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, 2016
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan |
38-3360865 |
(State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification No.) |
310 Leonard Street, NW, Grand Rapids, MI 49504
(Address of principal executive offices) (Zip Code)
(616) 406-3000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No ___
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes X No ___
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ___ |
Accelerated filer X |
Non-accelerated filer |
Smaller reporting company __ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes No X
At August 5, 2016, there were 16,279,351 shares of common stock outstanding.
MERCANTILE BANK CORPORATION
INDEX
PART I. |
Financial Information |
Page No. |
Condensed Consolidated Balance Sheets (Unaudited) - June 30, 2016 and December 31, 2015 |
1 | |
2 | ||
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3 | ||
| ||
4 | ||
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6 | ||
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Notes to Condensed Consolidated Financial Statements (Unaudited) |
8 | |
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations |
73 | |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk |
92 | |
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95 | ||
| ||
PART II. |
Other Information |
|
| ||
96 | ||
| ||
96 | ||
| ||
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
96 | |
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96 | ||
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96 | ||
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96 | ||
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97 | ||
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98 |
MERCANTILE BANK CORPORATION
PART I --- FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, 2016 |
December 31, 2015 |
|||||||
ASSETS |
||||||||
Cash and due from banks |
$ | 60,087,000 | $ | 42,829,000 | ||||
Interest-earning deposits |
46,896,000 | 46,463,000 | ||||||
Federal funds sold |
0 | 599,000 | ||||||
Total cash and cash equivalents |
106,983,000 | 89,891,000 | ||||||
Securities available for sale |
323,452,000 | 346,992,000 | ||||||
Federal Home Loan Bank stock |
8,026,000 | 7,567,000 | ||||||
Loans |
2,379,940,000 | 2,277,727,000 | ||||||
Allowance for loan losses |
(17,110,000 | ) | (15,681,000 | ) | ||||
Loans, net |
2,362,830,000 | 2,262,046,000 | ||||||
Premises and equipment, net |
45,558,000 | 46,862,000 | ||||||
Bank owned life insurance |
66,537,000 | 58,971,000 | ||||||
Goodwill |
49,473,000 | 49,473,000 | ||||||
Core deposit intangible |
11,228,000 | 12,631,000 | ||||||
Other assets |
25,849,000 | 29,123,000 | ||||||
Total assets |
$ | 2,999,936,000 | $ | 2,903,556,000 | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY |
||||||||
Deposits |
||||||||
Noninterest-bearing |
$ | 733,573,000 | $ | 674,568,000 | ||||
Interest-bearing |
1,546,145,000 | 1,600,814,000 | ||||||
Total deposits |
2,279,718,000 | 2,275,382,000 | ||||||
Securities sold under agreements to repurchase |
136,690,000 | 154,771,000 | ||||||
Federal Home Loan Bank advances |
178,000,000 | 68,000,000 | ||||||
Subordinated debentures |
44,494,000 | 55,154,000 | ||||||
Accrued interest and other liabilities |
16,457,000 | 16,445,000 | ||||||
Total liabilities |
2,655,359,000 | 2,569,752,000 | ||||||
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; 16,271,061 shares outstanding at June 30, 2016 and 16,358,711 shares outstanding at December 31, 2015 |
303,336,000 | 304,819,000 | ||||||
Retained earnings |
38,553,000 | 27,722,000 | ||||||
Accumulated other comprehensive income |
2,688,000 | 1,263,000 | ||||||
Total shareholders’ equity |
344,577,000 | 333,804,000 | ||||||
Total liabilities and shareholders’ equity |
$ | 2,999,936,000 | $ | 2,903,556,000 |
See accompanying notes to condensed consolidated financial statements.
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended June 30, 2016 |
Three Months Ended June 30, 2015 |
Six Months Ended June 30, 2016 |
Six Months Ended June 30, 2015 |
|||||||||||||
Interest income |
||||||||||||||||
Loans, including fees |
$ | 26,887,000 | $ | 25,587,000 | $ | 53,666,000 | $ | 50,898,000 | ||||||||
Securities, taxable |
2,657,000 | 1,489,000 | 4,173,000 | 3,174,000 | ||||||||||||
Securities, tax-exempt |
540,000 | 523,000 | 1,077,000 | 1,060,000 | ||||||||||||
Other interest-earning assets |
63,000 | 64,000 | 120,000 | 120,000 | ||||||||||||
Total interest income |
30,147,000 | 27,663,000 | 59,036,000 | 55,252,000 | ||||||||||||
Interest expense |
||||||||||||||||
Deposits |
1,819,000 | 1,775,000 | 3,685,000 | 3,675,000 | ||||||||||||
Short-term borrowings |
47,000 | 39,000 | 91,000 | 76,000 | ||||||||||||
Federal Home Loan Bank advances |
575,000 | 151,000 | 925,000 | 303,000 | ||||||||||||
Subordinated debentures and other borrowings |
606,000 | 657,000 | 1,353,000 | 1,308,000 | ||||||||||||
Total interest expense |
3,047,000 | 2,622,000 | 6,054,000 | 5,362,000 | ||||||||||||
Net interest income |
27,100,000 | 25,041,000 | 52,982,000 | 49,890,000 | ||||||||||||
Provision for loan losses |
1,100,000 | (600,000 | ) | 1,700,000 | (1,000,000 | ) | ||||||||||
Net interest income after provision for loan losses |
26,000,000 | 25,641,000 | 51,282,000 | 50,890,000 | ||||||||||||
Noninterest income |
||||||||||||||||
Services charges on deposit and sweep accounts |
1,090,000 | 812,000 | 2,038,000 | 1,582,000 | ||||||||||||
Credit and debit card income |
1,080,000 | 1,079,000 | 2,095,000 | 2,291,000 | ||||||||||||
Mortgage banking activities |
744,000 | 999,000 | 1,342,000 | 1,687,000 | ||||||||||||
Earnings on bank owned life insurance |
298,000 | 262,000 | 584,000 | 548,000 | ||||||||||||
Gain on trust preferred securities repurchase |
0 | 0 | 2,970,000 | 0 | ||||||||||||
Other income |
852,000 | 869,000 | 2,121,000 | 1,607,000 | ||||||||||||
Total noninterest income |
4,064,000 | 4,021,000 | 11,150,000 | 7,715,000 | ||||||||||||
Noninterest expense |
||||||||||||||||
Salaries and benefits |
10,801,000 | 11,074,000 | 21,796,000 | 21,158,000 | ||||||||||||
Occupancy |
1,480,000 | 1,479,000 | 3,084,000 | 3,052,000 | ||||||||||||
Furniture and equipment |
522,000 | 596,000 | 1,047,000 | 1,220,000 | ||||||||||||
Data processing costs |
1,970,000 | 1,872,000 | 3,962,000 | 3,642,000 | ||||||||||||
FDIC insurance costs |
365,000 | 483,000 | 757,000 | 960,000 | ||||||||||||
Other expense |
4,055,000 | 4,846,000 | 8,415,000 | 9,559,000 | ||||||||||||
Total noninterest expenses |
19,193,000 | 20,350,000 | 39,061,000 | 39,591,000 | ||||||||||||
Income before federal income tax expense |
10,871,000 | 9,312,000 | 23,371,000 | 19,014,000 | ||||||||||||
Federal income tax expense |
3,437,000 | 2,754,000 | 7,388,000 | 5,810,000 | ||||||||||||
Net income |
$ | 7,434,000 | $ | 6,558,000 | $ | 15,983,000 | $ | 13,204,000 | ||||||||
Basic earnings per share |
$ | 0.46 | $ | 0.39 | $ | 0.98 | $ | 0.78 | ||||||||
Diluted earnings per share |
$ | 0.46 | $ | 0.39 | $ | 0.98 | $ | 0.78 | ||||||||
Cash dividends per share |
$ | 0.16 | $ | 0.14 | $ | 0.32 | $ | 0.28 | ||||||||
Average basic shares outstanding |
16,240,966 | 16,767,393 | 16,266,311 | 16,852,002 | ||||||||||||
Average diluted shares outstanding |
16,268,839 | 16,803,846 | 16,293,250 | 16,887,702 |
See accompanying notes to condensed consolidated financial statements.
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended June 30, 2016 |
Three Months Ended June 30, 2015 |
Six Months Ended June 30, 2016 |
Six Months Ended June 30, 2015 |
|||||||||||||
Net income |
$ | 7,434,000 | $ | 6,558,000 | $ | 15,983,000 | $ | 13,204,000 | ||||||||
Other comprehensive income (loss): |
||||||||||||||||
Unrealized holding gains (losses) on securities available for sale |
299,000 | (2,722,000 | ) | 2,218,000 | 165,000 | |||||||||||
Fair value of interest rate swap |
(4,000 | ) | 71,000 | (25,000 | ) | (126,000 | ) | |||||||||
295,000 | (2,651,000 | ) | 2,193,000 | 39,000 | ||||||||||||
Tax effect of unrealized holding gains (losses) on securities available for sale |
(105,000 | ) | 981,000 | (777,000 | ) | (30,000 | ) | |||||||||
Tax effect of fair value of interest rate swap |
1,000 | (25,000 | ) | 9,000 | 44,000 | |||||||||||
(104,000 | ) | 956,000 | (768,000 | ) | 14,000 | |||||||||||
Other comprehensive income (loss), net of tax |
191,000 | (1,695,000 | ) | 1,425,000 | 53,000 | |||||||||||
Comprehensive income |
$ | 7,625,000 | $ | 4,863,000 | $ | 17,408,000 | $ | 13,257,000 |
See accompanying notes to condensed consolidated financial statements.
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
($ in thousands except per share amounts) |
Preferred Stock |
Common Stock |
Retained Earnings (Deficit) |
Accumulated Other Comprehensive Income (Loss) |
Total Shareholders’ Equity |
|||||||||||||||
Balances, January 1, 2016 |
$ | 0 | $ | 304,819 | $ | 27,722 | $ | 1,263 | $ | 333,804 | ||||||||||
Employee stock purchase plan (773 shares) |
18 | 18 | ||||||||||||||||||
Dividend reinvestment plan (38,195 shares) |
909 | 909 | ||||||||||||||||||
Stock option exercises (31,249 shares) |
379 | 379 | ||||||||||||||||||
Stock grants to directors for retainer fees (13,000 shares) |
327 | 327 | ||||||||||||||||||
Stock-based compensation expense |
616 | 616 | ||||||||||||||||||
Share repurchase program (167,878 shares) |
(3,732 | ) | (3,732 | ) | ||||||||||||||||
Cash dividends ($0.32 per common share) |
(5,152 | ) | (5,152 | ) | ||||||||||||||||
Net income for the six months ended June 30, 2016 |
15,983 | 15,983 | ||||||||||||||||||
Change in net unrealized holding gain on securities available for sale, net of tax effect |
1,441 | 1,441 | ||||||||||||||||||
Change in fair value of interest rate swap, net of tax effect |
(16 | ) | (16 | ) | ||||||||||||||||
Balances, June 30, 2016 |
$ | 0 | $ | 303,336 | $ | 38,553 | $ | 2,688 | $ | 344,577 |
See accompanying notes to condensed consolidated financial statements.
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
(Unaudited)
($ in thousands except per share amounts) |
Preferred Stock |
Common Stock |
Retained Earnings (Deficit) |
Accumulated Other Comprehensive Income (Loss) |
Total Shareholders’ Equity |
|||||||||||||||
Balances, January 1, 2015 |
$ | 0 | $ | 317,904 | $ | 10,218 | $ | 16 | $ | 328,138 | ||||||||||
Employee stock purchase plan (1,110 shares) |
23 | 23 | ||||||||||||||||||
Dividend reinvestment plan (13,788 shares) |
283 | 283 | ||||||||||||||||||
Stock option exercises (26,375 shares) |
275 | 275 | ||||||||||||||||||
Stock grants to directors for retainer fees (20,094 shares) |
402 | 402 | ||||||||||||||||||
Stock-based compensation expense |
359 | 359 | ||||||||||||||||||
Share repurchase program (463,060 shares) |
(9,110 | ) | (9,110 | ) | ||||||||||||||||
Cash dividends ($0.28 per common share) |
(4,656 | ) | (4,656 | ) | ||||||||||||||||
Net income for the six months ended June 30, 2015 |
13,204 | 13,204 | ||||||||||||||||||
Change in net unrealized holding gain on securities available for sale, net of tax effect |
135 | 135 | ||||||||||||||||||
Change in fair value of interest rate swap, net of tax effect |
(82 | ) | (82 | ) | ||||||||||||||||
Balances, June 30, 2015 |
$ | 0 | $ | 310,136 | $ | 18,766 | $ | 69 | $ | 328,971 |
See accompanying notes to condensed consolidated financial statements.
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30, 2016 |
Six Months Ended June 30, 2015 |
|||||||
Cash flows from operating activities |
||||||||
Net income |
$ | 15,983,000 | $ | 13,204,000 | ||||
Adjustments to reconcile net income to net cash from operating activities |
||||||||
Depreciation and amortization |
4,275,000 | 5,588,000 | ||||||
Accretion of acquired loans |
(2,251,000 | ) | (2,910,000 | ) | ||||
Provision for loan losses |
1,700,000 | (1,000,000 | ) | |||||
Stock-based compensation expense |
616,000 | 359,000 | ||||||
Stock grants to directors for retainer fee |
327,000 | 402,000 | ||||||
Proceeds from sales of mortgage loans held for sale |
46,441,000 | 57,735,000 | ||||||
Origination of mortgage loans held for sale |
(46,715,000 | ) | (56,853,000 | ) | ||||
Net gain from sales of mortgage loans held for sale |
(1,290,000 | ) | (1,706,000 | ) | ||||
Gain on trust preferred securities repurchase |
(2,970,000 | ) | 0 | |||||
Net gain from sales and valuation write-down of foreclosed assets |
(322,000 | ) | (71,000 | ) | ||||
Net gain from sales and valuation write-down of former bank premises |
(10,000 | ) | 0 | |||||
Net (gain) loss from sales of fixed assets |
171,000 | (10,000 | ) | |||||
Net (gain) loss from sales of available for sale securities |
1,000 | (5,000 | ) | |||||
Earnings on bank owned life insurance |
(584,000 | ) | (548,000 | ) | ||||
Net change in: |
||||||||
Accrued interest receivable |
568,000 | 212,000 | ||||||
Other assets |
(120,000 | ) | (188,000 | ) | ||||
Accrued interest and other liabilities |
(13,000 | ) | 896,000 | |||||
Net cash from operating activities |
15,807,000 | 15,105,000 | ||||||
Cash flows from investing activities |
||||||||
Loan originations and payments, net |
(99,276,000 | ) | (82,399,000 | ) | ||||
Purchases of securities available for sale |
(60,873,000 | ) | (4,868,000 | ) | ||||
Proceeds from maturities, calls and repayments of securities available for sale |
86,872,000 | 62,135,000 | ||||||
Proceeds from sales of securities available for sale |
264,000 | 665,000 | ||||||
Proceeds from sales of foreclosed assets |
1,371,000 | 1,131,000 | ||||||
Proceeds from sales of former bank premises |
46,000 | 0 | ||||||
Proceeds from FHLB stock redemption |
0 | 6,132,000 | ||||||
Purchases of FHLB stock |
(459,000 | ) | 0 | |||||
Purchases of bank owned life insurance |
(7,000,000 | ) | 0 | |||||
Net purchases of premises and equipment |
(307,000 | ) | (589,000 | ) | ||||
Net cash for investing activities |
(79,362,000 | ) | (17,793,000 | ) |
See accompanying notes to condensed consolidated financial statements.
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
Six Months Ended June 30, 2016 |
Six Months Ended June 30, 2015 |
|||||||
Cash flows from financing activities |
||||||||
Net decrease in time deposits |
(17,540,000 | ) | (84,451,000 | ) | ||||
Net increase in all other deposits |
21,876,000 | 87,505,000 | ||||||
Net decrease in securities sold under agreements to repurchase |
(18,081,000 | ) | (15,488,000 | ) | ||||
Maturities of Federal Home Loan Bank advances |
0 | (6,000,000 | ) | |||||
Proceeds from Federal Home Loan Bank advances |
110,000,000 | 0 | ||||||
Proceeds from stock option exercises |
379,000 | 275,000 | ||||||
Employee stock purchase plan |
18,000 | 23,000 | ||||||
Dividend reinvestment plan |
909,000 | 283,000 | ||||||
Repurchase of common stock shares |
(3,732,000 | ) | (9,110,000 | ) | ||||
Repurchase of trust preferred securities |
(8,030,000 | ) | 0 | |||||
Payment of cash dividends to common shareholders |
(5,152,000 | ) | (4,656,000 | ) | ||||
Net cash from (for) financing activities |
80,647,000 | (31,619,000 | ) | |||||
Net change in cash and cash equivalents |
17,092,000 | (34,307,000 | ) | |||||
Cash and cash equivalents at beginning of period |
89,891,000 | 172,738,000 | ||||||
Cash and cash equivalents at end of period |
$ | 106,983,000 | $ | 138,431,000 | ||||
Supplemental disclosures of cash flows information |
||||||||
Cash paid during the period for: |
||||||||
Interest |
$ | 6,016,000 | $ | 5,564,000 | ||||
Federal income tax |
6,700,000 | 5,700,000 | ||||||
Noncash financing and investing activities: |
||||||||
Transfers from loans to foreclosed assets |
236,000 | 1,098,000 | ||||||
Transfers from bank premises to other real estate owned |
371,000 | 0 |
See accompanying notes to condensed consolidated financial statements.
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, 2016 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, 2016 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, 2015.
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.
Approximately 150,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and six months ended June 30, 2016. In addition, stock options for approximately 92,000 shares of common stock were included in determining diluted earnings per share for the three and six months ended June 30, 2016. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and six months ended June 30, 2016.
Approximately 100,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and six months ended June 30, 2015. In addition, stock options for approximately 108,000 shares of common stock were included in determining diluted earnings per share for the three and six months ended June 30, 2015. Stock options for approximately 91,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and six months ended June 30, 2015.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Securities: Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold prior to maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Federal Home Loan Bank stock is carried at cost.
Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Declines in the fair value of debt securities below their amortized cost that are other than temporary (“OTTI”) are reflected in earnings or other comprehensive income, as appropriate. For those debt securities whose fair value is less than their amortized cost, we 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 whether we expect to recover the entire amortized cost of the security based on our assessment of the issuer’s financial condition. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies, and whether downgrades by bond rating agencies have occurred. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) OTTI related to other factors, such as liquidity conditions in the market or changes in market interest rates, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.
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.
(Continued)
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, 2016 and December 31, 2015, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $2.9 million and $1.3 million, respectively. Loans held for sale are reported as part of our total loans on the balance sheet.
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 approximately $597 million as of June 30, 2016.
Mortgage Banking Activities: Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan 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 revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.
Servicing fee income is recorded for fees earned for serving mortgage 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 loan servicing rights is netted against mortgage loan servicing income and recorded in mortgage banking activities in the income statement.
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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 below 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.
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.
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 9. We do not use derivatives for trading purposes.
Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various loans and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.
(Continued)
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 the derivatives and 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 should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We may elect to perform a qualitative assessment for the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. The quantitative test is a two-step process consisting of comparing the carrying value of the reporting unit to an estimate of its fair value. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value. In 2014 and 2015, we elected to perform a qualitative assessment for our annual impairment test and concluded it is more likely than not our fair value was greater than its carrying amount; therefore, no further testing was required.
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 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 was originally effective for annual and interim periods beginning after December 15, 2016, with three transition methods available – full retrospective, retrospective and cumulative effect approach. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers – Deferral of Effective Date, which delays the implementation of this guidance by one year. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
In January 2016, the FASB issued ASU 2016-1, Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU requires an entity to (i) measure equity investments at fair value through net income, with certain exceptions; (ii) present in OCI the changes in instrument-specific credit risk for financial liabilities measured using the fair value option; (iii) present financial assets and financial liabilities by measurement category and form of financial asset; (iv) calculate the fair value of financial instruments for disclosure purposes based on an exit price; and (v) assess a valuation allowance on deferred tax assets related to unrealized losses on available for sale debt securities in combination with other deferred tax assets. This ASU provides an election to subsequently measure certain nonmarketable equity investments at cost less any impairment and adjusted for certain observable price changes. This ASU also requires a qualitative impairment assessment of such equity investments and amends certain fair value disclosure requirements. The amendments are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, and are not expected to have a material effect on our financial position or results of operations when adopted.
In February 2016, the FASB issued ASU 2016-02, Leases. This ASU establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The ASU is effective for annual and interim periods beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.
In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting. This ASU requires that, prospectively, all tax effects related to share-based payments be made through the income statement at the time of settlement as opposed to excess tax benefits being recognized in additional paid-in capital under the current guidance. The ASU also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings. Additionally, all tax related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. Finally, entities will be allowed to withhold an amount up to the employees’ maximum individual tax rate (as opposed to the minimum statutory tax rate) in the relevant jurisdiction without resulting in liability classification of the award. The change in withholding requirements will be applied on a modified retrospective approach. This standard will be effective for annual and interim periods beginning after December 15, 2016. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans, and expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019, and early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). We are currently evaluating the provisions of this ASU to determine the potential impact the new standard will have on our consolidated financial statements.
2. SECURITIES
The amortized cost and fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
|||||||||||||
June 30, 2016 |
||||||||||||||||
U.S. Government agency debt obligations |
$ | 132,085,000 | $ | 895,000 | $ | (38,000 | ) | $ | 132,942,000 | |||||||
Mortgage-backed securities |
56,616,000 | 979,000 | (50,000 | ) | 57,545,000 | |||||||||||
Municipal general obligation bonds |
119,878,000 | 2,602,000 | (94,000 | ) | 122,386,000 | |||||||||||
Municipal revenue bonds |
8,498,000 | 95,000 | 0 | 8,593,000 | ||||||||||||
Other investments |
1,962,000 | 24,000 | 0 | 1,986,000 | ||||||||||||
$ | 319,039,000 | $ | 4,595,000 | $ | (182,000 | ) | $ | 323,452,000 | ||||||||
December 31, 2015 |
||||||||||||||||
U.S. Government agency debt obligations |
$ | 146,660,000 | $ | 1,932,000 | $ | (1,552,000 | ) | $ | 147,040,000 | |||||||
Mortgage-backed securities |
66,670,000 | 708,000 | (304,000 | ) | 67,074,000 | |||||||||||
Municipal general obligation bonds |
120,679,000 | 1,549,000 | (205,000 | ) | 122,023,000 | |||||||||||
Municipal revenue bonds |
8,841,000 | 76,000 | (3,000 | ) | 8,914,000 | |||||||||||
Other investments |
1,946,000 | 0 | (5,000 | ) | 1,941,000 | |||||||||||
$ | 344,796,000 | $ | 4,265,000 | $ | (2,069,000 | ) | $ | 346,992,000 |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. SECURITIES (Continued)
Securities with unrealized losses at June 30, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:
Less than 12 Months |
12 Months or More |
Total |
||||||||||||||||||||||
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
Fair Vaule |
Unrealized Loss |
|||||||||||||||||||
June 30, 2016 |
||||||||||||||||||||||||
U.S. Government agency debt obligations |
$ | 3,991,000 | $ | 9,000 | $ | 2,958,000 | $ | 29,000 | $ | 6,949,000 | $ | 38,000 | ||||||||||||
Mortgage-backed securities |
3,212,000 | 16,000 | 9,899,000 | 34,000 | 13,111,000 | 50,000 | ||||||||||||||||||
Municipal general obligation bonds |
850,000 | 5,000 | 9,042,000 | 89,000 | 9,892,000 | 94,000 | ||||||||||||||||||
Municipal revenue bonds |
557,000 | 0 | 0 | 0 | 557,000 | 0 | ||||||||||||||||||
Other investments |
0 | 0 | 0 | 0 | 0 | 0 | ||||||||||||||||||
$ | 8,610,000 | $ | 30,000 | $ | 21,899,000 | $ | 152,000 | $ | 30,509,000 | $ | 182,000 |
Less than 12 Months |
12 Months or More |
Total |
||||||||||||||||||||||
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
|||||||||||||||||||
December 31, 2015 |
||||||||||||||||||||||||
U.S. Government agency debt obligations |
$ | 0 | $ | 0 | $ | 76,496,000 | $ | 1,552,000 | $ | 76,496,000 | $ | 1,552,000 | ||||||||||||
Mortgage-backed securities |
18,025,000 | 69,000 | 34,660,000 | 235,000 | 52,685,000 | 304,000 | ||||||||||||||||||
Municipal general obligation bonds |
1,981,000 | 4,000 | 30,134,000 | 201,000 | 32,115,000 | 205,000 | ||||||||||||||||||
Municipal revenue bonds |
0 | 0 | 1,134,000 | 3,000 | 1,134,000 | 3,000 | ||||||||||||||||||
Other investments |
1,446,000 | 5,000 | 0 | 0 | 1,446,000 | 5,000 | ||||||||||||||||||
$ | 21,452,000 | $ | 78,000 | $ | 142,424,000 | $ | 1,991,000 | $ | 163,876,000 | $ | 2,069,000 |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. SECURITIES (Continued)
We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.
At June 30, 2016, 93 debt securities with fair values totaling $30.5 million have unrealized losses aggregating $0.2 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, 2016, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.
Weighted Average Yield |
Amortized Cost |
Fair Value |
||||||||||
Due in 2016 |
1.44 | % | $ | 32,582,000 | $ | 32,601,000 | ||||||
Due in 2017 through 2021 |
1.83 | 119,275,000 | 120,413,000 | |||||||||
Due in 2022 through 2026 |
3.10 | 55,510,000 | 56,994,000 | |||||||||
Due in 2027 and beyond |
3.27 | 53,094,000 | 53,913,000 | |||||||||
Mortgage-backed securities |
1.76 | 56,616,000 | 57,545,000 | |||||||||
Other investments |
3.06 | 1,962,000 | 1,986,000 | |||||||||
2.24 | % | $ | 319,039,000 | $ | 323,452,000 |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. SECURITIES (Continued)
Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $107 million and $106 million at June 30, 2016 and December 31, 2015, respectively, with estimated market values of $109 million and $107 million, respectively. Securities issued by all other states and their political subdivisions had a combined amortized cost of $21.5 million and $24.0 million at June 30, 2016 and December 31, 2015, respectively, with estimated market values of $21.8 million and $24.1 million, respectively. 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 $137 million and $155 million at June 30, 2016, and December 31, 2015, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.
3. LOANS AND ALLOWANCE FOR LOAN LOSSES
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. These loans were recorded at estimated fair value at the merger 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 merger date and are accounted for in pools.
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 merger 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)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. 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 merger 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 undiscounted 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 lives 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 merger 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 merger 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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Our total loans at June 30, 2016 were $2.38 billion compared to $2.28 billion at December 31, 2015, an increase of $102 million, or 4.5%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at June 30, 2016 and December 31, 2015, and the percentage change in loans from the end of 2015 to the end of the second quarter of 2016, are as follows:
Percent |
||||||||||||||||||||
June 30, 2016 |
December 31, 2015 |
Increase |
||||||||||||||||||
Balance |
% |
Balance |
% |
(Decrease) |
||||||||||||||||
Originated loans |
||||||||||||||||||||
Commercial: |
||||||||||||||||||||
Commercial and industrial |
$ | 653,135,000 | 36.3 | % | $ | 577,872,000 | 35.7 | % | 13.0 | % | ||||||||||
Vacant land, land development, and residential construction |
30,232,000 | 1.7 | 30,138,000 | 1.9 | 0.3 | |||||||||||||||
Real estate – owner occupied |
338,909,000 | 18.8 | 330,798,000 | 20.5 | 2.5 | |||||||||||||||
Real estate – non-owner occupied |
603,236,000 | 33.5 | 520,754,000 | 32.2 | 15.8 | |||||||||||||||
Real estate – multi-family and residential rental |
39,233,000 | 2.2 | 33,954,000 | 2.1 | 15.5 | |||||||||||||||
Total commercial |
1,664,745,000 | 92.5 | 1,493,516,000 | 92.4 | 11.5 | |||||||||||||||
Retail: |
||||||||||||||||||||
Home equity and other |
69,396,000 | 3.9 | 67,816,000 | 4.2 | 2.3 | |||||||||||||||
1-4 family mortgages |
65,813,000 | 3.6 | 55,255,000 | 3.4 | 19.1 | |||||||||||||||
Total retail |
135,209,000 | 7.5 | 123,071,000 | 7.6 | 9.9 | |||||||||||||||
Total originated loans |
$ | 1,799,954,000 | 100.0 | % | $ | 1,616,587,000 | 100.0 | % | 11.3 | % |
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Percent |
||||||||||||||||||||
June 30, 2016 |
December 31, 2015 |
Increase |
||||||||||||||||||
Balance |
% |
Balance |
% |
(Decrease) |
||||||||||||||||
Acquired loans |
||||||||||||||||||||
Commercial: |
||||||||||||||||||||
Commercial and industrial |
$ | 97,001,000 | 16.7 | % | $ | 118,431,000 | 17.9 | % | (18.1 | )% | ||||||||||
Vacant land, land development, and residential construction |
10,297,000 | 1.8 | 14,982,000 | 2.3 | (31.3 | ) | ||||||||||||||
Real estate – owner occupied |
99,889,000 | 17.2 | 115,121,000 | 17.4 | (13.2 | ) | ||||||||||||||
Real estate – non-owner occupied |
113,694,000 | 19.6 | 123,597,000 | 18.7 | (8.0 | ) | ||||||||||||||
Real estate – multi-family and residential rental |
74,129,000 | 12.8 | 81,049,000 | 12.3 | (8.5 | ) | ||||||||||||||
Total commercial |
395,010,000 | 68.1 | 453,180,000 | 68.6 | (12.8 | ) | ||||||||||||||
Retail: |
||||||||||||||||||||
Home equity and other |
61,671,000 | 10.6 | 72,830,000 | 11.0 | (15.3 | ) | ||||||||||||||
1-4 family mortgages |
123,305,000 | 21.3 | 135,130,000 | 20.4 | (8.7 | ) | ||||||||||||||
Total retail |
184,976,000 | 31.9 | 207,960,000 | 31.4 | (11.1 | ) | ||||||||||||||
Total acquired loans |
$ | 579,986,000 | 100.0 | % | $ | 661,140,000 | 100.0 | % | (12.3% | ) |
Percent | ||||||||||||||||||||
June 30, 2016 |
December 31, 2015 |
Increase |
||||||||||||||||||
Balance |
% |
Balance |
% |
(Decrease) |
||||||||||||||||
Total loans |
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Commercial: |
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Commercial and industrial |
$ | 750,136,000 | 31.5 | % | $ | 696,303,000 | 30.6 | % | 7.7 | % | ||||||||||
Vacant land, land development, and residential construction |
40,529,000 | 1.7 | 45,120,000 | 2.0 | (10.2 | ) | ||||||||||||||
Real estate – owner occupied |
438,798,000 | 18.4 | 445,919,000 | 19.6 | (1.6 | ) | ||||||||||||||
Real estate – non-owner occupied |
716,930,000 | 30.1 | 644,351,000 | 28.3 | 11.3 | |||||||||||||||
Real estate – multi-family and residential rental |
113,362,000 | 4.8 | 115,003,000 |