Item 1.
Business.
The Company
Mercantile Bank Corporation is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). Unless the text clearly suggests otherwise, references to “us,” “we,” “our,” or “the company” include Mercantile Bank Corporation and its wholly-owned subsidiaries. As a bank holding company, we are subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). We were organized on July 15, 1997, under the laws of the State of Michigan, primarily for the purpose of holding all of the stock of Mercantile Bank of Michigan (“our bank”), and of such other subsidiaries as we may acquire or establish. Our bank commenced business on December 15, 1997. During the third quarter of 2013, we filed an election to become a financial holding company, which election became effective April 14, 2014.
Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank, commenced operations during 2002 to offer insurance products. Mercantile Bank Real Estate Co., L.L.C., (“our real estate company”), a subsidiary of our bank, was organized on July 21, 2003, principally to develop, construct and own our facility in downtown Grand Rapids which serves as our bank’s main office and Mercantile Bank Corporation’s headquarters.
Our expenses have generally been paid using cash dividends from our bank. Our principal source of future operating funds is expected to be dividends from our bank.
Our Bank
Our bank is a state banking company that operates under the laws of the State of Michigan, pursuant to a charter issued by the Michigan Department of Insurance and Financial Services. Our bank’s deposits are insured to the maximum extent permitted by law by the Federal Deposit Insurance Corporation (“FDIC”). Our bank, through its 40 office locations, provides commercial banking services primarily to small- to medium-sized businesses and retail banking services. Our bank’s main office is located in Grand Rapids, and our operations are centered around the West and Central portions of Michigan, with branch office locations in Alma, Belding, Cadillac, Canadian Lakes, Clare, Comstock Park, Fairview, Forest Hills, Grand Rapids, Hastings, Holland, Howard City, Ionia, Ithaca, Kalamazoo, Lakeview, Lansing, Lowell, Merrill, Mt. Pleasant, Paw Paw, Portage, Remus, Rose City, Shepherd, St. Charles, St. Helen, St. Johns, Troy, Vestaburg, West Branch, and Wyoming.
Our bank makes secured and unsecured commercial, construction, mortgage and consumer loans, and accepts checking, savings and time deposits. Our bank owns 32 automated teller machines ("ATM") and eight video banking machines at a majority of our office locations that participate in the ACCEL/EXCHANGE and PLUS regional network systems, as well as other ATM networks throughout the country. Our bank also enables customers to conduct certain loan and deposit transactions by personal computer and through mobile applications. Courier service is provided to certain commercial customers, and safe deposit facilities are available at a vast majority of our office locations. Our bank does not have trust powers.
Our Insurance Company
Our insurance company acquired an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent. To date, we have not provided the insurance products noted above and currently have no plans to do so.
Our Real Estate Company
Our real estate company was organized on July 21, 2003, principally to develop, construct and own our facility in downtown Grand Rapids that serves as our bank’s main office and Mercantile Bank Corporation’s headquarters. This facility was placed into service during the second quarter of 2005. Our real estate company is 99% owned by our bank and 1% owned by our insurance company.
Our Trusts
We have five business trusts that are wholly-owned subsidiaries of Mercantile, four of which were assumed by Mercantile in conjunction with the merger with Firstbank Corporation (“Firstbank”). Each of the trusts was formed to issue preferred securities that were sold in private sales, as well as selling common securities to Mercantile. The proceeds from the preferred and common securities sales were used by the trusts to purchase floating rate notes issued by Mercantile. The rates of interest, interest payment dates, call features and maturity dates of each floating rate note are identical to its respective preferred securities. The net proceeds from the issuance of the floating rate notes were used for a variety of purposes, including contributions to our bank as capital to provide support for asset growth and the funding of stock repurchase programs and certain acquisitions. The only significant assets of our trusts are the floating rate notes, and the only significant liabilities of our trusts are the preferred securities. The floating rate notes are categorized on our Consolidated Balance Sheets as subordinated debentures, and the interest expense is recorded on our Consolidated Statements of Income under interest expense on other borrowings.
Firstbank Corporation Merger
We completed our merger with 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 merger substantially expanded our geographic footprint and increased the size of our balance sheet.
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, all of which are business trust subsidiaries formed to issue trust preferred securities. At the Merger Date, Firstbank had two Michigan-chartered bank subsidiaries that were consolidated into Mercantile Bank of Michigan effective June 30, 2014.
Effect of Government Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States Government, its agencies, and the Federal Reserve Board. The Federal Reserve Board’s monetary policies have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation, maintain or encourage employment, and mitigate economic recessions. The policies of the Federal Reserve Board have a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States Government securities, and through its regulation of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. Our bank maintains reserves directly with the Federal Reserve Bank of Chicago to the extent required by law. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.
Regulation and Supervision
Banks and bank holding companies, among other financial institutions, are regulated under federal and state law. These include, among others, minimum capital requirements, state usury laws, state laws relating to fiduciaries, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”), the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, the USA PATRIOT Act, the FACT Act, the Gramm-Leach-Bliley Act, the Sarbanes Oxley Act, the Bank Secrecy Act, electronic funds transfer laws, redlining laws, predatory lending laws, antitrust laws, environmental laws, money laundering laws and privacy laws. Our growth and earnings performance may be impacted by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those regulatory authorities include, but are not limited to, the Federal Reserve Board, the FDIC, the Michigan Department of Insurance and Financial Services, the Internal Revenue Service and state taxing authorities. The effect of such statutes, regulations and policies, and any changes thereto, can be significant and cannot necessarily be predicted.
As a registered bank holding company under the Bank Holding Company Act, we are required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require. We are also subject to examination by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding companies to banking and the management of banking organizations, and to certain non-banking activities. The permitted non-banking activities include those limited activities that the Federal Reserve Board found, by order or regulation as of the day prior to enactment of the Gramm-Leach-Bliley Act, to be so closely related to banking as to be a proper incident to banking. These permitted non-banking activities include, among other things: operating a mortgage company, finance company, or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, nonoperating basis; and providing discount securities brokerage services for customers. Neither we nor any of our subsidiaries engage in any of the non-banking activities listed above.
On April 14, 2014, our election to become a financial holding company, as permitted by the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley Act, was accepted by the Federal Reserve Board. In order to continue as a financial holding company, we and our bank must satisfy statutory requirements regarding capitalization, management and compliance with the Community Reinvestment Act. As a financial holding company, we are permitted to engage in a broader range of activities under the Bank Holding Company Act than are permitted to bank holding companies. Those expanded activities include any activity which the Federal Reserve Board (in certain instances in consultation with the Department of the Treasury) determines, by order or by regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity, and not to pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent or broker for such purposes; providing financial, investment or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. While our insurance company is permitted to engage in the insurance agency activities described above by virtue of our financial holding company status, neither we nor any of our subsidiaries currently engage in the expanded activities.
Our bank is subject to restrictions imposed by federal and state law and regulations. Among other things, these restrictions apply to any extension of credit to us or to our other subsidiaries, to securities borrowing or lending, derivatives, and repurchase transactions with us or our other subsidiaries, to investments in stock or other securities that we issue, to the taking of such stock or securities as collateral for loans to any borrower, and to acquisitions of assets or services from, and sales of certain types of assets to, us or our other subsidiaries. Michigan banking laws place restrictions on various aspects of banking, including branching, payment of dividends, loan interest rates and capital and surplus requirements. Federal law restricts our ability to borrow from our bank by limiting the aggregate amount we may borrow and by requiring that all loans to us be secured in designated amounts by specified forms of collateral.
With respect to the acquisition of banking organizations, we are generally required to obtain the prior approval of the Federal Reserve Board before we can acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank or bank holding company, if, after the acquisition, we would own or control more than 5% of the voting shares of the bank or bank holding company. Acquisitions of banking organizations across state lines are subject to restrictions imposed by federal and state laws and regulations.
The scope of regulations and supervision of various aspects of our business have expanded as a result of the adoption in July, 2010 of the Dodd-Frank Act, and may continue to expand as the result of implementing regulations being adopted by federal regulators. However, on May 24, 2018, EGRRCPA amended certain provisions of the Dodd-Frank Act to tailor them to the specific circumstances of various categories of financial institutions and transactions. For additional information on this legislation and its potential impact, refer to the Risk Factor entitled “The effect of financial services legislation and regulations remains uncertain” in Item 1A
Item 1A.
Risk Factors.
The following risk factors could affect our business, financial condition or results of operations. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report because they could cause the actual results and conditions to differ materially from those projected in forward-looking statements. Before you buy our common stock, you should know that investing in our common stock involves risks, including the risks described below. The risks that are highlighted here are not the only ones we face. If the adverse matters referred to in any of the risks actually occur, our business, financial condition or operations could be adversely affected. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
Adverse changes in economic conditions or interest rates may negatively affect our earnings, capital and liquidity.
The results of operations for financial institutions, including our bank, may be materially and adversely affected by changes in prevailing local and national economic conditions, including declines in real estate market values and the related declines in value of our real estate collateral, rapid increases or decreases in interest rates and changes in the monetary and fiscal policies of the federal government. Our profitability is heavily influenced by the spread between the interest rates we earn on loans and investments and the interest rates we pay on deposits and other interest-bearing liabilities. Substantially all of our loans are to businesses and individuals in Western, Central, and Southeastern Michigan, and any decline in the economy of these areas could adversely affect us. Like most banking institutions, our net interest spread and margin will be affected by general economic conditions and other factors that influence market interest rates and our ability to respond to changes in these rates. At any given time, our assets and liabilities may be such that they will be affected differently by a given change in interest rates.
Significant declines in the value of commercial real estate could adversely impact us.
Approximately 65% of our total commercial loans, or about 56% of our total loans, relate to commercial real estate. Stressed economic conditions may reduce the value of commercial real estate and strain the financial condition of our commercial real estate borrowers, especially in the land development and non-owner occupied commercial real estate segments of our loan portfolio. Those difficulties could adversely affect us and could produce losses and other adverse effects on our business.
Market volatility may adversely affect us.
The capital and credit markets may experience volatility and disruption. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without apparent regard to those issuers’ underlying financial strength. Future levels of market disruption and volatility may have an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. We compete for deposits, loans and other financial services with numerous Michigan-based and national and regional banks, thrifts, credit unions and other financial institutions as well as other entities that provide financial services, including securities firms and mutual funds. Some of the financial institutions and financial service organizations with which we compete are not subject to the same degree of regulation as we are. Many of our competitors have been in business for many years, have established customer bases, are larger, have substantially higher lending limits than we do and offer larger branch networks and other services which we do not, including trust and international banking services. Most of these entities have greater capital and other resources than we do, which, among other things, may allow them to price their services at levels more favorable to the customer and to provide larger credit facilities than we do. This competition may limit our growth or earnings. Under specified circumstances (that have been modified by the Dodd-Frank Act and EGRRCPA), securities firms and insurance companies that elect to become financial holding companies under the Bank Holding Company Act may acquire banks and other financial institutions. Federal banking law affects the competitive environment in which we conduct our business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
Our risk management systems may fall short of their intended objectives.
We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review processes and other mechanisms. Our risk management process seeks to balance our ability to profit from investing or lending positions with our exposure to potential losses. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Thus, we may, in the course of our activities, incur losses.
We may not be able to successfully adapt to evolving industry standards and market pressures.
Our success depends, in part, on the ability to adapt products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. This can reduce net interest income and noninterest income from fee-based products and services. In addition, the widespread adoption of new technologies could require us to make substantial capital expenditures to modify or adapt existing products and services or develop new products and services. We may not be successful in introducing new products and services in response to industry trends or developments in technology, or those new products may not achieve market acceptance. As a result, we could lose business, be forced to price products and services on less advantageous terms to retain or attract clients, or be subject to cost increases. As a result, our business, financial condition, or results of operations may be adversely affected.
Our inability to execute or integrate potential future acquisitions successfully could impede us from realizing all of the benefits of the acquisitions, which could weaken our operations.
In addition to pursuing organic growth, we may also pursue strategic acquisition opportunities that we believe will fit our core philosophy and culture, enhance our profitability and provide appropriate risk-adjusted returns. These acquisition opportunities could be material to our business and involve a number of risks, including the following:
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intense competition from other banking organizations and other acquirers for potential merger candidates drives market pricing;
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time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions may divert human and capital resources without producing the desired returns;
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estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution or assets are inherently complex and may be inaccurate;
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potential exposure to unknown or contingent liabilities of targets; and
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regulatory timeframes for review of applications may limit the number and frequency of transactions we may be able to consummate.
If we are unable to successfully integrate potential future acquisitions, we could be impeded from realizing all of the benefits of those acquisitions and could weaken our business operations. The integration process may disrupt our business and, if implemented ineffectively, may preclude realization of the full benefits expected by us and could harm our results of operations. In addition, the overall integration of the combining companies may result in unanticipated problems, expenses, liabilities and competitive responses, and may cause our stock price to decline. The difficulties of integrating an acquisition include, among others:
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unanticipated issues in integration of information, communications and other systems;
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unanticipated incompatibility of logistics, marketing and administrative methods;
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maintaining employee morale and retaining key employees;
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integrating the business cultures of both companies;
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preserving important strategic client relationships;
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coordinating geographically diverse organizations; and
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consolidating corporate and administrative infrastructures and eliminating duplicative operations.
Finally, even if the operations of an acquisition are integrated successfully, we may not realize the full benefits of the acquisition, including the synergies, cost savings or growth opportunities we expect. These benefits may not be achieved within the anticipated time frame as well.
Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy, which, in turn, could have an adverse effect on our business, financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Even routine funding transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
The timing and effect of Federal Reserve Board policy normalization remains uncertain.
In September 2014, the Federal Reserve Board announced principles it would follow to implement monetary policy normalization, that is, to raise the Federal funds rate and other short-term interest rates to more historically normal levels and to reduce the Federal Reserve’s securities holdings, so as to promote its statutory mandate of maximum employment and price stability. The Federal Open Market Committee (“FOMC”) took the initial step in that process by raising the Federal funds rate by 25 basis points in December 2015, the first such action since December 2008. Subsequently, the FOMC refined the normalization principles and announced greater detail about its planned approach. In September 2017, the FOMC announced the start of a gradual reduction in the Federal Reserve’s securities holdings, commencing in October 2017. In each of March, June, September and December 2018, the FOMC raised the Federal funds rate by 25 basis points, and announced its intention to continue to raise the Federal funds rate gradually over the next few years. In January 2019, the FOMC announced its intention to continue to implement monetary policy in a regime in which an ample supply of reserves ensures that control of the Federal funds and other short-term interest rates is exercised primarily through adjustment of its administered rates. The FOMC stated that it was prepared to adjust the details of the reduction of its balance sheet in light of economic and financial developments, and would be prepared to use its full range of tools, including changing the size and composition of its balance sheet, if future economic conditions warranted a more accommodative monetary policy than could be achieved solely by reducing the Federal funds rate.
In July 2019, the FOMC announced the cessation of the reduction in its securities portfolio and reduced the Federal funds rate by 25 basis points. In August 2019, the FOMC commenced reinvestment of principal payments received from agency debt and agency mortgage-backed securities (“MBS”) in Treasury securities and agency MBS, as well as the rollover of maturing Treasury securities in its portfolio. In September 2019, the FOMC again lowered the Federal funds rate by 25 basis points. In October 2019, the FOMC issued a reaffirmation of its January 2019 statement, and announced that in light of recent and expected increases in the Federal Reserve’s non-reserve liabilities and in order to maintain ample reserve balances over time at or above levels prevailing in early September 2019, the Federal Reserve would purchase Treasury bills at least into the second quarter of 2020. The statement also announced that the Federal Reserve would conduct term and overnight repurchase agreement operations at least through January 2020 to ensure that the supply of reserves remained ample, even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures. At its regular October 2019 meeting, the FOMC again lowered the Federal funds rate by 25 basis points. There can be no assurance that the operations announced in October 2019 will continue, that they will be effective to accomplish their stated policy goals, or as to the actual impact of those operations and policies on the financial markets, the broader economy, or on our business, financial condition, results of operations, access to credit or the trading price of our common stock.
The effect of financial services legislation and regulations remains uncertain.
In response to the financial crisis, on July 21, 2010, President Obama signed the Dodd-Frank Act, the most comprehensive reform of the regulation of the financial services industry since the Great Depression of the 1930’s. Among many other things, the Dodd-Frank Act provides for increased supervision of financial institutions by regulatory agencies, more stringent capital requirements for financial institutions, major changes to deposit insurance assessments by the FDIC, prohibitions on proprietary trading and sponsorship or investment in hedge funds and private equity funds by insured depository institutions, holding companies, and their affiliates, heightened regulation of hedging and derivatives activities, a greater focus on consumer protection issues, in part through the formation of a new Consumer Financial Protection Bureau (“CFPB”) having powers formerly split among different regulatory agencies, extensive changes to the regulation of residential mortgage lending, imposition of limits on interchange transaction and network fees for electronic debit transactions and repeal of the prohibition on payment of interest on demand deposits. Many of the Dodd-Frank Act’s provisions have delayed effective dates, while other provisions require implementing regulations of various federal agencies, some of which have not yet been adopted in final form.
On February 3, 2017, however, President Trump signed Executive Order 13772, specifying new core principles for regulating the U.S. financial system. Among other things, the President directed the Secretary of the Treasury, in consultation with federal regulatory agencies, to review existing laws and regulations and report on the extent to which they were consistent with the core principles. The Treasury Department has published several reports in response to the Executive Order. In addition, beginning in February 2017, Congress passed, and the President signed, more than a dozen resolutions under the Congressional Review Act, repealing various federal regulations, including regulations adopted by the CFPB.
On May 24, 2018, EGRRCPA was enacted, amending numerous provisions of the Dodd-Frank Act. While some of the changes affect only much larger institutions, a number of provisions relax or eliminate restrictions applicable to us and our bank. Among these latter changes are: simplified capital adequacy requirements; exemption from the proprietary trading and other restrictions of the Volcker Rule; less frequent periodic supervisory examinations; reductions in certain periodic reporting requirements; exclusion of specified amounts of reciprocal deposits, received by our bank from other insured depository institutions, from the “brokered deposit” limitations of the Federal Deposit Insurance Act; revised capital treatment for certain high volatility commercial real estate loans; and relaxation of certain requirements applicable to residential mortgage loans made to our customers.
While some of those EGRRCPA changes became effective immediately upon enactment, many others required implementing regulations by the federal banking agencies before becoming effective. At the dates indicated, the federal banking agencies adopted regulations in final form, applicable to us and our bank, implementing EGRRCPA provisions simplifying capital adequacy requirements (September 2019), granting exemption from the proprietary trading and other restrictions of the Volcker Rule (July 2019), reducing the frequency of periodic supervisory examinations (December 2018), reducing certain periodic reporting requirements (June 2019), excluding specified amounts of reciprocal deposits, received by our bank from other insured depository institutions, from the “brokered deposit” limitations of the Federal Deposit Insurance Act (March 2019), providing clarifications and revised capital treatment for certain high volatility commercial real estate loans as well as clarifying the capital treatment of certain financings of one-to-four family residential properties and the development of land (November 2019), and relaxing appraisal requirements for certain real property mortgage transactions (September 2019).
Other proposals to modify existing regulations are pending. For example, the FDIC (which regulates our bank) and the Office of the Comptroller of the Currency (“OCC”) proposed in December 2019 significant revisions to their respective versions of the existing uniform regulations (jointly adopted by the Federal Reserve, FDIC, and the OCC) that implement the Community Reinvestment Act. The Federal Reserve (which regulates our company) has not proposed changes to its version of the existing joint regulations. There can be no assurance whether or when any proposed changes in existing regulations will be adopted.
Thus, the effect of financial services legislation and regulations remains uncertain. The implementation, amendment, or repeal of federal financial services laws or regulations may limit our business opportunities, impose additional costs on us, impact our revenues or the value of our assets, or otherwise adversely affect our business.
Our credit losses could increase and our allowance may not be adequate to cover actual loan losses.
The risk of nonpayment of loans is inherent in all lending activities, and nonpayment, when it occurs, may have a materially adverse effect on our earnings and overall financial condition as well as the value of our common stock. Our focus on commercial lending may result in a larger concentration of loans to small businesses. As a result, we may assume different or greater lending risks than other banks. We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for losses based on several factors. If our assumptions are wrong, our allowance may not be sufficient to cover our losses, which would have an adverse effect on our operating results. The actual amounts of future provisions for loan losses cannot be determined at this time and may exceed the amounts of past provisions. Additions to our allowance decrease our net income.
We rely heavily on our management and other key personnel, and the loss of any of them may adversely affect our operations.
We are and will continue to be dependent upon the services of our management team, including our executive officers and our other senior managers. The unanticipated loss of our executive officers, or any of our other senior managers, could have an adverse effect on our growth and performance.
In addition, we continue to depend on our key commercial loan officers. Several of our commercial loan officers are responsible, or share responsibility, for generating and managing a significant portion of our commercial loan portfolio. Our success can be attributed in large part to the relationships these officers as well as members of our management team have developed and are able to maintain with our customers as we continue to implement our community banking philosophy. The loss of any of these commercial loan officers could adversely affect our loan portfolio and performance, and our ability to generate new loans. Many of our key employees have signed agreements with us agreeing not to compete with us in one or more of our markets for specified time periods if they leave employment with us. However, we may not be able to effectively enforce such agreements.
Some of the other financial institutions in our markets also require their key employees to sign agreements that preclude or limit their ability to leave their employment and compete with them or solicit their customers. These agreements make it more difficult for us to hire loan officers with experience in our markets who can immediately solicit their former or new customers on our behalf.
Future sales of our common stock or other securities may dilute the value of our common stock.
In many situations, our Board of Directors has the authority, without any vote of our shareholders, to issue shares of our authorized but unissued preferred or common stock, including shares authorized and unissued under our equity incentive plans. In the future, we may issue additional securities, through public or private offerings, in order to raise additional capital. Any such issuance would dilute the percentage of ownership interest of existing shareholders and may dilute the per share book value of the common stock. In addition, option holders under our stock-based incentive plans may exercise their options at a time when we would otherwise be able to obtain additional equity capital on more favorable terms.
We are subject to significant government regulation, and any regulatory changes may adversely affect us.
The banking industry is heavily regulated under both federal and state law. These regulations are primarily intended to protect customers, the federal deposit insurance fund, and the stability of the U.S. financial system, not our creditors or shareholders. Existing state and federal banking laws subject us to substantial limitations with respect to the making of loans, the purchase of securities, the payment of dividends and many other aspects of our business. Some of these laws may benefit us, others may increase our costs of doing business, or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, which may be accelerated by the recent change in the federal administration, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition. Federal economic and monetary policy may also affect our ability to attract deposits, make loans and achieve satisfactory interest spreads.
Minimum capital requirements have increased.
The provisions of the Dodd-Frank Act relating to capital to be maintained by financial institutions approach convergence with the standards (generally known as Basel III) adopted in December, 2010 by the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision. Among other things, those standards contain a narrower definition of elements qualifying for inclusion as Tier 1 capital and higher minimum risk-based capital levels than those specified in previous U.S. law and regulations. In July, 2013, the U.S. federal bank regulatory agencies adopted regulations to implement the provisions of the Dodd-Frank Act and Basel III for U.S. financial institutions. The new regulations became applicable to us and our bank effective January 1, 2015.
The new regulations implemented (i) revised definitions of regulatory capital elements, (ii) a new common equity Tier 1 (“CET 1”) minimum capital ratio requirement, (iii) an increase in the existing minimum Tier 1 capital ratio requirement, (iv) new limits on capital distributions and certain discretionary bonus payments if an institution does not hold a specified amount of CET 1 (called a capital conservation buffer) in addition to the amount required to meet its minimum risk-based capital requirements, (v) new risk-weightings for certain categories of assets, and (vi) other requirements applicable to banking organizations which have total consolidated assets or total consolidated on-balance sheet foreign exposure exceeding specified amounts (that are greatly in excess of those of us and our bank), which elect to use the advanced measurement approach for calculating risk-weighted assets, or which are subsidiaries of banking organizations that use the advanced measurement approach (“Advanced Approaches Entities”).
Among other things, the new regulations generally require banking organizations to recognize in regulatory capital most components of accumulated other comprehensive income (“AOCI”), including accumulated unrealized gains and losses on available for sale securities. This requirement, which was not imposed under previous risk-based capital regulations, may be avoided by banking organizations, such as us and our bank, that are not Advanced Approaches Entities, by making a one-time, irrevocable election on the first quarterly regulatory report following the date on which the regulations become effective as to them. We made the one-time, irrevocable election regarding the treatment of AOCI on March 31, 2015.
In addition, the new regulations (unlike the original proposal), permit companies such as us, which had total assets of less than $15 billion on December 31, 2009, and had issued trust preferred securities on or prior to May 19, 2010, to continue to include such securities in Tier 1 capital.
On January 1, 2015, for banking organizations such as us and our bank that are not Advanced Approaches Entities, the new regulations mandated a minimum ratio of CET 1 to standardized total risk-weighted assets (“RWA”) of 4.5%, an increased ratio of Tier 1 capital to RWA of 6.0% (compared to the prior requirement of 4.0%), a total capital ratio (that is, the sum of Tier 1 and Tier 2 capital to RWA) of 8.0%, and a minimum leverage ratio (that is, Tier 1 capital to adjusted average total consolidated assets) of 4.0%. The calculation of these amounts is affected by the new definitions of certain capital elements. The capital conservation buffer comprised solely of CET 1 was phased-in commencing January 1, 2016, beginning at 0.625% of RWA and rising to 2.5% of RWA on January 1, 2019. Failure by a banking organization to maintain the aggregate required minimum capital ratios and capital conservation buffer will impair its ability to make certain distributions (including dividends and stock repurchases) and discretionary bonus payments to executive officers.
In July 2019, the federal banking agencies adopted final rules applicable to banking organizations, like us and our bank, that are not Advanced Approaches Entities. Those rules, which became effective January 1, 2020, provide simpler regulatory capital requirements with respect to mortgage servicing assets, certain deferred tax assets arising from temporary differences, and investments in the capital of unconsolidated financial institutions, than those previously applied. The same rule-making also simplified the calculation for the amount of capital issued by a consolidated subsidiary of a banking organization and held by third parties (sometimes referred to as a minority interest) that is includable in regulatory capital.
The increased minimum capital requirements may adversely affect our ability (and that of our bank) to pay cash dividends, reduce our profitability, or otherwise adversely affect our business, financial condition or results of operations. In the event of a need for additional capital to meet these requirements, there can be no assurance of our ability to raise funding in the equity and capital markets. Factors that we cannot control, such as the disruption of financial markets or negative views of the financial services industry generally, could impair our ability to raise qualifying equity capital. In addition, our ability to raise qualifying equity capital could be impaired if investors develop a negative perception of our financial prospects. If we were unable to raise qualifying equity capital, it might be necessary for us to sell assets in order to maintain required capital ratios. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations, cash flow and financial condition.
On May 24, 2018, EGRRCPA was enacted, amending numerous provisions of the Dodd-Frank Act. Among other things, the new law directs the federal banking agencies to develop a Community Bank Leverage Ratio (“CBLR”). The CBLR, to be set between 8% and 10% of tangible equity capital to average total consolidated assets, would apply to Qualified Community Banks. The law defines Qualified Community Banks as those depository institutions and depository institution holding companies having total consolidated assets of less than $10 billion that meet other specified risk criteria, to be determined by regulations of the federal banking agencies based on factors prescribed in the statute. A Qualified Community Bank satisfying the CBLR, by reason of the EGRRCPA provision, would be deemed to be in compliance with all applicable leverage and risk-based capital requirements and, in the case of a depository institution, be deemed “well-capitalized” for purposes of the Federal Deposit Insurance Act.
In February 2019, the federal banking agencies published in the Federal Register a notice of proposed rule-making to implement this EGRRCPA capital adequacy provision. Final rules were adopted by each of the federal banking agencies in November 2019, which became effective January 1, 2020. The final rules represent an alternative to the capital adequacy rules that became applicable to us and our bank on January 1, 2015, and that are described above (the generally applicable rules).
The final rules are available to each “Qualifying Community Banking Organization” as defined in the final rules (a “QCBO”). To be a QCBO, a banking organization must satisfy the following criteria: (i) not be an Advanced Approaches Entity; (ii) have a leverage capital ratio greater than 9%; (iii) total consolidated assets of less than $10 billion; (iv) total off-balance sheet exposures (excluding certain derivatives) of 25% or less of total consolidated assets; and (v) a sum of total trading assets and trading liabilities of 5% or less of total consolidated assets. For this purpose, the leverage capital ratio of a banking organization is the ratio of its Tier 1 capital to its average total consolidated assets.
A banking organization meeting the QCBO criteria may elect to opt in to the CBLR framework (an electing banking organization). An electing banking organization is deemed to have met the “well-capitalized” ratio requirements of, and otherwise to be in compliance with, the generally applicable rules. It will not be required to calculate and report risk-based capital ratios under the generally applicable rules. In the case of an electing banking organization that is an insured bank, it will also be considered to have met the well-capitalized ratio requirements of the prompt corrective action provisions of the Federal Deposit Insurance Act.
If an electing banking organization subsequently fails to satisfy any of the criteria of a QCBO, but continues to report a leverage capital ratio greater than 8%, it may continue to use the CBLR framework for a grace period of up to two quarters. As long as the electing banking organization can return to compliance with all of the QCBO criteria within the two quarters, it will continue to be deemed to meet the “well-capitalized” ratio requirements and be in compliance with the generally applicable rules. A banking organization will be required to comply with the generally applicable rules, and file the relevant regulatory reports, if it: (i) is unable to restore compliance with all of the QCBO criteria (including the greater than 9% leverage capital ratio) during the two-quarter grace period; (ii) reports a leverage capital ratio of 8% or less; or (iii) ceases to satisfy the QCBO criteria because of a merger transaction.
In February 2019, the federal banking agencies published in the Federal Register a notice of proposed rule-making to implement this EGRRCPA capital adequacy provision. The proposal would establish a CBLR of 9% tangible equity to average total consolidated assets. Under the proposal, a bank or bank holding company having less than $10 billion in average total consolidated assets would need to meet several requirements in order to be a Qualified Community Bank. The proposed requirements include that the bank or bank holding company: have no affiliation with a banking organization subject to the advanced approaches capital rule; have mortgage servicing rights of 25% or less of CBLR tangible equity; have deferred tax assets arising from temporary timing differences, net of valuation allowances, of 25% or less of CBLR tangible equity; have off-balance-sheet exposures (excluding derivative exposures and unconditionally cancellable commitments) of 25% or less of total consolidated assets; have total trading assets and trading liabilities of 5% or less of total consolidated assets; and have a CBLR greater than 9%. As required by EGRRCPA, the proposal also includes detailed provisions addressing the treatment of a formerly Qualified Community Bank that failed to satisfy one or more of the proposed requirements, or whose CBLR fell below 9%. There can be no assurance whether, or when, this proposed rule-making will lead to the adoption of regulations, or as to the content of any regulations eventually adopted.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We may need or want to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Our ability to raise additional capital will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. Economic conditions and any loss of confidence in financial institutions generally may increase our cost of funding and limit access to certain customary sources of capital.
There can be no assurance that capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of equity or debt purchasers, or counterparties participating in the capital markets, may adversely affect our capital costs and our ability to raise capital and, potentially, our liquidity. Also, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our business, financial condition and results of operations.
Changes in the method of determining Libor, or the replacement of Libor with an alternative reference rate, may adversely affect interest income or expense.
Many of the commercial loans we make bear interest at a floating rate based on Libor, the London inter-bank offered rate. We pay interest on certain subordinated notes related to our trust preferred securities at rates based on Libor.
On July 27, 2017, the United Kingdom Financial Conduct Authority, which oversees Libor, formally announced that it could not assure the continued existence of Libor in its current form beyond the end of 2021, and that an orderly transition process to one or more alternative benchmarks should begin. In June 2017, the Alternative Reference Rates Committee (“ARRC”), a steering committee comprised of large U.S. financial institutions organized by the Federal Reserve, announced that it had selected a modified version of the unpublished Broad Treasuries Financing Rate as the preferred alternative reference rate for U.S. dollar obligations. That rate, now referred to as the Secured Overnight Funding Rate (“SOFR”), is determined based upon actual transactions in certain portions of the bi-lateral and tri-party overnight repurchase agreement markets for certain U.S. Treasury obligations. The Federal Reserve Bank of New York began publication of the SOFR in April 2018.
In February 2018, an international consortium of market participant trade associations published the IBOR Global Benchmark Survey 2018 Transition Roadmap (“Roadmap”). The Roadmap summarizes the background to the use of inter-bank offered rate benchmarks, discusses perceived reasons for reform, and identifies problems that may be encountered in making a transition to new interest rate benchmarks. Those potential problems include market adoption, liquidity, legal, valuation and risk management, infrastructure, tax, accounting, governance and control, and regulatory issues.
In May 2018, the Chicago Mercantile Exchange began trading SOFR futures contracts. The existence of a futures market may permit the development of a SOFR term curve. In July 2018, the Federal National Mortgage Association (“FNMA”) issued bonds using SOFR (an overnight rate) as a pricing mechanism. This was possible because of an unusual bond structure, in which interest was payable quarterly, but the interest reset period was daily.
In January 2019, ICE Benchmark Administration, the current provider of Libor, proposed for comment to market participants a U.S. Dollar ICE Bank Yield Index. This index would be based on two types of U.S. dollar-denominated transaction data: primary market wholesale, unsecured funding transactions for large, internationally active banks; and secondary market transactions in wholesale, unsecured bonds issued by large, internationally active banks. These data would be used to construct a yield curve from which one-month, three-month and six-month settings could be obtained. Following comments from market participants on its initial proposal, in October 2019, the ICE Benchmark Administration announced changes to the methodology of calculation of its index (which it is continuing to test), and its intent both to seek contractual commitments from large, internationally active banks to provide primary market U.S. dollar funding data, and to develop a robust governance framework for the production of its index. If those steps were accomplished and the resulting index were accepted by market participants, it might furnish commercial bank-based term rates more directly comparable to the existing structure of Libor than the government securities repurchase agreement-based overnight SOFR.
During 2019, among other things, the ARRC published a white paper on ways in which market participants could use SOFR in cash markets, conducted surveys of market participants, engaged with cognizant U.S. government agencies regarding tax, securities, and derivatives issues presented by the transition from Libor, published sample transition provisions for a variety of types of loan and note agreements, and investigated methods by which a forward-looking term SOFR index could be established. To facilitate the development of a generally-recognized forward-looking SOFR index, the Federal Reserve Bank of New York (“FRBNY”) recently announced that, on March 2, 2020, it would begin publication of 30-, 90-, and 180-day SOFR Averages, as well as a SOFR Index. The announcement described the respective methods of calculation of the SOFR Averages and the SOFR Index, and specifics regarding their publication. FRBNY also stated that, following launch of the SOFR Averages and the SOFR Index, it would consider the potential benefits of introducing calendar month-based rates and/or adding further tenors as additional reference rates.
In July 2019, both FNMA and the Federal Home Loan Mortgage Corporation (“FHLMC”) announced their intention to develop new adjustable-rate mortgage loan products based on SOFR. In February 2020, FNMA and FHLMC each announced that they would: (i) require inclusion of ARRC-recommended transition language in all single-family adjustable rate mortgage (“ARM”) loans closed on or after June 1, 2020; (ii) require all Libor-based single-family and multi-family ARM loans to have loan application dates on or before September 30, 2020 in order to be eligible for acquisition; and (iii) cease acquisition of single-family and multi-family Libor ARM loans on or before December 31, 2020. In addition, each of FNMA and FHLMC stated that they anticipate beginning acquisition of SOFR ARM loans during the second half of 2020, using an index based upon SOFR averages.
Bank regulatory agencies reiterated their resolve that the banking organizations they supervise should be prepared for the phase-out of Libor. In December 2019, the OCC highlighted the issue in its semiannual risk perspective, noting that its examiners will be monitoring institutions’ exposure to Libor and their strategies to mitigate resulting risks. Also in December 2019, the New York Department of Financial Services wrote to each of its regulated institutions, noting the impending unavailability of Libor, the development of SOFR, and the risks posed by transition, and required by February 2020, a written response from each institution regarding its own risk assessment and planning. In January 2020, the Bank of England and the United Kingdom Financial Conduct Authority underscored the unavailability of Libor after 2021, and demanded to see “clear evidence of engagement” from February 2020 that institutions were making the transition from Libor in their operations.
It is unclear whether, or in what form, Libor will continue to exist after 2021. Any transition to an alternative benchmark will require careful consideration and implementation so as not to disrupt the stability of financial markets. If Libor ceases to exist, we may need to take a variety of actions, including negotiating certain of our agreements based on an alternative benchmark that may be established, if any. There is no guarantee that a transition from Libor to an alternative benchmark will not result in financial market disruptions, significant changes in benchmark rates, or adverse changes in the value of certain of our loans, and our income and expense.
Our accounting policies and methods are the basis for how we prepare our consolidated financial statements, and they require management to make estimates about matters that are inherently uncertain.
Accounting policies and processes are fundamental to how we record and report our financial condition and results of operations. We must exercise judgment in selecting and applying many of these accounting policies and processes so they comply with U.S. GAAP. In some cases, we must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in our reporting materially different results than would have been reported under a different alternative.
We have identified certain accounting policies as being critical because they require us to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. We have established detailed policies and control procedures that are intended to ensure these critical accounting estimates and judgments are well controlled and applied consistently. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. Because of the uncertainty surrounding management’s judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust accounting policies or restate prior period financial statements. For additional information, see “Critical Accounting Policies and Estimates” beginning on page of this Annual Report and “Note 1 - Summary of Significant Accounting Policies” beginning on page of this Annual Report.
We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements.
The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we do. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
Our Articles of Incorporation and By-laws and the laws of the State of Michigan contain provisions that may discourage or prevent a takeover of our company and reduce any takeover premium.
Our Articles of Incorporation and By-laws, and the corporate laws of the State of Michigan, include provisions which are designed to provide our Board of Directors with time to consider whether a hostile takeover offer is in our and our shareholders’ best interest. These provisions, however, could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of our common stock to participate in tender offers, including tender offers at a price above the then-current market price for our common stock. These provisions could also prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interest.
The Michigan Business Corporation Act contains provisions intended to protect shareholders and prohibit or discourage various types of hostile takeover activities. In addition to these provisions and the provisions of our Articles of Incorporation and By-laws, federal law requires the Federal Reserve Board’s approval prior to acquiring “control” of a bank holding company. All of these provisions may delay or prevent a change in control without action by our shareholders and could adversely affect the price of our common stock.
The full impact of recent changes in U.S. tax laws remains uncertain.
The enactment of the Tax Cuts and Jobs Act (the “Act”) on December 22, 2017 made significant changes to the Internal Revenue Code, many of which are highly complex and may require interpretations and implementing regulations. As a result of the Act’s reduction of the corporate income tax rate from 35% to 21%, we recorded a one-time, non-cash charge to federal income tax expense of $1.3 million during the fourth quarter of 2017 to reduce the value of our net deferred tax assets. See Note 11 of our Consolidated Financial Statements.
Furthermore, the expected impact of certain aspects of the statute remains unclear and subject to change. The Act includes a number of provisions that will have an impact on the banking industry, borrowers and the market for residential real estate. These changes include: a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans; the elimination of interest deductions for home equity loans; a limitation on the deductibility of business interest expense; and a limitation on the deductibility of property taxes and state and local income taxes. The Act may have an adverse effect on the market for and the valuation of residential properties, as well as on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. The value of the properties securing such loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership. Such an impact could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.
There is a limited trading market for our common stock.
The price of our common stock has been, and will likely continue to be, subject to fluctuations based on, among other things, economic and market conditions for bank holding companies and the stock market in general, as well as changes in investor perceptions of our company. The issuance of new shares of our common stock also may affect the market for our common stock.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “MBWM.” The development and maintenance of an active public trading market depends upon the existence of willing buyers and sellers, the presence of which is beyond our control. While we are a publicly-traded company, the volume of trading activity in our stock is still relatively limited. Even if a more active market develops, there can be no assurance that such a market will continue, or that our shareholders will be able to sell their shares at or above the price at which they acquired shares.
Our business is subject to operational risks.
We, like most financial institutions, are exposed to many types of operational risks, including the risk of fraud by employees or outsiders, unauthorized transactions by employees or operational errors. Operational errors may include clerical or record keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Given our volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully corrected. Our necessary dependence upon automated systems to record and process our transaction volume may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.
We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, including, for example, computer viruses or electrical or telecommunications outages, which may give rise to losses in service to customers and to loss or liability to us. We are further exposed to the risk that our external vendors may be unable to fulfill their contractual obligations to us, or will be subject to the same risk of fraud or operational errors by their respective employees as are we, and to the risk that our or our vendors’ business continuity and data security systems prove not to be adequate. We also face the risk that the design of our controls and procedures proves inadequate or is circumvented, causing delays in detection or errors in information. Although we maintain a system of controls designed to keep operational risks at appropriate levels, there can be no assurance that we will not suffer losses from operational risks in the future that may be material in amount.
We face the risk of cyber-attack to our computer systems.
In the ordinary course of business, we collect and store sensitive data, including proprietary business information and personally identifiable information of our customers and employees in systems and on networks. The secure processing, maintenance and use of this information is critical to our operations. To date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but our systems and those of our customers and third-party service providers are under constant threat, and it is possible that we could experience a significant event in the future. Cybersecurity threats include unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of internet banking, mobile banking and other technology-based products and services by us and our customers. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.
In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. In August 2019, the federal bank regulatory agencies issued a statement recommending that banking organizations use a standardized approach to assess and improve cybersecurity preparedness. The agencies noted that the use of standardized tools, such as the FFIEC Cybersecurity Assessment Tool, makes firms better able to track their progress over time, and to share information and best practices with other financial institutions, a behavior which the bank regulatory agencies encourage. Although guidance of this nature does not have the full force and effect of law, it sets out supervisory priorities and expectations regarding safe and sound operation. Failure to observe such guidance may result in supervisory identification of unsafe or unsound practices or other deficiencies in risk management or other areas that do not constitute violations of law or regulation.
The value of securities in our investment securities portfolio may be negatively affected by disruptions in securities markets.
Prices and volumes of transactions in the nation’s securities markets can be affected suddenly by economic crises, or by other national or international crises, such as national disasters, acts of war or terrorism, changes in commodities markets, or instability in foreign governments. Disruptions in securities markets may detrimentally affect the value of securities that we hold in our investment portfolio, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that declines in market value associated with these disruptions will not result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
Damage to our reputation could materially harm our business.
Our relationship with many of our clients is predicated upon our reputation as a fiduciary and a service provider that adheres to the highest standards of ethics, service quality and regulatory compliance. Adverse publicity, regulatory actions, litigation, operational failures, the failure to meet client expectations and other issues with respect to one or more of our businesses could materially and adversely affect our reputation, our ability to attract and retain clients or our sources of funding for the same or other businesses. Preserving and enhancing our reputation also depends on maintaining systems and procedures that address known risks and regulatory requirements, as well as our ability to identify and mitigate additional risks that arise due to changes in our businesses and the marketplaces in which we operate, the regulatory environment and client expectations. If any of these developments has a material effect on our reputation, our business will suffer.
Item 1B.
Item 1B.
Unresolved Staff Comments
We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more before the end of our 2019 fiscal year and that remain unresolved.
Item 2.
Item 2.
Properties.
Our headquarters is located in our bank’s main office facility in Grand Rapids, Michigan. Our bank operates 40 banking offices primarily concentrated throughout Western and Central Michigan, most of which are full-service facilities. We also opened a banking office in Troy, Michigan during the first quarter of 2017. We have larger banking facilities in Alma, Holland, Ionia, Kalamazoo, Lansing, Mt. Pleasant and West Branch. The remaining banking offices generally range in size from 1,200 to 3,200 square feet, based on the location and number of employees located at the facility. All of our banking offices are owned by our bank except for three that are rented under various operating lease agreements. In several instances, the banking offices contain more usable space than what is needed for current banking operations. This excess space, totaling approximately 23,500 square feet, is generally leased to unrelated businesses. In addition, certain functions operate out of our standalone facility located in Alma.
We consider our properties and equipment to be well maintained, in good operating condition and capable of accommodating current growth forecasts. However, we may choose to add branch locations to expand our presence in current markets and/or in new markets or, alternatively, to consolidate, close or relocate branches if we believe it would be beneficial to our overall performance.
Item 3.
Item 3.
Legal Proceedings.
From time to time, we may be involved in various legal proceedings that are incidental to our business. In the opinion of management, we are not a party to any legal proceedings that are material to our financial condition, either individually or in the aggregate.
Item 4.
Item 4.
Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “MBWM.” At March 1, 2020, there were approximately 1,400 record holders of our common stock. In addition, we estimate that there were approximately 7,000 beneficial owners of our common stock who own their shares through brokers or banks.
The following table shows the high and low sales prices for our common stock as reported by the Nasdaq Global Select Market for the periods indicated and the quarterly and special cash dividends paid by us during those periods.
Holders of our common stock are entitled to receive dividends that the Board of Directors may declare from time to time. We may only pay dividends out of funds that are legally available for that purpose. We are a financial holding company and substantially all of our assets are held by our bank and its subsidiaries. Our ability to pay dividends to our shareholders depends primarily on our bank’s ability to pay dividends to us. Dividend payments and extensions of credit to us from our bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings, imposed by law and regulatory agencies with authority over our bank. The ability of our bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. In addition, under the terms of our subordinated debentures, we would be precluded from paying dividends on our common stock if an event of default has occurred and is continuing under the subordinated debentures, or if we exercised our right to defer payments of interest on the subordinated debentures, until the deferral ended.
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 our financial statements. Our bank’s ability to pay cash and stock dividends or repurchase equity securities is subject to limitations under various laws and regulations and to prudent and sound banking practices.
On January 17, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.26 per share that was paid on March 20, 2019 to shareholders of record as of March 8, 2019. On April 11, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.26 per share that was paid on June 19, 2019 to shareholders of record as of June 7, 2019. On July 11, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.27 per share that was paid on September 18, 2019 to shareholders of record as of September 6, 2019. On October 10, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.27 per share that was paid on December 18, 2019 to shareholders of record as of December 6, 2019.
On January 11, 2018, our Board of Directors declared a cash dividend on our common stock in the amount of $0.22 per share that was paid on March 21, 2018 to shareholders of record as of March 9, 2018. On April 12, 2018, our Board of Directors declared a cash dividend on our common stock in the amount of $0.22 per share that was paid on June 20, 2018 to shareholders of record as of June 8, 2018. On July 12, 2018, our Board of Directors declared a cash dividend on our common stock in the amount of $0.24 per share that was paid on September 19, 2018 to shareholders of record as of September 7, 2018. On October 11, 2018, our Board of Directors declared a cash dividend on our common stock in the amount of $0.25 per share that was paid on December 19, 2018 to shareholders of record as of December 7, 2018. In addition, on October 11, 2018, our Board of Directors declared a special cash dividend on our common stock in the amount of $0.75 per share that was paid on December 19, 2018 to shareholders of record as of December 7, 2018.
On January 16, 2020, our Board of Directors declared a cash dividend on our common stock in the amount of $0.28 per share that will be paid on March 18, 2020 to shareholders of record as of March 6, 2020.
Issuer Purchases of Equity Securities
On May 7, 2019, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. The actual timing, number and value of shares repurchased under the program will be determined by management in its discretion and will depend on a number of factors, including the market price of Mercantile’s stock, general market and economic conditions, Mercantile’s capital position, financial performance and alternative uses of capital, and applicable legal requirements. The program may be discontinued at any time. This stock repurchase plan was instituted in conjunction with the completion of our existing repurchase program that was introduced in January 2015 and later expanded in April 2016.
During 2019, we repurchased a total of 233,300 shares at a total price of $7.2 million, at an average price per share of $30.79. During 2018, we repurchased a total of 199,905 shares at a total price of $5.9 million, at an average price per share of $29.73. During the period of January 2015 through December 2019, we repurchased a total of about 1.4 million shares at a total price of $32.6 million, at an average price per share of $23.47. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank. Repurchases made during the fourth quarter of 2019 are detailed in the table below.
Shareholder Return Performance Graph
Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on our common stock (based on the last reported sales price of the respective year) with the cumulative total return of the Nasdaq Composite Index and the SNL Bank Nasdaq Index from December 31, 2014 through December 31, 2019. The following is based on an investment of $100 on December 31, 2014 in our common stock, the Nasdaq Composite Index and the SNL Bank Nasdaq Index, with dividends reinvested where applicable.
Item 6.
Item 6.
Selected Financial Data.
The Selected Financial Data in this Annual Report is incorporated here by reference.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management’s Discussion and Analysis included in this Annual Report is incorporated here by reference.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
The information under the heading “Market Risk Analysis” included in this Annual Report is incorporated here by reference.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
The Consolidated Financial Statements, the Notes to Consolidated Financial Statements and the Reports of Independent Registered Public Accounting Firm included in this Annual Report are incorporated here by reference.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None
Item 9A.
Item 9A.
Controls and Procedures.
As of December 31, 2019, 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 December 31, 2019.
There have been no significant changes in our internal control over financial reporting during the quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019. This evaluation was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2019. Refer to page for management’s report.
Our independent registered public accounting firm has issued an audit report on our internal control over financial reporting which is included in this Annual Report.
Item 9B.
Item 9B.
Other Information.
None
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The information presented under the captions “Election of Directors,” “Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance - Code of Ethics” in the definitive Proxy Statement of Mercantile for our May 28, 2020 Annual Meeting of Shareholders (the “Proxy Statement”), a copy of which will be filed with the Securities and Exchange Commission before April 30, 2020, is incorporated here by reference.
We have a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The members of the Audit Committee consist of David M. Cassard, Edward J. Clark, Michelle L. Eldridge, Jeff A. Gardner and Edward B. Grant. The Board of Directors has determined that Messrs. Cassard and Grant, members of the Audit Committee, are qualified as audit committee financial experts, as that term is defined in the rules of the Securities and Exchange Commission. All five members of the committee are independent, as independence for audit committee members is defined in the Nasdaq listing standards and the rules of the Securities and Exchange Commission.
Item 11.
Item 11.
Executive Compensation.
The information presented under the captions “Executive Compensation,” “Corporate Governance - Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the Proxy Statement is incorporated here by reference.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information presented under the caption “Stock Ownership of Certain Beneficial Owners and Management” in the Proxy Statement is incorporated here by reference.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2019, relating to compensation plans under which equity securities are authorized for issuance.
(1) Primarily includes Mercantile’s Stock Incentive Plan of 2016. Also, in conjunction with the merger with Firstbank, we 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 Stock Compensation Plan.
(2) These securities are available under the Stock Incentive Plan of 2016. Incentive awards may include, but are not limited to, stock options, restricted stock, stock appreciation rights and stock awards.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information presented under the captions “Transactions with Related Persons” and “Corporate Governance - Director Independence” in the Proxy Statement is incorporated here by reference.
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information presented under the caption “Principal Accountant Fees and Services” in the Proxy Statement is incorporated here by reference.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a) (1) Financial Statements. The following financial statements and reports of the independent registered public accounting firm of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:
Reports of Independent Registered Public Accounting Firm dated March 2, 2020 - BDO USA, LLP
Consolidated Balance Sheets --- December 31, 2019 and 2018
Consolidated Statements of Income for each of the three years in the period ended December 31, 2019
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2019
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2019
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2019
Notes to Consolidated Financial Statements
The Consolidated Financial Statements, the Notes to the Consolidated Financial Statements, and the Reports of Independent Registered Public Accounting Firm listed above are incorporated by reference in Item 8 of this report.
(2)
Financial Statement Schedules
Not applicable
(b)
Exhibits:
The Exhibit Index immediately preceding the Signatures Page hereto is incorporated by reference under this item.
(c)
Financial Statements Not Included In Annual Report
Not applicable
Item 16.
Form 10-K Summary
None.
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2019 and 2018
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2019 and 2018
CONTENTS
SELECTED FINANCIAL DATA
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SELECTED FINANCIAL DATA
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion and other portions of this Annual Report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “projects,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.
Future Factors include, among others, changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; changes in the method of determining Libor, or the replacement of Libor with an alternative reference rate; 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 other risk factors described in Item 1A of this Annual Report. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) is based on Mercantile Bank Corporation’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and actual results could differ from those estimates. We have reviewed the analyses with the Audit Committee of our Board of Directors.
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.
We complete a migration analysis quarterly to assist us in determining appropriate reserve allocation factors for non-impaired loans. Our migration takes into account various time periods; however, at year-end 2019 we placed most weight on the period starting December 31, 2010 through December 31, 2019. We believe this 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 market consensus of economic conditions in the near future.
Although the migration analysis provides an accurate 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 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 loan portfolio.
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 principal and interest 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 interest 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 are able to 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 taxing 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.
Accounting guidance requires us to 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 that may impact future operating results. Significant weight is given to evidence that can be objectively verified.
Securities: 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 and 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, we consider: (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) our 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 generally 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 mortgage 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 loan prepayment speeds, the remaining life of the mortgage loan pool, delinquency rates, our cost to service the mortgage loans and other factors to determine the cash flow that we will receive from servicing each grouping of mortgage 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 mortgage loans. Impairment is evaluated quarterly based on the fair value of the mortgage servicing rights, using groupings of the underlying mortgage loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.
Goodwill: 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. 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 2018 and 2019, 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. Our qualitative assessment considered factors such as macroeconomic conditions, market conditions specifically related to the banking industry and our overall financial condition and results of operations.
INTRODUCTION
This Management’s Discussion and Analysis should be read in conjunction with the consolidated financial statements contained in this Annual Report. This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiary, Mercantile Bank of Michigan (“our bank”), and of Mercantile Bank Real Estate Co., L.L.C. (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance company”), subsidiaries of our bank. Unless the text clearly suggests otherwise, references to “us,” “we,” “our,” or “the company” include Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.
FINANCIAL OVERVIEW
We recorded net income of $49.5 million, or $3.01 per diluted share, for 2019. For 2018, we recorded net income of $42.0 million, or $2.53 per diluted share. Full-year 2019 earnings benefited from bank owned life insurance claims and the net impact of gains and losses on sales and write-downs of former branch facilities, increasing reported net income by $2.7 million, or $0.16 per diluted share. In addition, the full-year benefit of interest income related to purchased loan accounting entries increased net income during 2019 by $1.1 million, or $0.07 per diluted share, and net income during 2018 by $3.2 million, or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share increased almost 19% during 2019 compared to 2018, in large part reflecting growth in net interest income and mortgage banking income that more than offset increases in various noninterest expense categories.
The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.08% of total loans as of December 31, 2019. Gross loan charge-offs during 2019 totaled $0.9 million, while recoveries of prior period loan charge-offs totaled $0.7 million, providing for net loan charge-offs of $0.2 million, or 0.01% of average total loans. We continue our collection efforts on charged-off loans, and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. Accruing loans past due 30 to 89 days remain very low.
New commercial term loan originations remain strong, and we also experienced net increases in commercial lines of credit. Net commercial loan growth equaled $81.4 million during 2019, compared to $157 million, $138 million and $119 million during 2018, 2017 and 2016, respectively. Net commercial loan growth in 2019 was negatively impacted by several commercial real estate loan payoffs late in the year involving larger borrowing relationships that refinanced the underlying real estate with secondary market participants that offered long-term, fixed rate non-recourse financing options. The new commercial loan pipeline remains strong, and at year-end 2019, we had $105 million in unfunded loan commitments on commercial construction and development projects that are in the construction phase. Our residential mortgage lending operations continued to expand during 2019, with total residential mortgage loan originations increasing from $214 million in 2018 to $369 million during 2019. We sold about 70% of the new loan volume to secondary market participants, while retaining the remainder, primarily consisting of adjustable rate residential mortgage loans. Residential mortgage loans residing on our balance sheet increased $32.2 million during 2019.
We believe our loan portfolio is well diversified, with loan composition remaining relatively consistent over the past several years. At December 31, 2019, commercial and industrial loans comprised 30%, commercial real estate non-owner occupied loans comprised 29%, commercial real estate owner occupied loans comprised 20% and residential mortgage and consumer loans aggregated 15% of total loans. As a percent of total commercial loans, commercial and industrial loans and commercial real estate owner occupied loans combined equaled 58% at both year-end 2019 and 2018.
Our funding structure is also well diversified. As of December 31, 2019, noninterest-bearing checking accounts comprised 29% of total funds, interest-bearing checking and securities sold under agreements to repurchase (“sweep accounts”) combined for 14%, savings and money market deposit accounts aggregated 25% and local time deposits accounted for 17%. Wholesale funds, comprised of brokered deposits and Federal Home Loan Bank of Indianapolis (“FHLBI”) advances, represented 15% of total funds.
FINANCIAL CONDITION
Our total assets increased $269 million during 2019, and totaled $3.63 billion as of December 31, 2019. Total loans increased $104 million and interest-earning deposits were up $170 million, while securities available for sale declined $2.7 million. Total deposits increased $227 million and FHLBI advances were up $4.0 million. Local deposit growth exceeded net loan growth, with the excess funds maintained with the Federal Reserve Bank of Chicago.
Earning Assets
Average earning assets equaled 93.4% of average total assets during 2019, similar to the 93.0% during 2018. The loan portfolio continued to comprise a majority of earning assets, followed by securities and interest-earning deposits. Average total loans equaled 85.8% of average earning assets during 2019, compared to 86.4% in 2018, while securities and other interest-earning assets combined comprised 14.2% of average earning assets during 2019, compared to 13.6% in 2018. We anticipate the level of earning assets to total assets to remain relatively stable at approximately 93%.
Our loan portfolio has historically been primarily comprised of commercial loans. Commercial loans increased $81.4 million during 2019, and at December 31, 2019 totaled $2.44 billion, or 85.5% of the loan portfolio. As of December 31, 2018, the commercial loan portfolio comprised 85.7% of total loans. Commercial and industrial loans were up $23.8 million, owner occupied commercial real estate (“CRE”) loans were up $30.4 million, non-owner occupied CRE loans increased $19.1 million and vacant land, land development and residential construction loans were up $11.2 million. Multi-family and residential rental loans declined $3.1 million. As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 58.4% as of December 31, 2019, compared to 58.1% at December 31, 2018.
New commercial term loan originations remain strong, and we also experienced net increases in commercial lines of credit. Net commercial loan growth equaled $81.4 million during 2019, compared to $157 million, $138 million and $119 million during 2018, 2017 and 2016, respectively. Net commercial loan growth in 2019 was negatively impacted by several commercial real estate loan payoffs late in the year involving larger borrowing relationships that refinanced the underlying real estate with secondary market participants that offered long-term, fixed rate non-recourse financing options. The new commercial loan pipeline remains strong, and at year-end 2019, we had $105 million in unfunded loan commitments on commercial construction and development projects that are in the construction phase. Our commercial loan officers also report significant additional opportunities they are currently discussing with existing borrowers and potential new customers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio.
Residential mortgage loans increased $32.2 million during 2019, totaling $340 million, or 11.9% of total loans, at December 31, 2019. We originated $369 million in residential mortgage loans during 2019, compared to $214 million in 2018. Notwithstanding an ongoing low level of inventory of homes listed for sale throughout our markets, the volume of residential mortgage loans originated for the purchase of homes in 2019 increased by over 27% when compared to 2018, in large part reflecting an increased residential mortgage loan origination staff. In addition, the increased staff and a lower residential mortgage loan interest rate environment provided for growth in the volume of residential mortgage loans for refinance activities by over 163% in 2019 when compared to 2018. We sold $257 million of the residential mortgage loans originated in 2019, or about 70%, generally comprised of longer-term fixed rate residential mortgage loans. The remaining $112 million was added to our balance sheet, in large part comprised of adjustable rate residential mortgage loans. We are pleased with the success of our strategic initiative to grow our residential mortgage banking operation over the past several years. We expect to sell 55% to 60% of the new residential mortgage loan originations in 2020, with a vast majority of the loans added to our balance sheet to be comprised of adjustable rate residential mortgage loans. Other consumer-related loans declined $10.1 million during 2019, and at December 31, 2019 totaled $75.4 million, or 2.6% of the loan portfolio. Other consumer-related loans equaled 3.1% of total loans as of December 31, 2018. We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed origination volumes.
The following table summarizes our loan portfolio:
The following table presents total loans outstanding as of December 31, 2019, according to scheduled repayments of principal on fixed rate loans and repricing frequency on variable rate loans. 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.
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 the internal loan 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, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $2.7 million (0.1% of total assets) as of December 31, 2019, compared to $5.0 million (0.2% of total assets) as of December 31, 2018. The volume of nonperforming assets has remained low over the past several years. Given the low level of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with a steady level of watch list credits and what we believe are strong credit administration practices, we are pleased with the overall quality of the loan portfolio.
The following tables provide a breakdown of nonperforming assets by property type:
The following tables provide a reconciliation of nonperforming assets:
Gross loan charge-offs during 2019 totaled $0.9 million, while recoveries of prior period loan charge-offs totaled $0.7 million, providing for net loan charge-offs of $0.2 million, or 0.01% of average total loans. We continue our collection efforts on charged-off loans, and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. Accruing loans past due 30 to 89 days remain very low.
The following table summarizes changes in the allowance for originated loan losses for the past five years:
The following table illustrates the breakdown of the allowance for originated loans balance by loan type (dollars in thousands) and of the total originated loan portfolio (in percentages):
The following table depicts the ratio of our allowance to nonperforming loans:
The increasing trend of the ratio of our allowance to nonperforming loans over the past several years generally reflects the combined impact of an increased allowance balance and reduction in nonperforming loans.
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 specific 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 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; lending concentrations; and other external factors, including 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 adjustments periodically based upon identifiable trends and experience.
A migration analysis is completed quarterly to assist us in determining appropriate reserve allocation factors for non-impaired loans. Our migration takes into account various time periods; however, at year-end 2019 we placed most weight on the period starting December 31, 2010 through December 31, 2019. We believe this 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 market consensus of economic conditions in the near future.
Although the migration analysis provides an accurate 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 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 loan portfolio.
The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and the 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 for originated loans equaled $23.2 million as of December 31, 2019, or 0.9% of total originated loans outstanding. The allowance for originated loans equaled 0.9% of total loans at year-end 2018. The allowance for acquired loans equaled $0.7 million as of December 31, 2019, compared to $0.8 million at year-end 2018. As of December 31, 2019, the allowance for originated loans was comprised of $21.8 million in general reserves relating to non-impaired loans and $1.4 million in specific allocations on other loans, primarily accruing loans designated as troubled debt restructurings.
Although we believe the allowance is adequate to absorb losses as they arise, there can be no assurance that we will not sustain losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.
Troubled debt restructurings totaled $12.1 million at December 31, 2019, consisting of $0.3 million that are on nonaccrual status and $11.8 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 $0.3 million as of December 31, 2019 had been subject to previous partial charge-offs aggregating $0.5 million. Those partial charge-offs were recorded as follows: less than $0.1 million in 2019, 2018, 2017, 2016, 2015 and 2013, and $0.3 million in 2011. As of December 31, 2019, specific reserves allocated to impaired loans that had been subject to a previous partial charge-off totaled less than $0.1 million.
The following table provides a breakdown of our loans categorized as troubled debt restructurings:
Securities available for sale decreased $2.7 million during 2019, totaling $335 million as of December 31, 2019. The securities portfolio equaled 10.3% of average earning assets during 2019, compared to 10.9% during 2018. During 2019, purchases of U.S. Government agency bonds totaled $36.0 million, U.S. Government agency issued or guaranteed mortgage-backed securities aggregated $8.4 million and municipal bonds totaled $17.6 million. Proceeds from matured and called U.S. Government agency and municipal bonds during 2019 totaled $47.6 million and $21.5 million, respectively, with another $10.4 million from principal paydowns on mortgage-backed securities. No bonds were sold during 2019. At December 31, 2019, the securities portfolio was primarily comprised of U.S. Government agency bonds (56%), municipal bonds (31%) and U.S. Government agency issued or guaranteed mortgage-backed securities (13%). All of our securities are currently designated as available for sale, and therefore are stated at fair value. The fair value of securities designated as available for sale at December 31, 2019 totaled $335 million, including a net unrealized gain of $4.7 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.
The following table reflects the composition of the securities portfolio:
FHLBI stock totaled $18.0 million as of December 31, 2019, compared to $16.0 million as of December 31, 2018. The $2.0 million increase reflects stock purchases to support the increased level of FHLBI advances during the course of 2019. Our investment in FHLBI stock is necessary to engage in their advance and other financing programs. We continue to receive regular quarterly cash dividends, and we expect a cash dividend will continue 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 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. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines. Reference is made to Note 17 of the Notes to Consolidated Financial Statements for additional information.
The following table shows by class of maturities as of December 31, 2019, the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities:
Other interest-earning assets, primarily consisting of excess funds deposited with the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate sensitivity. The average balance of these funds equaled 3.4% of average earning assets during 2019, compared to 2.3% during 2018. We anticipate the level of these earning assets to average approximately 2% of average earning assets in future periods.
Non-Earning Assets
Cash and due from bank balances averaged 1.5% of total assets during 2019, with no significant changes expected in future periods. Net premises and fixed assets equaled $57.3 million as of December 31, 2019, or 1.6% of total assets. Net purchases during 2019 totaled $13.5 million, while depreciation expense aggregated to $3.9 million. An addition to our main office comprised a majority of the increase in fixed assets during 2019. Foreclosed and repossessed assets totaled $0.5 million at December 31, 2019, compared to $0.8 million at December 31, 2018. Although we expect periodic transfers from loans to foreclosed and repossessed assets in future periods reflecting our collection efforts on certain impaired lending relationships, we believe the strong quality of our loan portfolio will limit any overall increase in, and average balance of, this nonperforming asset category.
Source of Funds
Total deposits increased $227 million during 2019, totaling $2.69 billion as of December 31, 2019. Out-of-area deposits increased $20.2 million during 2019, and equaled 5.0% of total deposits at year-end 2019, compared to 4.6% as of December 31, 2018. FHLBI advances increased $4.0 million during 2019, totaling $354 million as of December 31, 2019.
Noninterest-bearing checking accounts increased $35.1 million during 2019, generally due to deposit account openings as part of recently established commercial lending relationships. Interest-bearing checking accounts decreased $6.7 million and savings deposits declined $47.7 million, in large part due to individuals using deposited funds for investments and various expenditures. Money market deposit accounts increased $75.0 million during 2019, primarily reflecting increased deposit balances from certain existing large deposit customers. Local time deposits increased $151 million, generally reflecting the impact of a time deposit campaign in early 2019 and increased deposit balances from certain existing large deposit customers.
Sweep accounts decreased $0.8 million during 2019, totaling $103 million as of December 31, 2019. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.
FHLBI advances increased $4.0 million during 2019, totaling $354 million as of December 31, 2019. FHLBI advances are primarily used to assist in funding loan demand, as well as playing an integral role in our interest rate risk management program. FHLBI advances are generally collateralized by a blanket lien on our residential mortgage loan portfolio. Our borrowing line of credit at year-end 2019 totaled $813 million, with availability of $453 million.
Shareholders’ equity increased $41.3 million during 2019, totaling $417 million as of December 31, 2019. Positively impacting shareholders’ equity was net income of $49.5 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $17.1 million. Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by a total of $1.3 million. Share repurchases reduced shareholders’ equity by $7.2 million during 2019. Positively impacting shareholders’ equity during 2019 was an $11.9 million after-tax increase in the market value of available for sale securities.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2019 and 2018
Summary
We recorded net income of $49.5 million, or $3.01 per basic and diluted share, for 2019, compared to net income of $42.0 million, or $2.53 per basic and diluted share, for 2018. Bank owned life insurance claims and the net impact of gains and losses on sales and write-downs of former branch facilities increased reported net income during 2019 by approximately $2.7 million, or $0.16 per diluted share. Interest income related to purchased loan accounting entries increased net income during 2019 by $1.1 million, or $0.07 per diluted share, and net income during 2018 by $3.2 million, or $0.19 per diluted share. Excluding the impacts of these transactions, diluted earnings per share increased $0.44, or 18.8%, during 2019 compared to 2018.
Our earnings performance in 2019 benefited from increased net interest income and noninterest income, which more than offset increased provision expense and noninterest expense. The improved net interest income resulted from a higher level of earning assets. Noninterest income during 2019 included bank owned life insurance claims and gains on the sales of former branch facilities, while noninterest income during 2018 included a one-time accounting adjustment related to mortgage banking activities. In addition to increasing in 2019 compared to 2018 on a reported basis, noninterest income also grew after excluding the impacts of these transactions. Growth in noninterest income primarily resulted from increased mortgage banking activity income; increases in credit and debit card income, service charges on accounts, and payroll processing revenue also contributed to the improved level of noninterest income. The amount of provision expense necessitated by net loan growth during 2018 was partially mitigated by net loan recoveries being recorded during the period, resulting in a lower provision expense during 2018 compared to 2019. The higher level of noninterest expense primarily reflects increased salary costs.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2019 and 2018:
Net Interest Income
Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings. Interest income (adjusted for tax-exempt income) and interest expense totaled $159 million and $33.8 million during 2019, respectively, providing for net interest income of $125 million. During 2018, interest income and interest expense equaled $142 million and $21.9 million, respectively, providing for net interest income of $120 million.
In comparing 2019 with 2018, interest income increased 11.5%, interest expense was up 54.4%, and net interest income increased 3.7%. The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types and levels of assets and liabilities, the interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact net interest income as well as the net interest margin.
The $4.4 million increase in net interest income in 2019 compared to 2018 resulted from an increased level of average earning assets, which more than offset a lower net interest margin. During 2019, earning assets averaged $3.33 billion, or $285 million higher than average earning assets during 2018. Average loans increased $224 million, average interest-earning deposits increased $45.0 million, and average securities increased $15.6 million. During 2019, the net interest margin equaled 3.75%, down from 3.96% during 2018 due to a higher cost of funds, which more than offset an increased yield on average earning assets. The higher cost of funds primarily resulted from increased costs of time deposits and borrowed funds and a change in funding mix. The improved yield on average earning assets mainly resulted from an increased yield on commercial loans, primarily reflecting higher interest rates on variable-rate loans stemming from the Federal Open Market Committee (“FOMC”) raising the targeted federal funds rate by 25 basis points on four occasions during 2018. The positive impact of these rate increases more than offset the negative impact of decreased interest rates on variable-rate commercial loans resulting from the FOMC lowering the targeted federal funds rate by 25 basis points on three occasions during the last six months of 2019.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets, liabilities and shareholders’ equity during 2019, 2018 and 2017. The subsequent table also depicts the dollar amount of change in interest income and interest expense of interest-earning assets and interest-bearing liabilities, respectively, segregated between change due to volume and change due to rate. For tax-exempt investment securities, interest income and yield have been computed on a tax equivalent basis using a marginal tax rate of 21.0% in 2019 and 2018, and 35.0% in 2017. Securities interest income was increased by $0.2 million in 2019, $0.3 million in 2018 and $0.8 million in 2017 for this non-GAAP, but industry standard, adjustment. This adjustment equated to a one basis point increase in our net interest margin during 2019 and 2018 and a three basis point increase in our net interest margin during 2017.
Interest income is primarily generated from the loan portfolio, and to a significantly lesser degree, from securities and other interest-earning assets. Interest income increased $16.3 million during 2019 from that earned in 2018, totaling $159 million in 2019 compared to $142 million in the previous year. The increase in interest income is attributable to an increased level of, and a higher yield on, average earning assets. During 2019 and 2018, earning assets had an average yield (tax equivalent-adjusted basis) of 4.77% and 4.68%, respectively. The improved yield on average earning assets mainly resulted from an increased yield on commercial loans, primarily reflecting higher interest rates on variable-rate loans stemming from the previously-mentioned FOMC rate hikes. Increased yields on securities and interest-earning deposit balances also contributed to the higher yield on average earning assets.
Interest income generated from the loan portfolio increased $14.1 million in 2019 compared to the level earned in 2018; growth in the loan portfolio during 2019 resulted in an $11.4 million increase in interest income, while an increase in loan yield from 5.01% in 2018 to 5.11% in 2019 resulted in a $2.7 million increase in interest income. The higher yield on loans mainly resulted from an increased yield on commercial loans. The yield on commercial loans equaled 5.21% during 2019, up from 5.11% during 2018 primarily due to the FOMC rate hikes in 2018. Interest income related to purchased loan accounting entries totaled $1.4 million in 2019, compared to $4.0 million in 2018.
Interest income generated from the securities portfolio increased $1.1 million in 2019 compared to the level earned in 2018; an increase in the yield on securities from 2.69% during 2018 to 2.89% during 2019 resulted in a $0.6 million increase in interest income, while an increase in the average balance of the securities portfolio resulted in an increase in interest income of $0.5 million. The increased yield on securities mainly reflects $0.3 million in accelerated discount accretion on called U.S. Government agency bonds being recorded as interest income during 2019; no accelerated discount accretion was recorded during 2018. Interest income on interest-earning deposits increased $1.1 million in 2019 compared to the level earned in 2018; a higher average balance of interest-earning deposits resulted in a $0.9 million increase in interest income, while an increase in the yield on these balances resulted in a $0.2 million increase in interest income. The growth in average interest-earning deposits during 2019 primarily stemmed from certain deposit-gathering initiatives, an increase in wholesale funds, and several large commercial loan paydowns.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from borrowed funds. Interest expense increased $11.9 million during 2019 from that expensed in 2018, totaling $33.8 million in 2019 compared to $21.9 million in the previous year. The increase in interest expense resulted from an increase in the average balance of interest-bearing liabilities and a higher cost of funds. Average interest-bearing liabilities were $2.25 billion during 2019, up $225 million, or 11.1%, from the $2.02 billion average during 2018; the growth in average interest-bearing liabilities resulted in an increase in interest expense of $6.2 million. During 2019 and 2018, interest-bearing liabilities had a weighted average rate of 1.50% and 1.08%, respectively; an increase in interest expense of $5.7 million was recorded during 2019 due to the higher cost of funds. The higher average cost of interest-bearing liabilities mainly resulted from increased costs of time deposits and borrowed funds and a change in funding mix. The cost of time deposits increased from 1.59% during 2018 to 2.29% during 2019 due to higher rates being paid on each category of time deposits, primarily reflecting the rising interest rate environment during 2018. A higher-costing time deposit special campaign, which was introduced in mid-first quarter 2019 and ended in early April 2019, also contributed to the increased cost of time deposits. The cost of borrowed funds increased from 2.06% during 2018 to 2.39% during 2019, mainly reflecting a higher cost of FHLBI advances, which equaled 2.43% and 1.94% during 2019 and 2018, respectively. The higher cost of FHLBI advances primarily reflects the rising interest rate environment during 2018 and the lengthening of the average weighted maturity of the advance portfolio. Longer-term FHLBI advances totaling $194 million were obtained during the last eight months of 2018 and first month of 2019 to meet various funding needs. Average higher-costing time deposits and borrowed funds represented 28.7% and 23.4%, respectively, of average interest-bearing liabilities during 2019, compared to 23.7% and 19.3%, respectively, during 2018. Increased reliance on more costly wholesale funds during 2019, most of which occurred in late 2018 and January 2019, was necessitated by various funding requirements, including ongoing loan growth and seasonal deposit withdrawals by certain business customers for bonus and tax payments. Average lower-costing interest-bearing non-time deposits represented 47.9% of average interest-bearing liabilities during 2019, down from 57.0% during 2018.
A higher average rate paid on interest-bearing non-time deposits during 2019 resulted in a $0.3 million increase in interest expense, while a $76.8 million decrease in the average balance of these deposits equated to nominal decrease in interest expense. A $4.0 million increase in interest expense during 2019 resulted from a higher average rate paid on time deposits. Average time deposits increased $166 million during 2019; the increased average balance equated to an increase in interest expense of $3.1 million. Slight increases in the average balance of, and average rate paid on, short-term borrowings, comprised almost entirely of sweep accounts, resulted in nominal increases in interest expense during 2019. Average FHLBI advances increased $131 million during 2019, resulting in a $3.0 million increase in interest expense, while a higher average rate paid on the advances resulted in a $1.3 million increase in interest expense. A $0.4 million increase in average other borrowings resulted in a nominal increase in interest expense, while a higher average rate paid on the borrowings resulted in a $0.1 million increase in interest expense.
Net interest income and the net interest margin during 2019 and 2018 were affected by purchase accounting accretion and amortization associated with fair value measurements. Increases in interest income on loans totaling $1.4 million and $4.0 million were recorded during 2019 and 2018, respectively. Purchased loan accretion amounts vary from period to period as a result of periodic cash flow re-estimations, loan payoffs, and payment performance.
Provision for Loan Losses
A loan loss provision expense of $1.8 million was recorded in 2019, compared to a provision expense of $1.1 million recorded in 2018. The provision expense recorded during both 2019 and 2018 mainly reflected ongoing net loan growth. In addition, the provision expense recorded during 2019 depicted an increased allocation related to a change in the nature and volume of the consumer mortgage loan portfolio environmental factor, while the provision expense recorded during 2018 reflected increased allocations related to changes in the competition, economic conditions, and concentrations environmental factors. The amount of provision expense necessitated by net loan growth and environmental factor changes during 2018 was partially mitigated by net loan recoveries being recorded during the period.
Net loan charge-offs of $0.2 million were recorded during 2019, while net loan recoveries of $1.8 million were recorded during 2018. The allowance for originated loans, as a percentage of total originated loans, was 0.9% as of both December 31, 2019 and December 31, 2018. Our allowance for acquired loans totaled $0.7 million and $0.8 million as of December 31, 2019 and December 31, 2018, respectively.
Noninterest Income
Noninterest income was $27.0 million during 2019, compared to $19.0 million during 2018. Noninterest income during 2019 included bank owned life insurance claims totaling $2.6 million and gains on the sales of former branch facilities totaling $0.8 million, while noninterest income during 2018 included a one-time $0.9 million accounting adjustment related to mortgage banking activities in prior years. Excluding these transactions, noninterest income increased $5.4 million, or 29.9%, during 2019 compared to 2018. The improved level of noninterest income in 2019 compared to 2018 primarily resulted from increased mortgage banking activity income stemming from the success of continuing strategic initiatives designed to increase market presence, along with a higher level of refinance activity resulting from a decrease in residential mortgage loan interest rates and a higher percentage of originated loans being sold. Growth in credit and debit card income, service charges on accounts, and payroll processing fees also contributed to the improved level of noninterest income in 2019.
Noninterest Expense
Noninterest expense during 2019 was $89.3 million, an increase of $3.1 million, or 3.6%, from the $86.2 million expensed during 2018. The higher level of expense primarily resulted from increased salary costs, mainly reflecting annual employee merit pay increases, higher residential mortgage loan lender commissions, and increased stock-based compensation expense. Pay increases for all hourly employees, which went into effect on April 1, 2018, also contributed to the higher level of salary costs during 2019. Data processing costs were up $0.7 million during 2019 compared to 2018 primarily due to increases in debit and credit card and internet banking expenses stemming from growth in transaction volume and new product offerings, along with increased software amortization expense mainly resulting from the implementation of certain software solutions. Occupancy and furniture and equipment costs increased $0.5 million on a combined basis in 2019 compared to 2018 mainly due to higher depreciation expense, in large part stemming from an expansion of our main office and equipment purchases. Federal Deposit Insurance Corporation deposit insurance premiums were down $0.7 million in 2019 compared to 2018 as a result of deposit insurance credits being applied against regular assessments.
Federal Income Tax Expense
During 2019, we recorded income before federal income tax of $60.5 million and a federal income tax expense of $11.0 million, compared to income before federal income tax of $51.8 million and a federal income tax expense of $9.8 million during 2018. The increase in federal income tax expense in 2019 compared to 2018 resulted from the higher level of income before federal income tax. Our effective tax rate was 18.2% during 2019, compared to 18.9% during 2018. The aforementioned nontaxable bank owned life insurance claims positively impacted the effective tax rate in 2019.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2018 and 2017
Summary
We recorded net income of $42.0 million, or $2.53 per basic and diluted share, for 2018, compared to net income of $31.3 million, or $1.90 per basic and diluted share, for 2017. Our earnings performance in 2018 benefited from increased net interest income, lower provision expense, and decreased federal income tax expense, which more than offset increased noninterest expense. The improved net interest income resulted from an increased net interest margin and a higher level of average earning assets. The decreased provision expense mainly reflects the positive impact of net loan recoveries being recorded during the current year. The lower level of federal income tax expense depicts a reduction in our federal corporate income tax rate, which was lowered from 35.0% to 21.0% on January 1, 2018, as a result of the enactment of the Tax Cuts and Jobs Act. The increased noninterest expense was primarily attributable to higher salary costs, mainly reflecting annual employee merit pay increases, higher stock-based compensation, and a one-time pay increase for all hourly employees. Growth in several of our primary noninterest income revenue streams, including credit and debit card interchange fees, treasury management income, and payroll processing revenue, also contributed to the improved earnings performance.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2018 and 2017:
Net Interest Income
Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings. Interest income (adjusted for tax-exempt income) and interest expense totaled $142 million and $21.9 million during 2018, respectively, providing for net interest income of $120 million. During 2017, interest income and interest expense equaled $126 million and $15.8 million, respectively, providing for net interest income of $111 million.
In comparing 2018 with 2017, interest income increased 12.6%, interest expense was up 38.6%, and net interest income increased 8.9%. The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types and levels of assets and liabilities, the interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact net interest income as well as the net interest margin.
The $9.8 million increase in net interest income in 2018 compared to 2017 resulted from a higher net interest margin and an increased level of average earning assets. During 2018, the net interest margin equaled 3.96%, up from 3.79% during 2017 due to an increased yield on average earning assets, which more than offset a higher cost of funds. The improved yield on average earning assets mainly resulted from an increased yield on commercial loans, primarily reflecting higher interest rates on variable-rate loans stemming from the Federal Open Market Committee (“FOMC”) raising the targeted federal funds rate by 25 basis points on four occasions during 2018 and three occasions during 2017. The higher cost of funds primarily resulted from increased costs of certain non-time deposits, time deposits, and borrowed funds. During 2018, earning assets averaged $3.04 billion, or $127 million higher than average earning assets during 2017. Average loans increased $145 million, average interest-earning deposits decreased $21.4 million, and average securities increased $3.1 million.
Interest income is primarily generated from the loan portfolio, and to a significantly lesser degree, from securities and other interest-earning assets. Interest income increased $15.9 million during 2018 from that earned in 2017, totaling $142 million in 2018 compared to $126 million in the previous year. The increase in interest income is attributable to a higher yield on average earning assets and an increased level of average earning assets. During 2018 and 2017, earning assets had an average yield (tax equivalent-adjusted basis) of 4.68% and 4.33%, respectively. The improved yield on average earning assets mainly resulted from an increased yield on commercial loans, primarily reflecting higher interest rates on variable-rate loans stemming from the previously-mentioned FOMC rate hikes. A change in earning asset mix and higher yields on securities and interest-earning deposit balances also contributed to the increased yield on average earning assets. The change in earning asset mix mainly reflects loan growth and a reduction in interest-earning deposit balances. On average, higher-yielding loans represented 86.4% of earning assets during 2018, up from 85.2% during 2017, while lower-yielding interest-earning deposit balances represented 2.3% of earning assets during 2018, down from 3.1% during 2017. The increased yields on securities and interest-earning deposit balances primarily reflect the rising interest rate environment.
Interest income generated from the loan portfolio increased $14.9 million in 2018 compared to the level earned in 2017; an increase in loan yield from 4.70% in 2017 to 5.01% in 2018 resulted in a $7.9 million increase in interest income, while growth in the loan portfolio during 2018 resulted in a $7.0 million increase in interest income. The higher yield on loans mainly resulted from an increased yield on commercial loans, which more than offset a decreased yield on residential mortgage loans. The yield on commercial loans equaled 5.11% during 2018, up from 4.70% during 2017 primarily due to the FOMC rate hikes in 2017 and 2018. The decline in the yield on residential mortgage loans from 4.70% during 2017 to 4.32% during 2018 primarily reflected the booking of adjustable-rate mortgages with initial rates that were generally lower than the existing portfolio’s average rate. Interest income related to purchased loan accounting entries totaled $4.0 million in 2018, compared to $4.6 million in 2017.
Interest income generated from the securities portfolio increased $0.8 million in 2018 compared to the level earned in 2017; an increase in the yield on securities from 2.47% during 2017 to 2.69% during 2018 resulted in a $0.7 million increase in interest income, while an increase in the average balance of the securities portfolio resulted in an increase in interest income of $0.1 million. Proceeds from called and matured securities were reinvested into similar securities and additional securities were purchased to keep the securities portfolio at a desired level; the purchased securities’ coupon rates were generally higher than the existing portfolio’s average rate, reflecting the rising interest rate environment. Interest income on interest-earning deposit balances increased $0.1 million due to an increased yield.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from borrowed funds. Interest expense increased $6.1 million during 2018 from that expensed in 2017, totaling $21.9 million in 2018 compared to $15.8 million in the previous year. The increase in interest expense resulted from a higher cost of funds and an increase in interest-bearing liabilities. During 2018 and 2017, interest-bearing liabilities had a weighted average rate of 1.08% and 0.80%, respectively; an increase in interest expense of $5.4 million was recorded during 2018 due to the higher cost of funds. The higher weighted average cost of interest-bearing liabilities mainly resulted from increased costs of certain interest-bearing non-time deposits, time deposits, and borrowed funds. The cost of interest-bearing non-time deposit accounts increased from 0.28% during 2017 to 0.54% during 2018, primarily reflecting increased rates on certain account categories in response to the increasing interest rate environment; the increased cost also reflects a large depositor transferring funds from time deposits into a money market account product at rates higher than the average rate on the money market product at the time of transfer and the offering of a high balance money market account product with a higher rate, both of which occurred during the second quarter of 2017. The cost of time deposits increased from 1.24% during 2017 to 1.59% during 2018 due to higher rates being paid on each category of time deposits, reflecting the rising interest rate environment. The cost of borrowed funds increased from 1.68% during 2017 to 2.06% during 2018, mainly reflecting higher costs of FHLBI advances and subordinated debentures and a change in borrowing mix. The cost of FHLBI advances increased from 1.68% during 2017 to 1.94% during 2018; longer-term advances totaling $240 million were obtained during the last ten months of 2017 and first nine months of 2018 to meet loan funding and interest rate risk management needs. The cost of subordinated debentures was 6.54% during 2018, up from 5.53% during 2017 due to increased Libor rates stemming from the rising interest rate environment. Average higher-costing FHLBI advances represented 61.3% of average borrowed funds during 2018, up from 56.9% during 2017, while average lower-costing sweep accounts represented 25.9% and 30.4% of average borrowed funds during 2018 and 2017, respectively. Average interest-bearing liabilities were $2.02 billion during 2018, up $50.6 million, or 2.6%, from the $1.97 billion average during 2017.
An increase in interest-bearing non-time deposits during 2018, totaling $81.2 million, equated to an increase in interest expense of $0.9 million, while a higher average rate paid on these deposit accounts resulted in a $2.4 million increase in interest expense. A $1.7 million increase in interest expense resulted from a higher average rate paid on time deposits. Average time deposits decreased $37.8 million during 2018, reflecting a decline in public unit certificates of deposit $100,000 and over and the aforementioned transfer of funds into a money market account product; the decreased balance equated to a decline in interest expense of $0.5 million.
Average short-term borrowings, comprised almost entirely of sweep accounts, declined $14.5 million during 2018, resulting in a decrease in interest expense of less than $0.1 million, while a higher average rate paid on these accounts resulted in a $0.1 million increase in interest expense. Average FHLBI advances increased $21.2 million, resulting in a $0.4 million increase in interest expense, while a higher average rate paid on the advances resulted in a $0.6 million increase in interest expense. A $0.6 million increase in average other borrowings resulted in a nominal increase in interest expense, while a higher average rate paid on the borrowings resulted in a $0.5 million increase in interest expense.
Net interest income and the net interest margin during 2018 and 2017 were also affected by purchase accounting accretion and amortization entries associated with the fair value measurements recorded effective June 1, 2014. Increases in interest income on loans totaling $4.0 million and $4.6 million were recorded during 2018 and 2017, respectively. An increase in interest expense on subordinated debentures totaling $0.7 million was recorded during both 2018 and 2017. Purchased loan accretion amounts vary from period to period as a result of periodic cash flow re-estimations, loan payoffs, and payment performance.
Provision for Loan Losses
A loan loss provision expense of $1.1 million was recorded in 2018, compared to a provision expense of $3.0 million recorded in 2017. The provision expense recorded during 2018 and 2017 primarily reflects ongoing loan growth and periodic adjustments to loan loss reserve environmental factors.
Net loan recoveries of $1.8 million were recorded during 2018, while net loan charge-offs of $1.4 million were recorded during 2017. The allowance for originated loans, as a percentage of total originated loans, was 0.9% as of both December 31, 2018 and December 31, 2017. Our allowance for acquired loans totaled $0.8 million and $0.4 million as of December 31, 2018 and December 31, 2017, respectively.
Noninterest Income
Noninterest income totaled $19.0 million in both 2018 and 2017. Noninterest income during 2018 included a one-time $0.9 million accounting adjustment related to mortgage banking activities in prior years, while noninterest income in 2017 included a $1.4 million bank owned life insurance death benefit claim; excluding these transactions, noninterest income increased $0.5 million, or 2.9%, during 2018 compared to 2017. Growth in credit and debit card fees, payroll processing revenue, and treasury management income during 2018 more than offset a decline in mortgage banking activity income. Although we believe our market share increased during 2018, mortgage banking activity income declined during the year compared to 2017 primarily due to the impacts of a limited supply of homes for sale in our markets and lower refinance activity due to rising residential mortgage loan interest rates.
Noninterest Expense
Noninterest expense during 2018 was $86.2 million, an increase of $6.5 million, or 8.1%, from the $79.7 million expensed during 2017. The higher level of expense primarily resulted from increased salary costs, mainly reflecting annual employee merit pay increases and higher stock-based compensation expense. In addition, a one-time pay increase for all hourly employees that totaled $1.6 million on an annualized basis became effective on April 1, 2018. Occupancy and furniture and equipment costs increased $0.8 million on a combined basis in 2018, mainly resulting from higher depreciation and rent expenses. The increased rent expense primarily stemmed from the opening of our southeast Michigan office in early 2017.
Federal Income Tax Expense
During 2018, we recorded income before federal income tax of $51.8 million and a federal income tax expense of $9.8 million, compared to income before federal income tax of $46.1 million and a federal income tax expense of $14.8 million during 2017. The lower level of federal income tax expense primarily reflects a reduced corporate income tax rate stemming from the enactment of the Tax Cuts and Jobs Act; the rate was lowered from 35.0% to 21.0% effective January 1, 2018. Our effective tax rate was 18.9% during 2018, compared to 32.1% during 2017.
CAPITAL RESOURCES
Shareholders’ equity increased $41.3 million during 2019, totaling $417 million as of December 31, 2019. Positively impacting shareholders’ equity was net income of $49.5 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $17.1 million. Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by a total of $1.3 million. Share repurchases reduced shareholders’ equity by $7.2 million during 2019. Positively impacting shareholders’ equity during 2019 was an $11.9 million after-tax increase in the market value of available for sale securities.
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 December 31, 2019, our bank’s total risk-based capital ratio was 13.0%, compared to 12.3% at December 31, 2018. Our bank’s total regulatory capital increased $36.3 million during 2019, primarily reflecting the net impact of net income totaling $55.6 million and cash dividends paid to Mercantile Bank Corporation aggregating $22.1 million. Our bank’s total risk-based capital ratio was also impacted by a $111 million increase in total risk-weighted assets, primarily resulting from net commercial loan growth. As of December 31, 2019, our bank’s total regulatory capital equaled $425 million, or $97.3 million in excess of the amount necessary to attain the 10.0% minimum total risk-based capital ratio, which is among the requirements to be categorized as “well capitalized.”
We maintain a stock repurchase program, which is discussed in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in this Annual Report.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed funds, 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-earning deposit balances. Asset and liability management is the process of managing the 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 regularly obtained monies from wholesale funding sources. Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $487 million, or 15.5% of combined deposits and borrowed funds as of December 31, 2019, compared to $474 million, or 16.2% of combined deposits and borrowed funds, as of December 31, 2018.
Sweep accounts decreased $0.8 million during 2019, totaling $103 million as of December 31, 2019. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.
Information regarding our repurchase agreements as of December 31, 2019 and during 2019 is as follows:
FHLBI advances increased $4.0 million during 2019, totaling $354 million as of December 31, 2019. FHLBI advances are primarily used to assist in funding loan demand, as well as playing an integral role in our interest rate risk management program. FHLBI advances are generally collateralized by a blanket lien on our residential mortgage loan portfolio. Our borrowing line of credit at year-end 2019 totaled $813 million, with availability of $453 million.
We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. The average balance of federal funds purchased equaled $1.4 million during 2019. In contrast, our interest-earning deposit account at the Federal Reserve Bank of Chicago averaged $102 million during 2019. 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 $32.9 million at December 31, 2019. We did not utilize this line of credit during the past nine years, and do not plan to access this line of credit in future periods.
The following table reflects, as of December 31, 2019, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:
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. At December 31, 2019, we had a total of $1.02 billion in unfunded loan commitments and $22.8 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $914 million were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $102 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.
The following table depicts our loan commitments at the end of the past three years:
We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, economic or market conditions, reductions 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.
MARKET RISK ANALYSIS
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 interest-earning assets over the interest paid on 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 controls 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 the net interest margin during periods of changing market interest rates.
The following table depicts our GAP position as of December 31, 2019:
(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 expected maturities based upon prepayment trends as of December 31, 2019.
The second interest rate risk measurement used 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 December 31, 2019, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 200 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $121 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of December 31, 2019. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.
The resulting estimates have been significantly impacted by the current interest rate and economic environment, 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 and out-of-area deposits, 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.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Grand Rapids, Michigan
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 2, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
BDO USA, LLP
We have served as the Company’s auditor since 2006.
Grand Rapids, Michigan
March 2, 2020
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Grand Rapids, Michigan
Opinion on Internal Control over Financial Reporting
We have audited Mercantile Bank Corporation’s (the “Company’s”) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes, and our report dated March 2, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report by Mercantile Bank Corporation’s Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ BDO USA, LLP
BDO USA, LLP
Grand Rapids, Michigan
March 2, 2020
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Management assessed the Company’s system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles as of December 31, 2019. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2019, Mercantile Bank Corporation maintained an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles based on those criteria.
The Company’s independent auditors have issued an audit report on the effectiveness of the Company’s internal control over financial reporting as found on page.
Mercantile Bank Corporation
/s/ Robert B. Kaminski, Jr.
Robert B. Kaminski, Jr.
President and Chief Executive Officer
/s/ Charles E. Christmas
Charles E. Christmas
Executive Vice President, Chief Financial Officer and Treasurer
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2019 and 2018
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2019, 2018 and 2017
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2019, 2018 and 2017
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2019, 2018 and 2017
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2019, 2018 and 2017
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2019, 2018 and 2017
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the accounts of Mercantile Bank Corporation (“Mercantile”) and its subsidiary, Mercantile Bank of Michigan (“our bank”), and of Mercantile Bank Real Estate Co., L.L.C. (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance company”), subsidiaries of our bank, after elimination of significant intercompany transactions and accounts.
Mercantile has five separate business trusts: Mercantile Bank Capital Trust I, Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III and Firstbank Capital Trust IV (“our trusts”). Our trusts were formed to issue trust preferred securities. We issued subordinated debentures to our trusts in return for the proceeds raised from the issuance of the trust preferred securities. Our trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as liabilities.
Nature of Operations: Mercantile was incorporated on July 15, 1997 to establish and own the bank based in Grand Rapids, Michigan. Our bank began operations on December 15, 1997. 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 as of June 1, 2014.
Our bank is a community-based financial institution. Our bank’s primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial loans, residential mortgage loans, and instalment loans. Substantially all loans are secured by specific items of collateral including business assets, real estate or consumer assets. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by commercial or residential real estate. We have no material foreign loans or significant overdraft balances. Our bank’s loan accounts and retail deposits are primarily with customers located in the communities in which we have bank office locations. As an alternative source of funds, our bank has also issued certificates of deposit to depositors outside of its primary market areas. Substantially all revenues are derived from banking products and services and investment securities. While we monitor the revenue streams of the various products and services offered, we manage our business on the basis of one operating segment, banking.
Our real estate company was organized on July 21, 2003, principally to develop, construct, and own a facility in downtown Grand Rapids that serves as our bank’s main office and Mercantile’s headquarters. This facility was placed into service during the second quarter of 2005.
Our insurance company acquired an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent. To date, we have not provided the insurance products noted above and currently have no plans to do so.
We have evaluated subsequent events for potential recognition and/or disclosure through the date these financial statements were issued.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses and the fair values of financial instruments are particularly subject to change.
Cash and Cash Equivalents and Cash Flow Reporting: Cash and cash equivalents include cash on hand, demand deposits with other financial institutions, short-term investments (including securities with daily put provisions) and federal funds sold. Cash flows are reported net for customer loan and deposit transactions, interest-earning time deposits with other financial institutions and short-term borrowings with maturities of 90 days or less.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF 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. 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 impairment (“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. Net unamortized deferred loan fees amounted to $0.5 million and $0.9 million, respectively, at December 31, 2019 and 2018.
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.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. 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 mortgage 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 mortgage loan at the same time we make an interest rate commitment to the borrower.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Year-end mortgage loans held for sale, included in total loans in the balance sheet, were as follows:
Mortgage Loan Derivatives: We enter into forward contracts and interest rate lock commitments in the ordinary course of business, which are accounted for as derivatives. The derivatives are not designated as hedges and are carried at fair value. The net gain or loss on derivatives is included in mortgage banking activities in the income statement. The balance of derivatives was immaterial at December 31, 2019 and 2018.
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 servicing 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 statements of income.
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.
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 for loan losses in the same manner as other defaulted loans.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 loan portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. We estimate credit losses based on individual loans determined to be impaired and on all other loans grouped on similar risk characteristics. Our historical loss component is generally the most significant of the allowance components and is based on historical loss experience by credit risk grade for commercial loans and payment status for mortgage and consumer loans. Loans are pooled based on similar risk characteristics supported by observable data. The historical loss experience component of the allowance represents the results of migration analysis of historical net charge-offs for portfolios of loans, including groups of commercial loans within each credit risk grade. For measuring loss exposure in a pool of loans, the historical net charge-off or migration experience is utilized to estimate expected future losses to be realized from the pool of loans. These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative environmental factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, competition, increasing interest rates, external factors, and other considerations. 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 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 and collateral value. 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 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.
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from our bank and put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) our bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Our transfers of financial assets are generally limited to commercial loan participations sold and residential mortgage loans sold in the secondary market.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 33 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur and major improvements are capitalized. Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable based on future undiscounted cash flows. If impaired, the assets are recorded at the lower of carrying value or fair value.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Foreclosed Assets: Assets acquired through or in lieu of foreclosure are initially recorded at their estimated fair value net of estimated selling costs, establishing a new cost basis. If fair value subsequently declines, a valuation allowance is recorded through noninterest expense, as are collection and operating costs after acquisition. Foreclosed assets, included in other assets in the balance sheet, totaled $0.5 million and $0.8 million as of December 31, 2019 and 2018, respectively.
Bank Owned Life Insurance: Our bank has purchased life insurance policies on certain key officers. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.
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. 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 2018 and 2019, 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 merger with Firstbank 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.
Repurchase Agreements: Our bank sells certain securities under agreements to repurchase. The agreements are treated as collateralized financing transactions, with the obligations to repurchase the securities sold reflected as liabilities and the securities underlying the agreements remaining in assets in the Consolidated Balance Sheets.
Financial Instruments and Loan Commitments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit, that are considered financial guarantees are recorded at fair value.
Stock-Based Compensation: Compensation cost for equity-based awards is measured on the grant date based on the fair value of the award at that date, and is recognized over the requisite service period, net of estimated forfeitures. Fair value of stock option awards is estimated using a closed option valuation (Black-Scholes) model. Fair value of restricted stock awards is based upon the quoted market price of the common stock on the date of grant.
Revenue from Contracts with Customers: We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. No revenue has been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Advertising Costs: Advertising costs are expensed as incurred.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable, the change in deferred income tax assets and liabilities, and any adjustments related to unrecognized tax benefits. Deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates applicable to future years. A valuation allowance, if needed, reduces deferred income tax assets to the amount expected to be realized.
Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments.
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 using the treasury stock method. Our unvested stock awards, which contain non-forfeitable rights to dividends whether paid or unpaid (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 stock awards are excluded from the calculations of both basic and diluted earnings per share.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale and interest rate swaps which are also recognized as a separate component of equity.
Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have historically generally consisted of interest rate swap agreements that qualified for hedge accounting. 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 assets and liabilities 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 CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
If designated as a hedge, we formally document the relationship between the derivative instrument and the hedged item, as well as the risk-management objective and the strategy for undertaking the hedge transaction. This documentation includes linking cash flow hedges to specific assets 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 instrument that is used is 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 derivatives as a hedge is no longer appropriate or intended.
Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. We do not believe there are any such matters outstanding that would have a material effect on the financial statements.
Reclassifications: Certain items in the prior years’ financial statements have been reclassified to conform to the current year presentation.
Accounting Standards Updates: In February 2016, the FASB issued ASU 2016-02, Leases. This ASU (as subsequently amended by ASU 2018-01, ASU 2018-10, ASU 2018-11 and ASU 2018-20) 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. The adoption of this new standard as of January 1, 2019 resulted in the recording of a ROU asset and associated lease liability of approximately $1.3 million.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended by ASU 2018-19) 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: (i) financial assets subject to credit losses and measured at amortized cost, and (ii) 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.
We will adopt the guidance prospectively with a cumulative adjustment to retained earnings effective January 1, 2020. At adoption, we currently expect to recognize a decrease in the allowance for loan losses of approximately $1.0 million. In addition, we currently expect to record an increase of about $0.8 million in retained earnings associated with the anticipated decreased estimated allowance for credit losses. The adoption of the ASU is not expected to cause us to no longer meet the criteria for being considered well capitalized. As we are still finalizing the execution of our implementation controls and processes, the ultimate impact of the adoption of the ASU could differ from our current expectation.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 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”). Each share of Firstbank’s common stock was converted into the right to receive one share of Mercantile common stock, resulting 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.
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. Goodwill of $49.5 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.
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”). In addition, the loans are further categorized into different loan pools based primarily on the type and purpose of the loan.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 3 - SECURITIES
The amortized cost and fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
Securities with unrealized losses at year-end 2019 and 2018, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 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 December 31, 2019, 107 debt securities with fair values totaling $118 million had unrealized losses aggregating $1.3 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.
The amortized cost and fair values of debt securities at December 31, 2019, 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.
No mortgage-backed securities were sold in 2019 or 2018. Mortgage-backed securities totaling $5.0 million were sold in 2017, resulting in a nominal net gain. No municipal general obligation bonds were sold in 2019 or 2018. Municipal general obligation bonds totaling $2.6 million were sold during 2017, resulting in a nominal net gain/loss.
Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $96.5 million and $98.2 million at December 31, 2019 and December 31, 2018, respectively, with estimated market values of $99.4 million and $97.4 million at the respective dates. Securities issued by all other states and their political subdivisions had a combined amortized cost of $5.9 million and $8.7 million at December 31, 2019 and December 31, 2018, respectively, with estimated market values of $5.9 million and $8.7 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 $103 million and $104 million at December 31, 2019 and 2018, respectively. Investments in FHLBI stock are restricted and may only be resold to, or redeemed by, the issuer.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 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 included in other assets in the Consolidated Balance Sheets. 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 were recorded at estimated fair value at acquisition. 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.
The difference between the fair value of an acquired non-impaired loan and contractual amounts due at acquisition is accreted into interest 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 Sheets, reflects estimated future credit losses and uncollectable 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 contractually 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 acquisition. 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.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Increases in expected cash flows of acquired impaired loans subsequent to acquisition 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.
Year-end loans disaggregated by class of loan within the loan portfolio segments were as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The total contractually required payments and carrying value of acquired impaired loans were $5.7 million and $3.4 million, respectively, as of December 31, 2019. The total contractually required payments and carrying value of acquired impaired loans were $8.0 million and $4.6 million, respectively, as of December 31, 2018. Changes in the accretable yield for acquired impaired loans for the years ended December 31, 2019 and December 31, 2018 were as follows:
(1) Reductions primarily reflect the result of exit events, including loan payoffs and charge-offs.
Concentrations within the loan portfolio were as follows at year-end:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Year-end nonperforming originated loans were as follows:
Year-end nonperforming acquired loans were as follows:
The recorded principal balance of all nonperforming loans was as follows:
Acquired impaired loans 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)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
An age analysis of past due loans is as follows as of December 31, 2019:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
An age analysis of past due loans is as follows as of December 31, 2018:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired originated loans with no related allowance recorded were as follows as of December 31, 2019:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired originated loans with an allowance recorded and total impaired originated loans were as follows as of December 31, 2019:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired acquired loans with no related allowance recorded were as follows as of December 31, 2019:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired acquired loans with an allowance recorded and total impaired acquired loans were as follows as of December 31, 2019:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired originated loans with no related allowance recorded were as follows as of December 31, 2018:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired originated loans with an allowance recorded and total impaired originated loans were as follows as of December 31, 2018:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired acquired loans with no related allowance recorded were as follows as of December 31, 2018:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Impaired acquired loans with an allowance recorded and total impaired acquired loans were as follows as of December 31, 2018:
Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated collateral value. Interest income recognized on accruing troubled debt restructurings totaled $1.3 million, $1.1 million and $0.4 million during 2019, 2018 and 2017, respectively. Interest income recognized on nonaccrual loans totaled less than $0.1 million in 2019 and 2018, and $0.5 million during 2017, reflecting the collection of interest at the time of principal pay-off. Lost interest income on nonaccrual loans totaled $0.1 million in 2019 and $0.3 million during 2018 and 2017.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 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.
Loans by credit quality indicators were as follows as of December 31, 2019:
Originated Loans
Commercial credit exposure - credit risk profiled by internal credit risk grades:
Retail credit exposure - credit risk profiled by collateral type:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Acquired Loans
Commercial credit exposure - credit risk profiled by internal credit risk grades:
Retail credit exposure - credit risk profiled by collateral type:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Loans by credit quality indicators were as follows as of December 31, 2018:
Originated Loans
Commercial credit exposure - credit risk profiled by internal credit risk grades:
Retail credit exposure - credit risk profiled by collateral type:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Acquired Loans
Commercial credit exposure - credit risk profiled by internal credit risk grades:
Retail credit exposure - credit risk profiled by collateral type:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
All commercial loans are graded using the following number system:
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 their 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)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The allowance for originated loan losses and recorded investments in originated loans for the year-ended December 31, 2019 are as follows:
The allowance for acquired loan losses for the year-ended December 31, 2019 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The allowance for originated loan losses and recorded investments in originated loans for the year-ended December 31, 2018 are as follows:
The allowance for acquired loan losses for the year-ended December 31, 2018 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The allowance for originated loan losses and recorded investments in originated loans for the year-ended December 31, 2017 are as follows:
The allowance for acquired loan losses for the year-ended December 31, 2017 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Loans modified as troubled debt restructurings during the year-ended December 31, 2019 were as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Loans modified as troubled debt restructurings during the year-ended December 31, 2018 were as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 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 during the year-ended December 31, 2019 (amounts as of period end):
The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2019 (amounts as of period end):
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 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 during the year-ended December 31, 2018 (amounts as of period end):
The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2018 (amounts as of period end):
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity for originated loans categorized as troubled debt restructurings during the year-ended December 31, 2019 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity for acquired loans categorized as troubled debt restructurings during the year-ended December 31, 2019 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity for originated loans categorized as troubled debt restructurings during the year-ended December 31, 2018 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity for acquired loans categorized as troubled debt restructurings during the year-ended December 31, 2018 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity for originated loans categorized as troubled debt restructurings during the year-ended December 31, 2017 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity for acquired loans categorized as troubled debt restructurings during the year-ended December 31, 2017 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
The allowance related to loans categorized as troubled debt restructurings was as follows:
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.
NOTE 5 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment were as follows:
Future lease payments at December 31, 2019 totaled $3.8 million, comprised of $0.6 million in one year, $1.1 million in one to three years, $0.9 million in three to five years and $1.2 million in over five years. Future lease payments at December 31, 2018 totaled $3.0 million, comprised of $0.4 million in one year, $0.7 million in one to three years, $0.5 million in three to five years and $1.4 million in over five years. Depreciation expense totaled $3.9 million in 2019, $3.6 million in 2018, and $3.0 million in 2017.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 6 - MORTGAGE LOAN SERVICING
Mortgage loans serviced for others are not reported as assets in the Consolidated Balance Sheets. The year-end aggregate unpaid principal balances of mortgage loans serviced for others were as follows:
Custodial escrow balances, which are reported as deposits on the Consolidated Balance Sheets, maintained in connection with serviced loans were $6.4 million and $4.1 million as of December 31, 2019 and December 31, 2018, respectively.
Activity for capitalized mortgage loan servicing rights during 2019 and 2018 was as follows:
We determined that no valuation allowance was necessary as of December 31, 2019 or December 31, 2018. The estimated fair value of mortgage servicing rights was $7.4 million and $8.4 million as of December 31, 2019 and December 31, 2018, respectively. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. During 2019, fair value was determined using a discount rate of 10.0%, a weighted average constant prepayment rate of 15.3%, depending on the stratification of the specific right, and a weighted average delinquency rate of 0.32%. During 2018, fair value was determined using a discount rate of 10.0%, a weighted average constant prepayment rate of 9.3%, depending on the stratification of the specific right, and a weighted average delinquency rate of 0.32%.
The weighted average amortization period was 5.3 years and 7.3 years as of December 31, 2019 and December 31, 2018, respectively. Estimated amortization as of December 31, 2019 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 7 - CORE DEPOSIT INTANGIBLE ASSET, NET
The gross carrying amount of core deposit intangible assets totaled $17.5 million as of December 31, 2019 and December 31, 2018. As of December 31, 2019, the accumulated amortization on core deposit intangible assets was $13.7 million, providing for a net carry balance of $3.8 million. As of December 31, 2018, the accumulated amortization on core deposit intangible assets was $11.9 million, providing for a net carry balance of $5.6 million.
The scheduled amortization expense on core deposit intangible assets in future periods is:
NOTE 8 - DEPOSITS
Deposits at year-end are summarized as follows:
Out-of-area time deposits consist of deposits obtained from depositors outside of our primary market areas exclusively through deposit brokers.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 8 - DEPOSITS (Continued)
The following table depicts the maturity distribution for time deposits at year-end:
The following table depicts the maturity distribution for time deposits with balances of $100,000 or more at year-end:
Total time deposits of more than $250,000 totaled $320 million and $232 million at year-end 2019 and 2018, respectively.
NOTE 9 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Information regarding securities sold under agreements to repurchase at year-end is summarized below:
Securities sold under agreements to repurchase (“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 repurchase agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank. Repurchase agreements are offered principally to certain large deposit customers. Repurchase agreements are secured by securities with an aggregate fair value equal to the aggregate outstanding balance.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $354 million at December 31, 2019, and were expected to mature at varying dates from April 2020 through June 2025, with fixed rates of interest from 1.36% to 3.18% and averaging 2.45%. FHLBI advances totaled $350 million at December 31, 2018, and were expected to mature at varying dates ranging from January 2019 through June 2025, with fixed rates of interest from 1.20% to 3.18% and averaging 2.30%.
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 generally collateralized by a blanket lien on our residential mortgage loan portfolio. Our borrowing line of credit as of December 31, 2019 totaled $813 million, with availability of $453 million.
Scheduled maturities as of December 31, 2019:
NOTE 11 - FEDERAL INCOME TAXES
On December 22, 2017, H.R.1, commonly known as the Tax Cuts and Jobs Act (the “Act”) was signed into law. The Act reduced our corporate federal tax rate from 35% to 21% effective January 1, 2018 and changed certain other provisions. As a result, we were required to re-measure our deferred tax assets and liabilities using the enacted rate at which we expect them to be recovered or settled. The effect of this re-measurement was recorded to income tax expense in the year the tax law was enacted. For 2017, the re-measurement of our net deferred tax asset resulted in additional income tax expense of $1.3 million. Concurrent with the enactment of the Act, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which allowed companies to recognize the cumulative impact of the income tax effects triggered by the enactment of the Act over a period of up to twelve months in the reporting period in which the adjustment is identified. We applied SAB 118 effective December 22, 2017. At the conclusion of our analysis of H.R.1, we determined that no adjustments to our initial analysis were required.
The consolidated income tax expense is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 11 - FEDERAL INCOME TAXES (Continued)
A reconciliation of the differences between the federal income tax expense recorded and the amount computed by applying the federal statutory rate to income before income taxes is as follows:
The statutory tax rate was 21% for 2019 and 2018 and 35% for 2017.
Significant components of deferred tax assets and liabilities as of December 31, 2019 and 2018 are as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 11 - FEDERAL INCOME TAXES (Continued)
A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized. At December 31, 2019 and 2018, we carried a valuation allowance of $0.1 million against capital loss carryforwards generated by the disposal of certain capital investments acquired in our merger with Firstbank. The $0.1 million of capital loss carryforwards will expire at December 31, 2020 and we continue to carry a valuation allowance against the related deferred tax asset. We believe the remainder of our deferred tax assets is more likely than not to be realized.
We had no unrecognized tax benefits at any time during 2019 or 2018 and do not anticipate any significant increase in unrecognized tax benefits during 2020. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income tax accounts; no such accruals existed at any time during 2019 or 2018. Our U.S. federal income tax returns are no longer subject to examination for all years before 2016.
NOTE 12 - 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. During 2014 and 2015, stock option and restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2006. During the years 2016 through 2019, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2016. Stock option grants were also provided to certain employees during 2016 from the Stock Incentive Plan of 2016, as well as stock grants to directors as retainer payments during the years 2016 through 2019. The Stock Incentive Plan of 2006 expired on January 18, 2016, and was effectively replaced with the Stock Incentive Plan of 2016 that was approved by shareholders in May, 2016.
Under the Stock Incentive Plan of 2006 and the Stock Incentive Plan of 2016, 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. Price, vesting and expiration date parameters are determined by Mercantile’s Compensation Committee on a grant-by-grant basis. No payments are required from employees for restricted stock awards. The restricted stock awards granted during the years 2014 through 2019 fully vest after three years and, in the case of performance-based restricted stock issued to executive officers in 2018 and 2019, are subject to the attainment of pre-determined performance goals. The stock options granted during 2014, 2015 and 2016, which were at 110% of the market price on the date of grant, fully vest after two years and expire after seven years. At year-end 2019, there were approximately 102,000 shares authorized for future incentive awards.
In conjunction with the Firstbank merger, we issued Mercantile stock options in replacement of all outstanding Firstbank stock option grants that had been previously 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 date of grant. The stock option grants expire ten years from 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 date of merger. The remaining 23,800 stock option grants vested during 2015.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 12 - STOCK-BASED COMPENSATION (Continued)
A summary of restricted stock activity from grants issued under Mercantile plans during the past three years is as follows:
Of the restricted stock shares granted in 2019 and 2018, a total of 23,596 and 24,633 (at the target level), respectively, are performance-based awards made to our Named Executive Officers and are subject to the attainment of pre-determined performance goals.
A summary of stock option activity from grants issued under Mercantile plans during the past three years is as follows:
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. No stock option grants were made during the past three years.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 12 - STOCK-BASED COMPENSATION (Continued)
Options issued under Mercantile plans outstanding at year-end 2019 were as follows:
Information related to options issued under various Mercantile plans outstanding at year-end 2019, 2018 and 2017 is as follows:
Information related to stock option grants and exercises issued under various Mercantile plans during 2019, 2018 and 2017 is as follows:
The aggregate intrinsic value of in-the-money stock options issued under Mercantile plans outstanding and exercisable at December 31, 2019 was less than $0.1 million. Shares issued as a result of the exercise of stock option grants have been authorized and were previously unissued shares.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 12- STOCK-BASED COMPENSATION (Continued)
A summary of stock option activity from grants issued under Firstbank plans that became part of Mercantile’s plans upon consummation of the merger on June 1, 2014 is as follows:
Options issued under Firstbank plans outstanding at year-end 2019 were as follows:
Information related to options issued under Firstbank plans outstanding at year-end 2019, 2018 and 2017 is as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 12 - STOCK-BASED COMPENSATION (Continued)
Information related to stock option grants and exercises issued under Firstbank plans during 2018, 2017 and 2016 is as follows:
The aggregate intrinsic value of all stock options issued under various Firstbank plans outstanding and exercisable at December 31, 2019 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.
On June 6, 2016, we granted about 13,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2016 through May 31, 2017. The associated $0.3 million cost was expensed on a straightline basis over the respective twelve month period. On May 25, 2017, we granted about 12,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2017 through May 31, 2018. The associated $0.4 million cost was expensed on a straightline basis over the respective twelve month period. On May 24, 2018, we granted about 11,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2018 through May 31, 2019. The associated $0.4 million cost was expensed on a straightline basis over the respective twelve month period. On October 25, 2018, we granted about 1,000 shares of common stock to newly appointed Bank Board members for retainer payments for the period of October 1, 2018 through May 31, 2019. The associated less than $0.1 million cost was expensed over the respective eight-month period. On May 23, 2019, we granted about 12,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2019 through May 31, 2020. The associated $0.4 million cost is being expensed on a straightline basis over the respective twelve month period.
NOTE 13 - RELATED PARTIES
Certain directors and executive officers of our bank, including their immediate families and companies in which they are principal owners, were loan customers of our bank. At year-end 2019 and 2018, our bank had $115 million and $41.3 million in loan commitments to directors and executive officers, of which $104 million and $92.0 million were outstanding at year-end 2019 and 2018, respectively, as reflected in the following table.
Related party deposits and repurchase agreements totaled $15.0 million and $14.8 million at year-end 2019 and 2018, respectively.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 14 - COMMITMENTS AND OFF-BALANCE-SHEET RISK
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our 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 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. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on management’s credit assessment of the borrower. If required, estimated loss exposure resulting from these instruments is expensed and recorded as a liability. There was no liability balance for these instruments as of December 31, 2019 and 2018.
At year-end 2019 and 2018, the rates on existing off-balance sheet instruments were substantially equivalent to current market rates, considering the underlying credit standing of the counterparties.
Our maximum exposure to credit losses for loan commitments and standby letters of credit outstanding at year-end was as follows:
Commitments to make loans generally reflect our binding obligations to existing and prospective customers to extend credit, including line of credit facilities secured by accounts receivable and inventory, and term debt secured by either real estate or equipment. In most instances, line of credit facilities are for a one-year term and are at a floating rate tied to the Wall Street Journal Prime Rate or the 30-Day Libor rate. For term debt secured by real estate, customers are generally offered a floating rate tied to the Wall Street Journal Prime Rate or the 30-Day Libor rate, and a fixed rate currently ranging from 4.00% to 6.00%. These credit facilities generally balloon within five years, with payments based on amortizations ranging from 10 to 20 years. For term debt secured by non-real estate collateral, customers are generally offered a floating rate tied to the Wall Street Journal Prime Rate or the 30-Day Libor rate, and a fixed rate currently ranging from 4.50% to 6.00%. These credit facilities generally mature and fully amortize within three to seven years.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 14 - COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
The following instruments are considered financial guarantees under current accounting guidance. These instruments are carried at fair value.
We were required to have $10.7 million and $9.1 million of cash on hand or on deposit with the Federal Reserve Bank of Chicago to meet regulatory reserve and clearing requirements at December 31, 2019 and December 31, 2018, respectively.
NOTE 15 - BENEFIT PLANS
We have a 401(k) benefit plan that covers substantially all of our employees. The percent of our matching contributions to the 401(k) benefit plan is determined annually by the Board of Directors. The matching contribution had been 4.25% since January 1, 2014; effective April 1, 2018, the matching contribution was increased to 5.00%. Matching contributions, if made, are immediately vested. Our 2019, 2018 and 2017 matching 401(k) contributions charged to expense were $1.7 million, $1.6 million and $1.3 million, respectively.
We have a deferred compensation plan in which all persons serving on the Board of Directors may defer all or portions of their annual retainer and meeting fees, with distributions to be paid upon termination of service as a director or specific dates selected by the director. We also have a non-qualified deferred compensation program in which selected officers may defer all or portions of salary and bonus payments. The deferred amounts, totaling $2.7 million and $3.0 million as of December 31, 2019 and 2018, respectively, are categorized as other liabilities in the Consolidated Balance Sheets, and are paid interest at a rate equal to the Wall Street Journal Prime Rate. Interest expense was $0.1 million during 2019 and 2018, and less than $0.1 million during 2017.
The Mercantile Bank Corporation Employee Stock Purchase Plan of 2014 is a non-compensatory plan intended to encourage full- and part-time employees of Mercantile and its subsidiaries to promote our best interests and to align employees’ interests with the interests of our shareholders by permitting employees to purchase shares of our common stock through regular payroll deductions. Shares are purchased on the last business day of each calendar quarter at a price equal to the consolidated closing bid price of our common stock reported on The Nasdaq Stock Market. A total of 250,000 shares of common stock may be issued under the existing plan; however, the number of shares may be adjusted to reflect any stock dividends and other changes in our capitalization. The number of shares issued totaled 1,507 and 1,579 in 2019 and 2018, respectively. As of December 31, 2019, there were approximately 241,000 shares available under our current plan.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 16 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount, estimated fair value and level within the fair value hierarchy of financial instruments were as follows at year-end (dollars in thousands):
(1)
See Note 17 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 FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount.
Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. 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. Fair value for loans is based on an exit price model as required by ASU 2016-01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposit accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The fair values of subordinated debentures and FHLBI advances are based on current rates for similar financing. The fair value of off-balance sheet items is estimated to be nominal.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 17 - FAIR VALUE MEASUREMENTS
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 developed based on market data obtained from independent sources, or unobservable, meaning those that reflect our own estimates about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.
Level 3: Significant unobservable inputs that reflect our own estimates 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 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 debt obligations, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal general obligation and revenue bonds. 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 an impairment. There was no such impairment as of December 31, 2019 or 2018. We have no Level 1 securities available for sale.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 17 - FAIR VALUE MEASUREMENTS (Continued)
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 December 31, 2019 and 2018, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $5.0 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. The fair values of impaired loans are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.
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 on foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.
Derivatives. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves.
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 December 31, 2019 are as follows:
There were no transfers in or out of Level 1, Level 2 or Level 3 during 2019. The $1.7 million reduction in Level 3 municipal general obligation bonds during 2019 reflects the scheduled maturities of such bonds.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 17 - FAIR VALUE MEASUREMENTS (Continued)
The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2018 are as follows:
There were no transfers in or out of Level 1, Level 2 or Level 3 during 2018. The $1.5 million reduction in Level 3 municipal general obligation bonds during 2018 reflects the scheduled maturities of such bonds.
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 December 31, 2019 are as follows:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 17 - FAIR VALUE MEASUREMENTS (Continued)
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2018 are as follows:
The carrying values are based on the estimated value of the property or other assets. Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. For real estate dependent loans and foreclosed assets, we generally assign a 15% to 25% discount factor for commercial-related properties, and a 25% to 50% discount factor for residential-related properties. In a vast majority of cases, we assign a 10% discount factor for estimated selling costs.
NOTE 18 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow:
Stock options for approximately 7,000 shares of common stock were antidilutive and were not included in determining dilutive earnings per share in 2019, 2018 and 2017.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 19 - SUBORDINATED DEBENTURES
We have five business trusts that are wholly-owned subsidiaries of Mercantile, four of which were assumed by Mercantile in conjunction with the Firstbank merger. A fair value discount of $15.0 million was recorded at the time of the merger, which is being amortized at $0.7 million annually over the following 21.5 years. Each of the trusts was formed to issue Preferred Securities that were sold in private sales, as well as selling Common Securities to Mercantile. The proceeds from the Preferred and Common Securities sales were used by the trusts to purchase Floating Rate Notes issued by Mercantile. The rates of interest, interest payment dates, call features and maturity dates of each Floating Rate Note are identical to its respective Preferred Securities. The net proceeds from the issuance of the Floating Rate Notes were used for a variety of purposes, including contributions to our bank as capital to provide support for asset growth and the funding of stock repurchase programs and certain acquisitions.
The only significant assets of our trusts are the Floating Rate Notes, and the only significant liabilities of our trusts are the Preferred Securities. The Floating Rate Notes are categorized on our Consolidated Balance Sheets as subordinated debentures and the interest expense is recorded on our Consolidated Statements of Income under interest expense on other borrowings.
On January 26, 2016, we closed on a repurchase of trust preferred securities that were auctioned as part of a pooled collateralized debt obligation (“Fund”). The Fund owned $11.0 million of the $32.0 million in trust preferred securities that had been issued by Mercantile Bank Capital Trust I. The $11.0 million in trust preferred securities was retired upon the repurchase, resulting in a commensurate reduction in the related Floating Rate Junior Subordinate Note, leaving $21.0 million outstanding.
The following table depicts our five business trusts as of December 31, 2019:
NOTE 20 - 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 the financial statements.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 20 - 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 year-end 2019 and 2018, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since December 31, 2019 that we believe have changed our bank’s categorization.
Our actual capital levels (dollars in thousands) and minimum required levels were:
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 20 - REGULATORY MATTERS (Continued)
Under the final Basel III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement has been phased in over three years beginning in 2016. The capital buffer requirement effectively raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of December 31, 2019, our bank met all capital adequacy requirements under the Basel III capital rules.
Federal and state banking laws and regulations place certain restrictions on the amount of dividends our bank can transfer to Mercantile and on the capital levels that must be maintained. At year-end 2019, under the most restrictive of these regulations, our bank could distribute $75.2 million to Mercantile as dividends without prior regulatory approval. 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 17, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.26 per share that was paid on March 20, 2019 to shareholders of record as of March 8, 2019. On April 11, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.26 per share that was paid on June 19, 2019 to shareholders of record as of June 7, 2019. On July 11, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.27 per share that was paid on September 18, 2019 to shareholders of record as of September 6, 2019. On October 10, 2019, our Board of Directors declared a cash dividend on our common stock in the amount of $0.27 per share that was paid on December 18, 2019 to shareholders of record as of December 6, 2019.
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 20 - REGULATORY MATTERS (Continued)
On January 16, 2020, our Board of Directors declared a cash dividend on our common stock in the amount of $0.28 per share that will be paid on March 18, 2020 to shareholders of record as of March 6, 2020.
In May 2019, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. This stock repurchase plan was instituted in conjunction with the completion of our existing program that was introduced in January 2015 and later expanded in April 2016. During 2019, we repurchased a total of 233,300 shares at a total price of $7.2 million, at an average price per share of $30.79. During the period of January 2015 through December 2019, we repurchased a total of about 1.4 million shares at a total price of $32.6 million, at an average price per share of $23.47. The stock buybacks have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.
Our consolidated capital levels as of December 31, 2019 and 2018 include $44.8 million and $44.1 million, respectively, of trust preferred securities. 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 capital elements that may be included in 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. At December 31, 2019 and 2018, all $44.8 million and $44.1 million, respectively, of the trust preferred securities were included as Tier 1 capital of Mercantile.
NOTE 21 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
At December 31, 2019, accumulated other comprehensive income, net of tax effects (as applicable), consisted of a net unrealized gain on available for sale securities of $3.7 million. At December 31, 2018, accumulated other comprehensive income, net of tax effects (as applicable), consisted of a net unrealized loss on available for sale securities of $8.2 million.
NOTE 22 - QUARTERLY FINANCIAL DATA (Unaudited)
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 23 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
(Continued)
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
NOTE 23 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
EXHIBIT INDEX
Exhibit No.
EXHIBIT DESCRIPTION
10.11
Amended and Restated Employment Agreement of Robert B. Kaminski, Jr. dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.1 of our Form 8-K filed December 3, 2018*
10.12
Amended and Restated Employment Agreement of Charles E. Christmas dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.2 of our Form 8-K filed December 3, 2018*
10.13
Amended and Restated Employment Agreement of Raymond E. Reitsma dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.3 of our Form 8-K filed December 3, 2018*
10.14
Amended and Restated Employment Agreement of Robert T. Worthington dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.4 of our Form 8-K filed December 3, 2018*
10.15
Amended and Restated Employment Agreement of Lonna L. Wiersma dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.5 of our Form 8-K filed December 3, 2018*
10.16
Amended and Restated Change in Control Agreement of Robert B. Kaminski, Jr. dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.6 of our Form 8-K filed December 3, 2018*
10.17
Amended and Restated Change in Control Agreement of Charles E. Christmas dated November 29, 2018, effective December 31, 2018, incorporated by reference to exhibit 10.7 of our Form 8-K filed December 3, 2018*
10.18
Form of Performance Based Restricted Stock Award Agreement, incorporated by reference to exhibit 10.8 of our Form 8-K filed December 3, 2018*
10.19
2019 Mercantile Executive Officer Bonus Plan, incorporated by reference to exhibit 10.1 of our Form 8-K filed May 24, 2019*
10.20
Director Fee Summary*
Subsidiaries of the company
Consent of BDO USA, LLP
Rule 13a-14(a) Certifications
32.1
Section 1350 Chief Executive Officer Certification
32.2
Section 1350 Chief Financial Officer Certification
The following information from Mercantile’s Annual Report on Form 10-K for the year ended December 31, 2019, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements
* Management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 March 2, 2020.
MERCANTILE BANK CORPORATION
/s/ Robert B. Kaminski, Jr.
Robert B. Kaminski, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 2, 2020.
/s/ David M. Cassard /s/ Robert B. Kaminski, Jr.
David M. Cassard, Director Robert B. Kaminski, Jr.
Director, President and Chief Executive Officer
/s/ Edward J. Clark (principal executive officer)
Edward J. Clark, Director
/s/ Michael H. Price
/s/ Michelle L. Eldridge Michael H. Price, Chairman of the Board
Michelle L. Eldridge, Director
/s/ Charles E. Christmas
/s/ Jeff A. Gardner Charles E. Christmas, Executive Vice President,
Jeff A. Gardner, Director Chief Financial Officer and Treasurer
(principal financial and accounting officer)
/s/ Edward B. Grant
Edward B. Grant, Director