash flows from financing activities

               

Net decrease in time deposits

    (15,516,000 )     (51,608,000 )

Net decrease in all other deposits

    (29,743,000 )     (22,281,000 )

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

    319,000       (7,437,000 )

Net increase in other borrowed money

    12,728,000       49,000  

Proceeds from stock option exercises

    75,000       0  

Employee stock purchase plan

    0       19,000  

Dividend reinvestment plan

    0       33,000  

Stock grants to directors for retainer fee

    155,000       0  

Payment of cash dividends to common shareholders

    (20,417,000 )     (1,814,000 )

Net cash for financing activities

    (52,399,000 )     (83,039,000 )
                 

Net change in cash and cash equivalents

    (28,112,000 )     (78,026,000 )

Cash and cash equivalents at beginning of period

    146,965,000       136,003,000  

Cash and cash equivalents at end of period

  $ 118,853,000     $ 57,977,000  

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 
6.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

 


 

Supplemental disclosures of cash flows information

               

Cash paid during the period for:

               

Interest

  $ 5,336,000     $ 6,068,000  

Federal income tax

    1,400,000       0  

Noncash financing and investing activities:

               

Transfers from loans to foreclosed assets

    175,000       1,710,000  

 

 


 

See accompanying notes to condensed consolidated financial statements.

 

 
7.

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 six months ended June 30, 2014 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 June 30, 2014 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, 2013.

 

We have five separate business trusts that were formed to issue trust preferred securities. Subordinated debentures were issued to the trusts in return for the proceeds raised from the issuance of the trust preferred securities. The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts 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 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.

 

Stock options for approximately 159,000 shares of common stock were included in determining diluted earnings per share for the three and six months ended June 30, 2014. Stock options for approximately 177,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and six months ended June 30, 2014.

 

Approximately 64,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and six months ended June 30, 2013. In addition, stock options for approximately 21,000 shares of common stock were included in determining diluted earnings per share for the three and six months ended June 30, 2013. Stock options for approximately 132,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and six months ended June 30, 2013.

 


 

(Continued)

 

 
8.

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)

 

 
9.

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.

 

Investments: Investments are presented at fair value as required by accounting principles. Our investment portfolio is classified as available for sale, as such: adjustments to the fair value are reported as a change in equity. If a security is deemed to be other than temporarily impaired, the adjustment to fair value is recorded through the income statement.

 

Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value and the related unrealized holding gain or loss (the difference between the fair value and amortized cost of the securities so classified) is reported in other comprehensive income. Other securities such as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premium or accretion of purchase discount. Premiums and discounts on securities are amortized or accreted on the level-yield method. Gains and losses on sales are recorded on the trade date and are determined using the specific identification method.

 

Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near-term prospects of the issuer; and (3) the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

 


 

 (Continued)

 

 
10.

Table Of Contents
 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

1.     SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of June 30, 2014 and December 31, 2013, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $1.9 million and $1.1 million, respectively.

 

Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the loan at the same time we make a rate commitment to the borrower. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives is included in the gain on sale of loans. Mortgage loans serviced for others totaled $593.0 million as of June 30, 2014.

 

Mortgage Banking Activities: Servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans as to interest rates, types of loans, loan size, term and other factors. Any temporary impairment of a grouping is reported as a valuation allowance which is recovered when impairment no longer exists. Other-than-temporary impairments are recorded as a direct write-down to the carrying value of the servicing assets.

 

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage servicing rights is netted against loan servicing income in the income statement.

 

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 generally 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. The current outstanding interest rate swap is discussed in more detail in Note 11. 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.

 

Goodwill and Core Deposit Intangible: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur. We use a discounted income approach and a market valuation model, which compares the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill has been impaired.

 

The core deposit intangible that arose from the Firstbank Corporation acquisition was initially measured at fair value and is being amortized into noninterest expense over a ten-year period using the sum-of-the-years-digits methodology.

 

Adoption of New Accounting Standards: In January of 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The ASU also requires additional related interim and annual disclosures. The guidance in this ASU is effective for annual and interim periods beginning after December 15, 2014. The adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 


 

(Continued)

 

 
12.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

1.     SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. This ASU is effective for annual and interim periods beginning after December 15, 2016 with three transition methods available – full retrospective, retrospective and cumulative effect approach. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This ASU requires two accounting changes. First, repurchase-to-maturity transactions will be accounted for as secured borrowing transactions on the balance sheet, rather than sales. Second, for repurchase financing arrangements, the ASU requires separate accounting for a transfer of a financial asset executed contemporaneously with (or in contemplation of) a repurchase agreement with the same counterparty, which also will generally result in secured borrowing accounting for the repurchase agreement. The ASU also introduces new disclosures to increase transparency about the types of collateral pledged for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The ASU also requires a transferor to disclose information about transactions accounted for as a sale in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets through an agreement with the transferee. The accounting changes and disclosure for certain transactions accounted for as a sale are effective for the first interim or annual period beginning after December 15, 2014. The disclosure for transactions accounted for as secured borrowings is required for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 

 

2.     BUSINESS COMBINATION

 

We completed the merger of Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $1.5 billion in total assets and 46 branch locations, into Mercantile Bank Corporation as of June 1, 2014 (“Merger Date”). The results of operations due to the Firstbank transaction have been included in Mercantile’s financial results since the Merger Date. All of Firstbank’s common stock was converted into the right to receive one share of Mercantile common stock for each share of Firstbank common stock. The conversion of Firstbank’s common stock into Mercantile’s common stock resulted in Mercantile issuing 8,087,272 shares of its common stock. The merger provided an expanded geographic footprint for the Company and increased the size of the balance sheet wherein the combined companies can realize economies of scale and other operating efficiencies. In conjunction with the completion of the merger, Mercantile assumed the obligations of Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III and Firstbank Capital Trust IV.

 


 

(Continued)

 

 
13.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

2.     BUSINESS COMBINATION (Continued)

 

The Firstbank transaction was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Merger Date. Preliminary goodwill of $50.9 million was calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created from combining the two banking organizations as well as the economies of scale expected from combining the operations of the two companies. None of the goodwill is deductible for income tax purposes as the merger is accounted for as a tax-free exchange.

 

The following table provides the purchase price calculation as of the Merger Date and the identifiable assets purchased and the liabilities assumed at their estimated fair values. These fair value measurements are provisional based on third-party valuations that are currently under review and are subject to refinement for up to one year after the Merger Date based on additional information that may be obtained by us that existed as of the Merger Date.

 

Purchase Price:

Mercantile common shares issued for Firstbank common shares

            8,087,272  

Price per share, based on Mercantile closing price on May 30, 2014

          $ 21.43  

Value of common stock issued

            173,310,000  

Replacement stock options

            1,664,000  

Total purchase price

          $ 174,974,000  

 

Preliminary Statement of Net Assets Acquired at Fair Value:

Assets

               

Cash and cash equivalents

  $ 91,806,000          

Securities

    358,599,000          

Total loans

    943,662,000          

Premises and equipment

    24,049,000          

Core deposit intangible

    17,478,000          

Mortgage servicing rights

    7,389,000          

Other assets

    8,500,000          

Total Assets

  $ 1,451,483,000          

Liabilities

               

Deposits

  $ 1,229,609,000          

Borrowings

    87,615,000          

Other liabilities

    10,155,000          

Total Liabilities

  $ 1,327,379,000          

Net Identifiable Assets Acquired

          $ 124,104,000  

Goodwill

          $ 50,870,000  

 


 

(Continued)

 

 
14.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

2.     BUSINESS COMBINATION (Continued)

 

The fair value of mortgage servicing rights was $7.4 million at the Acquisition Date. During the month of June 2014, new servicing rights amounting to less than $0.1 million and amortization expense of $0.1 million were recorded.

 

Firstbank’s results of operations prior to the Merger Date are not included in our consolidated statements of income or consolidated statements of comprehensive income. The operations of the former Firstbank organization provided approximately $4.5 million in net interest income for the period from the Merger Date to June 30, 2014.

 

We recorded merger-related expenses of $3.5 million and $3.8 million during the three month and six month periods ended June 30, 2014, respectively. Such expenses were generally for professional services, costs related to termination of existing contractual arrangements for various services, retention and severance compensation costs, marketing and promotional expenses, travel costs, and printing and supplies costs. Virtually all of Mercantile and Firstbank’s operating systems are now integrated.

 

The following table provides the unaudited pro forma information for the results of operations for the three and six month periods ended June 30, 2014 and 2013, as if the acquisition had occurred on January 1 of each year. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily comprised of Firstbank’s loan and deposit portfolios. In addition, the $3.8 million in merger-related expenses noted earlier are included in each period presented. We expect to achieve further operating cost savings and other business synergies as a result of the merger which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes only and are not intended to represent or be indicative of the actual results of operations of the combined banking organization that would have been achieved had the merger occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.

 

   

Three months ended June 30,

    Six months ended June 30,  
   

2014

   

2013

   

2014

    2013  
                                 

Net interest income

  $ 15,453,000     $ 11,212,000     $ 26,417,000     $ 22,566,000  

Noninterest expense

    17,160,000       13,407,000       26,862,000       22,786,000  

Net income

    863,000       900,000       4,186,000       5,043,000  

Net income per diluted share

    0.05       0.05       0.25       0.30  

 

In most instances, determining the fair value of the acquired assets and assumed liabilities required us to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Firstbank’s previously established allowance for loan losses.

 


(Continued) 

 

 
15.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

2.     BUSINESS COMBINATION (Continued)

 

The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (“acquired impaired”), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (“acquired non-impaired”). In addition, the loans are further categorized into different loan pools based primarily on the type and purpose of the loan.

 

The provisional fair value of loans at the Acquisition Date is presented in the following table:

 

   

Acquired

   

Acquired

   

Acquired

 
   

Impaired

   

Non-Impaired

    Total Loans  

Commercial Loans:

                       

Commercial & industrial

  $ 878,000     $ 163,316,000     $ 164,194,000  

Commercial real estate

    12,973,000       378,016,000       390,989,000  

Construction & development

    1,289,000       33,726,000       35,015,000  

Total Commercial Loans

  $ 15,140,000     $ 575,058,000     $ 590,198,000  
                         

Consumer Loans:

                       

Residential mortgages

  $ 9,694,000     $ 216,653,000     $ 226,347,000  

Instalment

    167,000       61,657,000       61,824,000  

Home equity lines

    288,000       52,054,000       52,342,000  

Construction

    76,000       12,875,000       12,951,000  

Total Consumer Loans

  $ 10,225,000     $ 343,239,000     $ 353,464,000  

Total Loans

  $ 25,365,000     $ 918,297,000     $ 943,662,000  

  

The following table presents data on acquired impaired loans at the Acquisition Date:

 

           

Acquired

         

 

          Impaired          
                         

Contractual required payments

          $ 44,936,000          

Nonaccretable difference

            17,057,000          

Expected cash flows

            27,879,000          

Accretable yield

            2,514,000          

Carrying balance

          $ 25,365,000          

 

The nonaccretable difference includes $10.4 million in principal cash flows not expected to be collected, $2.8 million of pre-acquisition charge-offs and $3.9 million of future interest not expected to be collected. The unpaid principal balance of acquired performing loans was $926.4 million at the Acquisition Date, and the unaccreted discount on such loans was $8.1 million.

 


(Continued) 

 

 
16.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

2.     BUSINESS COMBINATION (Continued)

 

We also assumed obligations under junior subordinated debentures with an aggregate balance of $36.1 million and an aggregate fair value of $21.1 million as of the Acquisition Date, payable to four unconsolidated trusts (Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III, and Firstbank Capital Trust IV) that have issued trust preferred securities. The junior subordinated debentures are the sole assets of each trust. Interest rates on all trust preferred securities issued by the trusts are tied to the 90 Day Libor rate with spreads ranging from 135 basis points to 199 basis points, and reset quarterly. The trust preferred securities have maturity dates ranging from October, 2034 to July, 2037, and are callable by us in whole or in part quarterly. The junior subordinated debentures are unsecured obligations of Mercantile, who has guaranteed that interest payments on the junior subordinated debentures made to the trust will be distributed by the trust to the holders of the trust preferred securities. The trust preferred securities currently fully qualify as Tier 1 Capital, and under current risk-based capital guidelines, will remain fully qualified as Tier 1 Capital until maturity unless called by us at an earlier date. 

 

3.     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:

 

           

Gross

    Gross          
   

Amortized

   

Unrealized

   

Unrealized

    Fair  
   

Cost

   

Gains

   

Losses

    Value  

June 30, 2014

                               

U.S. Government agency debt obligations

  $ 219,141,000     $ 731,000     $ (6,166,000 )   $ 213,706,000  

Mortgage-backed securities

    107,145,000       1,249,000       (222,000 )     108,172,000  

Municipal general obligation bonds

    139,996,000       894,000       (721,000 )     140,169,000  

Municipal revenue bonds

    11,244,000       115,000       (35,000 )     11,324,000  

Other Investments

    1,909,000       0       (5,000 )     1,904,000  
                                 
    $ 479,435,000     $ 2,989,000     $ (7,149,000 )   $ 475,275,000  
                                 

December 31, 2013

                               

U.S. Government agency debt obligations

  $ 108,279,000     $ 263,000     $ (10,065,000 )   $ 98,477,000  

Mortgage-backed securities

    12,456,000       1,102,000       0       13,558,000  

Municipal general obligation bonds

    16,488,000       388,000       (4,000 )     16,872,000  

Municipal revenue bonds

    878,000       38,000       0       916,000  

Mutual funds

    1,386,000       0       (31,000 )     1,355,000  
                                 
    $ 139,487,000     $ 1,791,000     $ (10,100,000 )   $ 131,178,000  

 


 

(Continued)

 

 
17.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


  

3.     SECURITIES (Continued) 

 

Securities with unrealized losses at June 30, 2014 and December 31, 2013, 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

   

Unrealized

   

Fair

   

Unrealized

   

Fair

    Unrealized  
   

Value

   

Loss

   

Value

   

Loss

   

Value

    Loss  
                                                 

June 30, 2014

                                               

U.S. Government agency debt obligations

  $ 90,627,000     $ (373,000 )   $ 69,159,000     $ (5,793,000 )   $ 159,786,000     $ (6,166,000 )

Mortgage-backed securities

    64,108,000       (222,000 )     0       0       64,108,000       (222,000 )

Municipal general obligation bonds

    92,461,000       (721,000 )     0       0       92,461,000       (721,000 )

Municipal revenue bonds

    7,775,000       (35,000 )     0       0       7,775,000       (35,000 )

Other Investments

    0       0       1,395,000       (5,000 )     1,395,000       (5,000 )
                                                 
    $ 254,971,000     $ (1,351,000 )   $ 70,554,000     $ (5,798,000 )   $ 325,525,000     $ (7,149,000 )
                                                 
                                                 

December 31, 2013

                                               

U.S. Government agency debt obligations

  $ 57,117,000     $ (5,798,000 )   $ 29,679,000     $ (4,267,000 )   $ 86,796,000     $ (10,065,000 )

Mortgage-backed securities

    0       0       0       0       0       0  

Municipal general obligation bonds

    295,000       (4,000 )     0       0       295,000       (4,000 )

Municipal revenue bonds

    0       0       0       0       0       0  

Mutual funds

    1,355,000       (31,000 )     0       0       1,355,000       (31,000 )
                                                 
    $ 58,767,000     $ (5,833,000 )   $ 29,679,000     $ (4,267,000 )   $ 88,446,000     $ (10,100,000 )

 


(Continued) 

 

 
18.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


  

3.     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 June 30, 2014, 452 debt securities and one mutual fund with fair values totaling $325.5 million have unrealized losses aggregating $7.1 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 value of debt securities at June 30, 2014, 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

   

Amortized

    Fair  
   

Yield

   

Cost

    Value  
                         

Due in 2014

       0.86%     $ 20,435,000     $ 20,538,000  

Due in 2015 through 2019

    1.25       178,246,000       182,962,000  

Due in 2020 through 2024

    2.95       78,336,000       88,647,000  

Due in 2025 and beyond

    3.63       89,198,000       73,052,000  

Mortgage-backed securities

    1.73       103,209,000       108,172,000  

Other Investments

    1.55       1,909,000       1,904,000  
                         
         2.07%     $ 471,333,000     $ 475,275,000  

 


 

(Continued)

 

 
19.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

3.     SECURITIES (Continued)

 

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $114.8 million and $17.4 million at June 30, 2014 and December 31, 2013, respectively, with estimated market values of $115.2 million and $17.8 million, respectively. Securities issued by all other states and their political subdivisions had a combined amortized cost of $36.4 million and estimated market value of $36.3 million at June 30, 2014. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, 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 $272.6 million and $94.4 million at June 30, 2014 and December 31, 2013, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer. 

 

 

 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans originated for investment are stated at their principal amount outstanding adjusted for partial charge-offs, the allowance, and net deferred loan fees and costs. Interest income on loans is accrued over the term of the loans primarily using the simple interest method based on the principal balance outstanding. Interest is not accrued on loans where collectability is uncertain. Accrued interest is presented separately in the consolidated balance sheet. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.

 

Acquired loans are those purchased in the Firstbank merger (See Note 2 – Business Combination for further information). These loans were recorded at estimated fair value at the Acquisition Date with no carryover of the related allowance. The acquired loans were segregated between those considered to be performing (“acquired non-impaired loans”) and those with evidence of credit deterioration (“acquired impaired loans”). Acquired loans are considered impaired if there is evidence of credit deterioration and if it is probable, at acquisition, all contractually required payments will not be collected. Acquired loans restructured after acquisition are not considered or reported as troubled debt restructurings if the loans evidenced credit deterioration as of the Acquisition Date and are accounted for in pools. No acquired loans were modified as troubled debt restructurings after the Acquisition Date.

 

The fair value estimates for acquired loans are based on expected prepayments and the amount and timing of discounted expected principal, interest and other cash flows. Credit discounts representing the principal losses expected over the life of the loan are also a component of the initial fair value. In determining the Acquisition Date fair value of acquired impaired loans, and in subsequent accounting, we have generally aggregated acquired commercial and consumer loans into pools of loans with common risk characteristics.

 


 

(Continued) 

 

 
20.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The difference between the fair value of an acquired non-impaired loan and contractual amounts due at the Acquisition Date is accreted into income over the estimated life of the loan. Contractually required payments represent the total undiscounted amount of all uncollected principal and interest payments. Acquired non-impaired loans are placed on nonaccrual status and reported as nonperforming or past due using the same criteria applied to the originated loan portfolio.

 

The excess of an acquired impaired loan’s contractually required payments over the amount of its undiscounted cash flows expected to be collected is referred to as the non-accretable difference. The non-accretable difference, which is neither accreted into income nor recorded on the consolidated balance sheet, reflects estimated future credit losses and uncollectible contractual interest expected to be incurred over the life of the acquired impaired loan. The excess cash flows expected to be collected over the carrying amount of the acquired loan is referred to as the accretable yield. This amount is accreted into interest income over the remaining life of the acquired loans or pools using the level yield method. The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment speed assumptions and changes in expected principal and interest payments over the estimated lives of the acquired impaired loans.

 

We evaluate quarterly the remaining contractual required payments receivable and estimate cash flows expected to be collected over the life of the impaired loans. Contractually required payments receivable may increase or decrease for a variety of reasons, for example, when the contractual terms of the loan agreement are modified, when interest rates on variable rate loans change, or when principal and/or interest payments are received. Cash flows expected to be collected on acquired impaired loans are estimated by incorporating several key assumptions similar to the initial estimate of fair value. These key assumptions include probability of default, loss given default, and the amount of actual prepayments after the Acquisition Date. Prepayments affect the estimated lives of loans and could change the amount of interest income, and possibly principal, expected to be collected. In re-forecasting future estimated cash flows, credit loss expectations are adjusted as necessary. The adjustments are based, in part, on actual loss severities recognized for each loan type, as well as changes in the probability of default. For periods in which estimated cash flows are not re-forecasted, the prior reporting period’s estimated cash flows are adjusted to reflect the actual cash received and credit events that transpired during the current reporting period.

 

Increases in expected cash flows of acquired impaired loans subsequent to the Acquisition Date are recognized prospectively through adjustments of the yield on the loans or pools over their remaining lives, while decreases in expected cash flows are recognized as impairment through a provision for loan losses and an increase in the allowance.

 

Our total loans at June 30, 2014 were $2.07 billion compared to $1.05 billion at December 31, 2013, an increase of $1.02 billion, or 96.9%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at June 30, 2014 and December 31, 2013, and the percentage change in loans from the end of 2013 to the end of the second quarter of 2014, are as follows:

 


 

(Continued) 

 

 
21.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


  

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

                                    Percent  
   

June 30, 2014

    December 31, 2013     Increase  
   

Balance

       %     Balance        %     (Decrease)  

Originated loans

                                       

Commercial:

                                       

Commercial and industrial

  $ 342,375,000       29.9 %   $ 286,373,000       27.2 %     19.6 %

Vacant land, land development, and residential construction

    32,214,000       2.8       36,741,000       3.5       (12.3 )

Real estate – owner occupied

    264,596,000       23.1       261,877,000       24.9       1.0  

Real estate – non-owner occupied

    399,855,000       34.9       364,066,000       34.6       9.8  

Real estate – multi-family and residential rental

    37,569,000       3.3       37,639,000       3.5       (0.2 )

Total commercial

    1,076,609,000       94.0       986,696,000       93.7       9.1  
                                         

Retail:

                                       

Home equity and other

    35,151,000       3.1       35,080,000       3.3       0.2  

1-4 family mortgages

    33,337,000       2.9       31,467,000       3.0       5.9  

Total retail

    68,488,000       6.0       66,547,000       6.3       2.9  
                                         

Total originated loans

  $ 1,145,097,000       100.0 %   $ 1,053,243,000       100.0 %     8.7 %

 

 

                                  Percent  
   

June 30, 2014

    December 31, 2013     Increase  
   

Balance

       %     Balance      %     (Decrease)  

Acquired loans

                                   

Commercial:

                                   

Commercial and industrial

  $ 273,684,000       29.5 %   $ 0    

NA

   

NM

 

Vacant land, land development, and residential construction

    21,091,000       2.3       0    

NA

   

NM

 

Real estate – owner occupied

    119,818,000       12.9       0    

NA

   

NM

 

Real estate – non-owner occupied

    149,434,000       16.1       0    

NA

   

NM

 

Real estate – multi-family and residential rental

    47,099,000       5.1       0    

NA

   

NM

 

Total commercial

    611,126,000       65.8       0    

NA

   

NM

 
                                     

Retail:

                                   

Home equity and other

    134,557,000       14.5       0    

NA

   

NM

 

1-4 family mortgages

    182,702,000       19.7       0    

NA

   

NM

 

Total retail

    317,259,000       34.2       0    

NA

   

NM

 
                                     

Total acquired loans

  $ 928,385,000       100.0 %   $ 0    

NA

   

NM

 

 


(Continued) 

 

 
22.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

                Percent  
   

June 30, 2014

    December 31, 2013     Increase  
    Balance     %     Balance     %     (Decrease)  

Total loans

                                       

Commercial:

                                       

Commercial and industrial

  $ 616,059,000       29.7 %   $ 286,373,000       27.2 %     115.1 %

Vacant land, land development, and residential construction

    53,305,000       2.6       36,741,000       3.5       45.1  

Real estate – owner occupied

    384,414,000       18.5       261,877,000       24.9       46.8  

Real estate – non-owner occupied

    549,289,000       26.5       364,066,000       34.6       50.9  

Real estate – multi-family and residential rental

    84,668,000       4.1       37,639,000       3.5       124.9  

Total commercial

    1,687,735,000       81.4       986,696,000       93.7       71.0  
                                         

Retail:

                                       

Home equity and other

    169,708,000       8.2       35,080,000       3.3       383.8  

1-4 family mortgages

    216,039,000       10.4       31,467,000       3.0       586.6  

Total retail

    385,747,000       18.6       66,547,000       6.3       479.7  
                                         

Total loans

  $ 2,073,482,000       100.0 %   $ 1,053,243,000       100.0 %     96.9 %

 

 

The total outstanding balance and carrying value of acquired impaired loans was $42.6 million and $26.1 million, respectively, as of June 30, 2014. Changes in the accretable yield for acquired impaired loans for the three and six months ended June 30, 2014 were as follows:

 

Balance at January 1, 2014

  $ 0  

Additions

    2,514,000  

Accretion

    (103,000 )

Net reclassification from nonaccretable to accretable

    0  

Disposals

    0  
         

Ending balance

  $ 2,411,000  

 


 

(Continued) 

 

 
23.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Nonperforming originated loans as of June 30, 2014 and December 31, 2013 were as follows:

 

   

June 30,

   

December 31,

 
   

2014

    2013  
                 

Loans past due 90 days or more still accruing interest

  $ 0     $ 0  

Nonaccrual loans

    5,741,000       6,718,000  
                 

Total nonperforming originated loans

  $ 5,741,000     $ 6,718,000  

 

 

The recorded principal balance of nonaccrual loans was as follows:

   

June 30,

   

December 31,

 
   

2014

    2013  

Commercial:

               

Commercial and industrial

  $ 824,000     $ 1,501,000  

Vacant land, land development, and residential construction

    235,000       785,000  

Real estate – owner occupied

    640,000       389,000  

Real estate – non-owner occupied

    129,000       168,000  

Real estate – multi-family and residential rental

    470,000       208,000  

Total commercial

    2,298,000       3,051,000  
                 

Retail:

               

Home equity and other

    772,000       788,000  

1-4 family mortgages

    2,671,000       2,879,000  

Total retail

    3,443,000       3,667,000  
                 

Total nonaccrual loans

  $ 5,741,000     $ 6,718,000  

 

Acquired impaired loans are not subject to individual evaluation for impairment and are not reported as nonperforming loans based on acquired impaired loan accounting. Acquired non-impaired loans are placed on nonaccrual status and reported as nonperforming or past due using the same criteria applied to the originated loan portfolio.

 


 

(Continued)

 

 
24.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

An age analysis of past due loans is as follows as of June 30, 2014:

 

                   

Greater

                            Recorded  
   

30 – 59

   

60 – 89

    Than 89                             Balance > 89  
   

Days

   

Days

   

Days

   

Total

            Total     Days and  
   

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Current

    Loans     Accruing  

Originated loans

                                                       

  Commercial:

                                                       

Commercial and industrial

  $ 0     $ 0     $ 121,000     $ 121,000     $ 342,254,000     $ 342,375,000     $ 0  

Vacant land, land development, and residential construction

    0       0       0       0       32,214,000       32,214,000       0  

Real estate – owner occupied

    35,000       0       90,000       125,000       264,471,000       264,596,000       0  

Real estate – non-owner occupied

    0       0       0       0       399,855,000       399,855,000       0  

Real estate – multi-family and residential rental

    0       0       0       0       37,569,000       37,569,000       0  

Total commercial

    35,000       0       211,000       246,000       1,076,363,000       1,076,609,000       0  
                                                         

  Retail:

                                                       

Home equity and other

    2,000       0       0       2,000       35,149,000       35,151,000       0  

1-4 family mortgages

    0       0       347,000       347,000       32,990,000       33,337,000       0  

Total retail

    2,000       0       347,000       349,000       68,139,000       68,488,000       0  
                                                         

Total past due loans

  $ 37,000     $ 0     $ 558,000     $ 595,000     $ 1,144,502,000     $ 1,145,097,000     $ 0  

 


 

(Continued)

 

 
25.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

                    Greater                             Recorded  
    30 – 59    

60 – 89

   

Than 89

                            Balance > 89  
   

Days

   

Days

   

Days

   

Total

            Total     Days and  
   

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Current

   

Loans

    Accruing  

Acquired loans

                                                       

  Commercial:

                                                       

Commercial and  industrial

  $ 587,000     $ 19,000     $ 1,202,000     $ 1,808,000     $ 271,876,000     $ 273,684,000     $ 0  

Vacant land, land development, and residential construction

    0       0       748,000       748,000       20,343,000       21,091,000       0  

Real estate – owner occupied

    363,000       0       949,000       1,312,000       118,506,000       119,818,000       0  

Real estate – non-owner occupied

    65,000       1,347,000       1,436,000       2,848,000       146,586,000       149,434,000       0  

Real estate – multi-family and residential rental

    0       0       0       0       47,099,000       47,099,000       0  

Total commercial

    1,015,000       1,366,000       4,335,000       6,716,000       604,410,000       611,126,000       0  
                                                         

  Retail:

                                                       

Home equity  and other

    681,000       142,000       12,000       835,000       133,722,000       134,557,000       0  

1-4 family mortgages

    1,796,000       115,000       860,000       2,771,000       179,931,000       182,702,000       0  

Total retail

    2,477,000       257,000       872,000       3,606,000       313,653,000       317,259,000       0  
                                                         

Total past due loans

  $ 3,492,000     $ 1,623,000     $ 5,207,000     $ 10,322,000     $ 918,063,000     $ 928,385,000     $ 0  

 


 

(Continued)

 

 
26.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

An age analysis of past due loans is as follows as of December 31, 2013:

 

                    Greater                             Recorded  
    30 – 59    

60 – 89

   

Than 89

                            Balance > 89  
   

Days

   

Days

   

Days

   

Total

            Total     Days and  
   

Past Due

   

Past Due

   

Past Due

   

Past Due

   

Current

   

Loans

    Accruing  

Originated loans

                                                       

  Commercial:

                                                       

Commercial and industrial

  $ 0     $ 0     $ 309,000     $ 309,000     $ 286,064,000     $ 286,373,000     $ 0  

Vacant land, land development, and residential construction

    0       0       0       0       36,741,000       36,741,000       0  

Real estate – owner occupied

    65,000       0       50,000       115,000       261,762,000       261,877,000       0  

Real estate – non-owner occupied

    0       0       0       0       364,066,000       364,066,000       0  

Real estate – multi-family and residential rental

    0       0       64,000       64,000       37,575,000       37,639,000       0  

Total commercial

    65,000       0       423,000       488,000       986,208,000       986,696,000       0  
                                                         

  Retail:

                                                       

Home equity and other

    14,000       0       0       14,000       35,066,000       35,080,000       0  

1-4 family mortgages

    21,000       44,000       375,000       440,000       31,027,000       31,467,000       0  

Total retail

    35,000       44,000       375,000       454,000       66,093,000       66,547,000       0  
                                                         

Total past due loans

  $ 100,000     $ 44,000     $ 798,000     $ 942,000     $ 1,052,301,000     $ 1,053,243,000     $ 0  

 


 

(Continued)

 

 
27.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Impaired loans as of June 30, 2014, and average impaired loans for the three and six months ended June 30, 2014, were as follows:

 

                            Second Quarter     Year-To-Date  
   

Unpaid

                    Average     Average   
   

Contractual

   

Recorded

            Recorded     Recorded  
   

Principal

    Principal     Related    

Principal

   

Principal

 
   

Balance

   

Balance

    Allowance    

Balance

   

Balance

 
                                         

With no related allowance recorded

                                       

Commercial:

                                       

Commercial and industrial

  $ 1,620,000     $ 132,000             $ 169,000     $ 283,000  

Vacant land, land development and residential construction

    0       0               171,000       235,000  

Real estate – owner occupied

    1,171,000       640,000               662,000       703,000  

Real estate – non-owner occupied

    578,000       577,000               1,169,000       1,024,000  

Real estate – multi-family and residential rental

    41,000       0               1,000       1,000  

Total commercial

    3,410,000       1,349,000               2,172,000       2,246,000  

Retail:

                                       

Home equity and other

    707,000       644,000               647,000       585,000  

1-4 family mortgages

    1,107,000       559,000               585,000       606,000  

Total retail

    1,814,000       1,203,000               1,232,000       1,191,000  
                                         

Total with no related allowance recorded

  $ 5,224,000     $ 2,552,000             $ 3,404,000     $ 3,437,000  

 


 

 (Continued)

 

 
28.

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

                          Second Quarter     Year-To-Date  
   

Unpaid

   

 

            Average     Average  
   

Contractual

   

Recorded

            Recorded     Recorded  
   

Principal

   

Principal

    Related    

Principal

    Principal  
   

Balance

   

Balance

    Allowance    

Balance

    Balance  

With an allowance recorded

                                       

Commercial:

                                       

Commercial and industrial

  $ 939,000     $ 810,000     $ 322,000     $ 882,000     $ 1,068,000  

Vacant land, land development and residential construction

    3,614,000       3,300,000       351,000       3,604,000       3,782,000  

Real estate – owner occupied

    2,460,000       2,460,000       679,000       1,974,000       1,820,000  

Real estate – non-owner occupied

    17,753,000       17,731,000       7,414,000       18,591,000       19,418,000  

Real estate – multi-family and residential rental

    1,677,000       1,549,000       674,000       1,319,000       1,774,000  

Total commercial

    26,443,000       25,850,000       9,440,000       26,370,000       27,862,000  

Retail:

                                       

Home equity and other

    118,000       90,000       90,000       91,000       157,000  

1-4 family mortgages

    2,220,000       2,112,000       832,000       2,136,000       2,168,000  

Total retail

    2,338,000       2,202,000       922,000       2,227,000       2,325,000  
                                         

Total with an allowance recorded

  $ 28,781,000     $ 28,052,000     $ 10,362,000     $ 28,597,000     $ 30,187,000  
                                         

Total impaired loans:

                                       

Commercial

  $ 29,853,000     $ 27,199,000     $ 9,440,000     $ 28,542,000     $ 30,108,000  

Retail

    4,152,000       3,405,000       922,000       3,459,000       3,516,000  

Total impaired loans

  $ 34,005,000     $ 30,604,000     $ 10,362,000     $ 32,001,000     $ 33,624,000  

 

Acquired impaired loans are not subject to individual evaluation for impairment and are not reported as impaired loans based on acquired impaired loan accounting. Acquired non-impaired loans are placed on nonaccrual status and reported as impaired using the same criteria applied to the originated loan portfolio. In accordance with purchase accounting rules, acquired loans were recorded at fair value at the Acquisition Date and the prior allowance was eliminated. No allowance has been established on these acquired loans through June 30, 2014. Interest income of $0.4 million and $0.8 million was recognized on impaired loans during the second quarter and first six months of 2014, respectively.

 


 

(Continued)

 

 
29.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

 

                           

Second Quarter

   

Year-To-Date

 
   

Unpaid

                   

Average

   

Average

 
   

Contractual

   

Recorded

           

Recorded

    Recorded  
   

Principal

   

Principal

   

Related

   

Principal

   

Principal

 
   

Balance

   

Balance

   

Allowance

   

Balance

   

Balance

 

With no related allowance recorded

                                       

Commercial:

                                       

Commercial and industrial

  $ 2,793,000     $ 1,277,000             $ 1,416,000     $ 1,483,000  

Vacant land, land development and residential construction

    1,543,000       1,010,000               1,194,000       1,263,000  

Real estate – owner occupied

    2,020,000       1,383,000               1,366,000       1,430,000  

Real estate – non-owner occupied

    8,067,000       5,194,000               4,956,000       5,134,000  

Real estate – multi-family and residential rental

    1,468,000       514,000               599,000       537,000  

Total commercial

    15,891,000       9,378,000               9,531,000       9,847,000  

Retail:

                                       

Home equity and other

    508,000       468,000               474,000       477,000  

1-4 family mortgages

    1,235,000       676,000               721,000       744,000  

Total retail

    1,743,000       1,144,000               1,195,000       1,221,000  
                                         

Total with no related allowance recorded

  $ 17,634,000     $ 10,522,000             $ 10,726,000     $ 11,068,000  

 


 

(Continued)

 

 
30.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

                            Second Quarter     Year-To-Date  
   

Unpaid

                    Average     Average  
   

Contractual

    Recorded             Recorded     Recorded  
   

Principal

   

Principal

   

Related

   

Principal

    Principal  
   

Balance

   

Balance

   

Allowance

   

Balance

    Balance  

With an allowance recorded

                                       

Commercial:

                                       

Commercial and industrial

  $ 1,708,000     $ 1,587,000     $ 1,154,000     $ 2,046,000     $ 2,006,000  

Vacant land, land development and residential construction

    5,058,000       4,515,000       1,223,000       2,998,000       2,738,000  

Real estate – owner occupied

    2,402,000       2,350,000       922,000       2,652,000       2,976,000  

Real estate – non-owner occupied

    29,249,000       29,233,000       9,672,000       29,778,000       30,840,000  

Real estate – multi-family and residential rental

    2,589,000       2,527,000       835,000       2,609,000       3,047,000  

Total commercial

    41,006,000       40,212,000       13,806,000       40,083,000       41,607,000  

Retail:

                                       

Home equity and other

    350,000       324,000       134,000       335,000       355,000  

1-4 family mortgages

    2,644,000       2,619,000       896,000       1,545,000       1,189,000  

Total retail

    2,994,000       2,943,000       1,030,000       1,880,000       1,544,000  
                                         

Total with an allowance recorded

  $ 44,000,000     $ 43,155,000     $ 14,836,000     $ 41,963,000     $ 43,151,000  
                                         

Total impaired loans:

                                       

Commercial

  $ 56,897,000     $ 49,590,000     $ 13,806,000     $ 49,614,000     $ 51,454,000  

Retail

    4,737,000       4,087,000       1,030,000       3,075,000       2,765,000  

Total impaired loans

  $ 61,634,000     $ 53,677,000     $ 14,836,000     $ 52,689,000     $ 54,219,000  

 

     Interest income of $0.7 million and $1.3 million was recognized on impaired loans during the second quarter and first six months of 2013, respectively.               

 


 

(Continued)

 

 
31.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     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.

 

Credit quality indicators were as follows as of June 30, 2014:

 

Originated Loans

 

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

 

           

Commercial

                    Commerical  
           

Vacant Land,

   

Commerical

    Commercial     Real Estate -  
   

Commerical

   

Land Development,

   

Real Estate -

   

Real Estate -

    Multi-Family  
   

and

   

and Residential

   

Owner

   

Non-Owner

    and Residential  
   

Industrial

   

Construction

   

Occupied

   

Occupied

    Rental  
                                         

Internal credit risk grade groupings:

                                       

Grades 1 – 4

  $ 220,771,000     $ 7,310,000     $ 163,184,000     $ 253,470,000     $ 17,258,000  

Grades 5 – 7

    120,587,000       21,604,000       97,802,000       132,604,000       18,745,000  

Grades 8 – 9

    1,017,000       3,300,000       3,610,000       13,781,000       1,566,000  

Total commercial

  $ 342,375,000     $ 32,214,000     $ 264,596,000     $ 399,855,000     $ 37,569,000  

 

 

Retail credit exposure – credit risk profiled by collateral type:

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

 

   

 

       
   

and Other

   

Mortgages

   

 

   

 

       
                                         
Total retail   $ 35,151,000     $ 33,337,000                          

 


 

(Continued)

 

 
32.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Acquired loans

 

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

 

            Commercial                     Commerical  
           

Vacant Land,

    Commerical     Commerical     Real Estate -  
   

Commercial

    Land Development,    

Real Estate -

   

Real Estate -

    Multi-Family  
   

and

   

and Residential

   

Owner

   

Non-Owner

    and Residential  
   

Industrial

    Construction    

Occupied

   

Occupied

    Rental  
                                         

Internal credit risk grade groupings:

                                       

Grades 1 – 4

  $ 111,223,000     $ 4,240,000     $ 28,670,000     $ 44,344,000     $ 19,438,000  

Grades 5 – 7

    154,550,000       15,552,000       83,142,000       100,032,000       27,051,000  

Grades 8 – 9

    7,911,000       1,299,000       8,006,000       5,058,000       610,000  

Total commercial

  $ 273,684,000     $ 21,091,000     $ 119,818,000     $ 149,434,000     $ 47,099,000  

 

 

Retail credit exposure – credit risk profiled by collateral type:

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

   

       
   

and Other

   

Mortgages

   

   

       
                                         
Total retail   $ 134,557,000     $ 182,702,000                          

   


 

 (Continued)

 

 
33.

Table Of Contents
 

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Credit quality indicators were as follows as of December 31, 2013:

 

Originated loans

 

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

 

           

Commerical

                    Commercial  
           

Vacant Land,

   

Commerical

    Commercial     Real Estate -  
   

Commerical

   

Land Development,

   

Real Estate -

   

Real Estate

    Multi-Family  
    and    

and Residential

    Owner    

Non-Owner

    and Residential  
   

Industrial

   

Construction

   

Occupied

   

Occupied

    Rental  
                                         

Internal credit risk grade groupings:

                                       

Grades 1 – 4

  $ 208,151,000     $ 6,973,000     $ 156,230,000     $ 219,325,000     $ 15,465,000  

Grades 5 – 7

    76,237,000       25,535,000       103,066,000       122,717,000       19,469,000  

Grades 8 – 9

    1,985,000       4,233,000       2,581,000       22,024,000       2,705,000  

Total commercial

  $ 286,373,000     $ 36,741,000     $ 261,877,000     $ 364,066,000     $ 37,639,000  

 

 

Retail credit exposure – credit risk profiled by collateral type:

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

   

       
   

and Other

   

Mortgages

   

   

       
                                         
Total retail   $ 35,080,000     $ 31,467,000                          

  


 

(Continued)

 

 
34.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

 

4.     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)

 

 
35.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity in the allowance for loan losses and the recorded investments in originated loans as of and during the three and six months ended June 30, 2014 are as follows:

 

   

Commercial

   

Retail

                 
   

Loans

   

Loans

   

Unallocated

    Total  
                                 

Allowance for loan losses:

                               

Balance at March 31, 2014

  $ 19,001,000     $ 1,957,000     $ (4,000 )   $ 20,954,000  

Provision for loan losses

    (334,000 )     (345,000 )     (21,000 )     (700,000 )

Charge-offs

    (98,000 )     (5,000 )     0       (103,000 )

Recoveries

    538,000       167,000       0       705,000  

Ending balance

  $ 19,107,000     $ 1,774,000     $ (25,000 )   $ 20,856,000  
                                 
                                 

Allowance for loan losses:

                               

Balance at December 31, 2013

  $ 20,455,000     $ 2,358,000     $ 8,000     $ 22,821,000  

Provision for loan losses

    (1,788,000 )     (779,000 )     (33,000 )     (2,600,000 )

Charge-offs

    (684,000 )     (7,000 )     0       (691,000 )

Recoveries

    1,124,000       202,000       0       1,326,000  

Ending balance

  $ 19,107,000     $ 1,774,000     $ (25,000 )   $ 20,856,000  
                                 

Ending balance: individually evaluated for impairment

  $ 9,440,000     $ 922,000     $ 0     $ 10,362,000  
                                 

Ending balance: collectively evaluated for impairment

  $ 9,667,000     $ 852,000     $ (25,000 )   $ 10,494,000  
                                 
                                 

Total loans:

                               

Ending balance

  $ 1,076,609,000     $ 68,488,000             $ 1,145,097,000  
                                 

Ending balance: individually evaluated for impairment

  $ 27,199,000     $ 3,405,000             $ 30,604,000  
                                 

Ending balance: collectively evaluated for impairment

  $ 1,049,410,000     $ 65,083,000             $ 1,114,493,000  

 

 

In accordance with purchase accounting rules, acquired loans were recorded at fair value at the Acquisition Date and the prior allowance was eliminated. No allowance has been established on these acquired loans through June 30, 2014.

 


 

 (Continued)

 

 
36.

Table Of Contents
 

 

 MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

 

   

Commercial

   

Retail

                 
   

Loans

   

Loans

   

Unallocated

    Total  
                                 

Allowance for loan losses:

                               

Balance at March 31, 2013

  $ 23,717,000     $ 2,302,000     $ 16,000     $ 26,035,000  

Provision for loan losses

    (1,480,000 )     (10,000 )     (10,000 )     (1,500,000 )

Charge-offs

    (363,000 )     (19,000 )     0       (382,000 )

Recoveries

    508,000       286,000       0       794,000  

Ending balance

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

Allowance for loan losses:

                               

Balance at December 31, 2012

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

Provision for loan losses

    (2,644,000 )     (373,000 )     17,000       (3,000,000 )

Charge-offs

    (2,775,000 )     (22,000 )     0       (2,797,000 )

Recoveries

    1,758,000       309,000       0       2,067,000  

Ending balance

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

Ending balance: individually evaluated for impairment

  $ 13,806,000     $ 1,030,000     $ 0     $ 14,836,000  
                                 

Ending balance: collectively evaluated for impairment

  $ 8,576,000     $ 1,529,000     $ 6,000     $ 10,111,000  
                                 
                                 

Total loans:

                               

Ending balance

  $ 985,616,000     $ 73,046,000             $ 1,058,662,000  
                                 

Ending balance: individually evaluated for impairment

  $ 49,590,000     $ 4,087,000             $ 53,677,000  
                                 

Ending balance: collectively ealuated for impairment

  $ 936,026,000     $ 68,959,000             $ 1,004,985,000  

 


 

 (Continued)

 

 
37.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Loans modified as troubled debt restructurings during the three months ended June 30, 2014 were as follows:

            Pre-     Post-  
            Modification     Modification  
            Recorded     Recorded  
   

Number of

   

Principal

    Principal  
   

Contracts

   

Balance

    Balance  

Originated loans

                       

Commercial:

                       

Commercial and industrial

    0     $ 0     $ 0  

Vacant land, land development and residential construction

    0       0       0  

Real estate – owner occupied

    1       996,000       996,000  

Real estate – non-owner occupied

    0       0       0  

Real estate – multi-family and residential rental

    0       0       0  

Total originated commercial

    1       996,000       996,000  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    0       0       0  

Total originated retail

    0       0       0  
                         

Total originated loans

    1     $ 996,000     $ 996,000  
                         

Acquired loans

                       

Commercial:

                       

Commercial and industrial

    0     $ 0     $ 0  

Vacant land, land development and residential construction

    0       0       0  

Real estate – owner occupied

    0       0       0  

Real estate – non-owner occupied

    0       0       0  

Real estate – multi-family and residential rental

    0       0       0  

Total acquired commercial

    0       0       0  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    0       0       0  

Total acquired retail

    0       0       0  
                         

Total acquired loans

    0     $ 0     $ 0  

 


 

(Continued) 

 

 
38.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

           

Pre-

    Post-  
            Modification     Modification  
            Recorded     Recorded  
   

Number of

   

Principal

    Principal  
   

Contracts

   

Balance

    Balance  

Total loans

                       

Commercial:

                       

Commercial and industrial

    0     $ 0     $ 0  

Vacant land, land development and  residential construction

    0       0       0  

Real estate – owner occupied

    1       996,000       996,000  

Real estate – non-owner occupied

    0       0       0  

Real estate – multi-family and  residential rental

    0       0       0  

Total commercial

    1       996,000       996,000  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    0       0       0  

Total retail

    0       0       0  
                         

Total loans

    1     $ 996,000     $ 996,000  

  

Loans modified as troubled debt restructurings during the six months ended June 30, 2014 were as follows:

           

Pre-

    Post-  
            Modification     Modification  
            Recorded     Recorded  
   

Number of

   

Principal

    Principal  
   

Contracts

   

Balance

    Balance  

Originated loans

                       

Commercial:

                       

Commercial and industrial

    1     $ 14,000     $ 14,000  

Vacant land, land development and residential construction

    0       0       0  

Real estate – owner occupied

    1       996,000       996,000  

Real estate – non-owner occupied

    1       146,000       146,000  

Real estate – multi-family and residential rental

    0       0       0  

Total originated commercial

    3       1,156,000       1,156,000  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    0       0       0  

Total originated retail

    0       0       0  
                         

Total originated loans

    3     $ 1,156,000     $ 1,156,000  

 


 

(Continued)

 

 
39.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

           

Pre-

    Post-  
            Modification     Modification  
            Recorded     Recorded  
   

Number of

   

Principal

    Principal  
   

Contracts

   

Balance

    Balance  

Acquired loans

                       

Commercial:

                       

Commercial and industrial

    0     $ 0     $ 0  

Vacant land, land development and residential construction

    0       0       0  

Real estate – owner occupied

    0       0       0  

Real estate – non-owner occupied

    0       0       0  

Real estate – multi-family and residential rental

    0       0       0  

Total acquired commercial

    0       0       0  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    0       0       0  

Total acquired

    0       0       0  
                         

Total acquired loans

    0     $ 0     $ 0  
                         

Total loans

                       

Commercial:

                       

Commercial and industrial

    1     $ 14,000     $ 14,000  

Vacant land, land development and residential construction

    0       0       0  

Real estate – owner occupied

    1       996,000       996,000  

Real estate – non-owner occupied

    1       146,000       146,000  

Real estate – multi-family and residential rental

    0       0       0  

Total commercial

    3       1,156,000       1,156,000  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    0       0       0  

Total retail

    0       0       0  
                         

Total loans

    3     $ 1,156,000     $ 1,156,000  

 


 

(Continued) 

 

 
40.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

           

Pre-

    Post-  
            Modification     Modification  
            Recorded     Recorded  
   

Number of

   

Principal

    Principal  
   

Contracts

   

Balance

    Balance  

Originated loans

                       

Commercial:

                       

Commercial and industrial

    1     $ 60,000     $ 60,000  

Vacant land, land development and residential construction

    2       3,247,000       3,247,000  

Real estate – owner occupied

    2       680,000       680,000  

Real estate – non-owner occupied

    0       0       0  

Real estate – multi-family and residential rental

    0       0       0  

Total originated commercial

    5       3,987,000       3,987,000  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    1       1,879,000       1,879,000  

Total originated retail

    1       1,879,000       1,879,000  
                         

Total originated loans

    6     $ 5,866,000     $ 5,866,000  

 


 

 (Continued)

 

 
41.

Table Of Contents
 

 

 MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

           

Pre-

    Post-  
            Modification     Modification  
            Recorded     Recorded  
   

Number of

   

Principal

    Principal  
   

Contracts

   

Balance

    Balance  

Originated loans

                       

Commercial:

                       

Commercial and industrial

    1     $ 60,000     $ 60,000  

Vacant land, land development and residential construction

    2       3,247,000       3,247,000  

Real estate – owner occupied

    3       904,000       904,000  

Real estate – non-owner occupied

    2       2,068,000       2,068,000  

Real estate – multi-family and residential rental

    0       0       0  

Total originated commercial

    8       6,279,000       6,279,000  
                         

Retail:

                       

Home equity and other

    0       0       0  

1-4 family mortgages

    1       1,879,000       1,879,000  

Total originated retail

    1       1,879,000       1,879,000  
                         

Total originated loans

    9     $ 8,158,000     $ 8,158,000  

 


 

(Continued) 

 

 
42.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

The following originated loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended June 30, 2014 (amounts as of period end):

            Recprded  
   

Number of

    Principal  
   

Contracts

    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 originated loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the six months ended June 30, 2014 (amounts as of period end):

            Recorded  
   

Number of

    Principal  
   

Contracts

    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)

 

 
43.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

            Recorded  
   

Number of

    Principal  
   

Contracts

    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 originated loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the six months ended June 30, 2013 (amounts as of period end):

            Recorded  
   

Number of

    Principal  
   

Contracts

    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)

 

 
44.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for originated loans categorized as troubled debt restructurings during the three months ended June 30, 2014 is as follows:

 

           

Commercial

                    Commercial  
           

Vacant Land,

   

Commercial

    Commercial     Real Estate -  
   

Commercial

   

Land Development,

   

Real Estate -

    Real Estate -     Multi-Family  
   

and

   

and Residential

   

Owner

    Non-Owner     and Residential  
   

Industrial

   

Construction

   

Occupied

   

Occupied

    Rental  
                                         

Commercial Loan Portfolio:

                                       

Beginning Balance

  $ 1,404,000     $ 4,250,000     $ 1,756,000     $ 21,629,000     $ 732,000  

Charge-Offs

    (67,000 )     0       0       0       0  

Payments

    (161,000 )     (464,000 )     (42,000 )     (2,965,000 )     (13,000 )

Transfers to ORE

    0       0       0       0       0  

Net Additions/Deletions

    0       0       997,000       0       0  

Ending Balance

  $ 1,176,000     $ 3,786,000     $ 2,711,000     $ 18,664,000     $ 719,000  

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

   

       
   

and Other

   

Mortgages

   

   

       
Retail Loan Portfolio:                                        
Beginning Balance   $ 0     $ 2,122,000                          
Charge-Offs     0       0                          
Payments     0       (45,000 )                        
Transfers to ORE     0       0                          
Net Additions/Deletions     0       0                          
Ending Balance   $ 0     $ 2,077,000                          

 


 

 (Continued)

 

 
45.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for originated loans categorized as troubled debt restructurings during the six months ended June 30, 2014 is as follows:

 

           

Commercial

                    Commercial  
           

Vacant Land,

   

Commerical

    Commercial     Real Estate -  
    Commercial    

Land Development,

   

Real Estate -

    Real Estate -     Multi-Family  
    and    

and Residential

   

Owner

    Non-Owner     and Residential  
    Industrial    

Construction

   

Occupied

   

Occupied

    Rental  
                                         

Commercial Loan Portfolio:

                                       

Beginning Balance

  $ 1,656,000     $ 4,501,000     $ 1,816,000     $ 22,311,000     $ 2,620,000  

Charge-Offs

    (67,000 )     0       (11,000 )     0       (420,000 )

Payments

    (427,000 )     (3,613,000 )     (90,000 )     (3,966,000 )     (1,481,000 )

Transfers to ORE

    0       0       0       0       0  

Net Additions/Deletions

    14,000       2,898,000       996,000       319,000       0  

Ending Balance

  $ 1,176,000     $ 3,786,000     $ 2,711,000     $ 18,664,000     $ 719,000  

 

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

   

       
   

and Other

   

Mortgages

   

   

       
Retail Loan Portfolio:                                        
Beginning Balance   $ 0     $ 2,191,000                          
Charge-Offs     0       0                          
Payments     0       (114,000 )                        
Transfers to ORE     0       0                          
Net Additions/Deletions     0       0                          
Ending Balance   $ 0     $ 2,077,000                          

 


 

(Continued)

 

 
46.

Table Of Contents
 

 

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

 

           

Commercial

                    Commercial  
           

Vacant Land,

   

Commercial

    Commercial     Real Estate -  
   

Commercial

   

Land Development,

   

Real Estate -

    Real Estate -     Multi-Family  
   

and

   

and Residential

   

Owner

    Non-Owner     and Residential  
   

Industrial

   

Construction

   

Occupied

   

Occupied

    Rental  
                                         

Commercial Loan Portfolio:

                                       

Beginning Balance

  $ 3,269,000     $ 2,327,000     $ 3,879,000     $ 35,003,000     $ 2,958,000  

Charge-Offs

    0       (30,000 )     (70,000 )     (5,000 )     0  

Payments

    (1,063,000 )     (104,000 )     (979,000 )     (574,000 )     (183,000 )

Transfers to ORE

    0       0       0       0       0  

Net Additions/Deletions

    60,000       3,247,000       749,000       0       0  

Ending Balance

  $ 2,266,000     $ 5,440,000     $ 3,579,000     $ 34,424,000     $ 2,775,000  

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

   

       
   

and Other

   

Mortgages

   

   

       
Retail Loan Portfolio:                                        
Beginning Balance   $ 0     $ 152,000                          
Charge-Offs     0       0                          
Payments     0       (2,000 )                        
Transfers to ORE     0       0                          
Net Additions/Deletions     0       1,879,000                          
Ending Balance   $ 0     $ 2,029,000                          
  


 

 (Continued)

 

 
47.

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Activity for originated loans categorized as troubled debt restructurings during the six months ended June 30, 2013 is as follows:

 

            Commercial                     Commercial  
           

Vacant Land,

   

Commercial

    Commercial     Real Estate -  
    Commercial     Land Development,    

Real Estate -

    Real Estate -     Multi-Family  
    and    

and Residential

   

Owner

    Non-Owner     and Residential  
   

Industrial

   

Construction

   

Occupied

   

Occupied

    Rental  
                                         

Commercial Loan Portfolio:

                                       

Beginning Balance

  $ 2,721,000     $ 3,071,000     $ 4,115,000     $ 37,672,000     $ 3,025,000  

Charge-Offs

    (34,000 )     (725,000 )     (70,000 )     (716,000 )     (15,000 )

Payments

    (1,578,000 )     (153,000 )     (1,039,000 )     (3,786,000 )     (235,000 )

Transfers to ORE

    (74,000 )     0       (363,000 )     (802,000 )     0  

Net Additions/Deletions

    1,231,000       3,247,000       936,000       2,056,000       0  

Ending Balance

  $ 2,266,000     $ 5,440,000     $ 3,579,000     $ 34,424,000     $ 2,775,000  

 

   

Retail

   

Retail

                   
   

Home Equity

   

1-4 Family

   

   

       
   

and Other

   

Mortgages

   

   

       
Retail Loan Portfolio:                                        
Beginning Balance   $ 0     $ 155,000                          
Charge-Offs     0       0                          
Payments     0       (5,000 )                        
Transfers to ORE     0       0                          
Net Additions/Deletions     0       1,879,000                          
Ending Balance   $ 0     $ 2,029,000                          

  


 

(Continued)

 

 
48.

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

4.     LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

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

 

   

June 30,

   

December 31,

 
   

2014

    2013  
                 

Commercial:

               

Commercial and industrial

  $ 60,000     $ 187,000  

Vacant land, land development, and residential construction

    341,000       798,000  

Real estate – owner occupied

    679,000       528,000  

Real estate – non-owner occupied

    7,285,000       7,828,000  

Real estate – multi-family and residential rental

    499,000       1,010,000  

Total commercial

    8,864,000       10,351,000  
                 

Retail:

               

Home equity and other

    0       0  

1-4 family mortgages

    0       0  

Total retail

    0       0  
                 

Total related allowance

  $ 8,864,000     $ 10,351,000  

 

In general, our policy dictates that a renewal or modification of an 8- or 9-rated commercial 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)

 

 
49.

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

5.     PREMISES AND EQUIPMENT, NET

 

Premises and equipment are comprised of the following:

 

   

June 30,

   

December 31,

 
   

2014

    2013  
                 

Land, buildings and improvements

  $ 55,352,000     $ 33,289,000  

Furniture and equipment

    15,518,000       12,718,000  
      70,870,000       46,007,000  

Less: accumulated depreciation

    21,867,000       21,109,000  
                 

Premises and equipment, net

  $ 49,003,000     $ 24,898,000  

 

Depreciation expense totaled $0.5 million during the second quarter of 2014, compared to $0.3 million during the second quarter of 2013. Depreciation expense totaled $0.8 million during the first six months of 2014, compared to $0.7 million during the first six months of 2013.

 

 

6.     DEPOSITS

 

Our total deposits at June 30, 2014 totaled $2.30 billion compared to $1.12 billion at December 31, 2013, an increase of $1.18 billion, or 105.8%. A vast majority of the increase reflects the consummation of the merger with Firstbank effective June 1, 2014. The components of our outstanding balances at June 30, 2014 and December 31, 2013, and percentage change in deposits from the end of 2013 to the end of the second quarter of 2014, are as follows:

                                    Percent  
    June 30, 2014     December 31, 2013     Increase  
   

Balance

    %     Balance    

%

    (Decrease)  
                                         

Noninterest-bearing checking

  $ 515,646,000       22.4 %   $ 224,580,000       20.1 %     129.6 %
Interest-bearing checking     424,362,000       18.4       197,388,000       17.6       115.0  

Money market

    237,798,000       10.3       133,369,000       11.9       78.3  
Savings     341,924,000       14.8       52,606,000       4.7       550.0  

Time, under $100,000

    208,417,000       9.1       43,251,000       3.9       381.9  
Time, $100,000 and over     387,305,000       16.8       254,600,000       22.8       52.1  
      2,115,452,000       91.8       905,794,000       81.0       133.5  
                                         

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

    3,150,000       0.2       4,078,000       0.4       (22.8 )
                                         

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

    184,659,000       8.0       209,039,000       18.6       (11.7 )
      187,809,000       8.2       213,117,000       19.0       (11.9 )
                                         

Total deposits

  $ 2,303,261,000       100.0 %   $ 1,118,911,000       100.0 %     105.8 %

 


 

(Continued)

 

 
50.

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

7.     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:

 

   

Six Months Ended

   

Twelve Months Ended

 
   

June 30, 2014

    December 31, 2013  
                 

Outstanding balance at end of period

  $ 124,108,000     $ 69,305,000  

Average interest rate at end of period

    0.10 %     0.12 %
                 

Average daily balance during the period

  $ 79,003,000     $ 65,939,000  

Average interest rate during the period

    0.12 %     0.12 %
                 

Maximum daily balance during the period

  $ 126,621,000     $ 78,960,000  

 

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.

 

 

8.     FEDERAL HOME LOAN BANK ADVANCES

 

Federal Home Loan Bank advances totaled $57.0 million at June 30, 2014, and mature at varying dates from October 2014 through September, 2017, with fixed rates of interest from 0.41% to 1.51% and averaging 1.21%. Federal Home Loan Bank advances totaled $45.0 million at December 31, 2013, maturing at varying dates from March 2017 through September 2017, with fixed rates of interest from 1.22% to 1.51% and averaging 1.34%. The $12.0 million increase during the first six months of 2014 reflects the consummation of the merger with Firstbank effective June 1, 2014.

 

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 June 30, 2014 totaled about $570 million, with availability based on collateral approximating $509 million.

 

Maturities of currently outstanding FHLB advances are as follows:

 

2014

  $ 3,000,000  

2015

    6,000,000  

2016

    3,044,000  

2017

    45,000,000  

2018

    0  

 


 

(Continued)

 

 
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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

9.     STOCK-BASED COMPENSATION

 

Stock-based compensation plans are used to provide directors and employees with an increased incentive to contribute to our long-term performance and growth, to align the interests of directors and employees with the interests of our shareholders through the opportunity for increased stock ownership and to attract and retain directors and employees. From 2000 through 2005, stock option grants were provided to directors and certain employees through several stock option plans, including the 2000 Employee Stock Option Plan, 2004 Employee Stock Option Plan and Independent Director Stock Option Plan. During 2006, 2007 and 2008, stock option and restricted stock grants were provided to certain employees through the Stock Incentive Plan of 2006. No stock option or restricted stock grants were made during 2009, 2010 or 2011. During 2012, restricted stock grants were provided to directors and certain employees through the Stock Incentive Plan of 2006. No stock option or restricted stock grants were made during 2013 or during the first six months of 2014 due to the pending merger with Firstbank.

 

Under our 2000 Employee Stock Option Plan and 2004 Employee Stock Option Plan, stock options granted to employees were granted at the market price on the date of grant, generally fully vested after one year and expired ten years from the date of grant. Stock options granted to non-executive officers during 2005 vested about three weeks after being granted. Under our Independent Director Stock Option Plan, stock options granted to non-employee directors are at 125% of the market price on the date of grant, fully vested after five years and expire ten years from the date of grant.

 

The Stock Incentive Plan of 2006 replaced all of our outstanding stock option plans for stock options not previously granted. Under the Stock Incentive Plan of 2006, incentive awards may include, but are not limited to, stock options, restricted stock, stock appreciation rights and stock awards. Incentive awards that are stock options or stock appreciation rights are granted with an exercise price not less than the closing price of our common stock on the date of grant, or for stock options granted in 2006 or 2007, the day before the date of grant, if the closing price was higher on the day before the date of grant. Price, vesting and expiration date parameters are determined by Mercantile’s Compensation Committee on a grant-by-grant basis. Generally, the stock options granted to employees during 2006, 2007 and 2008 fully vested after two years and expire after seven years. The restricted stock awards granted to certain employees during 2006, 2007 and 2008 fully vested after four years, while the restricted stock awards granted to directors and certain employees during 2012 fully vest after two years. No payments were required from employees for the restricted stock awards. At year-end 2013, there were approximately 384,000 shares authorized for future incentive awards.

 

In conjunction with the Firstbank merger, all of our outstanding restricted stock awards, which were schedule to cliff vest in full in November, 2014, became fully vested as of June 1, 2014, resulting in the recognition of compensation expense of $0.2 million in the second quarter of 2014 to reflect the accelerated vesting of the restricted stock awards. As of June 30, 2014, there was no unrecognized compensation cost related to unvested stock option grants under our various stock-based compensation plans, and no unrecognized compensation cost related to unvested restricted stock awards under our Stock Incentive Plan of 2006.


 

(Continued) 

 

 
52.

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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


  

9.     STOCK-BASED COMPENSATION (Continued)

 

Also in conjunction with the Firstbank merger, we assumed, and issued Mercantile stock options in replacement of, all outstanding stock option grants that had been issued to Firstbank employees under the Firstbank Corporation Stock Option and Restricted Stock Plan of 1997 and the Firstbank Corporation 2006 Stock Compensation Plan. In general, stock option grants for 50 shares or less fully vested after one year from date of grant, while stock option grants for more than 50 shares vested over a five-year period at 20% of the grant per annum starting one year from the date of grant. The stock option grants expire ten years from the date of grant. There were approximately 282,200 Mercantile stock options issued as a result of the merger, with about 258,400 of the stock option grants fully vested and exercisable, on the Merger Date. The remaining 23,800 stock options vest over the next six to 18 months. Unrecognized compensation cost related to the unvested stock options was less than $100,000 as of June 30, 2014, which is expected to be fully recognized by November, 2015.

 

A summary of restricted stock activity from grants issued under the Mercantile plans during the first six months of 2014 and the 2013 and 2012 calendar years is as follows:

 

   

2014

   

2013

    2012  
           

Weighted

            Weighted             Weighted  
           

Average

            Average             Average  
   

Shares

   

Fair Value

   

Shares

   

Fair Value

    Shares     Fair Value  

Nonvested at beginning of year

    63,800     $ 14.30       66,100     $ 14.30       38,650     $ 6.20  

Granted

    0    

NA

      0    

NA

      66,100       14.30  

Vested

    (63,300 )     14.30       0    

NA

      (38,266 )     6.20  

Forfeited

    (500 )     14.30       (2,300 )     14.30       (384 )     6.20  

Nonvested at end of period

    0    

$

NA       63,800     $ 14.30       66,100     $ 14.30  

 

 

A summary of stock option activity from grants issued under the various Mercantile plans during the first six months of 2014 and the 2013 and 2012 calendar years is as follows:

 

   

2014

   

2013

    2012  
           

Weighted

            Weighted             Weighted  
           

Average

            Average             Average  
           

Exercise

            Exercise             Exercise  
   

Shares

   

Price

   

Shares

   

Price

   

Shares

    Price  

Outstanding at beginning of year

    60,876     $ 33.11       152,896     $ 26.15       214,903     $ 22.40  

Granted

    0    

NA

      0    

NA

      0    

NA

 

Exercised

    (2,845 )     17.74       (51,055 )     13.72       (50,930 )     10.83  

Forfeited or expired

    (1,141 )     37.55       (40,965 )     31.30       (11,077 )     23.77  

Outstanding at end of period

    56,890     $ 33.79       60,876     $ 33.11       152,896     $ 26.15  
                                                 

Options exercisable at period-end

    56,890     $ 33.79       60,876     $ 33.11       152,896     $ 26.15  

 


(Continued)

 
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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

9.     STOCK-BASED COMPENSATION (Continued)

 

The fair value of each stock option award is estimated on the date of grant using a closed option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities on our common stock. Historical data is used to estimate stock option expense and post-vesting termination behavior. The expected term of stock options granted is based on historical data and represents the period of time that stock options granted are expected to be outstanding, which takes into account that the stock options are not transferable. The risk-free interest rate for the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of the stock option grant. Except for the stock options awarded in connection with the merger, no stock option grants were made during 2012 or 2013 or during the first six months of 2014.

 

Options issued under the various Mercantile plans outstanding at June 30, 2014 were as follows:

 

              Outstanding     Exercisable  
                    Weighted Average   Weighted             Weighted  
Range of           Remaining   Average             Average  
Exercise           Contractual   Exercise             Exercise  

Prices

   

Number

 

Life (years)

 

Price

   

Number

   

Price

 
                                             
  $6.21 - $ 8.00       2,700  

1.4

  $ 6.21       2,700     $ 6.21  
  $32.01 - $ 36.00       51,300  

0.9

    34.87       51,300       34.87  
  $40.01 - $ 44.00       2,890  

0.3

    40.28       2,890       40.28  
                                             
  Outstanding at end of period       56,890   0.9   $ 33.79       56,890     $ 33.79  

 

 

Information related to options issued under the various Mercantile plans outstanding at June 30, 2014 and year-end 2013 and 2012 is as follows:

 

   

2014

   

2013

   

2012

 
                         

Minimum exercise price

  $ 6.21     $ 6.21     $ 6.21  

Maximum exercise price

    40.28       40.28       40.28  

Average remaining option term (years)

    0.9       1.4       1.9  

 

 

Information related to stock option grants and exercises issued under the various Mercantile plans during the first six months of 2014 and the 2013 and 2012 calendar years is as follows:

 

   

2014

   

2013

   

2012

 
                         

Aggregate intrinsic value of stock options exercised

  $ 11,000     $ 408,000     $ 307,000  

Cash received from stock option exercises

    50,000       289,000       227,000  

Tax benefit realized from stock option exercises

    0       0       0  

Weighted average per share fair value of stock options granted

 

NA

   

NA

   

NA

 

 


 

(Continued) 

 

 
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MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

9.     STOCK-BASED COMPENSATION (Continued)

 

The aggregate intrinsic value of all stock options issued under the various Mercantile plans outstanding and exercisable at June 30, 2014 was less than $0.1 million. Shares issued as a result of the exercise of stock option grants have been authorized and previously unissued shares.

 

A summary of stock option activity from grants issued under the various former Firstbank plans that became part of Mercantile’s plans upon consummation of the merger during the month of June, 2014, is as follows:

 

            Weighted  
            Average  
            Exercise  
   

Shares

    Price  

Outstanding at beginning of year

    0    

$

NA  

Granted

    0      

NA

 

Assumed as part of merger

    282,178       15.48  

Exercised

    (3,075 )     7.80  

Forfeited or expired

    0    

NA

 

Outstanding at end of period

    279,103     $ 15.57  
                 

Options exercisable at period-end

    255,373     $ 16.44  

 

 

Options issued under the various Firstbank plans outstanding at June 30, 2014 were as follows:

 

             

Outstanding

    Exercisable  
                   

Weighted Average

  Weighted             Weighted  

Range of

         

Remaining

 

Average

            Average  

Exercise

         

Contractual

 

Exercise

            Exercise  

Prices

   

Number

 

Life (years)

 

Price

   

Number

   

Price

 
                                             
  $4.00 - $ 8.00        78,855   5.4    $ 6.54       62,215     6.90  
  $8.01 - $ 12.00       31,830   5.4     8.60       24,740       8.60  
  $12.01 - $ 16.00       46,000   3.4     16.00       46,000       16.00  
  $20.01 - $ 24.00       85,962   1.9     22.43       85,962       22.43  
  $24.01 - $ 28.00       36,456   0.4     24.46       36,456       24.46  
                                             

Outstanding at end of period
      279,103  

3.3

  $ 15.57       255,373     $ 16.44  

 


 

 (Continued)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

 

9.     STOCK-BASED COMPENSATION (Continued)

 

Information related to options issued under the various Firstbank plans outstanding at June 30, 2014 is as follows:

 

Minimum exercise price

  $ 7.80  

Maximum exercise price

    24.46  

Average remaining option term (in years)

 

3.3

 

 

Information related to stock option grants and exercises issued under the various Firstbank plans during the month of June, 2014, is as follows:

 

Aggregate intrinsic value of stock options exercised

  $ 40,000  

Cash received from stock option exercises

    24,000  

Tax benefit realized from stock option exercises

    0  

Weighted average per share fair value of stock options granted

 

NA

 

 

 

The aggregate intrinsic value of all stock options issued under the various Firstbank plans outstanding and exercisable at June 30, 2014 was $2.1 million.

 

On June 26, 2014, we granted a total of 7,375 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of July 1, 2014 through December 31, 2014. The associated $155,000 cost will be expensed on a straightline basis over the last six months of 2014.

 

 

10.   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 June 30, 2014 and December 31, 2013.

 


 

(Continued)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

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

 

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at June 30, 2014 and December 31, 2013 follows:

 

   

June 30,

   

December 31,

 
   

2014

    2013  
                 

Commercial unused lines of credit

  $ 339,146,000     $ 257,937,000  

Unused lines of credit secured by 1 – 4 family residential properties

    60,439,000       23,429,000  

Credit card unused lines of credit

    9,180,000       9,013,000  

Other consumer unused lines of credit

    9,302,000       5,695,000  

Commitments to make loans

    177,363,000       58,799,000  

Standby letters of credit

    37,598,000       19,670,000  
    $ 633,028,000     $ 374,543,000  

 

 

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 June 30, 2014, the total notional amount of the underlying interest rate swap agreements was $17.6 million, with a net fair value from our commercial loan customers’ perspective of negative $2.6 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.

 

 

11.   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.

 


 

(Continued)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

11.   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, which became effective in January 2013 and matures in January 2018. 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. 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 June 30, 2014 and December 31, 2013, the present value of the interest rate swap agreement was recorded as a liability in the amount of $0.4 million and $0.3 million, respectively.

 

 

12.   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 June 30, 2014 and December 31, 2013 (dollars in thousands):

 

   

Level in

   

June 30, 2014

    December 31, 2013  
   

Fair Value

   

Carrying

   

Fair

   

Carrying

    Fair  
   

Hierarchy

   

Values

   

Values

   

Values

    Values  
                                         

Financial assets:

                                       

Cash

 

Level 1

    $ 14,040     $ 14,040     $ 1,464     $ 1,464  

Cash equivalents

 

Level 2

      104,813       104,813       145,501       145,501  

Securities available for sale

    (1)       475,275       475,275       131,178       131,178  

FHLB stock

    (2)       19,226       19,226       11,961       11,961  

Loans, net

 

Level 3

      2,052,626       2,049,625       1,030,422       1,027,300  

Bank owned life insurance

 

Level 2

      55,693       55,693       51,377       51,377  

Accrued interest receivable

 

Level 2

      7,711       7,711       3,649       3,649  
                                         

Financial liabilities:

                                       

Deposits

 

Level 2

      2,303,261       2,305,253       1,118,911       1,120,576  

Repurchase agreements

 

Level 2

      124,108       124,108       69,305       69,305  

FHLB advances

 

Level 2

      57,044       57,235       45,000       45,139  

Subordinated debentures

 

Level 2

      54,131       54,087       32,990       32,974  

Accrued interest payable

 

Level 2

      2,159       2,159       2,041       2,041  

Interest rate swap

    (1)       390       390       264       264  

 

                                         
(1)   See Note 13 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)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

12.   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, noninterest checking deposits, securities sold under agreements to repurchase, and variable rate loans and deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. 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.

 

 

13.   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.

 


 

(Continued) 

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

13.   FAIR VALUES (Continued)

 

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.

 

Level 3: Significant unobservable inputs that reflect our own conclusions 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 and mutual funds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information becomes known which necessitates a valuation allowance. There was no such valuation allowance as of June 30, 2014 or December 31, 2013. We have no Level 1 securities available for sale.

 

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 and are 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 June 30, 2014 and December 31, 2013, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $1.9 million and $1.1 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)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

13.   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 June 30, 2014 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

  $ 213,706,000     $ 0     $ 213,706,000     $ 0  

Mortgage-backed securities

    108,172,000       0       108,172,000       0  

Municipal general obligation bonds

    140,169,000       0       128,791,000       11,378,000  

Municipal revenue bonds

    11,324,000       0       11,324,000       0  

Other investments

    1,904,000       0       1,904,000       0  

Interest rate swap

    (390,000 )     0       (390,000 )     0  

Total

  $ 474,885,000     $ 0     $ 463,507,000     $ 11,378,000  

 

There were no transfers in or out of Level 1, Level 2 or Level 3 during the first six months of 2014.

 

 

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

  $ 98,477,000     $ 0     $ 98,477,000     $ 0  

Mortgage-backed securities

    13,558,000       0       13,558,000       0  

Municipal general obligation bonds

    16,872,000       0       16,872,000       0  

Municipal revenue bonds

    916,000       0       916,000       0  

Other investments

    1,355,000       0       1,355,000       0  

Interest rate swap

    (264,000 )     0       (264,000 )     0  

Total

  $ 130,914,000     $ 0     $ 130,914,000     $ 0  

 

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

 


 

(Continued)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

13.   FAIR VALUES (Continued)

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2014 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)

  $ 18,899,000     $ 0     $ 0     $ 18,899,000  

Foreclosed assets (1)

    2,878,000       0       0       2,878,000  

Total

  $ 21,777,000     $ 0     $ 0     $ 21,777,000  

 

 

 

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 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)

  $ 23,405,000     $ 0     $ 0     $ 23,405,000  

Foreclosed assets (1)

    2,851,000       0       0       2,851,000  

Total

  $ 26,256,000     $ 0     $ 0     $ 26,256,000  

 

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

  

 

14.   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.

 


 

(Continue)

 

 
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

14.   REGULATORY MATTERS (Continued)

 

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 June 30, 2014 and December 31, 2013, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since June 30, 2014 that we believe have changed our bank’s categorization. Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:

 

                                    Minimum Required  
                                    to be Well  
                    Minimum Required     Capitalized Under  
                    for Capital     Prompt Corrective  
   

Actual

    Adequacy Purposes     Action Regulations  
   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

    Ratio  

June 30, 2014

                                               

Total capital (to risk weighted assets)

                                               

Consolidated

  $ 323,221       14.0 %   $ 184,700       8.0 %  

$

NA    

NA

 

Bank

    318,888       13.7       185,762       8.0       232,203       10.0 %

Tier 1 capital (to risk weighted assets)

                                               

Consolidated

    302,365       13.1       92,350       4.0    

NA

   

NA

 

Bank

    298,032       12.8       92,881       4.0       139,322       6.0  

Tier 1 capital (to average assets)

                                               

Consolidated

    302,365       16.7       72,553       4.0    

NA

   

NA

 

Bank

    298,032       16.4       72,810       4.0       91,012       5.0  
                                                 

December 31, 2013

                                               

Total capital (to risk weighted assets)

                                               

Consolidated

  $ 193,925       15.9 %   $ 97,498       8.0 %  

$

NA    

NA

 

Bank

    190,493       15.7       97,329       8.0       121,662       10.0 %

Tier 1 capital (to risk weighted assets)

                                               

Consolidated

    178,598       14.7       48,749       4.0    

NA

   

NA

 

Bank

    175,192       14.4       48,665       4.0       72,997       6.0  

Tier 1 capital (to average assets)

                                               

Consolidated

    178,598       12.5       57,006       4.0    

 

NA    

NA

 

Bank

    175,192       12.3       56,860       4.0       71,075       5.0  

 


 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 


 

14.   REGULATORY MATTERS (Continued)

 

Our consolidated capital levels as of June 30, 2014 and December 31, 2013 include $52.1 million and $32.0 million, respectively, of trust preferred securities 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 June 30, 2014 and December 31, 2013, all $52.1 million and $32.0 million, respectively, 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 January 16, 2014, our Board of Directors declared a cash dividend on our common stock in the amount of $0.12 per share that was paid on March 10, 2014 to shareholders of record as of February 10, 2014. On May 9, 2014, our Board of Directors declared a cash dividend on our common stock in the amount of $0.12 per share that was paid on June 25, 2014 to shareholders of record as of June 13, 2014. On July 17, 2014, 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 September 24, 2014 to shareholders of record as of September 12, 2014. In addition, on May 9, 2014, our Board of Directors declared a special cash dividend on our common stock in the amount of $2.00 per share that was paid on May 29, 2014 to shareholders of record as of May 22, 2014. The special cash dividend, in contemplation of the plan of merger with Firstbank, was paid to Mercantile shareholders prior to the effective date of the merger with Firstbank and before the issuance of Mercantile shares in exchange for Firstbank shares.

 


 

 
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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; our ability to successfully integrate the operations of Mercantile and Firstbank and their respective subsidiary banks; the ability of the combined company to compete in the highly competitive banking and financial services industry; 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, 2013 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, including 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 company”), at June 30, 2014 and December 31, 2013 and the results of operations for the three months and six months ended June 30, 2014 and June 30, 2013. 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-53 in our Form 10-K for the fiscal year ended December 31, 2013 (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.

 


 

 
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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 assets and liabilities 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 assets and liabilities 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 asset or liability 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.

 


 

 
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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.

 

Securities and Other Financial Instruments: Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rate, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as available for sale are reported at their fair value. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other than temporary losses, management considers: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near term prospects of the issuer; and (3) the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Fair values for securities available for sale are obtained from outside sources and applied to individual securities within the portfolio. The difference between the amortized cost and the current fair value of securities is recorded as a valuation adjustment and reported in other comprehensive income.

 

Mortgage Servicing Rights: Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from serving each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.

 

Goodwill: Generally accepted accounting principles require us to determine the fair value of all of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value. In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as goodwill.

 


 

 
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Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur. We use a discounted income approach and a market valuation model, which compares the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill has been impaired.

 

Firstbank Merger

We completed the merger of Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $1.5 billion in total assets and 46 branch locations, into Mercantile Bank Corporation as of June 1, 2014 (“Merger Date”). The results of operations due to the Firstbank transaction have been included in Mercantile’s financial results since the Merger Date. All of Firstbank’s common stock was converted into the right to receive one share of Mercantile common stock for each share of Firstbank common stock. The conversion of Firstbank’s common stock into Mercantile’s common stock resulted in Mercantile issuing 8,087,272 shares of its common stock. In conjunction with the completion of the merger, Mercantile assumed the obligations of four business trusts that were formed by Firstbank to issue trust preferred securities.

 

The Firstbank transaction was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Merger Date. In accordance with the applicable accounting guidance for business combinations, these fair values are preliminary and subject to refinement for up to one year after the closing date of the transaction as additional information relative to closing date fair value may become available.

 

In most instances, determining the fair value of the acquired assets and assumed liabilities required us to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Firstbank’s previously established allowance for loan losses. The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (“acquired impaired”), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (“acquired non-impaired”).

 

Our operating results for the quarter ended June 30, 2014 include the operating results of the acquired assets and assumed liabilities for the 30 days subsequent to the Merger Date. The operations of the former Firstbank organization provided approximately $4.5 million in net interest income for the period from the Merger Date to June 30, 2014, and are included in our consolidated financial statements for the three and six month periods ending June 30, 2014. Firstbank’s results of operations prior to the Merger Date are not included in our consolidated statements of income or comprehensive income.

 

We recorded merger-related expenses of $3.5 million and $3.8 million during the three month and six month periods ended June 30, 2014, respectively. Such expenses were generally for professional services, costs related to termination of existing contractual arrangements for various services, retention and severance compensation costs, marketing and promotional expenses, travel costs, and printing and supplies costs. Virtually all of Mercantile and Firstbank’s operating systems are now integrated.

 


 

 
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Financial Overview

We reported net income of $1.5 million, or $0.13 per diluted share, for the second quarter of 2014, and net income of $5.1 million, or $0.50 per diluted share, during the first six months of 2014.

 

Our second quarter and year-to-date earnings results were significantly impacted by the Firstbank merger. In addition to our earnings results reflecting one month of operations as a combined organization, we recorded relatively large merger-related costs during the first six months of 2014, primarily during the second quarter. Merger-related costs totaled $3.5 million during the second quarter and $3.8 million during the first six months of 2014. On an after-tax basis, that equated to $2.4 million, or $0.21 per diluted share, during the second quarter, and $2.7 million, or $0.27 per diluted share, during the first six months of 2014. We expect to record additional merger-related costs during the next several quarters, although we expect future costs to be considerably lower than the amounts expensed during the second quarter.

 

The quality of our loan portfolio continues to improve, which when combined with recoveries of prior loan charge-offs and the eliminations of and reductions in specific reserves, have produced a positive impact on our allowance calculations and allowed us to make negative provisions in six consecutive quarters and in eight of the last nine quarters. We have recorded a net loan recovery during the past five consecutive quarters and during seven out of the last nine quarters. The improvement in the quality of the loan portfolio and reductions in foreclosed asset balances have also resulted in significantly lower problem asset administration costs. In fact, when gains on the sale of foreclosed assets are netted against problem asset administration costs, we recorded a slightly negative net expense during both the first and second quarters of 2014.

 

New term loan originations totaled approximately $75 million during the second quarter of 2014 and about $121 million during the first six months of 2014. We have also experienced net increases in commercial lines of credit, in large part reflecting lines that are part of new commercial lending relationships established during recent quarterly periods. Our loan portfolio is well diversified post-merger, with commercial and industrial loans comprising 30% of total loans, commercial real estate non-owner occupied loans equaling 27%, and commercial real estate owner occupied along with residential mortgage and consumer loans both at 19% of total loans. As a percent of total commercial loans, commercial and industrial loans and commercial real estate owner occupied loans equal 59%.

 

The merger with Firstbank also had a significant positive impact on our funding structure, resulting in a well diversified funding mix. Noninterest-bearing checking accounts comprise 21% of total funds, interest-bearing checking and sweep accounts combine for 22%, savings deposits and money market accounts aggregate to 24% and local time deposits account for 23%. Wholesale funds, comprised of brokered deposits and FHLB advances, represent 10% of total funds.

 

Financial Condition

Primarily reflecting the merger with Firstbank, our total assets increased $1.45 billion during the first six months of 2014, and totaled $2.88 billion as of June 30, 2014. Total loans increased $1.02 billion and securities available for sale were up $344 million, while cash and cash equivalents decreased $28.1 million. Total deposits increased $1.18 billion and securities sold under agreements to repurchase (“repurchase agreements”) were up $54.8 million during the first six months of 2014.

 


 

 
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Our loan portfolio has historically been primarily comprised of commercial loans, although less so now with the Firstbank merger. Commercial loans increased $701 million during the first six months of 2014, and at June 30, 2014 totaled $1.69 billion, or 81.4% of the loan portfolio. As of December 31, 2013, the commercial loan portfolio comprised 93.7% of total loans. The increase in commercial loans during the first six months of 2014 includes about $121 million in new commercial term loans to existing and new borrowers, with the remainder generally reflecting the Firstbank merger. Commercial and industrial loans were up $330 million, non-owner occupied commercial real estate (“CRE”) loans increased $185 million, owner occupied CRE loans increased $123 million, multi-family and residential rental loans increased $47 million and vacant land, land development and residential construction loans were up $17 million. As a percent of total commercial loans, commercial and industrial loans and commercial real estate owner occupied loans equal 59%.

 

We significantly enhanced our commercial loan sales efforts over the past couple of years. We are very pleased with the approximately $525 million in new commercial term loan fundings since the beginning of 2012, and our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods. Also, as of June 30, 2014, availability on existing construction and development loans totaled over $51 million, with most of those funds expected to be drawn over the next twelve months. In addition, we have made additional lending commitments totaling about $177 million, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial lenders also report substantial additional opportunities they are currently discussing with existing and potentially new borrowers.

 

We continue to experience some commercial loan principal paydowns and payoffs. A majority of these principal paydowns and payoffs received thus far have been welcomed, such as on stressed loan relationships; however, we have also experienced 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 has remained relatively steady.

 

Reflecting the Firstbank merger, one-to-four family mortgage loans increased $185 million and other consumer loans were up $135 million during the first six months of 2014, and at June 30, 2014, totaled a combined $386 million, or 18.6% of total loans. One-to-four family mortgage loans and other consumer loans equated to 6.3% of total loans as of December 31, 2013.

 


 

 
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The following table summarizes our loan portfolio at June 30, 2014, broken out by loans originated by Mercantile and loans acquired in the Firstbank merger:

 

   

Originated

   

Acquired

   

Total

 
   

Loans

   

Loans

   

Loans

 
                         

Commercial:

                       

Commercial & Industrial

  $ 342,375,000     $ 273,684,000     $ 616,059,000  

Land Development & Construction

    32,214,000       21,091,000       53,305,000  

Owner Occupied Commercial RE

    264,596,000       119,818,000       384,414,000  

Non-Owner Occupied Commercial RE

    399,855,000       149,434,000       549,289,000  

Multi-Family & Residential Rental

    37,569,000       47,099,000       84,668,000  

Total Commercial

    1,076,609,000       611,126,000       1,687,735,000  
                         

Retail:

                       

1-4 Family Mortgages

    33,337,000       182,702,000       216,039,000  

Home Equity & Other Consumer

    35,151,000       134,557,000       169,708,000  

Total Retail

    68,488,000       317,259,000       385,747,000  
                         

Total

  $ 1,145,097,000     $ 928,385,000     $ 2,073,482,000  

 

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 effective 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.

 

Nonperforming assets, comprised of nonaccrual loans and foreclosed properties, totaled $8.6 million (0.3% of total assets) as of June 30, 2014, compared to $9.6 million (0.7% of total assets) as of December 31, 2013. 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. Reductions in nonperforming assets during the first six months of 2014 primarily reflect principal payments on nonaccrual loans and sales proceeds on foreclosed properties. Foreclosed properties acquired in the Firstbank merger totaled $1.2 million. Acquired loans are recorded at fair value with no allowance brought forward in accordance with acquisition accounting. Acquired impaired loans are considered performing due to the application of the accretion method under acquisition accounting.

 


 

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

  

NONPERFORMING LOANS  
                                         
   

6/30/14

   

3/31/14

   

12/31/13

   

9/30/13

   

6/30/13

 

Residential Real Estate:

                                       

Land Development

  $ 36,000     $ 38,000     $ 40,000     $ 43,000     $ 317,000  

Construction

    0       0       0       0       0  

Owner Occupied / Rental

    3,898,000       4,026,000       4,219,000       2,859,000       3,201,000  
      3,934,000       4,064,000       4,259,000       2,902,000       3,518,000  
                                         

Commercial Real Estate:

                                       

Land Development

    235,000       361,000       389,000       627,000       650,000  

Construction

    0       0       0       0       0  

Owner Occupied

    1,176,000       784,000       885,000       718,000       960,000  

Non-Owner Occupied

    129,000       335,000       169,000       3,251,000       4,642,000  
      1,540,000       1,480,000       1,443,000       4,596,000       6,252,000  
                                         

Non-Real Estate:

                                       

Commercial Assets

    267,000       798,000       1,016,000       1,111,000       755,000  

Consumer Assets

    0       0       0       0       1,000  
      267,000       798,000       1,016,000       1,111,000       756,000  
                                         

Total

  $ 5,741,000     $ 6,342,000     $ 6,718,000     $ 8,609,000     $ 10,526,000  

 

 

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS  
                                         
   

6/30/14

   

3/31/14

   

12/31/13

   

9/30/13

   

6/30/13

 

Residential Real Estate:

                                       

Land Development

  $ 427,000     $ 427,000     $ 427,000     $ 495,000     $ 619,000  

Construction

    22,000       22,000       22,000       89,000       89,000  

Owner Occupied / Rental

    968,000       186,000       207,000       219,000       315,000  
      1,417,000       635,000       656,000       803,000       1,023,000  
                                         

Commercial Real Estate:

                                       

Land Development

    92,000       92,000       92,000       6,000       31,000  

Construction

    0       0       0       0       0  

Owner Occupied

    300,000       75,000       164,000       501,000       606,000  

Non-Owner Occupied

    1,069,000       1,548,000       1,939,000       2,239,000       2,256,000  
      1,461,000       1,715,000       2,195,000       2,746,000       2,893,000  
                                         

Non-Real Estate:

                                       

Commercial Assets

    0       0       0       0       0  

Consumer Assets

    0       0       0       0       0  
      0       0       0       0       0  
                                         

Total

  $ 2,878,000     $ 2,350,000     $ 2,851,000     $ 3,549,000     $ 3,916,000  

 


 

 
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The following tables provide a reconciliation of nonperforming assets:

 

NONPERFORMING LOANS RECONCILIATION  
                                         
   

2nd Qtr

   

1st Qtr

   

4th Qtr

   

3rd Qtr

   

2nd Qtr

 
   

2014

   

2014

   

2013

   

2013

   

2013

 
                                         

Beginning balance

  $ 6,342,000     $ 6,718,000     $ 8,609,000     $ 10,526,000     $ 12,395,000  

Additions, net of transfers to ORE

    (11,000 )     174,000       1,734,000       502,000       438,000  

Principal payments

    (523,000 )     (449,000 )     (3,072,000 )     (2,363,000 )     (1,988,000 )

Loan charge-offs

    (67,000 )     (101,000 )     (553,000 )     (56,000 )     (319,000 )
                                         

Total

  $ 5,741,000     $ 6,342,000     $ 6,718,000     $ 8,609,000     $ 10,526,000  

 

 

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION  
                                         
   

2nd Qtr

   

1st Qtr

   

4th Qtr

   

3rd Qtr

   

2nd Qtr

 
   

2014

   

2014

   

2013

   

2013

   

2013

 
                                         

Beginning balance

  $ 2,350,000     $ 2,851,000     $ 3,549,000     $ 3,916,000     $ 6,505,000  

Additions - originated loans

    175,000       0       134,000       350,000       57,000  

Additions - merger ORE

    1,187,000       0       0       0       0  

Sale proceeds

    (790,000 )     (501,000 )     (797,000 )     (527,000 )     (2,374,000 )

Valuation write-downs

    (44,000 )     0       (35,000 )     (190,000 )     (272,000 )
                                         

Total

  $ 2,878,000     $ 2,350,000     $ 2,851,000     $ 3,549,000     $ 3,916,000  

 

During the first six months of 2014, loan charge-offs totaled $0.7 million while recoveries of prior period charge-offs aggregated to $1.3 million, resulting in a net recovery $0.6 million. We recorded a net recovery of prior period charge-offs of $1.3 million during all of 2013.

 


 

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

 

   

2nd Qtr

   

1st Qtr

   

4th Qtr

   

3rd Qtr

   

2nd Qtr

 
   

2014

   

2014

   

2013

   

2013

   

2013

 

Residential Real Estate:

                                       

Land Development

  $ (4,000 )   $ (1,000 )   $ (78,000 )   $ (387,000 )   $ (119,000 )

Construction

    0       0       0       0       0  

Owner Occupied / Rental

    (572,000 )     (139,000 )     (144,000 )     (105,000 )     (301,000 )
      (576,000 )     (140,000 )     (222,000 )     (492,000 )     (420,000 )
                                         

Commercial Real Estate:

                                       

Land Development

    (11,000 )     0       0       0       30,000  

Construction

    0       0       0       0       0  

Owner Occupied

    98,000       37,000       47,000       (74,000 )     (6,000 )

Non-Owner Occupied

    (70,000 )     336,000       1,206,000       (1,215,000 )     79,000  
      17,000       373,000       1,253,000       (1,289,000 )     103,000  
                                         

Non-Real Estate:

                                       

Commercial Assets

    (45,000 )     (267,000 )     (1,154,000 )     (172,000 )     (95,000 )

Consumer Assets

    2,000       1,000       (4,000 )     5,000       1,000  
      (43,000 )     (266,000 )     (1,158,000 )     (167,000 )     (94,000 )
                                         

Total

  $ (602,000 )   $ (33,000 )   $ (127,000 )   $ (1,948,000 )   $ (411,000 )

 

In each accounting period, we adjust the allowance to the amount we believe is necessary to maintain the allowance at an adequate level. Through the loan review and credit departments, we establish portions of the allowance based on specifically identifiable problem loans. The evaluation of the allowance is further based on, but not limited to, consideration of the internally prepared Allowance Analysis, loan loss migration analysis, composition of the loan portfolio, third party analysis of the loan administration processes and portfolio, and general economic conditions.

 

The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan balances, the result of which is combined with specific reserves to calculate an overall allowance dollar amount. For non-impaired commercial loans, reserve allocation factors are based on the loan ratings as determined by our standardized grade paradigms and by loan purpose. Our commercial loan portfolio is segregated into five classes: 1) commercial and industrial loans; 2) vacant land, land development and residential construction loans; 3) owner occupied real estate loans; 4) non-owner occupied real estate loans; and 5) multi-family and residential rental property loans. The reserve allocation factors are primarily based on the historical trends of net loan charge-offs through a migration analysis whereby net loan losses are tracked via assigned grades over various time periods, with adjustments made for environmental factors reflecting the current status of, or recent changes in, items such as: lending policies and procedures; economic conditions; nature and volume of the loan portfolio; experience, ability and depth of management and lending staff; volume and severity of past due, nonaccrual and adversely classified loans; effectiveness of the loan review program; value of underlying collateral; loan concentrations; and other external factors such as competition and regulatory environment. Adjustments for specific lending relationships, particularly impaired loans, are made on a case-by-case basis. Non-impaired retail loan reserve allocations are determined in a similar fashion as those for non-impaired commercial loans, except that retail loans are segmented by type of credit and not a grading system. We regularly review the Allowance Analysis and make needed adjustments based upon identifiable trends and experience.

 


 

 
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A migration analysis is completed quarterly to assist us in determining appropriate reserve allocation factors for non-impaired commercial loans. Our migration analysis takes into account various time periods, with most weight placed on a twelve-quarter time frame. We believe the twelve-quarter period represents an appropriate range of economic conditions, and that it provides for an appropriate basis in determining reserve allocation factors given current economic conditions and the general consensus of economic conditions in the near future.

 

Although the migration analysis provides a historical accounting of our net loan losses, it is not able to fully account for environmental factors that will also very likely impact the collectability of our commercial loans as of any quarter-end date. Therefore, we incorporate the environmental factors as adjustments to the historical data. Environmental factors include both internal and external items. We believe the most significant internal environmental factor is our credit culture and the relative aggressiveness in assigning and revising commercial loan risk ratings, with the most significant external environmental factor being the assessment of the current economic environment and the resulting implications on our commercial loan portfolio.

 

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 we have 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.

 

The allowance equaled $20.9 million as of June 30, 2014, or 1.8% of total originated loans outstanding, compared to 2.2% as of December 31, 2013. A large portion of the decline in the level of the allowance during the first six months of 2014 reflects elimination and reduction of specific reserves due to successful collection efforts, while the remainder of the decline is primarily associated with commercial loan upgrades and reductions in most reserve allocation factors on non-impaired commercial loans resulting from the impact of lower net loan charge-offs in recent periods on our migration calculations. The allowance equaled 363.3% of nonperforming loans as of June 30, 2014, compared to 339.7% as of December 31, 2013. This particular allowance measurement has increased significantly during the past several years primarily due to total nonperforming loans declining at a faster rate than the balance of the allowance and certain accruing higher-balance commercial loan relationships having been categorized as troubled debt restructurings resulting in higher specific reserve allocations.

 

As of June 30, 2014, the allowance was comprised of $10.5 million in general reserves relating to non-impaired loans, $1.5 million in specific reserve allocations relating to nonaccrual loans, and $8.9 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. Troubled debt restructurings totaled $29.1 million at June 30, 2014, consisting of $4.2 million that are on nonaccrual status and $24.9 million that are on accrual status. The latter, while considered and accounted for as impaired loans in accordance with accounting guidelines, is not included in our nonperforming loan totals. Impaired loans with an aggregate carrying value of $2.4 million as of June 30, 2014 had been subject to previous partial charge-offs aggregating $2.4 million. Those partial charge-offs were recorded as follows: $0.1 million during the first six months of 2014, $0.5 million in 2013, $1.1 million in 2012, $0.5 million in 2011 and $0.2 million in 2010. As of June 30, 2014, there were no specific reserves allocated to impaired loans that had been subject to a previous partial charge-off.

 


  

 
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The following table provides a breakdown of our loans categorized as troubled debt restructurings:

 

   

6/30/14

   

3/31/14

   

12/31/13

   

9/30/13

   

6/30/13

 
                                         

Performing

  $ 24,901,000     $ 27,093,000     $ 30,247,000     $ 41,707,000     $ 42,991,000  

Nonperforming

    4,232,000       4,800,000       4,645,000       5,782,000       7,523,000  
                                         

Total

  $ 29,133,000     $ 31,893,000     $ 34,892,000     $ 47,489,000     $ 50,514,000  

 

Although we believe the allowance is adequate to absorb loan losses in our originated loan portfolio as they arise, there can be no assurance that we will not sustain loan losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.

 

Reflecting the merger with Firstbank, securities increased $344 million during the first six months of 2014, totaling $475 million as of June 30, 2014. Purchases during the first six months of 2014, consisting almost exclusively of U.S. Government agency bonds, totaled $11.7 million. Proceeds from matured and called U.S. Government agency bonds and municipal bonds during the first six months of 2014 totaled $11.0 million and $7.8 million, respectively, with another $3.9 million from principal paydowns on mortgage-backed securities. At June 30, 2014, the portfolio was primarily comprised of U.S. Government agency bonds (45%), municipal bonds (32%) and U.S. Government agency issued or guaranteed mortgage-backed securities (23%). All of our securities are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at June 30, 2014 totaled $475 million, including a net unrealized loss of $4.2 million. We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations. In addition, the securities portfolio serves a primary interest rate risk management function.

 

FHLB stock totaled $19.2 million as of June 30, 2014, an increase of $7.3 million from the balance at December 31, 2013 resulting from the Firstbank merger. Our investment in FHLB stock is necessary to engage in their advance and other financing programs. We have received regularly quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.

 

Market values on our U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies and municipal bonds are generally determined on a monthly basis with the assistance of a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes and issuer spreads. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.

 

Federal funds sold, consisting of excess funds sold overnight to a correspondent bank, along with investments in interest-bearing deposits at correspondent and other banks, are used to manage daily liquidity needs and interest rate sensitivity. During the first six months of 2014, the average balance of these funds equaled $93.2 million, or 6.1% of average earning assets. We expect the level of these funds to average approximately 1% to 2% of average earning assets in future quarters.

 

Net premises and equipment equaled $49.0 million at June 30, 2014, an increase of $24.1 million during the first six months of 2014. The merger with Firstbank accounts for virtually the entire increase.

 


 

 
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Foreclosed and repossessed assets totaled $2.9 million at June 30, 2014, unchanged from the balance at December 31, 2013. Foreclosed property sales totaled $1.3 million during the first six months of 2014, while foreclosed properties from the Firstbank merger totaling $1.2 million were added during the period. While we expect some transfers from loans to foreclosed and repossessed assets in future periods reflecting our collection efforts on impaired lending relationships, we expect that sales activity will limit any increase in, and average balance of, this nonperforming asset category.

 

Primarily reflecting the merger with Firstbank, total deposits increased $1.18 billion during the first six months of 2014, totaling $2.30 billion at June 30, 2014. Out-of-area deposits decreased $25.3 million during the first six months of 2014, and as a percent of total deposits, equaled 8.2% as of June 30, 2014, compared to 19.0% as of December 31, 2013.

 

Noninterest-bearing checking accounts increased $291 million during the first six months of 2014. While the growth is primarily due to the Firstbank merger, noninterest-bearing checking accounts also increased due to deposit account openings as part of new commercial lending relationships. Also reflecting the impact of the Firstbank merger, interest-bearing checking accounts increased $227 million, money market deposit accounts grew $104 million, savings deposits increased $289 million and local time deposits grew $298 million during the first six months of 2014.

 

Repurchase agreements increased $54.8 million during the first six months of 2014, totaling $124 million as of June 30, 2014. The increase is primarily due to the merger with Firstbank. As part of our sweep account program, collected funds from certain business noninterest-bearing checking accounts and savings deposits are invested into over-night interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance.

 

Reflecting the merger with Firstbank, FHLB advances increased $12.0 million during the first six months of 2014. As of June 30, 2014, FHLB advances totaled $57.0 million. The FHLB 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 June 30, 2014 totaled about $570 million, with availability approximating $509 million.

 

 

Liquidity

Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and capital, or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-bearing balances. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.

 

To assist in providing needed funds, we have regularly obtained monies from wholesale funding sources. Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLB, totaled $245 million, or 9.9% of combined deposits and borrowed funds, as of June 30, 2014, compared to $258 million, or 20.9% of combined deposits and borrowed funds, as of December 31, 2013.

 


 

 
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As part of our sweep account program, collected funds from certain business noninterest-bearing checking accounts and savings deposits are invested into over-night interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. Repurchase agreements increased $54.8 million during the first six months of 2014, totaling $124 million as of June 30, 2014. The increase is primarily attributable to the merger with Firstbank. Information regarding our repurchase agreements as of June 30, 2014 and during the first six months of 2014 is as follows:

 

Outstanding balance at June 30, 2014

  $ 124,108,000  

Weighted average interest rate at June 30, 2014

    0.10 %

Maximum daily balance six months ended June 30, 2014

  $ 126,621,000  

Average daily balance for six months ended June 30, 2014

  $ 79,003,000  

Weighted average interest rate for six months ended June 30, 2014

    0.12 %

 

As a member of the FHLB, we have access to the FHLB advance borrowing programs. FHLB advances increased $12.0 million during the first six months of 2014, reflecting the merger with Firstbank. As of June 30, 2014, FHLB advances totaled $57.0 million. Based on available collateral at June 30, 2014, we could borrow an additional $509 million.

 

We also have the ability to borrow up to $63.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. We did not access these lines of credit during first six months of 2014; in fact, we have not accessed the lines of credit since January of 2010. In contrast, federal funds sold averaged $86.9 million during the first six months of 2014. We have a line of credit through the Discount Window of the Federal Reserve Bank of Chicago. Using certain municipal bonds as collateral, we could have borrowed up to $12.4 million as of June 30, 2014. We did not utilize this line of credit during the first six months of 2014 or at any time during the previous five fiscal years, and do not plan to access this line of credit in future periods.

 

The following table reflects, as of June 30, 2014, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

 

   

One Year

   

One to

   

Three to

   

Over

         
   

or Less

   

Three Years

   

Five Years

   

Five Years

   

Total

 
                                         

Deposits without a stated maturity

  $ 1,519,730,000     $ 0     $ 0     $ 0     $ 1,519,730,000  

Certificates of deposit

    382,018,000       287,746,000       113,767,000       0       783,531,000  

Short-term borrowings

    124,108,000       0       0       0       124,108,000  

Federal Home Loan Bank advances

    9,000,000       23,044,000       25,000,000       0       57,044,000  

Subordinated debentures

    0       0       0       54,131,000       54,131,000  

Other borrowed money

    9,545,000       1,455,000       0       3,348,000       14,348,000  

Property leases

    301,000       614,000       532,000       195,000       1,642,000  

 


 

 
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In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of June 30, 2014, we had a total of $595 million in unfunded loan commitments and $37.6 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $418 million were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $177 million were for loan commitments generally expected to close and become funded within the next twelve months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.

 

We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, changes in economic or market conditions, a reduction in earnings performance, declining capital levels or situations beyond our control could cause liquidity challenges. While we believe it is unlikely that a funding crisis of any significant degree is likely to materialize, we have developed a comprehensive contingency funding plan that provides a framework for meeting liquidity disruptions.

 

Capital Resources

Shareholders’ equity was $316 million at June 30, 2014, compared to $153 million at December 31, 2013. The $163 million increase during the first six months of 2014 was primarily due to the merger with Firstbank. We issued 8,087,272 shares of common stock, valued at $173 million, in connection with the merger. Net income during the first six months of 2014 totaled $5.1 million. Negatively impacting shareholder’s equity during the first six months of 2014 were cash dividends on common shares totaling $20.4 million. In accordance with the plan of merger with Firstbank, we declared and paid a special $2.00 per share cash dividend to Mercantile shareholders prior to the effective date of the merger and before the issuance of Mercantile shares in exchange for Firstbank shares. In addition, we declared and paid a $0.12 per share cash dividend in both the first and second quarters of 2014.

 

We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. As of June 30, 2014, our bank’s total risk-based capital ratio was 13.7%, with our bank’s total regulatory capital equaling $319 million, or approximately $87 million in excess of the 10.0% minimum which is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of June 30, 2014 and December 31, 2013 are disclosed in Note 14 of the Notes to Condensed Consolidated Financial Statements.

 

Results of Operations

We recorded net income of $1.5 million for the second quarter of 2014 ($0.13 per basic and diluted share), compared to net income of $4.0 million ($0.46 per basic and diluted share) recorded during the second quarter of 2013. We recorded net income of $5.1 million ($0.50 per basic and diluted share) for the first six months of 2014, compared to net income of $8.4 million ($0.97 per basic and diluted share) recorded during the first six months of 2013. The results for the second quarter and the first six months of 2014 were impacted by the merger with Firstbank, which was consummated on June 1, 2014; operating results for the 2014 periods include one month of operations as a combined organization. After-tax merger-related costs totaled $2.4 million, or $0.21 per diluted share, during the second quarter of 2014 and $2.7 million, or $0.27 per diluted share, during the first six months of 2014; total merger-related expenses were negligible during the respective 2013 periods. We expect to record additional merger-related costs during the next several quarters, although we expect future costs to be considerably lower than the amounts expensed during the second quarter.

 


 

 
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The decline in earnings performance in the second quarter and the first six months of 2014 compared to the respective prior-year periods primarily resulted from increased overhead costs. As noted above, significant merger-related costs were incurred in the 2014 periods, while a nominal level of such costs were recorded during the comparable 2013 periods. In addition, various nonmerger-related costs necessary to operate the combined company contributed to the increase in overhead costs. Higher net interest income, primarily resulting from the increase in average earning assets associated with the completion of the merger, partially mitigated the impact of the higher level of overhead costs on earnings performance.

 

Interest income during the second quarter of 2014 was $18.5 million, an increase of $4.5 million, or 32.1%, from the $14.0 million earned during the second quarter of 2013. Interest income during the first six months of 2014 was $32.1 million, an increase of $3.9 million, or 13.1%, from the $28.2 million earned during the first six months of 2013. The increase in interest income in the 2014 periods compared to the respective 2013 periods is attributable to an increase in earning assets, which more than offset a declining yield on earning assets. Average earning assets include Firstbank’s assets from the date of acquisition. The decreased yield on earning assets in the second quarter of 2014 was mainly attributable to a lower yield on average securities and a change in earning asset mix, while the decreased yield on earning assets during the first six months of 2014 was mainly due to decreased yields on average securities and average loans.

 

Interest expense during the second quarter of 2014 was $2.9 million, an increase of $0.2 million, or 9.3%, from the $2.7 million expensed during the second quarter of 2013. Interest expense during the first six months of 2014 was $5.5 million, a slight increase from the $5.4 million expensed during the first six months of 2013. The increase in interest expense in the 2014 periods compared to the respective 2013 periods is attributable to an increase in the volume of average interest-bearing liabilities. Average interest-bearing liabilities include Firstbank’s liabilities from the date of acquisition. The impact of the higher volume of average interest-bearing liabilities on interest expense was substantially offset by a decrease in the weighted average cost of interest-bearing liabilities. Maturing fixed-rate certificates of deposit were renewed at lower rates, replaced by lower-costing funds, or allowed to runoff during 2013 and the first six months of 2014. In addition, the lowering of interest rates on certain non-certificate of deposit accounts in the latter part of the fourth quarter of 2013 and the absorption of Firstbank’s lower-costing interest-bearing liability base positively impacted the cost of funds in the 2014 periods.

  

Net interest income during the second quarter of 2014 was $15.6 million, an increase of $4.3 million, or 37.5%, from the $11.3 million earned during the second quarter of 2013. Net interest income during the first six months of 2014 was $26.6 million, an increase of $3.8 million, or 16.9%, from the $22.8 million earned during the first six months of 2013. The increase in net interest income in the 2014 periods compared to the respective 2013 periods was due to an increase in earning assets, which more than offset a decline in the net interest margin. The net interest margin during the second quarter of 2014 was 3.62%, compared to 3.66% during the second quarter of 2013. During the first six months of 2014, the net interest margin was 3.53%, compared to 3.67% during the same time period in 2013. The declined net interest margin in the 2014 periods reflects the decreased yield on earning assets, which more than offset the reduction in the cost of funds.

 

The following table sets forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the second quarter of 2014 and 2013. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. Tax-exempt securities interest income and yield have been computed on a tax equivalent basis using a marginal tax rate of 35%. Securities interest income was increased by $100,000 and $114,000 in the second quarter of 2014 and 2013, respectively, for this adjustment.

 


 

 
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Quarters ended June 30,

 
   

2 0 1 4

    2 0 1 3  
      Average     

 

   

Average

    Average             Average  
      Balance     

Interest

   

Rate

   

Balance

   

Interest

    Rate  

 

    (dollars in thousands)  

ASSETS

                                               

Loans

  $ 1,377,986     $ 16,657       4.85 %   $ 1,044,527     $ 12,687       4.87 %

Investment securities

    267,273       1,867       2.79       145,614       1,378       3.79  

Federal funds sold

    65,622       41       0.25       55,796       35       0.25  

Interest-bearing deposits

    24,119       17       0.28       7,724       6       0.29  

Total interest - earning assets

    1,735,000       18,582       4.30       1,253,661       14,106       4.51  
                                                 

Allowance for loan losses

    (21,138 )                     (26,100                

Other assets

    168,756                       136,809                  
                                                 

Total assets

  $ 1,882,618                     $ 1,364,370                   
                                                 
                                                 

LIABILITIES AND SHAREHOLDERS’ EQUITY

                                               

Interest-bearing deposits

  $ 1,169,863     $ 2,272       0.78 %   $ 887,408     $ 2,223       1.00 %

Short-term borrowings

    81,565       27       0.12       63,526       19       0.12  

Federal Home Loan Bank advances

    48,971       156       1.26       35,000       119       1.35  

Other borrowings

    46,410       474       4.04       34,482       319       3.68  

Total interest-bearing liabilities

    1,346,809       2,929       0.87       1,020,416       2,680       1.05  
                                                 

Noninterest-bearing deposits

    318,632                       188,352                  

Other liabilities

    11,620                       5,124                  

Shareholders’ equity

    205,558                       150,478                   
                                                 

Total liabilities and shareholders’ equity

  $ 1,882,619     $               $ 1,364,370                  
                                                 

Net interest income

          $ 15,653                     11,426          
                                                 

Net interest rate spread

                     3.43                     3.46

Net interest spread on average assets

                     3.33                     3.36

Net interest margin on earning assets

                    3.62 %                     3.66

 

A negative loan loss provision expense of $0.7 million was recorded during the second quarter of 2014, compared to a negative provision expense of $1.5 million during the second quarter of 2013. A negative loan loss provision expense of $2.6 million was recorded during the first six months of 2014, compared to a negative provision expense of $3.0 million during the first six months of 2013. The negative provision expense reflects recoveries of previously charged-off loans, reversals of specific reserves, a reduced level of loan-rating downgrades, and ongoing loan-rating upgrades as the quality of the loan portfolio continued to improve. Continued progress in the stabilization of economic and real estate market conditions and resulting collateral valuations also positively impacted provision expense.

 


 

 
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Recoveries of previously charged-off loans totaled $0.7 million during the second quarter of 2014, while loan charge-offs not specifically reserved for in prior periods amounted to $0.1 million, resulting in a net positive impact of $0.6 million on provision expense. Recoveries of previously charged-off loans totaled $1.3 million during the first six months of 2014, while loan charge-offs not specifically reserved for in prior periods amounted to $0.2 million, resulting in a net positive impact of $1.1 million on provision expense. Net loan recoveries of $0.6 million were recorded during the second quarter of 2014, compared to net loan recoveries of $0.4 million during the prior-year second quarter. Net loan recoveries of $0.6 million were recorded during the first six months of 2014, compared to net loan charge-offs of $0.7 million during the same time period in 2013. Of the $0.7 million in gross loans charged-off during the first six months of 2014, $0.6 million, or about 80%, represents the elimination of specific reserves that were established through provision expense in earlier periods. Nonperforming loans totaled $5.7 million, or 0.5% of total originated loans, as of June 30, 2014, compared to $10.5 million, or 1.0% of total loans, as of June 30, 2013. The allowance equaled 1.8% of total originated loans as of June 30, 2014, compared to 2.4% of total loans as of June 30, 2013.

 

Noninterest income during the second quarter of 2014 was $2.3 million, an increase of $0.5 million, or 29.1%, from the $1.8 million earned during the prior-year second quarter. Noninterest income during the first six months of 2014 was $3.8 million, an increase of $0.2 million, or 5.4%, from the $3.6 million earned during the same time period in 2013. The increase in noninterest income in the 2014 periods was mainly due to higher debit and credit card fee income and service charges on deposit accounts. Increased mortgage referral and sale fees also contributed to the higher level of noninterest income during the second quarter of 2014. These categories of noninterest income benefited from the consummation of the merger with Firstbank.

 

Noninterest expense during the second quarter of 2014 was $16.1 million, an increase of $7.3 million, or 82.3%, from the $8.8 million expensed during the second quarter of 2013. Noninterest expense during the first six months of 2014 was $25.3 million, an increase of $7.9 million, or 45.3%, from the $17.4 million expensed during the same time period in 2013. The increase in noninterest expense in the second quarter of 2014 and the first six months of 2014 primarily resulted from higher merger-related costs and salary and benefit expenses. Merger-related costs totaled $3.5 million and $3.8 million during the second quarter of 2014 and the first six months of 2014, respectively; these costs were nominal during the respective 2013 periods. Salary and benefit expenses totaled $7.0 million during the second quarter of 2014, an increase of $2.0 million, or 41.3%, from the $5.0 million expensed during the prior-year second quarter. Salary and benefit expenses were $12.3 million during the first six months of 2014, an increase of $2.5 million, or 24.7%, from the $9.8 million expensed during the first six months of 2013. The increase in salary and benefit expenses was mainly due to the hiring of additional staff members over the past year and officer merit pay increases, along with the increase in employees associated with the completion of the merger with Firstbank. As of June 30, 2014, full-time equivalent employees numbered 645, up from 239 as of June 30, 2013. Increases in other categories of nonmerger-related costs necessary to operate the combined company also contributed to the higher level of overhead costs.

 


 

 
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During the second quarter of 2014, we recorded income before federal income tax of $2.5 million and a federal income tax expense of $1.0 million. During the second quarter of 2013, we recorded income before federal income tax of $5.8 million and a federal income tax expense of $1.8 million. The decrease in federal income tax expense in the second quarter of 2014 resulted from the lower level of income before federal income tax, which more than offset an increase in our effective tax rate from 30.4% in the second quarter of 2013 to 39.0% in the second quarter of 2014. During the first six months of 2014, we recorded income before federal income tax of $7.7 million and a federal income tax expense of $2.6 million. During the first six months of 2013, we recorded income before federal income tax of $12.0 million and a federal income tax expense of $3.6 million. The decrease in federal income tax expense during the first six months of 2014 resulted from the lower level of income before federal income tax, which more than offset an increase in our effective tax rate from 29.7% in the 2013 period to 34.2% in the 2014 period. The increase in the effective tax rate in the 2014 periods is primarily due to the recording of nondeductible merger-related expenses.

 

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates is assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates. We derive our income primarily from the excess of interest collected on our interest-earning assets over the interest paid on our interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness.

 

Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal control procedures are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk, we assess the existing and potential future effects of changes in interest rates on our financial condition, including capital adequacy, earnings, liquidity and asset quality.

 

We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to our net interest margin during periods of changing market interest rates.

 


 

 
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The following table depicts our GAP position as of June 30, 2014:

 

   

Within

   

Three to

   

One to

   

After

         
   

Three

   

Twelve

   

Five

   

Five

         
   

Months

   

Months

   

Years

   

Years

   

Total

 

Assets:

                                       

Commercial loans (1)

  $ 281,817,000     $ 240,418,000     $ 983,392,000     $ 157,418,000     $ 1,663,045,000  

Residential real estate loans

    28,126,000       22,729,000       123,824,000       171,764,000       346,443,000  

Consumer loans

    1,729,000       3,398,000       45,687,000       13,180,000       63,994,000  

Securities (2)

    30,465,000       31,026,000       159,516,000       273,494,000       494,501,000  

Federal funds sold

    11,973,000       0       0       0       11,973,000  

Interest-bearing deposits

    46,903,000       250,000       997,000       0       48,150,000  

Allowance for loan losses

    0       0       0       0       (20,856,000 )

Other assets

    0       0       0       0       272,032,000  

Total assets

    401,013,000       297,821,000       1,313,416,000       615,856,000     $ 2,879,282,000  
                                         

Liabilities:

                                       

Interest-bearing checking

    424,362,000       0       0       0       424,362,000  

Savings deposits

    341,924,000       0       0       0       341,924,000  

Money market accounts

    237,798,000       0       0       0       237,798,000  

Time deposits under $100,000

    36,474,000       80,858,000       94,235,000       0       211,567,000  

Time deposits $100,000 & over

    107,251,000       157,435,000       307,278,000       0       571,964,000  

Short-term borrowings

    124,108,000       0       0       0       124,108,000  

Federal Home Loan Bank advances

    0       6,000,000       51,044,000       0       57,044,000  

Other borrowed money

    66,479,000       545,000       1,455,000       0       68,479,000  

Noninterest-bearing checking

    0       0       0       0       515,646,000  

Other liabilities

    0       0       0       0       10,252,000  

Total liabilities

    1,338,396,000       244,838,000       454,012,000       0       2,563,144,000  

Shareholders' equity

    0       0       0       0       316,138,000  

Total liabilities & shareholders' equity

    1,338,396,000       244,838,000       454,012,000       0     $ 2,879,282,000  
                                         

Net asset (liability) GAP

  $ (937,383,000 )   $ 52,983,000     $ 859,404,000     $ 615,856,000          
                                         

Cumulative GAP

  $ (937,383,000 )   $ (884,400,000 )   $ (24,996,000 )   $ 590,860,000          
                                         

Percent of cumulative GAP to total assets

    (32.6% )     (30.7% )     (0.9% )     20.5 %        

 

(1)

Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.

(2)

Mortgage-backed securities are categorized by average life calculations based upon prepayment trends as of June 30, 2014.

 


 

 
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The second interest rate risk measurement we use is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, it serves as our primary interest rate risk measurement technique. The simulation model assesses the direction and magnitude of variations in net interest income resulting from potential changes in market interest rates.

 

Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment; therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions and our strategies, among other factors.

 

We conducted multiple simulations as of June 30, 2014, in which it was assumed that changes in market interest rates occurred ranging from up 400 basis points to down 400 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested impact on net interest income over the next twelve months in comparison to estimated net interest income based on our balance sheet structure, including the balances and interest rates associated with our specific loans, securities, deposits and borrowed funds, as of June 30, 2014. The resulting estimates are well within our policy parameters established to manage and monitor interest rate risk.

 

   

Dollar Change

   

Percent Change

 
   

In Net

   

In Net

 

Interest Rate Scenario

 

Interest Income

   

Interest Income

 
                 

Interest rates down 400 basis points

  $ (4,700,000 )     (4.8%)  

Interest rates down 300 basis points

    (3,100,000 )     (3.2)  

Interest rates down 200 basis points

    (1,400,000 )     (1.5)  

Interest rates down 100 basis points

    400,000       0.4  

No change in interest rates

    3,100,000       3.2  

Interest rates up 100 basis points

    5,300,000       5.5  

Interest rates up 200 basis points

    7,500,000       7.8  

Interest rates up 300 basis points

    9,700,000       10.1  

Interest rates up 400 basis points

    11,400,000       11.9  

 

The resulting estimates have been significantly impacted by the current interest rate and economic environments, as adjustments have been made to critical model inputs with regards to traditional interest rate relationships. This is especially important as it relates to floating rate commercial loans, which comprise a sizable portion of our balance sheet.

 

In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; level of nonperforming assets; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors.

 


 

 
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Item 4.  Controls and Procedures

 

As of June 30, 2014, an evaluation was performed under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of June 30, 2014.

 

There have been no changes in our internal control over financial reporting during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 


 

 
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PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings.

From time to time, we may be involved in various legal proceedings that are incidental to our business. In our opinion, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate.

 

 

Item 1A.  Risk Factors.

There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K for the year ended December 31, 2013, and incorporated therein by reference.

 

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

We made no unregistered sale of equity securities, nor did we purchase our equity securities, during the quarter ended June 30, 2014.

 

 

Item 3.  Defaults Upon Senior Securities.

Not applicable.

 

 

Item 4.  Mine Safety Disclosures.

Not applicable.

 

 

Item 5.  Other Information.

Not applicable.

 


 

 
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Item 6.  Exhibits

 

EXHIBIT NO.

 

EXHIBIT DESCRIPTION

     

2.1

 

Agreement and Plan of Merger dated August 14, 2013, incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed August 15, 2013

     

2.2

 

First Amendment to Merger Agreement dated February 20, 2014, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed February 21, 2014

     

3.1

 

Our Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2009

     

3.2

 

Our Amended and Restated Bylaws dated as of January 16, 2003 are incorporated by reference to Exhibit 3.2 of our Registration Statement on Form S-3 (Commission File No. 333-103376) that became effective on February 21, 2003

     

31

 

Rule 13a-14(a) Certifications

     

32.1

 

Section 1350 Chief Executive Officer Certification

     

32.2

 

Section 1350 Chief Financial Officer Certification

     

101

 

The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to Condensed Consolidated Financial Statements

 


 

 
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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 8, 2014.

 

 

MERCANTILE BANK CORPORATION

 

 

 

 

 

 

 

 

 

 

 

 

 

       
  By: /s/ Michael H. Price  
  Michael H. Price  
  President and Chief Executive Officer

 

(Principal Executive Officer)  

       
       
       
  By: /s/ Charles E. Christmas      
  Charles E. Christmas  
  Senior Vice President, Chief Financial Officer and Treasurer
  (Principal Financial and Accounting Officer)

 


 

 
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 EXHIBIT INDEX

 

 

EXHIBIT NO.

 

EXHIBIT DESCRIPTION

     

2.1

 

Agreement and Plan of Merger dated August 14, 2013, incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed August 15, 2013

     

2.2

 

First Amendment to Merger Agreement dated February 20, 2014, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed February 21, 2014

     

3.1

 

Our Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2009

     

3.2

 

Our Amended and Restated Bylaws dated as of January 16, 2003 are incorporated by reference to Exhibit 3.2 of our Registration Statement on Form S-3 (Commission File No. 333-103376) that became effective on February 21, 2003

     

31

 

Rule 13a-14(a) Certifications

     

32.1

 

Section 1350 Chief Executive Officer Certification

     

32.2

 

Section 1350 Chief Financial Officer Certification

     

101

 

The following financial information from Mercantile’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to Condensed Consolidated Financial Statements