Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

   

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FORM 10-K

 

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2017

or

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

For the transition period from __________________ to __________________

 

       Commission file number 000-26719

 

MERCANTILE BANK CORPORATION

(Exact name of registrant as specified in its charter)

 

Michigan		38-3360865
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
310 Leonard Street NW, Grand Rapids, Michigan		49504
(Address of principal executive offices)		(Zip Code)

 

(616) 406-3000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Name of each exchange on which registered
Common Stock	The Nasdaq Stock Market LLC

           

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes       No   X  

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of

the Act. Yes       No   X  

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site,

if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T

during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   X   No       

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or emerging growth company (as defined in Rule 12b-2 of the Exchange Act).

     Large accelerated filer ___                Accelerated filer  X        

     Non-accelerated filer ___                  Smaller reporting company      

     Emerging growth company             

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.       

 

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

 

The aggregate value of the common equity held by non-affiliates (persons other than directors and executive officers) of the registrant, computed by reference to the closing price of the common stock as of the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $506 million.

 

As of March 1, 2018, there were issued and outstanding 16,594,812 shares of the registrant’s common stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s proxy statement for the Annual Meeting of Shareholders to be held May 24, 2018 are incorporated by reference into Part III of this report.

 

 

PART I

 

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.

 

Firstbank Corporation Merger

 

We completed our merger with Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $1.5 billion in total assets and 46 branch locations, into Mercantile Bank Corporation as of June 1, 2014 (“Merger Date”). The 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.

 

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 49 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, DeWitt, Fairview, Grand Rapids, Hale, Hastings, Holland, Howard City, Ionia, Ithaca, Kalamazoo, Kentwood, Lakeview, Lansing, Lowell, Merrill, Mt. Pleasant, Paw Paw, Portage, Remus, Rose City, Shepherd, St. Charles, St. Helen, St. Johns, Vestaburg, West Branch, and Wyoming. We expanded into Southeast Michigan in 2017, opening a banking office in Troy during the first quarter.

 

Our bank makes secured and unsecured commercial, construction, mortgage and consumer loans, and accepts checking, savings and time deposits. Our bank owns 49 automated teller machines ("ATM") located at certain of our office locations and at one off-site location 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.

 

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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. 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.

 

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 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.

 

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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 engages 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, the new federal administration has indicated its intention to repeal or amend certain aspects of the Dodd-Frank Act and the precise scope of those changes has not yet been determined. 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- Risk Factors in this Annual Report.

 

 Employees

 

As of December 31, 2017, we employed 584 full-time and 117 part-time persons. Management believes that relations with employees are good.

 

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Lending Policy

 

As a routine part of our business, we make loans to businesses and individuals located within our market areas. Our lending policy states that the function of the lending operation is twofold: to provide a means for the investment of funds at a profitable rate of return with an acceptable degree of risk, and to meet the credit needs of the creditworthy businesses and individuals who are our customers. We recognize that in the normal business of lending, some losses on loans will be inevitable and should be considered a part of the normal cost of doing business.

 

Our lending policy anticipates that priorities in extending loans will be modified from time to time as interest rates, market conditions and competitive factors change. The policy sets forth guidelines on a nondiscriminatory basis for lending in accordance with applicable laws and regulations. The policy describes various criteria for granting loans, including the ability to pay; the character of the customer; evidence of financial responsibility; purpose of the loan; knowledge of collateral and its value; terms of repayment; source of repayment; payment history; and economic conditions.

 

The lending policy further limits the amount of funds that may be loaned against specified types of real estate collateral. For certain loans secured by real estate, the policy requires an appraisal of the property offered as collateral by a state certified independent appraiser. The policy also provides general guidelines for loan to value for other types of collateral, such as accounts receivable and machinery and equipment. In addition, the policy provides general guidelines as to environmental analysis, loans to employees, executive officers and directors, problem loan identification, maintenance of an allowance for loan losses, loan review and grading, mortgage and consumer lending, and other matters relating to our lending practices.

 

The Board of Directors has delegated significant lending authority to officers of our bank. The Board of Directors believes this empowerment, supported by our strong credit culture and the significant experience of our commercial lending staff, enables us to be responsive to our customers. The loan policy specifies lending authority for our lending officers with amounts based on the experience level and ability of each lender. Our loan officers and loan managers are able to approve loans up to $1.0 million and $2.5 million, respectively. We have established higher approval limits for our bank’s Senior Lender, President and Chief Executive Officer, and Executive Chairman of the Board ranging from $4.0 million up to $10.0 million. These lending authorities, however, are typically used only in rare circumstances where timing is of the essence. Generally, loan requests exceeding $2.5 million require approval by the Officers Loan Committee, and loan requests exceeding $7.5 million, up to the legal lending limit of approximately $80.2 million, require approval by the bank’s Board of Directors. We apply an in-house lending limit that is significantly less than our bank’s legal lending limit.

 

Provisions of recent legislation, including the Dodd-Frank Act, when fully implemented by regulations to be adopted by federal agencies, may have a significant impact on our lending policy, especially in the areas of single-family residential real estate and other consumer lending. 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- Risk Factors in this Annual Report.

 

Lending Activity

 

Commercial Loans. Our commercial lending group originates commercial loans primarily in our market areas. Our commercial lenders have extensive commercial lending experience, with most having at least ten years’ experience. Loans are originated for general business purposes, including working capital, accounts receivable financing, machinery and equipment acquisition, and commercial real estate financing, including new construction and land development.

 

Working capital loans are often structured as a line of credit and are reviewed periodically in connection with the borrower’s year-end financial reporting. These loans are generally secured by substantially all of the assets of the borrower and have a floating interest rate tied to the Wall Street Journal Prime Rate or 30-day Libor Rate. Loans for machinery and equipment purposes typically have a maturity of three to five years and are fully amortizing, while commercial real estate loans are usually written with a five-year maturity and amortize over a 10- to 20-year period. Commercial loans typically have an interest rate that is fixed to maturity or is tied to the Wall Street Journal Prime Rate or 30-day Libor Rate.

 

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We evaluate many aspects of a commercial loan transaction in order to minimize credit and interest rate risk. Underwriting includes an assessment of the management, products, markets, cash flow, capital, income and collateral of the borrowing entity. This analysis includes a review of the borrower’s historical and projected financial results. Appraisals are generally required to be performed by certified independent appraisers where real estate is the primary collateral, and in some cases, where equipment is the primary collateral. In certain situations, for creditworthy customers, we may accept title reports instead of requiring lenders’ policies of title insurance.

 

 Commercial real estate lending involves more risk than residential lending because loan balances are typically greater and repayment is dependent upon the borrower’s business operations. We attempt to minimize the risks associated with these transactions by generally limiting our commercial real estate lending to owner-operated properties and to owners of non-owner occupied properties who have an established profitable history and satisfactory tenant structure. In many cases, risk is further reduced by requiring personal guarantees, limiting the amount of credit to any one borrower to an amount considerably less than our legal lending limit and avoiding certain types of commercial real estate financings.

 

We have no material foreign loans, and only limited exposure to companies engaged in energy producing and agricultural-related activities.

 

Single-Family Residential Real Estate Loans. We originate single-family residential real estate loans in our market areas, generally according to secondary market underwriting standards. Loans not conforming to those standards are made in certain circumstances. Single-family residential real estate loans provide borrowers with a fixed or adjustable interest rate with terms up to 30 years and are generally sold to certain investors.

 

Our bank has a home equity line of credit program. Home equity lines of credit are generally secured by either a first or second mortgage on the borrower’s primary residence. The program provides revolving credit at a rate tied to the Wall Street Journal Prime Rate.

 

Consumer Loans. We originate various types of consumer loans, including new and used automobile and boat loans, credit cards and overdraft protection lines of credit for our checking account customers. Consumer loans generally have shorter terms and higher interest rates and usually involve more credit risk than single-family residential real estate loans because of the type and nature of the collateral.

 

We believe our consumer loans are underwritten carefully, with a strong emphasis on the amount of the down payment, credit quality, employment stability and monthly income of the borrower. These loans are generally repaid on a monthly repayment schedule with the source of repayment tied to the borrower’s periodic income. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and are thus likely to be adversely affected by job loss, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. We believe that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans, and that consumer loans are important to our efforts to serve the credit needs of the communities and customers that we serve.

 

Loan Portfolio Quality

 

We utilize a comprehensive grading system for our commercial loans, whereby 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 at various intervals.

 

Our independent loan review program is primarily responsible for the administration of the grading system and ensuring adherence to established lending policies and procedures. The loan review program is an integral part of maintaining our strong asset quality culture. The loan review function works closely with senior management, although it functionally reports to the Board of Directors. Using a risk-based approach to selecting credits for review, our loan review program has covered approximately 65% to 75% of total commercial loans outstanding during the past three years. In addition, a random sampling of retail loans is reviewed each quarter. Our watch list credits are reviewed monthly by our Board of Directors and our Watch List Committee, the latter of which is comprised of senior level officers from the administration, lending and loan review functions.

 

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 Loans are placed in a nonaccrual status when, in our opinion, uncertainty exists as to the ultimate collection of all principal and interest. As of December 31, 2017, loans placed in nonaccrual status totaled $7.1 million, or 0.3% of total loans, compared to $5.9 million, or 0.2% of total loans, at December 31, 2016. No loans were past due 90 days or more and still accruing interest at year-end 2017 or 2016.

 

Additional detail and information relative to the loan portfolio is incorporated by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) and Note 4 of the Notes to Consolidated Financial Statements in this Annual Report.

 

Allowance for Loan Losses

 

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 2017 we placed most weight on the period starting December 31, 2010 through December 31, 2017. 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.

 

Additional detail regarding the allowance is incorporated by reference to Management’s Discussion and Analysis and Note 4 of the Notes to Consolidated Financial Statements included in this Annual Report.

 

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Investments

 

Bank Holding Company Investments. The principal investments of our bank holding company are the investments in the common stock of our bank and the common securities of our trusts. Other funds of our bank holding company may be invested from time to time in various debt instruments.

 

Subject to the limitations of the Bank Holding Company Act and the “Volcker Rule”, we are also permitted to make portfolio investments in equity securities and to make equity investments in subsidiaries engaged in a variety of non-banking activities, which include real estate-related activities such as community development, real estate appraisals, arranging equity financing for commercial real estate, and owning and operating real estate used substantially by our bank or acquired for its future use. Our bank holding company has no plans at this time to make directly any of these equity investments at the bank holding company level. Our Board of Directors may, however, alter the investment policy at any time without shareholder approval.

 

Our Bank’s Investments. Our bank may invest its funds in a wide variety of debt instruments and may participate in the federal funds market with other depository institutions. Subject to certain exceptions, our bank is prohibited from investing in equity securities. Among the equity investments permitted for our bank under various conditions and subject in some instances to amount limitations, are shares of a subsidiary insurance agency, mortgage company, real estate company, or Michigan business and industrial development company, such as our insurance company and our real estate company. Under another such exception, in certain circumstances and with prior notice to or approval of the FDIC, our bank could invest up to 10% of its total assets in the equity securities of a subsidiary corporation engaged in the acquisition and development of real property for sale, or the improvement of real property by construction or rehabilitation of residential or commercial units for sale or lease. Our bank has no present plans to make such an investment. Real estate acquired by our bank in satisfaction of or foreclosure upon loans may be held by our bank for specified periods. Our bank is also permitted to invest in such real estate as is necessary for the convenient transaction of its business. Our bank’s Board of Directors may alter the bank’s investment policy without shareholder approval at any time.

 

Additional detail and information relative to the securities portfolio is incorporated by reference to Management’s Discussion and Analysis and Note 3 of the Notes to Consolidated Financial Statements included in this Annual Report.

 

Competition

 

We face substantial competition in all phases of our operations from a variety of different competitors. We compete for deposits, loans and other financial services with numerous Michigan-based and national and regional banks, savings banks, thrifts, credit unions and other financial institutions as well as from other entities that provide financial services. 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 primary 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. Most of these same entities have greater capital 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. Under specified circumstances (that have been modified by the Dodd-Frank Act), 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. We also face new competition as a result of our expansion into the Southeast Michigan marketplace.

 

Selected Statistical Information

 

Management’s Discussion and Analysis beginning on Page F-4 in this Annual Report includes selected statistical information.

 

Return on Equity and Assets

 

Return on Equity and Asset information is included in Management’s Discussion and Analysis beginning on Page F-4 in this Annual Report.

 

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Available Information

 

We maintain an internet website at www.mercbank.com. We make available on or through our website, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practical after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We do not intend the address of our website to be an active link or to otherwise incorporate the contents of our website into this Annual Report.

 

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 66% of our total commercial loans, or about 57% 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.

 

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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), 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 integrate potential future acquisitions successfully could impede us from realizing all of the benefits of the acquisitions, which could weaken our operations.

 

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:

 

° unanticipated issues in integration of information, communications and other systems;

° unanticipated incompatibility of logistics, marketing and administration methods;

° maintaining employee morale and retaining key employees;

° integrating the business cultures of both companies;

° preserving important strategic client relationships;

° coordinating geographically diverse organizations; and

° consolidating corporate and administrative infrastructures and eliminating duplicative operations.

 

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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.

 

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 gradual reduction in the Federal Reserve’s securities holdings, commencing in October 2017. In each of March, June, and December 2017, 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. There can be no assurance that these reductions in the Federal Reserve’s securities holdings, and increases in the Federal funds rate, will continue to occur, that they will be gradual if they do occur, or as to the actual impact of those 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. 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. Certain bills pending in Congress would, if enacted, repeal or substantially amend various provisions of the Dodd-Frank Act. Proposals to modify existing regulations in light of the new core principles are under consideration by various federal regulatory agencies, including the CFPB. There can be no assurance that any such legislation will be enacted, or that changes in existing regulations will be adopted to implement the new core principles.

 

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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.

 

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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 of $250 billion or more, total consolidated on-balance sheet foreign exposure of $10 billion or more, elect to use the advanced measurement approach for calculating risk-weighted assets, or 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 is being 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.

 

These 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.

 

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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, and a related interest rate swap agreement, 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, 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 has stated that it expected to begin publication of the SOFR in the first half of 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.

 

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.

 

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.

 

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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.

 

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.

 

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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. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties.

 

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.

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 2017 fiscal year and that remain unresolved.

 

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Item 2.

Properties.

 

Our headquarters is located in our bank’s main office facility in Grand Rapids, Michigan. Our bank operates 49 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. Forty-three of the banking offices are owned by our bank, and six 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.

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.

Mine Safety Disclosures.

 

Not applicable.

  

PART II

 

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, 2018, there were approximately 1,600 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.

 

		High				Low				Dividend
2017
First Quarter		$	37.97			$	30.65			$	0.18
Second Quarter			36.05				30.42				0.18
Third Quarter			35.86				28.92				0.19
Fourth Quarter			38.08				33.75				0.19
2016
First Quarter		$	24.37			$	20.84			$	0.16
Second Quarter			25.40				21.05				0.16
Third Quarter			27.99				23.42				0.17
Fourth Quarter			38.68				26.48				0.67

 

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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 is subject to limitations under various laws and regulations and to prudent and sound banking practices.

 

On January 12, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.18 per share that was paid on March 22, 2017 to shareholders of record as of March 10, 2017. On April 13, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.18 per share that was paid on June 21, 2017 to shareholders of record as of June 9, 2017. On July 13, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.19 per share that was paid on September 20, 2017 to shareholders of record as of September 8, 2017. On October 12, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.19 per share that was paid on December 20, 2017 to shareholders of record as of December 8, 2017.

 

On January 14, 2016, our Board of Directors declared a cash dividend on our common stock in the amount of $0.16 per share that was paid on March 23, 2016 to shareholders of record as of March 11, 2016. On April 14, 2016, our Board of Directors declared a cash dividend on our common stock in the amount of $0.16 per share that was paid on June 23, 2016 to shareholders of record as of June 10, 2016.

 

On July 14, 2016, our Board of Directors declared a cash dividend on our common stock in the amount of $0.17 per share that was paid on September 21, 2016 to shareholders of record as of September 9, 2016. On October 13, 2016, our Board of Directors declared a cash dividend on our common stock in the amount of $0.17 per share that was paid on December 21, 2016 to shareholders of record as of December 9, 2016. In addition, on October 13, 2016, our Board of Directors declared a special cash dividend on our common stock in the amount of $0.50 per share that was paid on December 21, 2016 to shareholders of record as of December 9, 2016.

  

On January 30, 2015, we announced that our Board of Directors had authorized a new 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. On April 19, 2016, we announced a $15.0 million expansion of the stock repurchase plan. Since inception, we have purchased a total of 956,419 shares at a total price of $19.5 million, at an average price per share of $20.38; no shares were purchased under the authorized plan during 2017. 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, which would also likely be funded from cash dividends paid to us from our bank.

 

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 will be paid on March 21, 2018 to shareholders of record as of March 9, 2018.

 

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Issuer Purchases of Equity Securities

 

We announced on January 30, 2015 that our Board of Directors had authorized a new 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. On April 19, 2016, we announced a $15.0 million expansion of the stock repurchase plan. No shares of our common stock were repurchased during the fourth quarter of 2017.

 

Period		(a) Total Number of Shares Purchased				(b) Average Price Paid Per Share				(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs				(d) Maximum Number of Shares or Approximate Dollar Value that May Yet Be Purchased Under the Plans or Programs
October 1 – 31			0				NA			$	0			$	15,505,000
November 1 – 30			0			NA					0				15,505,000
December 1 – 31			0			NA					0				15,505,000
Total			0			NA				$	0			$	15,505,000

  

 

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, 2012 through December 31, 2017. The following is based on an investment of $100 on December 31, 2012 in our common stock, the Nasdaq Composite Index and the SNL Bank Nasdaq Index, with dividends reinvested where applicable.

 

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		Period Ending
Index		12/31/12				12/31/13				12/31/14				12/31/15				12/31/16				12/31/17
Mercantile Bank Corporation			100.00				133.98				146.39				175.72				280.70				269.47
NASDAQ Composite			100.00				140.12				160.78				171.97				187.22				242.71
SNL Bank NASDAQ			100.00				143.73				148.86				160.70				222.81				234.58

 

Item 6.

Selected Financial Data.

 

The Selected Financial Data in this Annual Report is incorporated here by reference.

  

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.

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.

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.

 

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Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

None

  

Item 9A.

Controls and Procedures.

 

As of December 31, 2017, 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, 2017.

 

There have been no significant changes in our internal control over financial reporting during the quarter ended December 31, 2017, 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, 2017. 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, 2017. Refer to page F-33 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.

Other Information.

 

None

 

 

PART III

 

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 24, 2018 Annual Meeting of Shareholders (the “Proxy Statement”), a copy of which will be filed with the Securities and Exchange Commission before April 30, 2018, 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.

 

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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.

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, 2017, relating to compensation plans under which equity securities are authorized for issuance.

 

Plan Category		Number of securities to be issued upon exercise of outstanding options, warrants and rights				Weighted- average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
		(a)				(b)				(c)
Equity compensation plans approved by security holders (1)			30,908			$	18.67				314,000	(2)
Equity compensation plans not approved by security holders			0				0				0
Total			30,908			$	18.67				314,000

 

(1) Includes Mercantile’s Stock Incentive Plan of 2006 and 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. No further issuances will be made under Mercantile’s Stock Incentive Plan of 2006, the Firstbank Corporation Stock Option and Restricted Stock Plan of 1997 or the Firstbank Corporation Stock Compensation Plan.

  

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.

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.

 

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PART IV

 

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 5, 2018 – BDO USA, LLP

 

Consolidated Balance Sheets --- December 31, 2017 and 2016

 

Consolidated Statements of Income for each of the three years in the period ended December 31, 2017

 

Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2017

 

Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2017

 

Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2017

 

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 following 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.

 

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MERCANTILE BANK CORPORATION

 

FINANCIAL INFORMATION

December 31, 2017 and 2016

 

 

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MERCANTILE BANK CORPORATION

 

FINANCIAL INFORMATION

December 31, 2017 and 2016

      

CONTENTS

  

SELECTED FINANCIAL DATA	F-3
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	F-4
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	F-31
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING	F-33
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS	F-34
CONSOLIDATED STATEMENTS OF INCOME	F-35
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME	F-36
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY	F-37
CONSOLIDATED STATEMENTS OF CASH FLOWS	F-40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	F-42

 

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SELECTED FINANCIAL DATA

      

Consolidated Results of Operations:		2017				2016				2015				2014(*)				2013
		(Dollars in thousands except per share data)
Interest income		$	125,543			$	118,457			$	112,328			$	89,118			$	58,242
Interest expense			15,795				12,590				11,154				11,340				10,786
Net interest income			109,748				105,867				101,174				77,778				47,456
Provision for loan losses			2,950				2,900				(1,000	)			(3,000	)			(7,200	)
Noninterest income			19,001				21,038				16,038				10,028				6,872
Noninterest expense			79,716				77,118				79,381				65,610				36,403
Income before income tax expense			46,083				46,887				38,831				25,196				25,125
Income tax expense			14,809				14,974				11,811				7,865				8,092
Net income		$	31,274			$	31,913			$	27,020			$	17,331			$	17,033
Consolidated Balance Sheet Data:
Total assets		$	3,286,704			$	3,082,571			$	2,903,556			$	2,893,379			$	1,426,966
Cash and cash equivalents			200,101				183,596				89,891				172,738				146,965
Securities			346,780				336,086				354,559				446,611				143,139
Loans			2,558,552				2,378,620				2,277,727				2,089,277				1,053,243
Allowance for loan losses			19,501				17,961				15,681				20,041				22,821
Bank owned life insurance			68,689				67,198				58,971				57,861				51,377
Deposits			2,522,365				2,374,985				2,275,382				2,276,915				1,118,911
Securities sold under agreements to repurchase			118,748				131,710				154,771				167,569				69,305
Federal Home Loan Bank advances			220,000				175,000				68,000				54,022				45,000
Subordinated debentures			45,517				44,835				55,154				54,472				32,990
Shareholders’ equity			365,870				340,811				333,804				328,138				153,325
Consolidated Financial Ratios:
Return on average assets			1.00	%			1.07	%			0.94	%			0.76	%			1.22	%
Return on average shareholders’ equity			8.82	%			9.35	%			8.19	%			6.91	%			11.36	%
Average shareholders’ equity to average assets			11.28	%			11.42	%			11.45	%			11.05	%			10.77	%
Nonperforming loans to total loans			0.28	%			0.25	%			0.24	%			1.41	%			0.64	%
Allowance for loan losses to total originated loans			0.88	%			0.95	%			0.94	%			1.55	%			2.17	%
Tier 1 leverage capital			11.27	%			11.17	%			11.56	%			11.15	%			12.53	%
Common equity risk-based capital			10.74	%			10.88	%			10.89	%		NA				NA
Tier 1 risk-based capital			12.21	%			12.47	%			12.83	%			13.57	%			14.65	%
Total risk-based capital			12.88	%			13.13	%			13.45	%			14.43	%			15.91	%
Per Common Share Data:
Net income:
Basic		$	1.90			$	1.96			$	1.63			$	1.28			$	1.96
Diluted			1.90				1.96				1.62				1.28				1.95
Tangible book value per share at end of period			18.61				17.14				16.61				15.49				17.54
Dividends declared			0.74				1.16				0.58				2.48				0.45
Dividend payout ratio			38.52	%			58.70	%			35.22	%			141.16	%			22.83	%

 

(*) – Merger with Firstbank effective June 1, 2014.

 

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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; impact of technological advances; governmental and regulatory policy changes; 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 2017 we placed most weight on the period starting December 31, 2010 through December 31, 2017. 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.

 

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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.

 

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Securities and Other Financial Instruments: Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest 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: Generally accepted accounting principles require us to determine the fair value of all of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons and projected revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value. In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the fair value of its balance sheet is recorded as 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. The quantitative test is a two-step process consisting of comparing the carrying value of the reporting unit to an estimate of its fair value. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value. In 2016 and 2017, 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.

 

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FINANCIAL OVERVIEW

 

We recorded net income of $31.3 million, or $1.90 per diluted share, for 2017. For 2016, we recorded net income of $31.9 million, or $1.96 per diluted share. Excluding the impacts of certain one-time transactions, diluted earnings per share during 2017 and 2016 equaled $1.89 and $1.76, respectively. These transactions included a bank owned life insurance death benefit claim during the first quarter of 2017, the revaluation of our net deferred tax asset in response to the Tax Cuts and Jobs Act becoming law in late 2017, the repurchase of trust preferred securities at a large discount during the first quarter of 2016, and accelerated purchase discount accretion on called U.S. Government agency bonds during 2016.

 

The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.28% of total loans as of December 31, 2017. Gross loan charge-offs during 2017 totaled $3.2 million, while recoveries of prior period loan charge-offs totaled $1.8 million, providing for net loan charge-offs of $1.4 million, or only 0.06% 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 totaled approximately $529 million in 2017, similar to the $549 million and $532 million we booked during 2016 and 2015, respectively. We also experienced net increases in commercial lines of credit during the past three years, in large part reflecting lines that are part of new commercial lending relationships established during recent quarterly periods. Net loan growth equaled $180 million during 2017, compared to $101 million and $188 million during 2016 and 2015, respectively, with all years reflecting the impact of scheduled monthly payments as well as expected and unexpected commercial loan payoffs. During 2017, total commercial loans grew $138 million, or 6.7%, reflecting growth in the commercial and industrial, commercial real estate owner occupied and commercial real estate non-owner occupied segments. The new loan pipeline remains strong, and at year-end 2017, we had $154 million in unfunded loan commitments on commercial construction and development projects that are in the construction phase. We believe our loan portfolio is well diversified, with commercial real estate non-owner occupied loans comprising 31%, commercial and industrial loans equaling 29%, commercial real estate owner occupied loans comprising 21% and residential mortgage and consumer loans aggregating 14% of total loans as of December 31, 2017. As a percent of total commercial loans, commercial and industrial loans and commercial real estate owner occupied loans combined equaled 58% at year-end 2017, compared to 56% at December 31, 2016.

 

Our funding structure is also well diversified. As of December 31, 2017, noninterest-bearing checking accounts comprised 31% of total funds, interest-bearing checking and securities sold under agreements to repurchase (“sweep accounts”) combined for 18%, savings and money market deposit accounts aggregated to 26% and local time deposits accounted for 14%. Wholesale funds, comprised of brokered deposits and Federal Home Loan Bank of Indianapolis (“FHLBI”) advances, represented 11% of total funds.

 

 

FINANCIAL CONDITION

 

Our total assets increased $204 million during 2017, and totaled $3.29 billion as of December 31, 2017. Total loans increased $180 million, securities available for sale were up $7.7 million and interest-earning deposits grew $11.6 million. Total deposits increased $147 million and FHLBI advances were up $45.0 million, while sweep accounts were down $13.0 million during 2017.

 

Earning Assets

Average earning assets equaled 92.8% of average total assets during 2017, similar to the 92.5% during 2016. The loan portfolio continued to comprise a majority and increasing level of earning assets, followed by securities and interest-earning deposits. Average total loans equaled 85.2% of average earning assets during 2017, compared to 84.9% in 2016, while securities and other interest-earning assets combined comprised 14.8% of average earning assets during 2017, compared to 15.1% in 2016. We anticipate the level of earning assets to total assets remaining relatively stable at approximately 93%.

 

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Our loan portfolio has historically been primarily comprised of commercial loans. Commercial loans increased $138 million during 2017, and at December 31, 2017 totaled $2.20 billion, or 86.1% of the loan portfolio. As of December 31, 2016, the commercial loan portfolio comprised 86.8% of total loans. Owner occupied commercial real estate (“CRE”) loans increased $75.9 million, commercial and industrial loans were up $39.9 million and non-owner occupied CRE loans increased $43.4 million, while multi-family and residential rental loans declined $16.0 million and vacant land, land development and residential construction loans were down $5.0 million. As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 58.1% as of December 31, 2017, compared to 56.4% as of December 31, 2016.

 

We have significantly enhanced our commercial loan calling efforts over the past several years. We are very pleased with the $1.61 billion in new commercial term loan fundings over the past three years, and our current commercial loan pipeline reports indicate continued strong commercial loan funding opportunities in future periods. Also, as of December 31, 2017, availability on existing construction and development loans totaled $154 million, with most of those commitments expected to be drawn during 2018. Further, we have made additional lending commitments totaling $185 million, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial loan officers also report significant additional opportunities they are currently discussing with existing borrowers and potential new customers.

 

We continue to experience commercial loan principal paydowns and payoffs. While a portion of the principal paydowns and payoffs received thus far have been welcomed, such as on stressed lending relationships, we have also experienced significant instances where well-performing relationships have been refinanced at other financial institutions or non-bank companies, and other situations where the borrower has sold the underlying asset. In many of those cases where the loans have been refinanced elsewhere, we believed the terms and conditions of the new lending arrangements were too aggressive, generally reflecting the very competitive banking environment in our markets. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. In addition, we continue to receive accelerated principal paydowns from certain borrowers who have elevated deposit balances generally resulting from profitable operations and an apparent unwillingness to expand their business and/or replace equipment due to economic- and tax-related uncertainties. Usage of existing commercial lines of credit has remained relatively steady.

 

Residential mortgage loans increased $59.3 million during 2017, totaling $255 million or 10.0% of total loans, at December 31, 2017. We originated $223 million in residential mortgage loans during 2017, an almost 37% increase from the volume originated in 2016, in large part reflecting our enhanced residential mortgage banking operation over the past couple of years. We sold $108 million of the residential mortgage loans originated in 2017, or about 48%, generally comprised of longer-term fixed rate mortgage loans. The remaining $115 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, and expect origination volume to increase in future periods. We expect to sell 50% to 55% of the new residential mortgage loan originations in 2018, with a vast majority of the loans added to our balance sheet to be comprised of adjustable rate mortgage loans. Other consumer-related loans declined $17.6 million during 2017, and at December 31, 2017 totaled $100 million, or 3.9% of the loan portfolio. Other consumer-related loans equaled 5.0% of total loans as of December 31, 2016. We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed origination volumes.

 

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The following table summarizes our loan portfolio:

 

		12/31/17				12/31/16				12/31/15				12/31/14				12/31/13
Commercial:
Commercial & Industrial		$	753,764,000			$	713,903,000			$	696,303,000			$	550,629,000			$	286,373,000
Land Development & Construction			29,873,000				34,828,000				45,120,000				51,977,000				36,741,000
Owner Occupied Commercial Real Estate			526,328,000				450,464,000				445,919,000				430,406,000				261,877,000
Non-Owner Occupied Commercial Real Estate			791,685,000				748,269,000				644,351,000				559,594,000				364,066,000
Multi-Family & Residential Rental			101,918,000				117,883,000				115,003,000				122,772,000				37,639,000
Total Commercial			2,203,568,000				2,065,347,000				1,946,696,000				1,715,378,000				986,696,000
Retail:
1-4 Family Mortgages			254,559,000				195,226,000				190,385,000				214,695,000				31,467,000
Home Equity & Other Consumer Loans			100,425,000				118,047,000				140,646,000				159,204,000				35,080,000
Total Retail			354,984,000				313,273,000				331,031,000				373,899,000				66,547,000
Total Loans		$	2,558,552,000			$	2,378,620,000			$	2,277,727,000			$	2,089,277,000			$	1,053,243,000

  

 

The following table presents total loans outstanding as of December 31, 2017, 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.

 

		Less Than				One Through				More Than
		One Year				Five Years				Five Years				Total
Construction and land development		$	114,903,000			$	24,124,000			$	54,714,000			$	193,741,000
Real estate - residential properties			82,211,000				125,236,000				131,648,000				339,095,000
Real estate - multi-family properties			12,702,000				29,335,000				3,372,000				45,409,000
Real estate - commercial properties			523,594,000				443,967,000				226,295,000				1,193,856,000
Commercial and industrial			570,250,000				159,891,000				22,534,000				752,675,000
Consumer			3,147,000				25,374,000				5,255,000				33,776,000
Total loans		$	1,306,807,000			$	807,927,000			$	443,818,000			$	2,558,552,000
Fixed rate loans		$	117,767,000			$	748,981,000			$	374,529,000			$	1,241,277,000
Floating rate loans			1,189,040,000				58,946,000				69,289,000				1,317,275,000
Total loans		$	1,306,807,000			$	807,927,000			$	443,818,000			$	2,558,552,000

 

 

Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to provide effective loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur quickly because of changing economic conditions. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on 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.

 

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Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $9.4 million (0.3% of total assets) as of December 31, 2017, compared to $6.4 million (0.2% of total assets) as of December 31, 2016. The volume of nonperforming assets has generally been on a steady trend over the past several years. One commercial loan relationship, which was placed on nonaccrual during late 2014, accounted for approximately 70% of total nonperforming assets at year-end 2014. This relationship was resolved during mid-2015. 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:

 

NONPERFORMING LOANS
		12/31/17				12/31/16				12/31/15				12/31/14				12/31/13
Residential Real Estate:
Land Development		$	0			$	16,000			$	23,000			$	84,000			$	40,000
Construction			0				0				0				0				0
Owner Occupied / Rental			3,381,000				2,739,000				2,917,000				4,229,000				4,219,000
			3,381,000				2,755,000				2,940,000				4,313,000				4,259,000
Commercial Real Estate:
Land Development			35,000				95,000				155,000				209,000				389,000
Construction			0				0				0				0				0
Owner Occupied			2,241,000				285,000				2,131,000				18,091,000				885,000
Non-Owner Occupied			0				488,000				108,000				378,000				169,000
			2,276,000				868,000				2,394,000				18,678,000				1,443,000
Non-Real Estate:
Commercial Assets			1,444,000				2,293,000				69,000				6,401,000				1,016,000
Consumer Assets			42,000				23,000				41,000				42,000				0
			1,486,000				2,316,000				110,000				6,443,000				1,016,000
Total		$	7,143,000			$	5,939,000			$	5,444,000			$	29,434,000			$	6,718,000

  

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS
		12/31/17				12/31/16				12/31/15				12/31/14				12/31/13
Residential Real Estate:
Land Development		$	0			$	0			$	0			$	329,000			$	427,000
Construction			0				0				0				0				22,000
Owner Occupied / Rental			193,000				144,000				598,000				722,000				207,000
			193,000				144,000				598,000				1,051,000				656,000
Commercial Real Estate:
Land Development			0				0				0				0				92,000
Construction			0				0				0				0				0
Owner Occupied			2,031,000				325,000				612,000				247,000				164,000
Non-Owner Occupied			36,000				0				83,000				697,000				1,939,000
			2,067,000				325,000				695,000				944,000				2,195,000
Non-Real Estate:
Commercial Assets			0				0				0				0				0
Consumer Assets			0				0				0				0				0
			0				0				0				0				0
Total		$	2,260,000			$	469,000			$	1,293,000			$	1,995,000			$	2,851,000

 

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The following tables provide a reconciliation of nonperforming assets:

 

NONPERFORMING LOANS RECONCILIATION
		2017				2016				2015				2014				2013
Beginning balance		$	5,939,000			$	5,444,000			$	29,434,000			$	6,718,000			$	18,970,000
Additions, net of transfers to other real estate owned			7,604,000				5,655,000				4,543,000				25,871,000				1,726,000
Returns to performing status			(232,000	)			(13,000	)			(48,000	)			(779,000	)			0
Principal payments			(4,234,000	)			(4,166,000	)			(23,641,000	)			(2,063,000	)			(10,934,000	)
Loan charge-offs			(1,934,000	)			(981,000	)			(4,844,000	)			(313,000	)			(3,044,000	)
Total		$	7,143,000			$	5,939,000			$	5,444,000			$	29,434,000			$	6,718,000

  

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION
		2017				2016				2015				2014				2013
Beginning balance		$	469,000			$	1,293,000			$	1,995,000			$	2,851,000			$	6,970,000
Additions			4,401,000				725,000				2,186,000				2,593,000				2,181,000
Sale proceeds			(677,000	)			(1,428,000	)			(2,377,000	)			(3,183,000	)			(5,585,000	)
Valuation write-downs			(1,933,000	)			(121,000	)			(511,000	)			(266,000	)			(715,000	)
Total		$	2,260,000			$	469,000			$	1,293,000			$	1,995,000			$	2,851,000

 

 

Gross loan charge-offs equaled $3.2 million during 2017, while recoveries of prior period charge-offs totaled $1.8 million. Resulting net loan charge-offs equaled $1.4 million, or only 0.06% of average total loans. Gross loan charge-offs equaled $2.2 million during 2016, while recoveries of prior period charge-offs totaled $1.6 million. Resulting net loan charge-offs equaled $0.6 million, or only 0.03% 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 recoveries.

 

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The following table summarizes changes in the allowance for originated loan losses for the past five years:

 

		2017				2016				2015				2014				2013
Originated loans outstanding at year-end		$	2,169,957,000			$	1,884,548,000			$	1,616,587,000			$	1,246,116,000			$	1,053,243,000
Daily average balance of originated loans outstanding during the year		$	2,054,809,000			$	1,784,978,000			$	1,428,150,000			$	1,141,682,000			$	1,050,961,000
Balance of allowance for originated loans at beginning of year		$	17,868,000			$	15,233,000			$	19,299,000			$	22,821,000			$	28,677,000
Originated loans charged-off:
Commercial, financial and agricultural			(2,272,000	)			(980,000	)			(4,910,000	)			(840,000	)			(3,596,000	)
Construction and land development			(20,000	)			0				(4,000	)			(36,000	)			(822,000	)
Residential real estate			(687,000	)			(809,000	)			(1,053,000	)			(484,000	)			(862,000	)
Instalment loans to individuals			(204,000	)			(344,000	)			(228,000	)			(70,000	)			(10,000	)
Total charge-offs			(3,183,000	)			(2,133,000	)			(6,195,000	)			(1,430,000	)			(5,290,000	)
Recoveries of previously charged-off originated loans:
Commercial, financial and agricultural			1,445,000				754,000				2,535,000				1,117,000				4,795,000
Construction and land development			129,000				334,000				122,000				180,000				897,000
Residential real estate			131,000				522,000				122,000				404,000				933,000
Instalment loans to individuals			102,000				60,000				51,000				0				9,000
Total recoveries			1,807,000				1,670,000				2,830,000				1,701,000				6,634,000
Net loan (charge-offs) recoveries			(1,376,000	)			(463,000	)			(3,365,000	)			271,000				1,344,000
Provision for loan losses for originated loans			2,641,000				3,098,000				(701,000	)			(3,793,000	)			(7,200,000	)
Balance of allowance for originated loans at end of year		$	19,133,000			$	17,868,000			$	15,233,000			$	19,299,000			$	22,821,000
Ratio of net loan (charge-offs) recoveries to average loans outstanding during the year			(0.07	%)			(0.03	%)			(0.24	%)			0.02	%			0.13	%
Ratio of allowance to originated loans outstanding at year-end			0.88	%			0.95	%			0.94	%			1.55	%			2.17	%

 

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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):

 

		12/31/2017								12/31/2016								12/31/2015								12/31/2014								12/31/2013
		Amount				Loan Portfolio				Amount				Loan Portfolio				Amount				Loan Portfolio				Amount				Loan Portfolio				Amount				Loan Portfolio
Commercial, financial and agricultural		$	15,616				77.8	%		$	15,035				85.8	%		$	12,017				80.7	%		$	16,112				82.8	%		$	17,860				84.0	%
Construction and land development			1,260				7.6				991				6.0				1,655				10.9				1,012				8.8				1,858				8.9
Residential real estate			1,758				13.3				1,374				6.4				1,235				6.4				1,974				7.2				3,027				6.8
Instalment loans to individuals			406				1.3				508				1.8				186				2.0				125				1.2				68				0.3
Unallocated			93				0.0				(40	)			0.0				140				0.0				76				0.0				8				0.0
Total		$	19,133				100.0	%		$	17,868				100.0	%		$	15,233				100.0	%		$	19,299				100.0	%		$	22,821				100.0	%

 

 

The following table depicts the ratio of our allowance to nonperforming loans:

 

		12/31/17				12/31/16				12/31/15				12/31/14				12/31/13
Ratio of allowance to nonperforming loans			273.0	%			302.4	%			288.0	%			68.1	%			339.7	%

 

The decline in the ratio of our allowance to nonperforming loans during 2014 primarily reflects the aforementioned one distressed commercial loan relationship that was placed into nonaccrual status in late 2014 but resolved during mid-2015.

 

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.

 

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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 2017 we placed most weight on the period starting December 31, 2010 through December 31, 2017. 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 $19.1 million as of December 31, 2017, or 0.9% of total originated loans outstanding, compared to 1.0% at year-end 2016. The allowance for acquired loans equaled $0.4 million as of December 31, 2017, compared to $0.1 million at year-end 2016. As of December 31, 2017, the allowance for originated loans was comprised of $17.3 million in general reserves relating to non-impaired loans, $1.4 million in specific reserve allocations relating to nonaccrual loans, and $0.4 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 $8.6 million at December 31, 2017, consisting of $2.5 million that are on nonaccrual status and $6.1 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 $0.9 million as of December 31, 2017 had been subject to previous partial charge-offs aggregating $1.4 million. Those partial charge-offs were recorded as follows: $0.7 million in 2017, less than $0.1 million in 2016, 2015, 2013 and 2012, $0.4 million in 2011 and $0.2 million in 2010. As of December 31, 2017, 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:

 

		12/31/17				12/31/16				12/31/15				12/31/14				12/31/13
Performing		$	6,128,000			$	12,480,000			$	19,336,000			$	24,001,000			$	30,247,000
Nonperforming			2,434,000				1,132,000				2,358,000				26,433,000				4,645,000
Total		$	8,562,000			$	13,612,000			$	21,694,000			$	50,434,000			$	34,892,000

 

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Securities available for sale increased $7.7 million during 2017, totaling $336 million as of December 31, 2017. The securities portfolio equaled 11.3% of average earning assets during 2017. During 2017, purchases of U.S. Government agency bonds totaled $35.6 million, U.S. Government agency issued or guaranteed mortgage-backed securities aggregated $10.2 million and municipal bonds totaled $21.2 million. Proceeds from matured and called U.S. Government agency and municipal bonds during 2017 totaled $18.8 million and $20.6 million, respectively, with another $13.0 million from principal paydowns on mortgage-backed securities. In addition, proceeds from the sales of U.S. Government agency issued or guaranteed mortgage-backed securities and municipal bonds totaled $5.0 million and $2.6 million, respectively. At December 31, 2017, the securities portfolio was primarily comprised of U.S. Government agency bonds (51%), municipal bonds (37%) and U.S. Government agency issued or guaranteed mortgage-backed securities (12%). 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, 2017 totaled $336 million, including a net unrealized loss of $6.2 million. We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations. In addition, the securities portfolio serves a primary interest rate risk management function.

 

The following table reflects the composition of the securities portfolio:

 

		12/31/17								12/31/16								12/31/15
		Carrying								Carrying								Carrying
		Value				Percent				Value				Percent				Value				Percent
U.S. Government agency debt obligations		$	169,700,000				50.5	%		$	152,040,000				46.3	%		$	147,040,000				42.4	%
Mortgage-backed securities			38,792,000				11.6				47,392,000				14.5				67,074,000				19.3
Municipal general obligations			121,293,000				36.1				119,047,000				36.3				122,023,000				35.2
Municipal revenue bonds			3,978,000				1.2				7,631,000				2.3				8,914,000				2.6
Other investments			1,981,000				0.6				1,950,000				0.6				1,941,000				0.5
Totals		$	335,744,000				100.0	%		$	328,060,000				100.0	%		$	346,992,000				100.0	%

  

 

FHLBI stock totaled $11.0 million as of December 31, 2017, compared to $8.0 million as of December 31, 2016. The $3.0 million increase reflects stock purchases to support the increased level of FHLBI advances during 2017. 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 18 of the Notes to Consolidated Financial Statements for additional information.

 

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The following table shows by class of maturities as of December 31, 2017, the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities: 

 

		Carrying				Average
		Value				Yield
Obligations of U.S. Government agencies:
One year or less		$	9,278,000				1.56	%
Over one through five years			17,718,000				1.68
Over five through ten years			59,564,000				2.30
Over ten years			83,140,000				2.84
			169,700,000				2.46
Obligations of states and political subdivisions:
One year or less			20,397,000				1.82
Over one through five years			47,220,000				2.29
Over five through ten years			38,380,000				2.90
Over ten years			19,274,000				3.21
			125,271,000				2.54
Mortgage-backed securities			38,792,000				2.17
Other investments			1,981,000				2.71
Totals		$	335,744,000				2.46	%

 

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 3.1% of average earning assets during 2017, compared to 2.8% during 2016. 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 1.6% of total assets during 2017, with no significant changes expected in future periods. Net premises and fixed assets equaled $46.0 million as of December 31, 2017, or 1.4% of total assets. Net purchases during 2017 totaled $5.4 million, while depreciation expense aggregated to $3.0 million. Foreclosed and repossessed assets totaled $2.3 million at December 31, 2017, compared to $0.5 million at December 31, 2016; the $1.8 million increase during the current year primarily reflects the transfer of a bank-owned parcel of real estate, which is no longer being considered for use as a bank facility, in the amount of $1.6 million from fixed assets to other real estate owned. The parcel of real estate is expected to be sold in the next six months for an amount that approximates current book value. While we expect further transfers from loans to foreclosed and repossessed assets in future periods reflecting our collection efforts on some 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 $147 million during 2017, totaling $2.52 billion as of December 31, 2017. Out-of-area deposits increased $26.5 million during 2017, and equaled 4.1% of total deposits at year-end 2017, compared to 3.2% as of December 31, 2016. FHLBI advances increased $45.0 million during 2017, totaling $220 million as of December 31, 2017.

 

Noninterest-bearing checking accounts increased $55.8 million during 2017, generally due to deposit account openings as part of recently established commercial lending relationships and transfers from sweep accounts to new noninterest-bearing checking accounts reflecting updated interest rate and fee structures. Interest-bearing checking accounts increased $9.8 million, while savings deposits declined $17.5 million, the latter primarily reflecting typical fluctuations in certain public unit savings accounts. Money market deposit accounts increased $155 million during 2017, while local time deposits decreased $82.3 million, in large part reflecting one depositor transferring their funds from time deposits to money market deposit accounts. This negotiated transfer was completed at the request of the depositor to ease recordkeeping burdens; although the funds are no longer in time deposit products, we believe the stability of this long-standing deposit relationship is unchanged. In addition, money market deposit accounts increased due to an enhanced high balance money market deposit account product offering that was initiated in mid-2017.

 

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Sweep accounts decreased $13.0 million during 2017, totaling $119 million as of December 31, 2017. The decline primarily reflects certain customers transferring funds from the sweep product to noninterest-bearing checking accounts reflecting updated interest rate and fee structures. 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 $45.0 million during 2017, totaling $220 million as of December 31, 2017. 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 2017 totaled $731 million, with availability of $511 million.

 

Shareholders’ equity increased $25.1 million during 2017, totaling $366 million as of December 31, 2017. Positively impacting shareholders’ equity was net income of $31.3 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $12.0 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 $2.3 million.

 

 

RESULTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2017 and 2016

 

Summary

We recorded net income of $31.3 million, or $1.90 per basic and diluted share, for 2017, compared to net income of $31.9 million, or $1.96 per basic and diluted share, for 2016. Excluding the impacts of certain one-time transactions, net income was $31.2 million, or $1.89 per basic and diluted share, in 2017, and $28.7 million, or $1.76 per basic and diluted share, in 2016. A bank owned life insurance death benefit claim in the first quarter of 2017 increased net income during 2017 by $1.4 million, or $0.09 per basic and diluted share, while the revaluation of the net deferred tax asset in response to the Tax Cuts and Jobs Act becoming law in December 2017 decreased net income in the current year by $1.3 million, or $0.08 per basic and diluted share. The repurchase of $11.0 million in trust preferred securities at a 27% discount during the first quarter of 2016 increased net income during 2016 by $1.8 million, or $0.11 per basic and diluted share. We also recorded accelerated discount accretion on called U.S. Government agency bonds during 2016 that increased net income by $1.4 million, or $0.09 per basic and diluted share.

 

Our earnings performance in 2017 benefited from increased net interest income, which more than offset increased noninterest expense. The increased net interest income resulted from a higher level of average earning assets. The increased noninterest expense was primarily attributable to expected increases in various operating expenses stemming from recent expansion initiatives and increased salary expense, mainly reflecting annual employee merit pay increases, the hiring of additional staff, a larger bonus accrual, and greater stock-based compensation expense. Growth in our primary noninterest income revenue streams, including treasury management income, credit and debit card interchange fees, mortgage banking activity income, payroll processing revenue, and customer service fees, 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, 2017 and 2016:

 

		2017				2016
Return on average assets			1.00	%			1.07	%
Return on average shareholders’ equity			8.82	%			9.35	%
Average shareholders’ equity to average assets			11.28	%			11.42	%

 

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 $126 million and $15.8 million during 2017, respectively, providing for net interest income of $111 million. During 2016, interest income and interest expense equaled $119 million and $12.6 million, respectively, providing for net interest income of $107 million.

 

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In comparing 2017 with 2016, interest income increased 6.0%, interest expense was up 25.5%, 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 $3.9 million increase in net interest income in 2017 compared to 2016 resulted from a higher level of average earning assets, which more than offset a lower net interest margin. During 2017, earning assets averaged $2.92 billion, or $152 million higher than average earning assets during 2016. Average loans increased $138 million, average other interest-earning assets increased $13.1 million, and average securities increased $0.6 million. During 2017, the net interest margin equaled 3.79%, down from 3.86% during 2016 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 certain non-time deposits, time deposits, and borrowed funds. The improved yield on average earning assets mainly resulted from an increased yield on loans, primarily reflecting higher interest rates on variable-rate commercial loans stemming from recent Federal Open Market Committee (“FOMC”) rate hikes, which more than offset a decreased yield on securities, mainly reflecting a decreased level of accelerated purchase discount accretion on called U.S. Government agency bonds.

 

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The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets, liabilities and shareholders’ equity during 2017, 2016 and 2015. 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 35%. Securities interest income was increased by $0.8 million in both 2017 and 2016 and $0.6 million in 2015 for this non-GAAP, but industry standard, adjustment. This adjustment equated to a three basis point increase in our net interest margin during both 2017 and 2016 and a two basis point increase in our net interest margin during 2015.

 

(Dollars in thousands)		Years ended December 31,
		2 0 1 7												2 0 1 6												2 0 1 5
		Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate
Taxable securities		$	224,786			$	5,326				2.37	%		$	224,297			$	6,842				3.05	%		$	281,476			$	5,918				2.10	%
Tax-exempt securities			115,984				3,103				2.68				115,875				2,932				2.53				114,603				2,650				2.31
Total securities			340,770				8,429				2.47				340,172				9,774				2.87				396,079				8,568				2.16
Loans			2,483,440				116,816				4.70				2,345,308				109,049				4.65				2,178,276				104,106				4.78
Interest-earning deposits			90,925				1,096				1.21				77,852				401				0.51				68,234				188				0.28
Federal funds sold			0				0				0.00				11			<1					0.25				10,719				27				0.25
Total earning assets			2,915,135				126,341				4.33				2,763,343				119,224				4.31				2,653,308				112,889				4.25
Allowance for loan losses			(18,949	)											(16,895	)											(18,082	)
Cash and due from banks			48,061												45,890												46,714
Other non-earning assets			198,426												195,446												199,557
Total assets		$	3,142,673											$	2,987,784											$	2,881,497
Interest-bearing demand deposits		$	377,933			$	507				0.13	%		$	360,180			$	336				0.09	%		$	404,866			$	721				0.18	%
Savings deposits			341,175				351				0.10				340,076				296				0.09				341,265				401				0.12
Money market accounts			354,145				2,122				0.60				290,528				360				0.12				268,071				420				0.16
Time deposits			516,525				6,382				1.24				577,062				6,557				1.14				657,938				6,048				0.92
Total interest-bearing deposits			1,589,778				9,362				0.59				1,567,846				7,549				0.48				1,672,140				7,590				0.45
Short-term borrowings			116,615				190				0.16				149,079				211				0.14				146,826				157				0.11
Federal Home Loan Bank advances			217,849				3,657				1.68				149,344				2,263				1.51				55,556				765				1.38
Other borrowings			48,453				2,586				5.34				48,711				2,567				5.27				58,509				2,642				4.52
Total interest-bearing liabilities			1,972,695				15,795				0.80				1,914,980				12,590				0.66				1,933,031				11,154				0.58
Demand deposits			802,024												715,550												606,750
Other liabilities			13,506												15,914												11,929
Total liabilities			2,788,225												2,646,444												2,551,710
Average equity			354,448												341,340												329,787
Total liabilities and equity		$	3,142,673											$	2,987,784											$	2,881,497
Net interest income						$	110,546											$	106,634											$	101,735
Rate spread											3.53	%											3.65	%											3.67	%
Net interest margin											3.79	%											3.86	%											3.83	%

 

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		Years ended December 31,
		2017 over 2016												2016 over 2015
		Total				Volume				Rate				Total				Volume				Rate
Increase (decrease) in interest income
Taxable securities		$	(1,516,000	)		$	15,000			$	(1,531,000	)		$	923,000			$	(1,371,000	)		$	2,294,000
Tax exempt securities			171,000				3,000				168,000				283,000				30,000				253,000
Loans			7,767,000				6,485,000				1,282,000				4,943,000				7,823,000				(2,880,000	)
Interest-earning deposit balances			695,000				77,000				618,000				213,000				30,000				183,000
Federal funds sold			0				0				0				(27,000	)			(20,000	)			(7,000	)
Net change in tax-equivalent interest income			7,117,000				6,580,000				537,000				6,335,000				6,492,000				(157,000	)
Increase (decrease) in interest expense
Interest-bearing demand deposits			171,000				17,000				154,000				(385,000	)			(72,000	)			(313,000	)
Savings deposits			55,000				1,000				54,000				(105,000	)			(1,000	)			(104,000	)
Money market accounts			1,762,000				95,000				1,667,000				(60,000	)			33,000				(93,000	)
Time deposits			(175,000	)			(721,000	)			546,000				509,000				(804,000	)			1,313,000
Short-term borrowings			(21,000	)			(50,000	)			29,000				54,000				2,000				52,000
Federal Home Loan Bank advances			1,394,000				1,129,000				265,000				1,498,000				1,414,000				84,000
Other borrowings			19,000				(14,000	)			33,000				(75,000	)			(479,000	)			404,000
Net change in interest expense			3,205,000				457,000				2,748,000				1,436,000				93,000				1,343,000
Net change in tax-equivalent net interest income		$	3,912,000			$	6,123,000			$	(2,211,000	)		$	4,899,000			$	6,399,000			$	(1,500,000	)

 

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 $7.1 million during 2017 from that earned in 2016, totaling $126 million in 2017 compared to $119 million in the previous year. The increase in interest income is primarily attributable to a higher level of average earning assets; a slightly higher yield on average earning assets also contributed to the increased interest income. During 2017 and 2016, earning assets had an average yield (tax equivalent-adjusted basis) of 4.33% and 4.31%, respectively. The improved yield on average earning assets mainly resulted from an increased yield on loans, primarily reflecting higher interest rates on variable-rate commercial loans stemming from the previously-mentioned FOMC rate hikes, which more than offset a decreased yield on securities, mainly reflecting a decreased level of accelerated purchase discount accretion on called U.S. Government agency bonds. A change in earning asset mix also contributed to the increased yield on average earning assets; average loans represented 85.2% of average earning assets during 2017, up from 84.9% during 2016.

 

Interest income generated from the loan portfolio increased $7.8 million in 2017 compared to the level earned in 2016; growth in the loan portfolio during 2017 resulted in a $6.5 million increase in interest income, while an increase in loan yield from 4.65% in 2016 to 4.70% in 2017 resulted in a $1.3 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 4.70% during 2017, up from 4.60% during 2016 as the positive impacts of the FOMC rate hikes in December 2016 and March, June, and December 2017 more than offset the negative impacts of loans being originated and renewed at lower rates in light of the ongoing relatively low interest rate environment and competitive pressures. The decline in the yield on residential mortgage loans from 5.10% during 2016 to 4.70% during 2017 primarily reflected the booking of adjustable-rate mortgages with initial rates that were generally lower than the existing portfolio’s average rate. Interest income on acquired loans totaled $4.6 million in 2017, compared to $4.9 million in 2016.

 

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Interest income generated from the securities portfolio decreased $1.3 million in 2017 compared to the level earned in 2016; a decline in the yield on securities from 2.87% during 2016 to 2.47% during 2017 resulted in a $1.4 million decrease in interest income, while an increase in the average balance of the securities portfolio resulted in an increase in interest income of less than $0.1 million. The decreased yield on securities mainly reflects a lower level of accelerated discount accretion on called U.S. Government agency bonds being recorded as interest income. The accelerated discount accretion totaled $2.2 million during 2016, positively impacting the net interest margin by eight basis points; a nominal level of accelerated discount accretion was recorded as interest income during 2017. Interest income on other interest-earning assets increased $0.7 million primarily 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 $3.2 million during 2017 from that expensed in 2016, totaling $15.8 million in 2017 compared to $12.6 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 2017 and 2016, interest-bearing liabilities had a weighted average rate of 0.80% and 0.66%, respectively; an increase in interest expense of $2.7 million was recorded during 2017 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 0.10% during 2016 to 0.28% during 2017, primarily reflecting one 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. The cost of time deposits increased from 1.14% during 2016 to 1.24% during 2017, primarily reflecting higher costs of public unit certificates of deposit $100,000 and over and brokered certificates of deposit $100,000 and over. The cost of borrowed funds increased from 1.45% during 2016 to 1.68% during 2017 primarily due to a change in borrowing mix and an increased cost of FHLBI advances. Average lower-costing sweep accounts represented 30.4% of average borrowed funds during 2017, down from 42.9% during 2016, while average higher-costing FHLBI advances represented 56.9% and 43.0% of average borrowed funds during the respective periods. Longer-term FHLBI advances totaling $90 million were obtained during 2017 to meet loan funding and interest rate risk management needs. Average interest-bearing liabilities were $1.97 billion during 2017, up $57.7 million, or 3.0%, from the $1.91 billion average during 2016.

 

An increase in interest-bearing non-time deposits during 2017, totaling $82.5 million, equated to an increase in interest expense of $0.1 million, while a higher average rate paid on these deposit accounts resulted in a $1.9 million increase in interest expense. Average time deposits decreased $60.5 million during 2017, in large part reflecting the aforementioned transfer of funds into a money market account product; the decreased balance equated to a decline in interest expense of $0.7 million. A $0.5 million increase in interest expense resulted from a higher average rate paid on time deposits.

 

Average short-term borrowings, comprised entirely of sweep accounts, declined $32.5 million during 2017, resulting in a $0.1 million decrease in interest expense, while a higher average rate paid on these accounts resulted in a nominal increase in interest expense. Average FHLBI advances increased $68.5 million, resulting in a $1.1 million increase in interest expense, while a higher average rate paid on the advances resulted in a $0.3 million increase in interest expense. A $0.3 million decrease in average other borrowings, coupled with a slight increase in the average rate paid on these borrowings, resulted in a nominal increase in interest expense.

 

Net interest income and the net interest margin during 2017 and 2016 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 $4.6 million and $4.9 million were recorded during 2017 and 2016, respectively. An increase in interest expense on subordinated debentures totaling $0.7 million was recorded during both 2017 and 2016. 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 $3.0 million was recorded in 2017, compared to a provision expense of $2.9 million recorded in 2016. The provision expense recorded during 2017 primarily reflects ongoing loan growth and an assessment change in our economic conditions environmental factor, while the provision expense incurred during 2016 mainly reflects loan growth and an assessment change in our concentrations environmental factor.

 

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Net loan charge-offs of $1.4 million were recorded during 2017, compared to $0.6 million during the prior year. The allowance for originated loans, as a percentage of total originated loans, was 0.9% and 1.0% as of December 31, 2017 and December 31, 2016, respectively. Our allowance for acquired loans totaled $0.4 million and $0.1 million as of December 31, 2017 and December 31, 2016, respectively.

 

Noninterest Income

Noninterest income totaled $19.0 million in 2017, a decrease of $2.0 million, or 9.7%, from the $21.0 million earned in 2016. Our primary noninterest income revenue streams, including treasury management income, credit and debit card interchange fees, mortgage banking activity income, payroll processing revenue, and customer service fees, increased $1.2 million, or 8.5%, on a combined basis in 2017 compared to the prior year. The increase in mortgage banking activity income primarily reflects the positive impact of strategic initiatives that were implemented in the latter half of 2016 and throughout 2017, including the hiring of additional loan originators, introduction of new and enhanced products, loan programs and increased marketing efforts. Noninterest income during both 2017 and 2016 benefited from certain one-time transactions, including a $1.4 million bank owned life insurance death benefit claim in 2017 and a $2.9 million pre-tax gain associated with a trust preferred securities repurchase transaction and $0.4 million in reimbursements related to certain medical insurance premiums charged in prior years in 2016.

 

Noninterest Expense

Noninterest expense during 2017 totaled $79.7 million, an increase of $2.6 million, or 3.4%, from the $77.1 million expensed in 2016. The higher level of expense primarily resulted from increased salary expense and expected increases in various operating expenses stemming from recent expansion initiatives. Salary expense was $37.2 million during 2017, an increase of $2.7 million, or 7.8%, from the $34.5 million expensed during 2016. The increased salary expense primarily reflects annual employee merit pay increases, the hiring of additional staff, a larger bonus accrual, and greater stock-based compensation expense. A significant portion of the increased salary expense resulting from staff additions reflects the opening of the southeast Michigan office. Employee benefit costs during 2017 were $8.2 million, a decrease of $0.8 million, or 9.0%, from the $9.0 million expensed in 2016, primarily reflecting lower health insurance costs. Occupancy and furniture and equipment costs increased $0.2 million on a combined basis in 2017, mainly resulting from higher depreciation expense. Data processing costs totaled $8.2 million in 2017, up $0.3 million, or 3.6%, from the $7.9 million expensed in 2016, primarily reflecting higher costs related to credit and debit card services. FDIC insurance premiums during 2017 were $1.0 million, a decrease of $0.3 million, or 22.3%, from the $1.3 million expensed during 2016; the decrease mainly resulted from changes to the deposit insurance assessment calculation that became effective in the third quarter of 2016.

 

Federal Income Tax Expense

During 2017, we recorded income before federal income tax of $46.1 million and a federal income tax expense of $14.8 million, compared to income before federal income tax of $46.9 million and a federal income tax expense of $15.0 million during 2016. Our effective tax rate was 32.1% during 2017, compared to 31.9% during 2016. The decrease in federal income tax expense during 2017 compared to 2016 period resulted from the lower level of income before federal income tax. The higher effective tax rate in 2017 compared to the prior year reflects the impact of the revaluation of our net deferred tax asset in response to the Tax Cuts and Jobs Act, which resulted in increased federal income tax expense of $1.3 million in the current year. The aforementioned nontaxable bank owned life insurance death benefit claim positively impacted the effective tax rate in 2017.

 

 

RESULTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 2016 and 2015

 

Summary

We recorded net income of $31.9 million, or $1.96 per basic and diluted share, for 2016, compared to net income of $27.0 million, or $1.63 per basic share and $1.62 per diluted share, for 2015. The repurchase of $11.0 million in trust preferred securities at a 27% discount during the first quarter of 2016 increased net income during 2016 by $1.8 million, or $0.11 per basic and diluted share. This unique opportunity resulted from a private investment fund that voluntarily liquidated and auctioned all of its investments. We also recorded accelerated discount accretion on called U.S. Government agency bonds that increased net income by $1.4 million, or $0.09 per basic and diluted share. Provision expense was $2.9 million, or $0.12 per basic and diluted share after tax in 2016, compared to negative $1.0 million, or $0.04 per basic and diluted share after tax in 2015.

 

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The improved earnings performance in 2016 compared to 2015 resulted from increased net interest income and noninterest income and decreased overhead costs, which more than offset increased provision expense. The increased net interest income primarily resulted from a higher level of average earning assets; an improved net interest margin, resulting from an increased yield on total earning assets, also contributed to the higher level of net interest income. The increased noninterest income mainly resulted from the recording of a pre-tax gain associated with the trust preferred securities repurchase transaction in January of 2016 and higher service charges on deposit and sweep accounts. The decreased noninterest expense was primarily attributable to decreased problem asset costs, loan processing costs, and Federal Deposit Insurance Corporation (“FDIC”) insurance premiums and various cost reduction initiatives, including the cost efficiency program announced during the fourth quarter of 2015; the quarterly cost savings associated with the program were fully realized beginning in the second quarter of 2016. The higher provision expense mainly resulted from ongoing loan growth and increased allocations related to environmental factors. 

 

The following table shows some of the key performance and equity ratios for the years ended December 31, 2016 and 2015:

 

		2016				2015
Return on average assets			1.07	%			0.94	%
Return on average shareholders’ equity			9.35	%			8.19	%
Average shareholders’ equity to average assets			11.42	%			11.45	%

 

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 $119 million and $12.6 million during 2016, respectively, providing for net interest income of $107 million. During 2015, interest income and interest expense equaled $113 million and $11.2 million, respectively, providing for net interest income of $102 million.

 

In comparing 2016 with 2015, interest income increased 5.6%, interest expense was up 12.9%, and net interest income increased 4.8%. 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 $4.9 million increase in net interest income in 2016 compared to 2015 resulted from a higher level of average earning assets, and to a lesser degree, an improved net interest margin. During 2016, earning assets averaged $2.76 billion, or $110 million higher than average earning assets during 2015. Average loans increased $167 million, average securities decreased $55.9 million, and average other interest-earning assets decreased $1.1 million. During 2016, the net interest margin equaled 3.86%, up from 3.83% during 2015 due to an increased yield on average earning assets, which more than offset a higher cost of funds. The increased yield on average earning assets primarily resulted from a higher yield on securities and a reallocation of earning assets, which more than offset a decreased yield on loans. The higher yield on securities mainly reflects a significant level of accelerated discount accretion on called U.S. Government agency bonds being recorded as interest income, while the decreased yield on loans primarily reflects the ongoing low interest rate environment and competitive industry pressures. The yield on loans generally declined over the past ten quarters, consistent with the industry; however, the negative impact of the lower loan yield on the yield on average earning assets was somewhat offset by the aforementioned reallocation of earning assets. Capitalizing on an opportunity stemming from the 2014 merger with Firstbank, the earning asset mix was reallocated by reinvesting cash flows from monthly paydowns on lower-yielding mortgage-backed securities and matured and called U.S. Government Agency bonds into the higher-yielding loan portfolio. The reallocation of earning assets strategy was completed during the second quarter of 2016 as the level of investments reached our internal policy guideline.

 

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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 $6.3 million during 2016 from that earned in 2015, totaling $119 million in 2016 compared to $113 million in the previous year. The increase in interest income is attributable to a higher level of average earning assets and an increased yield on average earning assets. During 2016 and 2015, earning assets had an average yield (tax equivalent-adjusted basis) of 4.31% and 4.25%, respectively. The higher yield on average earning assets in 2016 primarily resulted from an increased yield on securities and a reallocation of earning assets, which more than offset a decreased yield on loans. The higher-yielding loan portfolio averaged $2.35 billion, or 84.9% of average earning assets, during 2016, compared to $2.18 billion, or 82.1% of average earning assets, during 2015.

 

Interest income generated from the loan portfolio increased $4.9 million in 2016 compared to the level earned in 2015; growth in the loan portfolio during 2016 resulted in a $7.8 million increase in interest income, while a decline in loan yield from 4.78% in 2015 to 4.65% in 2016 resulted in a $2.9 million decrease in interest income. The lower yield on average loans mainly resulted from a decreased yield on average commercial loans, which equaled 4.60% in 2016 compared to 4.70% in 2015. The decreased commercial loan yield primarily reflects the ongoing low interest rate environment and competitive pressures. Accretion of acquired loans totaled $4.9 million during 2016, compared to $5.3 million during 2015.

 

Interest income generated from the securities portfolio increased $1.2 million in 2016 compared to the level earned in 2015; an increase in the yield on securities from 2.16% during 2015 to 2.87% during 2016 resulted in a $2.5 million increase in interest income, while a reduction in the securities portfolio resulted in a $1.3 million decrease in interest income. The increased yield on securities mainly reflects a significant level of accelerated discount accretion on called U.S. Government agency bonds being recorded as interest income. The accelerated discount accretion totaled $2.2 million during 2016, positively impacting the net interest margin by eight basis points. A nominal level of accelerated discount accretion on called U.S. Government agency bonds was recorded as interest income during 2015. Interest income on interest-earning deposits increased $0.2 million primarily due to an increased yield.

 

Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from subordinated debentures, FHLBI advances, sweep accounts, and other borrowings. Interest expense increased $1.4 million during 2016 from that expensed in 2015, totaling $12.6 million in 2016 compared to $11.2 million in the previous year. The increase in interest expense is attributable to a higher cost of funds. During 2016 and 2015, interest-bearing liabilities had a weighted average rate of 0.66% and 0.58%, respectively; an increase in interest expense of $1.3 million was recorded during 2016 due to the higher cost of funds. The higher weighted average cost of interest-bearing liabilities mainly resulted from an increased cost of certificates of deposit, which more than offset decreases in the costs of certain interest-bearing non-certificate of deposit account categories. The higher cost of certificates of deposit was expected in light of purchase accounting amortization entries, which were associated with fair value measurements recorded on the merger date, ending in July of 2015. A $1.4 million reduction in interest expense on certificates of deposit related to purchase accounting entries was recorded during 2015; no reduction in interest expense was recorded during 2016. Increased rates paid on certificates of deposit, subordinated debentures, and FHLBI advances also contributed to the higher weighted average cost of interest-bearing liabilities during 2016. The cost of interest-bearing non-certificate of deposit accounts decreased from 0.15% during 2015 to 0.10% during 2016 in light of rates being lowered during the latter part of 2015. Average interest-bearing liabilities were $1.91 billion during 2016, down $18.1 million, or 0.9%, from the $1.93 billion average during 2015.

 

Average certificates of deposit decreased $80.9 million during 2016, which equated to a decline in interest expense of $0.8 million. A $1.3 million increase in interest expense resulted from a higher average rate paid on certificates of deposit, primarily reflecting the impact of the purchase accounting amortization entries ending in July of 2015. A decrease in other average interest-bearing deposit accounts, totaling $23.4 million, equated to a decrease in interest expense of less than $0.1 million, while a decrease in the average rate paid on these deposit accounts resulted in a $0.5 million decline in interest expense.

 

Average short-term borrowings, comprised entirely of sweep accounts, increased $2.3 million during 2016, resulting in a nominal increase in interest expense, while a higher average rate paid on these accounts resulted in a $0.1 million increase in interest expense. Average FHLBI advances increased $93.8 million, resulting in a $1.4 million increase in interest expense, while a higher average rate paid on the advances resulted in a $0.1 million increase in interest expense. A $9.8 million decrease in average other borrowings, which is comprised of subordinated debentures and deferred director and officer compensation programs, equated to a $0.5 million decline in interest expense, while a higher average rate paid on these borrowings resulted in a $0.4 million increase in interest expense.

 

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Net interest income and the net interest margin during 2016 and 2015 were affected by purchase accounting accretion and amortization entries associated with the fair value measurements recorded on June 1, 2014. An increase in interest income on loans totaling $4.9 million and an increase in interest expense on subordinated debentures totaling $0.7 million were recorded during 2016. During 2015, we recorded an increase in interest income on loans totaling $5.3 million and a decrease in interest expense on deposits and FHLBI advances totaling $1.4 million. In addition, we recorded an increase in interest expense on subordinated debentures totaling $0.7 million during the same time period. The adjustments to interest expense on deposits and FHLBI advances ended in July and June of 2015, respectively. The resulting increase in interest expense negatively impacted the net interest margin by approximately eight to ten basis points after July 31, 2015.

 

Provision for Loan Losses

A loan loss provision expense of $2.9 million was recorded in 2016, compared to a negative provision expense of $1.0 million recorded in 2015. The provision expense recorded during 2016 primarily reflects ongoing loan growth and an assessment change in our concentrations environmental factor, while the negative provision expense recorded during 2015 resulted from multiple factors, including recoveries of previously charged-off loans, reversals of specific reserves, a reduced level of loan-rating downgrades and ongoing loan-rating upgrades.

 

Net loan charge-offs of $0.6 million were recorded during 2016, compared to $3.4 million during the prior year. Of the $6.3 million in gross loan charge-offs recorded during 2015, $4.2 million was related to one commercial loan relationship that was resolved during the second quarter of that year. The allowance for originated loans, as a percentage of total originated loans, was 0.9% as of December 31, 2016 and December 31, 2015. Our allowance for acquired loans totaled $0.1 million and $0.5 million as of December 31, 2016 and December 31, 2015, respectively.

 

Noninterest Income

Noninterest income totaled $21.0 million in 2016, an increase of $5.0 million, or 31.2%, from the $16.0 million earned in 2015. The increase mainly resulted from a $2.9 million pre-tax gain being recorded in the first quarter of 2016 in association with a trust preferred securities repurchase transaction and higher service charges on deposit and sweep accounts and mortgage banking income. Service charges on deposit and sweep accounts totaled $4.3 million during 2016, an increase of $1.0 million, or 28.6%, from the $3.3 million recorded during 2015. The increase in service charges on deposit and sweep accounts mainly reflects an ongoing project to ensure all depositors are in a product that best meets their needs and is priced appropriately as well as increased cash management fee income. Mortgage banking income was $3.9 million in 2016, an increase of $0.3 million, or 6.8%, from the $3.6 million recorded during 2015. The increase in mortgage banking income primarily reflects the positive impact of recently-implemented strategic initiatives, including the hiring of additional loan originators, introduction of new and enhanced products, loan programs, and increased marketing efforts. Reimbursements totaling $0.4 million recorded in the third quarter of 2016 related to certain medical insurance premiums charged in prior years also contributed to the increase in noninterest income.

 

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Noninterest Expense

Noninterest expense during 2016 totaled $77.1 million, a decrease of $2.3 million, or 2.9%, from the $79.4 million expensed in 2015. The decrease was mainly attributable to lower problem asset costs, loan processing costs, FDIC insurance premiums, core deposit intangible amortization expense, printing and supply costs, furniture and equipment costs, and miscellaneous expenses, which more than offset increased employee benefit and data processing costs. Problem asset costs during 2016 were $0.9 million lower than the amount expensed during 2015. Loan processing costs were $0.5 million during 2016, a decrease of $0.6 million, or 50.8%, from the $1.1 million expensed during 2015, primarily reflecting the elimination of certain retail loan promotion programs. FDIC insurance premiums during 2016 were $1.2 million, a decrease of $0.5 million, or 28.0%, from the $1.7 million expensed during 2015; the decrease resulted from improvements in certain financial ratios and changes to the deposit insurance assessment calculation that became effective in the third quarter of 2016. Core deposit intangible amortization expense totaled $2.7 million during 2016, compared to $3.0 million during 2015. Printing and supply costs were $1.1 million in 2016, a decrease of $0.3 million, or 21.3%, from the $1.4 million expensed during 2015; the decrease primarily resulted from an initiative to convert deposit customers from receiving physical account statements to receiving electronic statements and the implementation of a central purchasing program. Furniture and equipment costs were $2.1 million during 2016, a decrease of $0.2 million, or 9.1%, from the $2.3 million in costs incurred during 2015, mainly reflecting lower depreciation expense. Noninterest expense during 2016 was positively impacted by the cost efficiency program, which will save approximately $2.7 million per year on a pre-tax basis beginning in 2017; the quarterly cost savings were fully realized starting in the second quarter of 2016. Employee benefit costs during 2016 were $9.0 million, an increase of $0.4 million, or 4.2%, from the $8.6 million expensed in 2015, primarily resulting from higher health insurance costs. Data processing costs during 2016 totaled $7.9 million, an increase of $0.2 million, or 3.2%, from the $7.7 million expensed during 2015, primarily reflecting higher costs related to debit and credit card services.

 

Federal Income Tax Expense

During 2016, we recorded income before federal income tax of $46.9 million and a federal income tax expense of $15.0 million, compared to income before federal income tax of $38.8 million and a federal income tax expense of $11.8 million during 2015. The increase in federal income tax expense resulted from the higher level of income before federal income tax. Our effective tax rate was 31.9% during 2016, compared to 30.4% during 2015.

 

 

CAPITAL RESOURCES

 

Shareholders’ equity increased $25.1 million during 2017, totaling $366 million as of December 31, 2017. Positively impacting shareholders’ equity was net income of $31.3 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $12.0 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 $2.3 million.

 

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, 2017, our bank’s total risk-based capital ratio was 12.6%, compared to 13.1% at December 31, 2016. Our bank’s total regulatory capital increased $18.1 million during 2017, primarily reflecting the net impact of net income totaling $33.3 million and cash dividends paid to Mercantile Bank Corporation aggregating $16.1 million. Our bank’s total risk-based capital ratio was also impacted by a $249 million increase in total risk-weighted assets, primarily resulting from net commercial loan growth. As of December 31, 2017, our bank’s total regulatory capital equaled $371 million, or $77.0 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.”

 

On January 30, 2015, we announced that our Board of Directors had authorized a new 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. On April 19, 2016, we announced a $15.0 million expansion of the stock repurchase plan. Since inception, we have purchased a total of 956,419 shares at a total price of $19.5 million, at an average price per share of $20.38; no shares were purchased under the authorized plan during 2017. 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, which would also likely be funded from cash dividends paid to us from our bank.

 

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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 $323 million, or 11.3% of combined deposits and borrowed funds as of December 31, 2017, compared to $251 million, or 9.4% of combined deposits and borrowed funds, as of December 31, 2016.

 

Sweep accounts decreased $13.0 million during 2017, totaling $119 million as of December 31, 2017. The decline primarily reflects certain customers transferring funds from the sweep product to noninterest-bearing checking accounts reflecting updated interest rate and fee structures. 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, 2017 and during 2017 is as follows:

 

Outstanding balance at December 31, 2017		$	118,748,000
Weighted average interest rate at December 31, 2017			0.16	%
Maximum daily balance twelve months ended December 31, 2017		$	142,459,000
Average daily balance for twelve months ended December 31, 2017		$	116,587,000
Weighted average interest rate for twelve months ended December 31, 2017			0.16	%

 

FHLBI advances increased $45.0 million during 2017, totaling $220 million as of December 31, 2017. 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 2017 totaled $731 million, with availability of $511 million.

 

We also have the ability to borrow up to $50.0 million on a daily basis through a correspondent bank using an established unsecured federal funds purchased line of credit. We accessed this line of credit on two occasions during 2017; prior to these borrowings, we had not accessed any federal funds purchased lines of credit since January of 2010. In contrast, our interest-earning deposit account at the Federal Reserve Bank of Chicago averaged $88.4 million during 2017. 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 $19.9 million at December 31, 2017. We did not utilize this line of credit during the past seven years, and do not plan to access this line of credit in future periods.

 

The following table reflects, as of December 31, 2017, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

 

		One Year				One to				Three to				Over
		or Less				Three Years				Five Years				Five Years				Total
Deposits without a stated maturity		$	2,008,787,000			$	0			$	0			$	0			$	2,008,787,000
Certificates of deposit			283,844,000				155,779,000				73,955,000				0				513,578,000
Short-term borrowings			118,748,000				0				0				0				118,748,000
Federal Home Loan Bank advances			20,000,000				70,000,000				80,000,000				50,000,000				220,000,000
Subordinated debentures			0				0				0				45,517,000				45,517,000
Other borrowed money			0				0				0				3,203,000				3,203,000
Property leases			360,000				520,000				321,000				241,000				1,442,000

  

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In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. At December 31, 2017, we had a total of $986 million in unfunded loan commitments and $26.0 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $801 million were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $185 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:

 

		12/31/17				12/31/16				12/31/15
Commercial unused lines of credit		$	682,202,000			$	553,345,000			$	522,658,000
Unused lines of credit secured by 1-4 family residential properties			61,606,000				56,275,000				61,905,000
Credit card unused lines of credit			39,807,000				22,689,000				15,612,000
Other consumer unused lines of credit			17,629,000				8,489,000				8,583,000
Commitments to make loans			184,923,000				154,338,000				178,034,000
Standby letters of credit			26,030,000				26,202,000				34,946,000
Total		$	1,012,197,000			$	821,338,000			$	821,738,000

 

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.

 

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The following table depicts our GAP position as of December 31, 2017:

 

		Within				Three to				One to				After
		Three				Twelve				Five				Five
		Months				Months				Years				Years				Total
Assets:
Commercial loans (1)		$	1,159,620,000			$	61,829,000			$	657,317,000			$	306,915,000			$	2,185,681,000
Residential real estate loans			63,584,000				18,627,000				125,236,000				131,648,000				339,095,000
Consumer loans			1,899,000				1,248,000				25,374,000				5,255,000				33,776,000
Securities (2)			16,140,000				27,578,000				95,042,000				208,020,000				346,780,000
Interest-earning deposits			143,474,000				0				1,500,000				0				144,974,000
Allowance for loan losses			0				0				0				0				(19,501,000	)
Other assets			0				0				0				0				255,899,000
Total assets			1,384,717,000				109,282,000				904,469,000				651,838,000			$	3,286,704,000
Liabilities:
Interest-bearing checking			387,758,000				0				0				0				387,758,000
Savings deposits			327,530,000				0				0				0				327,530,000
Money market accounts			427,119,000				0				0				0				427,119,000
Time deposits under $100,000			17,691,000				50,933,000				83,670,000				0				152,294,000
Time deposits $100,000 & over			50,258,000				164,962,000				146,064,000				0				361,284,000
Short-term borrowings			118,748,000				0				0				0				118,748,000
Federal Home Loan Bank advances			0				20,000,000				150,000,000				50,000,000				220,000,000
Other borrowed money			48,720,000				0				0				0				48,720,000
Noninterest-bearing checking			0				0				0				0				866,380,000
Other liabilities			0				0				0				0				11,001,000
Total liabilities			1,377,824,000				235,895,000				379,734,000				50,000,000				2,920,834,000
Shareholders' equity			0				0				0				0				365,870,000
Total liabilities & shareholders' equity			1,377,824,000				235,895,000				379,734,000				50,000,000			$	3,286,704,000
Net asset (liability) GAP		$	6,893,000			$	(126,613,000	)		$	524,735,000			$	601,838,000
Cumulative GAP		$	6,893,000			$	(119,720,000	)		$	405,015,000			$	1,006,853,000
Percent of cumulative GAP to total assets			0.2	%			(3.6	%)			12.3	%			30.6	%

 

(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, 2017.

 

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.

 

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We conducted multiple simulations as of December 31, 2017, in which it was assumed that changes in market interest rates occurred ranging from up 400 basis points to down 400 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested impact on net interest income over the next twelve months in comparison to estimated net interest income based on our balance sheet structure, including the balances and interest rates associated with our specific loans, securities, deposits and borrowed funds, as of December 31, 2017.

 

		Dollar Change				Percent Change
		In Net				In Net
Interest Rate Scenario		Interest Income				Interest Income
Interest rates down 400 basis points		$	(19,430,000	)			(17.6	%)
Interest rates down 300 basis points			(16,260,000	)			(14.7	)
Interest rates down 200 basis points			(12,100,000	)			(11.0	)
Interest rates down 100 basis points			(6,540,000	)			(5.9	)
No change in interest rates			(770,000	)			(0.7	)
Interest rates up 100 basis points			1,450,000				1.3
Interest rates up 200 basis points			3,610,000				3.3
Interest rates up 300 basis points			5,800,000				5.3
Interest rates up 400 basis points			7,950,000				7.2

 

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.

 

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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”) and subsidiaries as of December 31, 2017 and 2016, 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, 2017, 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 and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

We have also 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, 2017, 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 5, 2018 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 supporting 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 5, 2018

 

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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, 2017, 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, 2017, 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, 2017 and 2016, 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, 2017, and the related notes, and our report dated March 5, 2018 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 5, 2018

 

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March 5, 2018

 

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, 2017. 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, 2017, 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 F-32.

   

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

 

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MERCANTILE BANK CORPORATION

CONSOLIDATED BALANCE SHEETS

December 31, 2017 and 2016

 

 

		2017				2016
ASSETS
Cash and due from banks		$	55,127,000			$	50,200,000
Interest-earning deposits			144,974,000				133,396,000
Total cash and cash equivalents			200,101,000				183,596,000
Securities available for sale			335,744,000				328,060,000
Federal Home Loan Bank stock			11,036,000				8,026,000
Loans			2,558,552,000				2,378,620,000
Allowance for loan losses			(19,501,000	)			(17,961,000	)
Loans, net			2,539,051,000				2,360,659,000
Premises and equipment, net			46,034,000				45,456,000
Bank owned life insurance			68,689,000				67,198,000
Goodwill			49,473,000				49,473,000
Core deposit intangible			7,600,000				9,957,000
Other assets			28,976,000				30,146,000
Total assets		$	3,286,704,000			$	3,082,571,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing		$	866,380,000			$	810,600,000
Interest-bearing			1,655,985,000				1,564,385,000
Total deposits			2,522,365,000				2,374,985,000
Securities sold under agreements to repurchase			118,748,000				131,710,000
Federal Home Loan Bank advances			220,000,000				175,000,000
Subordinated debentures			45,517,000				44,835,000
Accrued interest and other liabilities			14,204,000				15,230,000
Total liabilities			2,920,834,000				2,741,760,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares authorized; 0 shares outstanding at December 31, 2017 and December 31, 2016			0				0
Common stock, no par value; 40,000,000 shares authorized; 16,592,125 shares outstanding at December 31, 2017 and 16,416,695 shares outstanding at December 31, 2016			309,772,000				305,488,000
Retained earnings			61,001,000				40,904,000
Accumulated other comprehensive loss			(4,903,000	)			(5,581,000	)
Total shareholders’ equity			365,870,000				340,811,000
Total liabilities and shareholders’ equity		$	3,286,704,000			$	3,082,571,000

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 2017, 2016 and 2015

 

 

		2017				2016				2015
Interest income
Loans, including fees		$	116,816,000			$	109,049,000			$	104,106,000
Securities, taxable			5,326,000				6,842,000				5,918,000
Securities, tax-exempt			2,305,000				2,165,000				2,089,000
Other interest-earning assets			1,096,000				401,000				215,000
Total interest income			125,543,000				118,457,000				112,328,000
Interest expense
Deposits			9,362,000				7,549,000				7,590,000
Short-term borrowings			190,000				211,000				157,000
Federal Home Loan Bank advances			3,657,000				2,263,000				765,000
Subordinated debentures and other borrowings			2,586,000				2,567,000				2,642,000
Total interest expense			15,795,000				12,590,000				11,154,000
Net interest income			109,748,000				105,867,000				101,174,000
Provision for loan losses			2,950,000				2,900,000				(1,000,000	)
Net interest income after provision for loan losses			106,798,000				102,967,000				102,174,000
Noninterest income
Service charges on deposit and sweep accounts			4,233,000				4,253,000				3,308,000
Credit and debit card fees			4,760,000				4,278,000				4,329,000
Mortgage banking activities			4,421,000				3,866,000				3,619,000
Earnings on bank owned life insurance			2,731,000				1,264,000				1,113,000
Payroll processing			1,305,000				1,016,000				969,000
Letter of credit fees			348,000				493,000				457,000
Gain on trust preferred securities repurchase			0				2,970,000				0
Other income			1,203,000				2,898,000				2,243,000
Total noninterest income			19,001,000				21,038,000				16,038,000
Noninterest expense
Salaries and benefits			45,397,000				43,524,000				42,594,000
Occupancy			6,186,000				6,063,000				5,976,000
Furniture and equipment rent, depreciation and maintenance			2,168,000				2,119,000				2,332,000
Data processing			8,222,000				7,939,000				7,696,000
Advertising			1,608,000				1,586,000				1,363,000
FDIC insurance costs			960,000				1,236,000				1,717,000
Problem asset costs			355,000				338,000				1,212,000
Efficiency program-related costs			0				172,000				765,000
Other expense			14,820,000				14,141,000				15,726,000
Total noninterest expenses			79,716,000				77,118,000				79,381,000
Income before federal income tax expense			46,083,000				46,887,000				38,831,000
Federal income tax expense			14,809,000				14,974,000				11,811,000
Net income		$	31,274,000			$	31,913,000			$	27,020,000
Earnings per common share:
Basic		$	1.90			$	1.96			$	1.63
Diluted		$	1.90			$	1.96			$	1.62

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years ended December 31, 2017, 2016 and 2015

 

 

		2017				2016				2015
Net income		$	31,274,000			$	31,913,000			$	27,020,000
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale			2,297,000				(10,697,000	)			1,874,000
Fair value of interest rate swap			82,000				169,000				0
Total other comprehensive income (loss)			2,379,000				(10,528,000	)			1,874,000
Tax effect of unrealized holding gains (losses) on securities available for sale			(804,000	)			3,743,000				(627,000	)
Tax effect of fair value of interest rate swap			(28,000	)			(59,000	)			0
Total tax effect of other comprehensive income (loss)			(832,000	)			3,684,000				(627,000	)
Other comprehensive income (loss), net of tax effect			1,547,000				(6,844,000	)			1,247,000
Comprehensive income		$	32,821,000			$	25,069,000			$	28,267,000

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

Years ended December 31, 2017, 2016 and 2015

  

														Accumulated Other				Total
		Preferred				Common				Retained				Comprehensive				Shareholders’
($ in thousands except per share amounts)		Stock				Stock				Earnings				Income/(Loss)				Equity
Balances, January 1, 2015		$	0			$	317,904			$	10,218			$	16			$	328,138
Employee stock purchase plan (2,058 shares)							44												44
Dividend reinvestment plan (30,467 shares)							655												655
Stock option exercises (59,117 shares)							891												891
Stock grants to directors for retainer fees (20,094 shares)							403												403
Stock-based compensation expense							684												684
Share repurchase program (788,541 shares)							(15,762	)											(15,762	)
Cash dividends ($0.58 per common share)											(9,516	)							(9,516	)
Net income for 2015											27,020								27,020
Change in net unrealized gain/(loss) on securities available for sale, net of tax effect															1,247				1,247
Change in fair value of interest rate swap, net of tax effect															0				0
Balances, December 31, 2015		$	0			$	304,819			$	27,722			$	1,263			$	333,804

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

Years ended December 31, 2017, 2016 and 2015

 

 

														Accumulated Other				Total
		Preferred				Common				Retained				Comprehensive				Shareholders’
($ in thousands except per share amounts)		Stock				Stock				Earnings				Income/(Loss)				Equity
Balances, January 1, 2016		$	0			$	304,819			$	27,722			$	1,263			$	333,804
Employee stock purchase plan (1,362 shares)							36												36
Dividend reinvestment plan (58,325 shares)							1,601												1,601
Stock option exercises (72,711 shares)							978												978
Stock grants to directors for retainer fees (13,000 shares)							327												327
Stock-based compensation expense							1,459												1,459
Share repurchase program (167,878 shares)							(3,732	)											(3,732	)
Cash dividends ($1.16 per common share)											(18,731	)							(18,731	)
Net income for 2016											31,913								31,913
Change in net unrealized gain/(loss) on securities available for sale, net of tax effect															(6,954	)			(6,954	)
Change in fair value of interest rate swap, net of tax effect															110				110
Balances, December 31, 2016		$	0			$	305,488			$	40,904			$	(5,581	)		$	340,811

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

Years ended December 31, 2017, 2016 and 2015

 

 

														Accumulated Other				Total
		Preferred				Common				Retained				Comprehensive				Shareholders’
($ in thousands except per share amounts)		Stock				Stock				Earnings				Income/(Loss)				Equity
Balances, January 1, 2017		$	0			$	305,488			$	40,904			$	(5,581	)		$	340,811
Employee stock purchase plan (1,351 shares)							46												46
Dividend reinvestment plan (48,012 shares)							1,576												1,576
Stock option exercises, net of shares tendered (28,082 shares)							318												318
Stock grants to directors for retainer fees (11,712 shares)							363												363
Stock-based compensation expense							1,981												1,981
Cash dividends ($0.74 per common share)											(12,046	)							(12,046	)
Net income for 2017											31,274								31,274
Change in net unrealized gain/(loss) on securities available for sale, net of tax effect															1,493				1,493
Reclassification of stranded tax effect related to available for sale securities resulting from Tax Cuts and Jobs Act											869				(869	)			0
Change in fair value of interest rate swap, net of tax effect															54				54
Balances, December 31, 2017		$	0			$	309,772			$	61,001			$	(4,903	)		$	365,870

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2017, 2016 and 2015

 

 

		2017				2016				2015
Cash flows from operating activities
Net income		$	31,274,000			$	31,913,000			$	27,020,000
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization			10,358,000				9,576,000				11,654,000
Accretion of acquired loans			(2,338,000	)			(4,925,000	)			(5,338,000	)
Provision for loan losses			2,950,000				2,900,000				(1,000,000	)
Deferred income tax expense (benefit)			831,000				(812,000	)			4,412,000
Stock-based compensation expense			1,981,000				1,459,000				684,000
Stock grants to directors for retainer fee			363,000				327,000				403,000
Proceeds from sales of mortgage loans held for sale			111,311,000				114,757,000				120,880,000
Origination of mortgage loans held for sale			(108,857,000	)			(110,778,000	)			(116,997,000	)
Net gain on sales of mortgage loans held for sale			(3,972,000	)			(3,699,000	)			(3,626,000	)
Gain on trust preferred securities repurchase			0				(2,970,000	)			0
Net gain from sales and valuation write-downs of foreclosed assets			(319,000	)			(520,000	)			(62,000	)
Net loss from sales and valuation write-downs of former bank premises			133,000				35,000				0
Net loss from sales and disposals of premises and equipment			71,000				174,000				55,000
Net (gain) loss from sales of available for sale securities			(37,000	)			1,000				(17,000	)
Earnings on bank owned life insurance			(2,731,000	)			(1,264,000	)			(1,113,000	)
Net change in:
Accrued interest receivable			(1,056,000	)			122,000				(321,000	)
Other assets			(354,000	)			(648,000	)			(4,815,000	)
Accrued interest and other liabilities			(943,000	)			(1,046,000	)			4,185,000
Net cash from operating activities			38,665,000				34,602,000				36,004,000
Cash flows from investing activities
Purchases of securities available for sale			(67,027,000	)			(164,336,000	)			(10,645,000	)
Proceeds from maturities, calls and repayments of securities available for sale			52,504,000				172,173,000				93,873,000
Proceeds from sales of securities available for sale			7,619,000				264,000				1,483,000
Purchases of Federal Home Loan Bank stock			(3,010,000	)			(459,000	)			0
Proceeds from Federal Home Loan Bank stock redemption			0				0				6,132,000
Loan originations and payments, net			(178,373,000	)			(97,282,000	)			(188,932,000	)
Purchases of bank owned life insurance			(1,500,000	)			(7,000,000	)			0
Proceeds from bank owned life insurance cash value release and death benefits			2,720,000				0				0
Purchases of premises and equipment, net			(5,423,000	)			(2,025,000	)			(1,081,000	)
Proceeds from sales of former bank premises			25,000				45,000				0
Proceeds from sales of foreclosed assets			993,000				2,059,000				2,967,000
Net cash for investing activities			(191,472,000	)			(96,561,000	)			(96,203,000	)
Cash flows from financing activities
Net decrease in time deposits			(55,839,000	)			(20,854,000	)			(147,106,000	)
Net increase in all other deposits			203,219,000				120,457,000				146,944,000
Net decrease in securities sold under agreements to repurchase			(12,962,000	)			(23,061,000	)			(12,798,000	)
Proceeds from Federal Home Loan Bank advances			90,000,000				110,000,000				20,000,000
Maturities of Federal Home Loan Bank advances			(45,000,000	)			(3,000,000	)			(6,000,000	)
Proceeds from stock option exercises, net of cashless exercises			318,000				978,000				891,000
Employee stock purchase plan			46,000				36,000				44,000
Dividend reinvestment plan			1,576,000				1,601,000				655,000
Repurchase of common stock			0				(3,732,000	)			(15,762,000	)
Repurchase of trust preferred securities			0				(8,030,000	)			0
Payment of cash dividends to common shareholders			(12,046,000	)			(18,731,000	)			(9,516,000	)
Net cash from (for) financing activities			169,312,000				155,664,000				(22,648,000	)

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

Years ended December 31, 2017, 2016 and 2015

 

 

		2017				2016				2015
Net change in cash and cash equivalents			16,505,000				93,705,000				(82,847,000	)
Cash and cash equivalents at beginning of period			183,596,000				89,891,000				172,738,000
Cash and cash equivalents at end of period		$	200,101,000			$	183,596,000			$	89,891,000
Supplemental disclosures of cash flows information
Cash paid during the year for:
Interest		$	15,468,000			$	12,477,000			$	11,618,000
Federal income taxes			14,225,000				15,125,000				8,000,000
Noncash financing and investing activities:
Transfers from loans to foreclosed assets			887,000				414,000				2,203,000
Transfers from bank premises to other real estate owned			1,736,000				381,000				0

 

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See accompanying notes to consolidated financial statements.

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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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 (“Bank”), and of Mercantile Bank Real Estate Co., L.L.C. (“Mercantile Real Estate”) and Mercantile Insurance Center, Inc. (“Mercantile Insurance”), 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. The 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.

 

The Bank is a community-based financial institution. The 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. The 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, the 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.

 

Mercantile Real Estate 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.

 

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 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.

 

Securities: Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold prior to maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Federal Home Loan Bank stock is carried at cost.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

 

Declines in the fair value of debt securities below their amortized cost that are other than temporary (“OTTI”) are reflected in earnings or other comprehensive income, as appropriate. For those debt securities whose fair value is less than their amortized cost, we consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and whether we expect to recover the entire amortized cost of the security based on our assessment of the issuer’s financial condition. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies, and whether downgrades by bond rating agencies have occurred. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) OTTI related to other factors, such as liquidity conditions in the market or changes in market interest rates, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.

 

Loans: Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. Net unamortized deferred loan fees amounted to $1.0 million and $1.4 million, respectively, at December 31, 2017 and 2016.

 

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.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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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:

 

		2017				2016
Mortgage loans held for sale		$	2,553,000			$	1,035,000
Less: Allowance to adjust to lower of cost or market			0				0
Mortgage loans held for sale, net		$	2,553,000			$	1,035,000

 

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, 2017 and 2016.

 

Mortgage Banking Activities: Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.

 

Servicing fee income is recorded for fees earned for 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.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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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 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. 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 the 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) the 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.

 

Long-lived Assets: Premises and equipment and other long-lived assets 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.

 

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 $2.3 million and $0.5 million as of December 31, 2017 and 2016, respectively.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Bank Owned Life Insurance: The 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. The quantitative test is a two-step process consisting of comparing the carrying value of the reporting unit to an estimate of its fair value. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value. In 2016 and 2017, 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: The 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.

 

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.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

 

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.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Accounting Standards Updates: In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This ASU establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. This ASU was originally effective for annual and interim periods beginning after December 15, 2016, with three transition methods available – full retrospective, retrospective and cumulative effect approach. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers – Deferral of Effective Date, which delays the implementation of this guidance by one year. Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under GAAP, the new guidance will not have an impact on interest income. We have completed an overall assessment of revenue streams and reviewed the related contracts potentially affected by the ASU. We will adopt this ASU on January 1, 2018 utilizing the modified retrospective approach with a cumulative effect adjustment to opening retained earnings. We have determined that this ASU will not have a material effect on our financial position or results of operations. Expanded disclosure requirements will be included in the March 31, 2018 Form 10-Q.

 

In January 2016, the FASB issued ASU 2016-1, Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU requires an entity to (i) measure equity investments at fair value through net income, with certain exceptions; (ii) present in OCI the changes in instrument-specific credit risk for financial liabilities measured using the fair value option; (iii) present financial assets and financial liabilities by measurement category and form of financial asset; (iv) calculate the fair value of financial instruments for disclosure purposes based on an exit price; and (v) assess a valuation allowance on deferred tax assets related to unrealized losses on available for sale debt securities in combination with other deferred tax assets. This ASU provides an election to subsequently measure certain nonmarketable equity investments at cost less any impairment and adjusted for certain observable price changes. This ASU also requires a qualitative impairment assessment of such equity investments and amends certain fair value disclosure requirements. The amendments are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, and are not expected to have a material effect on our financial position or results of operations.

 

In February 2016, the FASB issued ASU 2016-02, Leases. This ASU establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The ASU is effective for annual and interim periods beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Adoption of this ASU is not expected to have a material effect on our financial position or results of operations.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting. This ASU requires that, prospectively, all tax effects related to share-based payments be made through the income statement at the time of settlement as opposed to excess tax benefits being recognized in additional paid-in capital under the current guidance. The ASU also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings. Additionally, all tax related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. Finally, entities will be allowed to withhold an amount up to the employees’ maximum individual tax rate (as opposed to the minimum statutory tax rate) in the relevant jurisdiction without resulting in liability classification of the award. The change in withholding requirements will be applied on a modified retrospective approach. This standard will be effective for annual and interim periods beginning after December 15, 2016. Adoption of this ASU did not have a material effect on our financial position or results of operations.

 

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (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, and early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). We are currently evaluating the provisions of this ASU to determine the potential impact the new standard will have on our consolidated financial statements. We are also in the process of selecting a software vendor for applying this new ASU, which we plan to implement later in 2018.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows and is effective for fiscal years beginning after December 15, 2017. The new standard will require adoption on a retrospective basis unless it is impractical to apply, in which case it would be required to apply the amendments prospectively as of the earliest date practicable. We are currently evaluating the provisions of this ASU to determine the potential impact the new standard will have on our consolidated financial statements.

 

In January 2017, the FASB issued ASU No. 2017-04, Goodwill and Other (Topic 350): Simplifying the Test for Goodwill impairment. This ASU simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this ASU, an entity should perform the Step 1 annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying value. If the carrying amount exceeds the fair value, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. This ASU is effective January 1, 2020 and early adoption is permitted. The ASU should be applied prospectively. We adopted this guidance on January 1, 2017. The adoption of this guidance had no material impact on our financial position, results of operations or cash flows.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In March 2017, the FASB issued ASU No. 2017-08, Premium Amortization on Purchased Callable Debt Securities. This ASU requires the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. Previously, entities were allowed to amortize to contractual maturity or to call date. This ASU is effective for annual reporting periods beginning after December 15, 2018, and early adoption is permitted. The provisions of this ASU will not have an impact on our financial position or results of operations as we have always amortized premiums to the earliest call date.

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The ASU changes the recognition and presentation requirements of hedge accounting, including eliminating the requirement to separately measure and report hedge ineffectiveness and presenting all items that affect earnings in the same income statement line as the hedged item. The ASU also eases certain documentation and assessment requirements and modifies the accounting components excluded from the assessment of hedge effectiveness. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the provisions of this ASU to determine the potential impact the new standard will have on our consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU requires reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The amount of the reclassification is the difference between the historical 35% corporate income tax rate and the newly enacted 21% corporate income tax rate. Because the amendments only relate to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws of rates be included in income from continuing operations is not affected. This ASU is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. We early adopted this ASU, which resulted in the reclassification of $0.9 million from accumulated other comprehensive income to retained earnings at December 31, 2017.

 

 

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.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 2 – BUSINESS COMBINATION (Continued)

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

 

 

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:

  

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
2017
U.S. Government agency debt obligations		$	175,953,000			$	99,000			$	(6,352,000	)		$	169,700,000
Mortgage-backed securities			38,967,000				335,000				(510,000	)			38,792,000
Municipal general obligation bonds			121,040,000				891,000				(638,000	)			121,293,000
Municipal revenue bonds			3,978,000				30,000				(30,000	)			3,978,000
Other investments			2,010,000				0				(29,000	)			1,981,000
		$	341,948,000			$	1,355,000			$	(7,559,000	)		$	335,744,000
2016
U.S. Government agency debt obligations		$	159,271,000			$	106,000			$	(7,337,000	)		$	152,040,000
Mortgage-backed securities			47,329,000				486,000				(423,000	)			47,392,000
Municipal general obligation bonds			120,284,000				312,000				(1,549,000	)			119,047,000
Municipal revenue bonds			7,699,000				23,000				(91,000	)			7,631,000
Other investments			1,979,000				0				(29,000	)			1,950,000
		$	336,562,000			$	927,000			$	(9,429,000	)		$	328,060,000

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 3 – SECURITIES (Continued)

Securities with unrealized losses at year-end 2017 and 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

 

		Less than 12 Months								12 Months or More								Total
Description of Securities		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
2017
U.S. Government agency debt obligations		$	35,677,000			$	434,000			$	115,374,000			$	5,918,000			$	151,051,000			$	6,352,000
Mortgage-backed securities			10,179,000				156,000				21,084,000				354,000				31,263,000				510,000
Municipal general obligation bonds			12,807,000				114,000				54,703,000				524,000				67,510,000				638,000
Municipal revenue bonds			0				0				1,187,000				30,000				1,187,000				30,000
Other investments			1,510,000				29,000				0				0				1,510,000				29,000
		$	60,173,000			$	733,000			$	192,348,000			$	6,826,000			$	252,521,000			$	7,559,000
2016
U.S. Government agency debt obligations		$	110,160,000			$	7,172,000			$	5,073,000			$	165,000			$	115,233,000			$	7,337,000
Mortgage-backed securities			3,670,000				4,000				37,072,000				419,000				40,742,000				423,000
Municipal general obligation bonds			65,895,000				1,360,000				27,734,000				189,000				93,629,000				1,549,000
Municipal revenue bonds			1,921,000				90,000				206,000				1,000				2,127,000				91,000
Other investments			1,479,000				29,000				0				0				1,479,000				29,000
		$	183,125,000			$	8,655,000			$	70,085,000			$	774,000			$	253,210,000			$	9,429,000

 

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, 2017, 325 debt securities and one mutual fund with fair values totaling $253 million had unrealized losses aggregating $7.6 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 3 – SECURITIES (Continued)

The amortized cost and fair values of debt securities at December 31, 2017, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

 

		Weighted Average Yield				Amortized Cost				Fair Value
Due in one year or less			1.74%			$	29,667,000			$	29,675,000
Due from one to five years			2.12				65,093,000				64,938,000
Due from five to ten years			2.52				100,128,000				97,943,000
Due after ten years			2.90				106,083,000				102,415,000
Mortgage-backed securities			2.17				38,967,000				38,792,000
Other investments			2.71				2,010,000				1,981,000
			2.46%			$	341,948,000			$	335,744,000

 

Mortgage-backed securities totaling $5.0 million were sold in 2017, resulting in a nominal net gain. No mortgage-backed securities were sold in 2016 or 2015. Municipal general obligation bonds totaling $2.6 million, $0.3 million and $1.5 million were sold during 2017, 2016 and 2015, respectively, 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 $112 million and $109 million at December 31, 2017 and December 31, 2016, respectively, with estimated market values of $112 million and $107 million at the respective dates. Securities issued by all other states and their political subdivisions had a combined amortized cost of $12.9 million and $19.5 million at December 31, 2017 and December 31, 2016, with estimated market values of $13.0 million and $19.5 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 $119 million and $132 million at December 31, 2017 and 2016, respectively. Investments in FHLBI stock are restricted and may only be resold to, or redeemed by, the issuer.

  

 

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.

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

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, 2017

 

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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:

 

		December 31, 2017								December 31, 2016								Percent Increase
		Balance				%				Balance				%				(Decrease)
Originated Loans
Commercial:
Commercial and industrial		$	680,805,000				31.3	%		$	636,771,000				33.8	%			6.9	%
Vacant land, land development, and residential construction			23,682,000				1.1				26,519,000				1.4				(10.7	)
Real estate – owner occupied			456,065,000				21.0				363,509,000				19.3				25.5
Real estate – non-owner occupied			708,824,000				32.7				652,054,000				34.6				8.7
Real estate – multi-family and residential rental			64,852,000				3.0				50,045,000				2.6				29.6
Total commercial			1,934,228,000				89.1				1,728,898,000				91.7				11.9
Retail:
Home equity and other			69,675,000				3.2				69,831,000				3.7				(0.2	)
1-4 family mortgages			166,054,000				7.7				85,819,000				4.6				93.5
Total retail			235,729,000				10.9				155,650,000				8.3				51.4
Total originated loans		$	2,169,957,000				100.0	%		$	1,884,548,000				100.0	%			15.1	%

 

---

(Continued)

 

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017 

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)  

		December 31, 2017								December 31, 2016								Percent Increase
		Balance				%				Balance				%				(Decrease)
Acquired Loans
Commercial:
Commercial and industrial		$	72,959,000				18.8	%		$	77,132,000				15.6	%			(5.4%	)
Vacant land, land development, and residential construction			6,191,000				1.6				8,309,000				1.7				(25.5	)
Real estate – owner occupied			70,263,000				18.1				86,955,000				17.6				(19.2	)
Real estate – non-owner occupied			82,861,000				21.3				96,215,000				19.5				(13.9	)
Real estate – multi-family and residential rental			37,066,000				9.5				67,838,000				13.7				(45.4	)
Total commercial			269,340,000				69.3				336,449,000				68.1				(19.9	)
Retail:
Home equity and other			30,750,000				7.9				48,216,000				9.8				(36.2	)
1-4 family mortgages			88,505,000				22.8				109,407,000				22.1				(19.1	)
Total retail			119,255,000				30.7				157,623,000				31.9				(24.3	)
Total acquired loans		$	388,595,000				100.0	%		$	494,072,000				100.0	%			(21.3%	)

 

 

		December 31, 2017								December 31, 2016								Percent Increase
		Balance				%				Balance				%				(Decrease)
Total Loans
Commercial:
Commercial and industrial		$	753,764,000				29.4	%		$	713,903,000				30.0	%			5.6	%
Vacant land, land development, and residential construction			29,873,000				1.2				34,828,000				1.5				(14.2	)
Real estate – owner occupied			526,328,000				20.6				450,464,000				18.9				16.8
Real estate – non-owner occupied			791,685,000				30.9				748,269,000				31.5				5.8
Real estate – multi-family and residential rental			101,918,000				4.0				117,883,000				4.9				(13.5	)
Total commercial			2,203,568,000				86.1				2,065,347,000				86.8				6.7
Retail:
Home equity and other			100,425,000				3.9				118,047,000				5.0				(14.9	)
1-4 family mortgages			254,559,000				10.0				195,226,000				8.2				30.4
Total retail			354,984,000				13.9				313,273,000				13.2				13.3
Total loans		$	2,558,552,000				100.0	%		$	2,378,620,000				100.0	%			7.6	%

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The total contractually required payments and carrying value of acquired impaired loans were $11.9 million and $5.2 million, respectively, as of December 31, 2017. The total contractually required payments and carrying value of acquired impaired loans were $15.5 million and $6.2 million, respectively, as of December 31, 2016. Changes in the accretable yield for acquired impaired loans for the years ended December 31, 2017 and December 31, 2016 were as follows:

 

		2017
Balance at December 31, 2016		$	1,726,000
Additions			223,000
Accretion income			(562,000	)
Net reclassification from nonaccretable to accretable			367,000
Reductions (1)			(350,000	)
Balance at December 31, 2017		$	1,404,000

 

		2016
Balance at December 31, 2015		$	5,193,000
Additions			245,000
Accretion income			(2,388,000	)
Net reclassification from nonaccretable to accretable			4,635,000
Reductions (1)			(1,761,000	)
Removal due to pool excess recovery (2)			(4,198,000	)
Balance at December 31, 2016		$	1,726,000

 

(1)

Reductions primarily reflect the result of exit events, including loan payoffs and charge-offs.

 

(2)

Cost recovery accounting occurs once a pool’s recorded investment is reduced to zero based on the outcome of the aggregated loan level activity at cash flow estimation. Proceeds received on pools in recovery status are deemed as recovery income, and are recorded as interest income as payments are received, with accretion no longer being recognized

 

 

Concentrations within the loan portfolio were as follows at year-end:

 

		2017								2016
						Percentage of								Percentage of
		Balance				Loan Portfolio				Balance				Loan Portfolio
Commercial real estate loans to lessors of non-residential buildings		$	547,841,000				21.4	%		$	562,902,000				23.7	%

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Year-end nonperforming originated loans were as follows:

		2017				2016
Loans past due 90 days or more still accruing interest		$	0			$	0
Nonaccrual loans			3,672,000				3,328,000
Total nonperforming loans		$	3,672,000			$	3,328,000

 

 

Year-end nonperforming acquired loans were as follows:

		2017				2016
Loans past due 90 days or more still accruing interest		$	0			$	0
Nonaccrual loans			3,471,000				2,611,000
Total nonperforming loans		$	3,471,000			$	2,611,000

 

 

The recorded principal balance of all nonperforming loans was as follows:

		December 31, 2017				December 31, 2016
Commercial:
Commercial and industrial		$	1,444,000			$	2,296,000
Vacant land, land development, and residential construction			35,000				95,000
Real estate – owner occupied			2,241,000				285,000
Real estate – non-owner occupied			0				488,000
Real estate – multi-family and residential rental			178,000				17,000
Total commercial			3,898,000				3,181,000
Retail:
Home equity and other			577,000				496,000
1-4 family mortgages			2,668,000				2,262,000
Total retail			3,245,000				2,758,000
Total nonperforming loans		$	7,143,000			$	5,939,000

 

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, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

An age analysis of past due loans is as follows as of December 31, 2017:

                    

		30 – 59 Days Past Due				60 – 89 Days Past Due				Greater Than 89 Days Past Due				Total Past Due				Current				Total Loans				Recorded Balance > 89 Days and Accruing
Originated Loans
Commercial:
Commercial and industrial		$	0			$	0			$	178,000			$	178,000			$	680,627,000			$	680,805,000			$	0
Vacant land, land development, and residential construction			0				0				35,000				35,000				23,647,000				23,682,000				0
Real estate – owner occupied			0				0				1,244,000				1,244,000				454,821,000				456,065,000				0
Real estate – non-owner occupied			0				0				0				0				708,824,000				708,824,000				0
Real estate – multi-family and residential rental			0				0				0				0				64,852,000				64,852,000				0
Total commercial			0				0				1,457,000				1,457,000				1,932,771,000				1,934,228,000				0
Retail:
Home equity and other			647,000				11,000				86,000				744,000				68,931,000				69,675,000				0
1- 4 family mortgages			0				0				250,000				250,000				165,804,000				166,054,000				0
Total retail			647,000				11,000				336,000				994,000				234,735,000				235,729,000				0
Total past due loans		$	647,000			$	11,000			$	1,793,000			$	2,451,000			$	2,167,506,000			$	2,169,957,000			$	0

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)                    

		30 – 59 Days Past Due				60 – 89 Days Past Due				Greater Than 89 Days Past Due				Total Past Due				Current				Total Loans				Recorded Balance > 89 Days and Accruing
Acquired Loans
Commercial:
Commercial and industrial		$	40,000			$	0			$	114,000			$	154,000			$	72,805,000			$	72,959,000			$	0
Vacant land, land development, and residential construction			14,000				0				0				14,000				6,177,000				6,191,000				0
Real estate – owner occupied			634,000				0				271,000				905,000				69,358,000				70,263,000				0
Real estate – non-owner occupied			0				0				0				0				82,861,000				82,861,000				0
Real estate – multi-family and residential rental			0				0				108,000				108,000				36,958,000				37,066,000				0
Total commercial			688,000				0				493,000				1,181,000				268,159,000				269,340,000				0
Retail:
Home equity and other			408,000				52,000				154,000				614,000				30,136,000				30,750,000				0
1- 4 family mortgages			690,000				333,000				661,000				1,684,000				86,821,000				88,505,000				0
Total retail			1,098,000				385,000				815,000				2,298,000				116,957,000				119,255,000				0
Total past due loans		$	1,786,000			$	385,000			$	1,308,000			$	3,479,000			$	385,116,000			$	388,595,000			$	0

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

An age analysis of past due loans is as follows as of December 31, 2016:

                    

		30 – 59 Days Past Due				60 – 89 Days Past Due				Greater Than 89 Days Past Due				Total Past Due				Current				Total Loans				Recorded Balance > 89 Days and Accruing
Originated Loans
Commercial:
Commercial and industrial		$	0			$	27,000			$	0			$	27,000			$	636,744,000			$	636,771,000			$	0
Vacant land, land development, and residential construction			0				0				0				0				26,519,000				26,519,000				0
Real estate – owner occupied			0				0				0				0				363,509,000				363,509,000				0
Real estate – non-owner occupied			0				0				0				0				652,054,000				652,054,000				0
Real estate – multi-family and residential rental			0				0				0				0				50,045,000				50,045,000				0
Total commercial			0				27,000				0				27,000				1,728,871,000				1,728,898,000				0
Retail:
Home equity and other			46,000				98,000				0				144,000				69,687,000				69,831,000				0
1- 4 family mortgages			758,000				122,000				337,000				1,217,000				84,602,000				85,819,000				0
Total retail			804,000				220,000				337,000				1,361,000				154,289,000				155,650,000				0
Total past due loans		$	804,000			$	247,000			$	337,000			$	1,388,000			$	1,883,160,000			$	1,884,548,000			$	0

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)                   

		30 – 59 Days Past Due				60 – 89 Days Past Due				Greater Than 89 Days Past Due				Total Past Due				Current				Total Loans				Recorded Balance > 89 Days and Accruing
Acquired Loans
Commercial:
Commercial and industrial		$	0			$	11,000			$	16,000			$	27,000			$	77,105,000			$	77,132,000			$	0
Vacant land, land development, and residential construction			0				0				0				0				8,309,000				8,309,000				0
Real estate – owner occupied			62,000				0				50,000				112,000				86,843,000				86,955,000				0
Real estate – non-owner occupied			0				0				353,000				353,000				95,862,000				96,215,000				0
Real estate – multi-family and residential rental			0				0				17,000				17,000				67,821,000				67,838,000				0
Total commercial			62,000				11,000				436,000				509,000				335,940,000				336,449,000				0
Retail:
Home equity and other			258,000				26,000				45,000				329,000				47,887,000				48,216,000				0
1- 4 family mortgages			1,255,000				467,000				439,000				2,161,000				107,246,000				109,407,000				0
Total retail			1,513,000				493,000				484,000				2,490,000				155,133,000				157,623,000				0
Total past due loans		$	1,575,000			$	504,000			$	920,000			$	2,999,000			$	491,073,000			$	494,072,000			$	0

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired originated loans with no related allowance recorded were as follows as of December 31, 2017:

  

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With no related allowance recorded:
Commercial:
Commercial and industrial		$	765,000			$	178,000							$	694,000
Vacant land, land development and residential construction			454,000				35,000								65,000
Real estate – owner occupied			1,528,000				1,452,000								442,000
Real estate – non-owner occupied			0				0								36,000
Real estate – multi-family and residential rental			349,000				349,000								221,000
Total commercial			3,096,000				2,014,000								1,458,000
Retail:
Home equity and other			693,000				680,000								526,000
1-4 family mortgages			1,126,000				456,000								596,000
Total retail			1,819,000				1,136,000								1,122,000
Total with no related allowance recorded		$	4,915,000			$	3,150,000							$	2,580,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2017:

 

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With an allowance recorded:
Commercial:
Commercial and industrial		$	3,038,000			$	2,989,000			$	963,000			$	3,314,000
Vacant land, land development and residential construction			0				0				0				449,000
Real estate – owner occupied			1,409,000				1,391,000				239,000				1,663,000
Real estate – non-owner occupied			0				0				0				2,055,000
Real estate – multi-family and residential rental			0				0				0				429,000
Total commercial			4,447,000				4,380,000				1,202,000				7,910,000
Retail:
Home equity and other			1,225,000				1,147,000				652,000				922,000
1-4 family mortgages			165,000				110,000				13,000				122,000
Total retail			1,390,000				1,257,000				665,000				1,044,000
Total with an allowance recorded		$	5,837,000			$	5,637,000			$	1,867,000			$	8,954,000
Total impaired loans:
Commercial		$	7,543,000			$	6,394,000			$	1,202,000			$	9,368,000
Retail			3,209,000				2,393,000				665,000				2,166,000
Total impaired originated loans		$	10,752,000			$	8,787,000			$	1,867,000			$	11,534,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired acquired loans with no related allowance recorded were as follows as of December 31, 2017:

 

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With no related allowance recorded:
Commercial:
Commercial and industrial		$	1,039,000			$	1,021,000							$	1,039,000
Vacant land, land development and residential construction			0				0								12,000
Real estate – owner occupied			1,027,000				659,000								1,005,000
Real estate – non-owner occupied			238,000				237,000								738,000
Real estate – multi-family and residential rental			237,000				218,000								408,000
Total commercial			2,541,000				2,135,000								3,202,000
Retail:
Home equity and other			694,000				507,000								417,000
1-4 family mortgages			2,703,000				2,153,000								1,885,000
Total retail			3,397,000				2,660,000								2,302,000
Total with no related allowance recorded		$	5,938,000			$	4,795,000							$	5,504,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2017:

   

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With an allowance recorded:
Commercial:
Commercial and industrial		$	0			$	0			$	0			$	10,000
Vacant land, land development and residential construction			0				0				0				0
Real estate – owner occupied			0				0				0				38,000
Real estate – non-owner occupied			0				0				0				0
Real estate – multi-family and residential rental			0				0				0				0
Total commercial			0				0				0				48,000
Retail:
Home equity and other			0				0				0				0
1-4 family mortgages			0				0				0				137,000
Total retail			0				0				0				137,000
Total with an allowance recorded		$	0			$	0			$	0			$	185,000
Total impaired loans:
Commercial		$	2,541,000			$	2,135,000			$	0			$	3,250,000
Retail			3,397,000				2,660,000				0				2,439,000
Total impaired acquired loans		$	5,938,000			$	4,795,000			$	0			$	5,689,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired originated loans with no related allowance recorded were as follows as of December 31, 2016:

  

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With no related allowance recorded:
Commercial:
Commercial and industrial		$	1,498,000			$	1,498,000							$	1,574,000
Vacant land, land development and residential construction			487,000				95,000								32,000
Real estate – owner occupied			0				0								270,000
Real estate – non-owner occupied			0				0								3,752,000
Real estate – multi-family and residential rental			130,000				130,000								43,000
Total commercial			2,115,000				1,723,000								5,671,000
Retail:
Home equity and other			114,000				114,000								99,000
1-4 family mortgages			1,270,000				630,000								813,000
Total retail			1,384,000				744,000								912,000
Total with no related allowance recorded		$	3,499,000			$	2,467,000							$	6,583,000

   

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2016:

 

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With an allowance recorded:
Commercial:
Commercial and industrial		$	2,405,000			$	2,382,000			$	673,000			$	717,000
Vacant land, land development and residential construction			999,000				999,000				28,000				1,011,000
Real estate – owner occupied			906,000				906,000				97,000				2,095,000
Real estate – non-owner occupied			5,020,000				5,020,000				247,000				3,641,000
Real estate – multi-family and residential rental			1,040,000				1,040,000				258,000				812,000
Total commercial			10,370,000				10,347,000				1,303,000				8,276,000
Retail:
Home equity and other			434,000				412,000				203,000				449,000
1-4 family mortgages			204,000				157,000				66,000				144,000
Total retail			638,000				569,000				269,000				593,000
Total with an allowance recorded		$	11,008,000			$	10,916,000			$	1,572,000			$	8,869,000
Total impaired loans:
Commercial		$	12,485,000			$	12,070,000			$	1,303,000			$	13,947,000
Retail			2,022,000				1,313,000				269,000				1,505,000
Total impaired originated loans		$	14,507,000			$	13,383,000			$	1,572,000			$	15,452,000

  

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired acquired loans with no related allowance recorded were as follows as of December 31, 2016:

   

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With no related allowance recorded:
Commercial:
Commercial and industrial		$	853,000			$	826,000							$	1,074,000
Vacant land, land development and residential construction			0				0								0
Real estate – owner occupied			1,281,000				1,210,000								1,145,000
Real estate – non-owner occupied			928,000				789,000								932,000
Real estate – multi-family and residential rental			152,000				89,000								303,000
Total commercial			3,214,000				2,914,000								3,454,000
Retail:
Home equity and other			531,000				351,000								389,000
1-4 family mortgages			2,081,000				1,629,000								1,562,000
Total retail			2,612,000				1,980,000								1,951,000
Total with no related allowance recorded		$	5,826,000			$	4,894,000							$	5,405,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2016:

 

		Unpaid Contractual Principal Balance				Recorded Principal Balance				Related Allowance				Year-To- Date Average Recorded Principal Balance
With an allowance recorded:
Commercial:
Commercial and industrial		$	19,000			$	19,000			$	2,000			$	207,000
Vacant land, land development and residential construction			0				0				0				0
Real estate – owner occupied			48,000				48,000				3,000				38,000
Real estate – non-owner occupied			0				0				0				0
Real estate – multi-family and residential rental			0				0				0				5,000
Total commercial			67,000				67,000				5,000				250,000
Retail:
Home equity and other			0				0				0				0
1-4 family mortgages			172,000				172,000				4,000				120,000
Total retail			172,000				172,000				4,000				120,000
Total with an allowance recorded		$	239,000			$	239,000			$	9,000			$	370,000
Total impaired loans:
Commercial		$	3,281,000			$	2,981,000			$	5,000			$	3,704,000
Retail			2,784,000				2,152,000				4,000				2,071,000
Total impaired acquired loans		$	6,065,000			$	5,133,000			$	9,000			$	5,775,000

 

 

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 $0.4 million, $1.2 million and $2.4 million during 2017, 2016 and 2015, respectively. Interest income recognized on nonaccrual loans totaled $0.5 million, less than $0.1 million, and $1.7 million during 2017, 2016 and 2015, respectively, reflecting the collection of interest at the time of principal pay-off. Lost interest income on nonaccrual loans totaled $0.3 million, $0.1 million and $0.3 million during 2017, 2016 and 2015, respectively.

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

 

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, 2017:

 

Originated Loans

 

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

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Internal credit risk grade groupings:
Grades 1 – 4		$	469,537,000			$	15,090,000			$	326,700,000			$	559,388,000			$	42,951,000
Grades 5 – 7			189,851,000				8,557,000				123,024,000				149,135,000				21,552,000
Grades 8 – 9			21,417,000				35,000				6,341,000				301,000				349,000
Total commercial		$	680,805,000			$	23,682,000			$	456,065,000			$	708,824,000			$	64,852,000

 

Retail credit exposure – credit risk profiled by collateral type:

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Total retail		$	69,675,000			$	166,054,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

 

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Acquired Loans

 

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

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Internal credit risk grade groupings:
Grades 1 – 4		$	46,263,000			$	1,446,000			$	28,706,000			$	52,674,000			$	17,499,000
Grades 5 – 7			25,654,000				4,745,000				39,565,000				30,102,000				19,212,000
Grades 8 – 9			1,042,000				0				1,992,000				85,000				355,000
Total commercial		$	72,959,000			$	6,191,000			$	70,263,000			$	82,861,000			$	37,066,000

 

Retail credit exposure – credit risk profiled by collateral type:

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Total retail		$	30,750,000			$	88,505,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

 

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

 

Loans by credit quality indicators were as follows as of December 31, 2016:

 

Originated Loans

 

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

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Internal credit risk grade groupings:
Grades 1 – 4		$	440,219,000			$	16,378,000			$	238,890,000			$	542,294,000			$	29,793,000
Grades 5 – 7			190,170,000				10,046,000				123,517,000				109,304,000				19,082,000
Grades 8 – 9			6,382,000				95,000				1,102,000				456,000				1,170,000
Total commercial		$	636,771,000			$	26,519,000			$	363,509,000			$	652,054,000			$	50,045,000

 

 

Retail credit exposure – credit risk profiled by collateral type:

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Total retail		$	69,831,000			$	85,819,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued) 

Acquired Loans

 

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

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Internal credit risk grade groupings:
Grades 1 – 4		$	40,911,000			$	1,887,000			$	36,246,000			$	57,671,000			$	39,574,000
Grades 5 – 7			35,233,000				6,164,000				49,255,000				37,040,000				28,015,000
Grades 8 – 9			988,000				258,000				1,454,000				1,504,000				249,000
Total commercial		$	77,132,000			$	8,309,000			$	86,955,000			$	96,215,000			$	67,838,000

 

 

Retail credit exposure – credit risk profiled by collateral type:

 

		Retail				Retail
		Home Equity				1-4 Family
		and Other				Mortgages
Total retail		$	48,216,000			$	109,407,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2017

 

---

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:

  

		Commercial Loans				Retail Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	16,026,000			$	1,882,000			$	(40,000	)		$	17,868,000
Provision for loan losses			1,148,000				1,360,000				133,000				2,641,000
Charge-offs			(2,292,000	)			(891,000	)			0				(3,183,000	)
Recoveries			1,574,000				233,000				0				1,807,000
Ending balance		$	16,456,000			$	2,584,000			$	93,000			$	19,133,000
Ending balance: individually evaluated for impairment		$	1,202,000			$	665,000			$	0			$	1,867,000
Ending balance: collectively evaluated for impairment		$	15,254,000			$	1,919,000			$	93,000			$	17,266,000
Total loans:
Ending balance		$	1,934,228,000			$	235,729,000							$	2,169,957,000
Ending balance: individually evaluated for impairment		$	6,394,000			$	2,393,000							$	8,787,000
Ending balance: collectively evaluated for impairment		$	1,927,834,000			$	233,336,000							$	2,161,170,000

 

 

The allowance for acquired loan losses for the year-ended December 31, 2017 is as follows:

  

		Commercial Loans				Retail Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	75,000			$	18,000			$	0			$	93,000
Provision for loan losses			210,000				99,000				0				309,000
Charge-offs			(12,000	)			(40,000	)			0				(52,000	)
Recoveries			18,000				0				0				18,000
Ending balance		$	291,000			$	77,000			$	0			$	368,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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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, 2016 are as follows:

 

		Commercial Loans				Retail Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	13,672,000			$	1,421,000			$	140,000			$	15,233,000
Provision for loan losses			2,247,000				1,031,000				(180,000	)			3,098,000
Charge-offs			(980,000	)			(1,153,000	)			0				(2,133,000	)
Recoveries			1,087,000				583,000				0				1,670,000
Ending balance		$	16,026,000			$	1,882,000			$	(40,000	)		$	17,868,000
Ending balance: individually evaluated for impairment		$	1,303,000			$	269,000			$	0			$	1,572,000
Ending balance: collectively evaluated for impairment		$	14,723,000			$	1,613,000			$	(40,000	)		$	16,296,000
Total loans:
Ending balance		$	1,728,898,000			$	155,650,000							$	1,884,548,000
Ending balance: individually evaluated for impairment		$	12,070,000			$	1,313,000							$	13,383,000
Ending balance: collectively evaluated for impairment		$	1,716,828,000			$	154,337,000							$	1,871,165,000

 

 

The allowance for acquired loan losses for the year-ended December 31, 2016 is as follows:

 

		Commercial Loans				Retail Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	420,000			$	28,000			$	0			$	448,000
Provision for loan losses			(303,000	)			105,000				0				(198,000	)
Charge-offs			0				(72,000	)			0				(72,000	)
Recoveries			(42,000	)			(43,000	)			0				(85,000	)
Ending balance		$	75,000			$	18,000			$	0			$	93,000

 

The negative loan recoveries reflected for acquired loans during 2016 resulted from reversals of prior period recoveries associated with certain purchased credit impaired loans that were subject to pre-acquisition charge-offs. Post-acquisition payments received on these loans were previously reported as loan loss recoveries in prior periods; during 2016 these recoveries were reversed and reported as recovery income if associated with specifically reviewed purchase credit impaired loans or retained gains if associated with purchase credit impaired pooled loans.

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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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, 2015 are as follows:

 

		Commercial Loans				Retail Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	17,736,000			$	1,487,000			$	76,000			$	19,299,000
Provision for loan losses			(1,771,000	)			1,006,000				64,000				(701,000	)
Charge-offs			(4,915,000	)			(1,280,000	)			0				(6,195,000	)
Recoveries			2,622,000				208,000				0				2,830,000
Ending balance		$	13,672,000			$	1,421,000			$	140,000			$	15,233,000
Ending balance: individually evaluated for impairment		$	1,218,000			$	256,000			$	0			$	1,474,000
Ending balance: collectively evaluated for impairment		$	12,454,000			$	1,165,000			$	140,000			$	13,759,000
Total loans:
Ending balance		$	1,493,516,000			$	123,071,000							$	1,616,587,000
Ending balance: individually evaluated for impairment		$	16,845,000			$	1,352,000							$	18,197,000
Ending balance: collectively evaluated for impairment		$	1,476,671,000			$	121,719,000							$	1,598,390,000

  

 

The allowance for acquired loan losses for the year-ended December 31, 2015 is as follows:

 

		Commercial Loans				Retail Loans				Unallocated				Total
Allowance for loan losses:
Beginning balance		$	738,000			$	4,000			$	0			$	742,000
Provision for loan losses			(286,000	)			(13,000	)			0				(299,000	)
Charge-offs			(77,000	)			(7,000	)			0				(84,000	)
Recoveries			45,000				44,000				0				89,000
Ending balance		$	420,000			$	28,000			$	0			$	448,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans modified as troubled debt restructurings during the year-ended December 31, 2017 were as follows:

 

						Pre-				Post-
						Modification				Modification
						Recorded				Recorded
		Number of				Principal				Principal
		Contracts				Balance				Balance
Originated Loans
Commercial:
Commercial and industrial			8			$	3,771,000			$	3,831,000
Vacant land, land development and residential construction			0				0				0
Real estate – owner occupied			4				1,195,000				1,195,000
Real estate – non-owner occupied			0				0				0
Real estate – multi-family and residential rental			0				0				0
Total commercial			12				4,966,000				5,026,000
Retail:
Home equity and other			8				670,000				671,000
1-4 family mortgages			0				0				0
Total retail			8				670,000				671,000
Total			20			$	5,636,000			$	5,697,000
Acquired Loans
Commercial:
Commercial and industrial			2			$	399,000			$	399,000
Vacant land, land development and residential construction			0				0				0
Real estate – owner occupied			1				33,000				33,000
Real estate – non-owner occupied			0				0				0
Real estate – multi-family and residential rental			0				0				0
Total commercial			3				432,000				432,000
Retail:
Home equity and other			7				192,000				195,000
1-4 family mortgages			4				200,000				200,000
Total retail			11				392,000				395,000
Total			14			$	824,000			$	827,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans modified as troubled debt restructurings during the year-ended December 31, 2016 were as follows:

 

						Pre-				Post-
						Modification				Modification
						Recorded				Recorded
		Number of				Principal				Principal
		Contracts				Balance				Balance
Originated Loans
Commercial:
Commercial and industrial			8			$	1,445,000			$	2,103,000
Vacant land, land development and residential construction			0				0				0
Real estate – owner occupied			1				167,000				167,000
Real estate – non-owner occupied			1				462,000				462,000
Real estate – multi-family and residential rental			4				165,000				276,000
Total commercial			14				2,239,000				3,008,000
Retail:
Home equity and other			3				240,000				240,000
1-4 family mortgages			1				33,000				40,000
Total retail			4				273,000				280,000
Total			18			$	2,512,000			$	3,288,000
Acquired Loans
Commercial:
Commercial and industrial			0			$	0			$	0
Vacant land, land development and residential construction			0				0				0
Real estate – owner occupied			3				739,000				739,000
Real estate – non-owner occupied			2				209,000				209,000
Real estate – multi-family and residential rental			1				7,000				7,000
Total commercial			6				955,000				955,000
Retail:
Home equity and other			4				93,000				94,000
1-4 family mortgages			1				19,000				19,000
Total retail			5				112,000				113,000
Total			11			$	1,067,000			$	1,068,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2017 (amounts as of period end):

 

		Number of Contracts				Recorded Principal Balance
Commercial:
Commercial and industrial			0			$	0
Vacant land, land development and residential construction			0				0
Real estate – owner occupied			0				0
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			0				0
Retail:
Home equity and other			0				0
1-4 family mortgages			0				0
Total retail			0				0
Total			0			$	0

  

 

The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2017 (amounts as of period end):

 

		Number of Contracts				Recorded Principal Balance
Commercial:
Commercial and industrial			1			$	114,000
Vacant land, land development and residential construction			0				0
Real estate – owner occupied			0				0
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			1				114,000
Retail:
Home equity and other			2				102,000
1-4 family mortgages			0				0
Total retail			2				102,000
Total			3			$	216,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2016 (amounts as of period end):

 

		Number of Contracts				Recorded Principal Balance
Commercial:
Commercial and industrial			0			$	0
Vacant land, land development and residential construction			0				0
Real estate – owner occupied			0				0
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			0				0
Retail:
Home equity and other			0				0
1-4 family mortgages			0				0
Total retail			0				0
Total			0			$	0

  

 

The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2016 (amounts as of period end):

 

		Number of Contracts				Recorded Principal Balance
Commercial:
Commercial and industrial			0			$	0
Vacant land, land development and residential construction			0				0
Real estate – owner occupied			0				0
Real estate – non-owner occupied			0				0
Real estate – multi-family and residential rental			0				0
Total commercial			0				0
Retail:
Home equity and other			0				0
1-4 family mortgages			0				0
Total retail			0				0
Total			0			$	0

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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:

  

		Commercial and				Commercial Vacant Land, Land Development, and Residential				Commercial Real Estate - Owner				Commercial Real Estate - Non-Owner				Commercial Real Estate - Multi-Family and Residential
		Industrial				Construction				Occupied				Occupied				Rental
Commercial Loan Portfolio:
Beginning Balance		$	1,503,000			$	1,488,000			$	906,000			$	5,110,000			$	716,000
Charge-Offs			0				0				0				0				0
Payments			(2,021,000	)			(1,105,000	)			(242,000	)			(232,000	)			(405,000	)
Transfers to ORE			0				0				0				0				0
Net Additions/Deletions			3,507,000				0				935,000				(4,878,000	)			(311,000	)
Ending Balance		$	2,989,000			$	383,000			$	1,599,000			$	0			$	0

 

  

		Retail Home Equity and Other				Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance		$	385,000			$	157,000
Charge-Offs			0				0
Payments			(57,000	)			(11,000	)
Transfers to ORE			0				0
Net Additions/Deletions			799,000				0
Ending Balance		$	1,127,000			$	146,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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:

          

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Commercial Loan Portfolio:
Beginning Balance		$	1,125,000			$	0			$	900,000			$	728,000			$	60,000
Charge-Offs			0				0				(249,000	)			0				0
Payments			(550,000	)			(33,000	)			(257,000	)			(922,000	)			(1,084,000	)
Transfers to ORE			0				0				0				(291,000	)			0
Net Additions/Deletions			426,000				33,000				33,000				722,000				1,065,000
Ending Balance		$	1,001,000			$	0			$	427,000			$	237,000			$	41,000

 

   

		Retail Home Equity and Other				Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance		$	208,000			$	326,000
Charge-Offs			(25,000	)			0
Payments			(121,000	)			(188,000	)
Transfers to ORE			0				0
Net Additions/Deletions			157,000				255,000
Ending Balance		$	219,000			$	393,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for originated loans categorized as troubled debt restructurings during the year-ended December 31, 2016 is as follows:

  

		Commercial and				Commercial Vacant Land, Land Development, and Residential				Commercial Real Estate - Owner				Commercial Real Estate - Non-Owner				Commercial Real Estate - Multi-Family and Residential
		Industrial				Construction				Occupied				Occupied				Rental
Commercial Loan Portfolio:
Beginning Balance		$	2,028,000			$	2,086,000			$	1,400,000			$	10,657,000			$	476,000
Charge-Offs			0				0				0				0				0
Payments			(555,000	)			(598,000	)			(591,000	)			(6,004,000	)			(30,000	)
Transfers to ORE			0				0				0				0				0
Net Additions/Deletions			30,000				0				97,000				457,000				270,000
Ending Balance		$	1,503,000			$	1,488,000			$	906,000			$	5,110,000			$	716,000

 

   

		Retail Home Equity and Other				Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance		$	146,000			$	128,000
Charge-Offs			0				0
Payments			(1,000	)			(11,000	)
Transfers to ORE			0				0
Net Additions/Deletions			240,000				40,000
Ending Balance		$	385,000			$	157,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for acquired loans categorized as troubled debt restructurings during the year-ended December 31, 2016 is as follows:

   

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Commercial Loan Portfolio:
Beginning Balance		$	1,686,000			$	0			$	1,652,000			$	647,000			$	331,000
Charge-Offs			(48,000	)			0				0				0				0
Payments			(513,000	)			0				(1,514,000	)			(110,000	)			(278,000	)
Transfers to ORE			0				0				0				0				0
Net Additions/Deletions			0				0				762,000				191,000				7,000
Ending Balance		$	1,125,000			$	0			$	900,000			$	728,000			$	60,000

 

 

		Retail Home Equity and Other				Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance		$	141,000			$	316,000
Charge-Offs			0				0
Payments			(30,000	)			(9,000	)
Transfers to ORE			0				0
Net Additions/Deletions			97,000				19,000
Ending Balance		$	208,000			$	326,000

   

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for originated loans categorized as troubled debt restructurings during the year-ended December 31, 2015 is as follows:

   

		Commercial and				Commercial Vacant Land, Land Development, and Residential				Commercial Real Estate - Owner				Commercial Real Estate - Non-Owner				Commercial Real Estate - Multi-Family and Residential
		Industrial				Construction				Occupied				Occupied				Rental
Commercial Loan Portfolio:
Beginning Balance		$	7,026,000			$	2,680,000			$	17,160,000			$	17,439,000			$	505,000
Charge-Offs			0				0				(4,198,000	)			0				0
Payments			(6,648,000	)			(594,000	)			(11,562,000	)			(6,782,000	)			(29,000	)
Transfers to ORE			0				0				0				0				0
Net Additions/Deletions			1,650,000				0				0				0				0
Ending Balance		$	2,028,000			$	2,086,000			$	1,400,000			$	10,657,000			$	476,000

 

 

		Retail Home Equity and Other				Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance		$	0			$	1,967,000
Charge-Offs			0				(148,000	)
Payments			0				(1,691,000	)
Transfers to ORE			0				0
Net Additions/Deletions			146,000				0
Ending Balance		$	146,000			$	128,000

   

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity for acquired loans categorized as troubled debt restructurings during the year-ended December 31, 2015 is as follows:

 

		Commercial and Industrial				Commercial Vacant Land, Land Development, and Residential Construction				Commercial Real Estate - Owner Occupied				Commercial Real Estate - Non-Owner Occupied				Commercial Real Estate - Multi-Family and Residential Rental
Commercial Loan Portfolio:
Beginning Balance		$	1,439,000			$	0			$	1,569,000			$	64,000			$	381,000
Charge-Offs			0				0				(31,000	)			0				(42,000	)
Payments			(444,000	)			0				(590,000	)			(9,000	)			(342,000	)
Transfers to ORE			0				0				0				0				0
Net Additions/Deletions			691,000				0				704,000				592,000				334,000
Ending Balance		$	1,686,000			$	0			$	1,652,000			$	647,000			$	331,000

 

 

		Retail Home Equity and Other				Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance		$	26,000			$	178,000
Charge-Offs			0				0
Payments			(39,000	)			(3,000	)
Transfers to ORE			0				0
Net Additions/Deletions			154,000				141,000
Ending Balance		$	141,000			$	316,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

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

  

		December 31, 2017				December 31, 2016
Commercial:
Commercial and industrial		$	107,000			$	9,000
Vacant land, land development, and residential construction			0				28,000
Real estate – owner occupied			141,000				100,000
Real estate – non-owner occupied			0				247,000
Real estate – multi-family and residential rental			0				258,000
Total commercial			248,000				642,000
Retail:
Home equity and other			196,000				48,000
1-4 family mortgages			0				4,000
Total retail			196,000				52,000
Total related allowance		$	444,000			$	694,000

 

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

  

 

NOTE 5 - PREMISES AND EQUIPMENT, NET

 

Year-end premises and equipment were as follows:

 

		2017				2016
Land and improvements		$	18,046,000			$	17,285,000
Buildings			41,179,000				39,691,000
Furniture and equipment			17,398,000				17,195,000
			76,623,000				74,171,000
Less: accumulated depreciation			30,589,000				28,715,000
Total premises and equipment		$	46,034,000			$	45,456,000

 

 

Future lease payments total $1.4 million, comprised of $0.4 million in one year, $0.5 million in one to three years, $0.3 million in three to five years and $0.2 million in over five years. Depreciation expense totaled $3.0 million in 2017, $2.9 million in 2016, and $3.0 million in 2015.

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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:

 

		2017				2016
Mortgage loan portfolios serviced for:
Federal Home Loan Mortgage Corporation		$	600,495,000			$	597,389,000
Federal Home Loan Bank			13,136,000				10,501,000
Total mortgage loans serviced for others		$	613,631,000			$	607,890,000

  

Custodial escrow balances maintained in connection with serviced loans were $4.7 million and $4.6 million as of December 31, 2017 and December 31, 2016, respectively.

 

Activity for capitalized mortgage loan servicing rights during 2017 and 2016 was as follows:

  

		2017				2016
Balance at beginning of year		$	5,544,000			$	6,121,000
Additions			1,229,000				1,378,000
Amortized to expense			(1,667,000	)			(1,955,000	)
Balance at end of year		$	5,106,000			$	5,544,000

 

We determined that no valuation allowance was necessary as of December 31, 2017 or December 31, 2016. The estimated fair value of mortgage servicing rights was $8.4 million and $8.0 million as of December 31, 2017 and December 31, 2016, 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 2017, fair value was determined using a discount rate of 7.50%, a weighted average constant prepayment rate of 11.8%, depending on the stratification of the specific right, and a weighted average delinquency rate of 0.73%. During 2016, fair value was determined using a discount rate of 7.01%, a weighted average constant prepayment rate of 11.5%, depending on the stratification of the specific right, and a weighted average delinquency rate of 0.68%.

 

The weighted average amortization period was 3.4 years and 3.6 years as of December 31, 2017 and December 31, 2016, respectively. Estimated amortization as of December 31, 2017 is as follows:

   

2018		$	1,213,000
2019			1,036,000
2020			867,000
2021			708,000
2022			557,000
Thereafter			725,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 7 – CORE DEPOSIT INTANGIBLE ASSETS, NET

The gross carrying amount of core deposit intangible assets totaled $17.5 million as of December 31, 2017 and December 31, 2016. As of December 31, 2017, the accumulated amortization on core deposit intangible assets was $9.9 million, providing for a net carry balance of $7.6 million. As of December 31, 2016, the accumulated amortization on core deposit intangible assets was $7.5 million, providing for a net carry balance of $10.0 million.

 

The scheduled amortization expense on core deposit intangible assets in future periods is:

   

2018		$	2,039,000
2019			1,721,000
2020			1,403,000
2021			1,086,000
2022			768,000
Thereafter			583,000

 

 

NOTE 8 – DEPOSITS

 

Deposits at year-end are summarized as follows:

		December 31, 2017								December 31, 2016								Percent Increase
		Balance				%				Balance				%				(Decrease)
Noninterest-bearing demand		$	866,380,000				34.3	%		$	810,600,000				34.1	%			6.9	%
Interest-bearing checking			387,758,000				15.4				377,929,000				15.9				2.6
Money market			427,119,000				16.9				272,051,000				11.5				57.0
Savings			327,530,000				13.0				344,988,000				14.5				(5.1	)
Time, under $100,000			152,294,000				6.0				146,169,000				6.2				4.2
Time, $100,000 and over			258,626,000				10.3				347,058,000				14.6				(25.5	)
Total local deposits			2,419,707,000				95.9				2,298,795,000				96.8				5.3
Out-of-area time, under $100,000			0				NM				0				NM				NM
Out-of-area time, $100,000 and over			102,658,000				4.1				76,190,000				3.2				34.7
Total out-of-area deposits			102,658,000				4.1				76,190,000				3.2				34.7
Total deposits		$	2,522,365,000				100.0	%		$	2,374,985,000				100.0	%			6.2	%

 

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, 2017

 

---

NOTE 8 – DEPOSITS (Continued)

The following table depicts the maturity distribution for time deposits at year-end:

 

		2017				2016
In one year or less		$	283,844,000			$	358,259,000
In one to two years			77,689,000				92,042,000
In two to three years			78,090,000				34,204,000
In three to four years			33,061,000				35,523,000
In four to five years			40,894,000				49,389,000
Total certificates of deposit		$	513,578,000			$	569,417,000

 

The following table depicts the maturity distribution for time deposits with balances of $100,000 or more at year-end:

 

		2017				2016
Up to three months		$	50,258,000			$	101,444,000
Three months to six months			68,011,000				87,277,000
Six months to twelve months			96,951,000				79,656,000
Over twelve months			146,064,000				154,871,000
Total certificates of deposit		$	361,284,000			$	423,248,000

 

Total time deposits of more than $250,000 totaled $266 million and $214 million at year-end 2017 and 2016, respectively.

 

 

NOTE 9 – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

 

Information regarding securities sold under agreements to repurchase at year-end is summarized below:

 

		2017				2016
Outstanding balance at year-end		$	118,748,000			$	131,710,000
Weighted average interest rate at year-end			0.16	%			0.16	%
Average daily balance during the year		$	116,587,000			$	149,079,000
Weighted average interest rate during the year			0.16	%			0.14	%
Maximum daily balance during the year		$	142,459,000			$	175,088,000

 

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, 2017

 

---

NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $220 million at December 31, 2017, and were expected to mature at varying dates from May 2018 through April 2024, with fixed rates of interest from 1.04% to 2.39% and averaging 1.72%. FHLBI advances totaled $175 million at December 31, 2016, and were expected to mature at varying dates ranging from March 2017 through April 2023, with fixed rates of interest from 1.04% to 2.11% and averaging 1.48%.

 

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, 2017 totaled $731 million, with availability of $511 million.

 

Scheduled maturities as of December 31, 2017:

  

2018		$	20,000,000
2019			40,000,000
2020			30,000,000
2021			40,000,000
2022			40,000,000
Thereafter			50,000,000

  

 

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 are 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 is recorded to income tax expense in the year the tax law is 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 allows 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, and will continue to refine the measurement of the net deferred tax balance during the preparation of our 2017 tax return as additional guidance and information becomes available.

 

The consolidated income tax expense is as follows:

 

		2017				2016				2015
Current expense		$	13,978,000			$	15,786,000			$	7,399,000
Deferred expense			(505,000	)			(699,000	)			4,592,000
Effect of federal tax law change			1,336,000				0				0
Change in valuation allowance			0				(113,000	)			(180,000	)
Tax expense		$	14,809,000			$	14,974,000			$	11,811,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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:

 

		2017				2016				2015
Tax at statutory rate (35%)		$	16,129,000			$	16,410,000			$	13,591,000
Increase (decrease) from
Tax-exempt interest			(1,030,000	)			(876,000	)			(781,000	)
Bank owned life insurance			(948,000	)			(440,000	)			(384,000	)
Effect of federal tax law change			1,336,000				0				0
Change in valuation allowance			0				(113,000	)			(180,000	)
Other			(678,000	)			(7,000	)			(435,000	)
Tax expense		$	14,809,000			$	14,974,000			$	11,811,000

 

 

Significant components of deferred tax assets and liabilities as of December 31, 2017 and 2016 are as follows:

 

		2017				2016
Deferred income tax assets
Allowance for loan losses		$	4,095,000			$	6,286,000
Deferred compensation			673,000				1,175,000
Stock compensation			501,000				786,000
Nonaccrual loan interest income			425,000				623,000
Deferred loan fees			211,000				496,000
Capital loss carryforward			94,000				157,000
Fair value write-downs on foreclosed properties			23,000				24,000
Fair value of interest rate swap			0				30,000
Unrealized loss on securities			1,303,000				2,976,000
Other			311,000				408,000
Deferred tax asset before valuation allowance			7,636,000				12,961,000
Valuation allowance			(94,000	)			(157,000	)
Deferred tax asset after valuation allowance			7,542,000				12,804,000
Deferred income tax liabilities
Depreciation			727,000				928,000
Prepaid expenses			244,000				463,000
Core deposit intangible			1,565,000				3,423,000
Mortgage loan servicing rights			1,072,000				1,940,000
Business combination adjustments			1,784,000				2,183,000
Other			146,000				199,000
Deferred tax liability			5,538,000				9,136,000
Total net deferred tax asset		$	2,004,000			$	3,668,000

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

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, 2017 and 2016, we carried a valuation allowance of $0.1 million and $0.2 million, respectively, against capital loss carryforwards generated by the disposal of certain capital investments acquired in our merger with Firstbank. During 2017 and 2016, we reversed $0.0 million and $0.1 million, respectively, of the valuation allowance due to generation of capital gains during the year. The remaining $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 2017 or 2016 and do not anticipate any significant increase in unrecognized tax benefits during 2018. 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 2017 or 2016. Our U.S. federal income tax returns are no longer subject to examination for all years before 2014.

 

 

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 through the Stock Incentive Plan of 2006. During 2016 and 2017, restricted stock grants were provided to certain employees through the Stock Incentive Plan of 2016. Stock option grants were also provided to certain employees during 2016 through the Stock Incentive Plan of 2016. Stock grants were provided to directors as retainer payments during 2014 and 2015 through the Stock Incentive Plan of 2006, and during 2016 and 2017 through the Stock Incentive Plan of 2016. 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 2014, 2015, 2016 and 2017 fully vest after three years. 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 2017, there were approximately 314,000 shares authorized for future incentive awards.

 

In conjunction with the Firstbank merger, all of our outstanding restricted stock awards, which were scheduled to vest in full in November, 2014, became fully vested on June 1, 2014. The unrecognized compensation cost related to restricted stock grants was $5.7 million as of December 31, 2017, which will be recognized as expense over the next three years.

 

Also 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, 2017

 

---

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:

 

		2017								2016								2015
		Shares				Weighted Average Fair Value				Shares				Weighted Average Fair Value				Shares				Weighted Average Fair Value
Nonvested at beginning of year			228,343			$	26.09				155,501			$	22.25				101,490			$	20.13
Granted			94,592				37.11				86,250				32.19				65,933				25.14
Vested			(74,979	)			20.17				(7,622	)			20.23				(4,666	)			20.13
Forfeited			(8,319	)			23.75				(5,786	)			21.90				(7,256	)			20.13
Nonvested at end of year			239,637			$	32.37				228,343			$	26.09				155,501			$	22.25

  

 

A summary of stock option activity from grants issued under Mercantile plans during the past three years is as follows:

 

		2017								2016								2015
		Shares				Weighted Average Exercise Price				Shares				Weighted Average Exercise Price				Shares				Weighted Average Exercise Price
Outstanding at beginning of year			16,808			$	29.17				11,308			$	24.50				35,335			$	31.09
Granted			0				NA				6,500				36.22				4,820				27.66
Exercised			(1,000	)			22.15				(1,000	)			22.15				(2,700	)			6.21
Forfeited or expired			0				NA				0				NA				(26,147	)			35.88
Outstanding at end of year			15,808			$	29.62				16,808			$	29.17				11,308			$	24.50
Options exercisable at year-end			9,308			$	25.00				5,488			$	22.15				0			$	NA

  

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.

  

The fair value of stock options granted during 2016 and 2015 was determined using the following weighted-average assumptions as of the grant date. No stock options were granted in 2017.    

		2016				2015
Risk-free interest rate			1.78	%			1.67	%
Expected option life (years)			5				5
Expected stock price volatility			26	%			29	%
Dividend yield			2.5	%			2.5	%

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

---

NOTE 12 – STOCK-BASED COMPENSATION (Continued)

Options issued under Mercantile plans outstanding at year-end 2017 were as follows:

  

				Outstanding												Exercisable
								Weighted Average				Weighted								Weighted
Range of								Remaining				Average								Average
Exercise								Contractual				Exercise								Exercise
Prices				Number				Life (Years)				Price				Number				Price
$20.00	-	$24.00			4,488				3.9			$	22.15				4,488				22.15
$24.01	-	$28.00			4,820				4.9				27.66				4,820				27.66
$36.00	-	$40.00			6,500				5.9				36.22				0			NA
Outstanding at year end					15,808				5.0			$	29.62				9,308				25.00

 

 

Information related to options issued under various Mercantile plans outstanding at year-end 2017, 2016 and 2015 is as follows:

    

		2017				2016				2015
Minimum exercise price		$	22.15			$	22.15			$	22.15
Maximum exercise price			36.22				36.22				27.66
Average remaining option term (years)			5.0				6.7				6.3

 

 

Information related to stock option grants and exercises issued under various Mercantile plans during 2017, 2016 and 2015 is as follows:

    

		2017				2016				2015
Aggregate intrinsic value of stock options exercised		$	15,000			$	6,000			$	36,000
Cash received from stock option exercises			0				22,000				17,000
Tax benefit realized from stock option exercises			0				0				0
Weighted average per share fair value of stock options granted			2.72				5.25				4.41

 

 

The aggregate intrinsic value of all stock options issued under Mercantile plans outstanding and exercisable at December 31, 2017 was $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, 2017

 

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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:

 

		2017								2016								2015
		Shares				Weighted Average Exercise Price				Shares				Weighted Average Exercise Price				Shares				Weighted Average Exercise Price
Outstanding at beginning of year			44,275			$	9.86				123,887			$	12.64				217,982			$	14.89
Granted			0			NA					0			NA					0			NA
Exercised			(27,675	)			11.50				(71,711	)			13.33				(56,417	)			15.50
Forfeited or expired			(1,500	)			6.33				(7,901	)			22.00				(37,678	)			21.39
Outstanding at end of year			15,100			$	7.20				44,275			$	9.86				123,887			$	12.64
Options exercisable at year-end			15,100			$	7.20				44,275			$	9.86				123,887			$	12.64

  

 

Options issued under Firstbank plans outstanding at year-end 2017 were as follows:

  

				Outstanding												Exercisable
								Weighted Average				Weighted								Weighted
Range of								Remaining				Average								Average
Exercise								Contractual				Exercise								Exercise
Prices				Number				Life (Years)				Price				Number				Price
$4.00	-	$8.00			12,400				1.6			$	6.89				12,400			$	6.89
$8.01	-	$12.00			2,700				1.9				8.60				2,700				8.60
Outstanding at year end					15,100				1.7			$	7.20				15,100			$	7.20

 

 

Information related to options issued under Firstbank plans outstanding at year-end 2017, 2016 and 2015 is as follows:

    

		2017				2016				2015
Minimum exercise price		$	6.89			$	5.19			$	5.19
Maximum exercise price			8.60				16.00				22.00
Average remaining option term (years)			1.7				1.8				2.7

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 12 – STOCK-BASED COMPENSATION (Continued)

Information related to stock option grants and exercises issued under Firstbank plans during 2017, 2016 and 2015 is as follows:

		2017				2016				2015
Aggregate intrinsic value of stock options exercised		$	594,000			$	1,945,000			$	420,000
Cash received from stock option exercises			318,000				956,000				874,000
Tax benefit realized from stock option exercises			208,000				681,000				147,000
Weighted average per share fair value of stock options granted		NA				NA				NA

 

The aggregate intrinsic value of all stock options issued under various Firstbank plans outstanding and exercisable at December 31, 2017 was $0.4 million. Shares issued as a result of the exercise of stock option grants have been authorized and previously unissued shares.

 

On January 2, 2015, we granted about 6,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of January 1, 2015 through May 31, 2015. The associated $0.1 million cost was expensed on a straightline basis over the first five months of 2015. On May 28, 2015, we granted about 14,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2015 through May 31, 2016. The associated $0.3 million cost was expensed on a straightline basis over the respective twelve month period. 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 is being expensed on a straightline basis over the respective twelve month period.

  

 

NOTE 13 – RELATED PARTIES

 

Certain directors and executive officers of the Bank, including their immediate families and companies in which they are principal owners, were loan customers of the Bank. At year-end 2017 and 2016, the Bank had $20.5 million and $11.5 million in loan commitments to directors and executive officers, of which $14.5 million and $8.9 million were outstanding at year-end 2017 and 2016, respectively, as reflected in the following table.

  

		2017				2016
Beginning balance		$	8,882,000			$	11,151,000
New loans			6,374,000				4,652,000
Repayments			(783,000	)			(6,921,000	)
Ending balance		$	14,473,000			$	8,882,000

 

Related party deposits and repurchase agreements totaled $15.4 million and $19.8 million at year-end 2017 and 2016, respectively.

    

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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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, 2017 and 2016.

 

At year-end 2017 and 2016, 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:

 

		2017				2016
Commercial unused lines of credit		$	682,202,000			$	553,345,000
Unused lines of credit secured by 1 – 4 family residential properties			61,606,000				56,275,000
Credit card unused lines of credit			39,807,000				22,689,000
Other consumer unused lines of credit			17,629,000				8,489,000
Commitments to make loans			184,923,000				154,338,000
Standby letters of credit			26,030,000				26,202,000
Total commitments		$	1,012,197,000			$	821,338,000

 

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 7.00%. 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 4.00% to 7.50%. These credit facilities generally mature and fully amortize within three to seven years.

 

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 14 – COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)

Certain of our commercial loan customers have entered into interest rate swap agreements directly with our correspondent banks. To assist our commercial loan customers in these transactions, and to encourage our correspondent banks to enter into the interest rate swap transactions with minimal credit underwriting analyses on their part, we have entered into risk participation agreements with the correspondent banks whereby we agree to make payments to the correspondent banks owed by our commercial loan customers under the interest rate swap agreement in the event that our commercial loan customers do not make the payments. We are not a party to the interest rate swap agreements under these arrangements. As of December 31, 2017, all such interest rate swap agreements had been terminated by our commercial loan customers. These risk participation agreements were considered financial guarantees in accordance with applicable accounting guidance and are therefore recorded as liabilities at fair value, generally equal to the fees collected at the time of their execution. These liabilities were accreted into income during the terms of the interest rate swap agreements, generally ranging from an original term of four to fifteen years.

 

The following instruments are considered financial guarantees under current accounting guidance. These instruments are carried at fair value.

 

		2017								2016
		Contract				Carrying				Contract				Carrying
		Amount				Value				Amount				Value
Standby letters of credit		$	26,030,000			$	122,000			$	26,202,000			$	156,000

 

We were required to have $9.6 million and $9.2 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, 2017 and December 31, 2016, 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 has been 4.25% since January 1, 2014. Matching contributions, if made, are immediately vested. Our 2017, 2016 and 2015 matching 401(k) contributions charged to expense were $1.3 million, $1.2 million and $1.2 million, respectively. Effective April 1, 2018, the matching contribution will be 5.00%.

 

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 $3.2 million and $3.4 million as of December 31, 2017 and 2016, 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 less than $0.1 million per year during the last three years.

   

---

(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 15 – BENEFIT PLANS (Continued)

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 1,351 and 1,362 in 2017 and 2016, respectively. As of December 31, 2017, there were approximately 244,000 shares available under our current plan.

 

 

NOTE 16 – HEDGING ACTIVITIES

 

Our interest rate risk policy includes guidelines for measuring and monitoring interest rate risk. Within these guidelines, parameters have been established for maximum fluctuations in net interest income. Possible fluctuations are measured and monitored using net interest income simulation. Our policy provides for the use of certain derivative instruments and hedging activities to aid in managing interest rate risk to within policy parameters.

 

In February 2012, we entered into an interest rate swap agreement with a correspondent bank to hedge the floating rate on the subordinated debentures issued to Mercantile Bank Capital Trust I, which became effective in January 2013 and matured in January 2018. The $32.0 million of subordinated debentures have a rate equal to the 90-Day Libor Rate plus a fixed spread of 218 basis points, and are subject to repricing quarterly. The interest rate swap agreement provided for us to pay our correspondent bank a fixed rate, while our correspondent bank paid us the 90-Day Libor Rate on a $32.0 million notional amount. The quarterly re-set dates for the floating rate on the interest rate swap agreement were the same as the re-set dates for the floating rate on the subordinated debentures. The interest rate swap agreement was accounted for under hedge accounting guidelines; therefore, fluctuations in the fair value of the interest rate swap agreement, net of tax effect, were recorded in other comprehensive income. As of December 31, 2017 and 2016, the fair value of the interest rate swap agreement was recorded as a liability in the amount of less than $0.1 million and $0.1 million, respectively.

 

Effective January 26, 2016, the notional amount of the interest rate swap agreement was reduced from $32.0 million down to $21.0 million, reflecting the $11.0 million repurchase of the associated trust preferred securities on that date. We recorded interest expense of approximately $154,000 in January 2016 as part of the transaction, in large part reflecting the market value of the interest rate swap on that date of the $11.0 million portion.    

 

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(Continued)

 

 MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 17 – 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):

 

		Level in					2017								2016
		Fair Value					Carrying				Fair				Carrying				Fair
		Hierarchy					Amount				Value				Amount				Value
Financial assets
Cash		Level 1				$	11,565			$	11,565			$	11,493			$	11,493
Cash equivalents		Level 2					188,536				188,536				172,103				172,103
Securities available for sale		(1)					335,744				335,744				328,060				328,060
Federal Home Loan Bank stock		(2)					11,036				11,036				8,026				8,026
Loans, net		Level 3					2,536,498				2,520,063				2,359,624				2,353,276
Loans held for sale		Level 2					2,553				2,553				1,035				1,035
Mortgage servicing rights		Level 2					5,106				8,373				5,544				7,997
Accrued interest receivable		Level 2					8,770				8,770				7,714				7,714
Financial liabilities
Deposits		Level 2					2,522,365				2,368,188				2,374,985				2,286,548
Securities sold under agreements to repurchase		Level 2					118,748				118,748				131,710				131,710
Federal Home Loan Bank advances		Level 2					220,000				217,130				175,000				174,734
Subordinated debentures		Level 2					45,517				45,732				44,835				45,220
Accrued interest payable		Level 2					1,919				1,919				1,592				1,592
Interest rate swap		(1)					2				2				84				84

 

(1)	See Note 18 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.

 

Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, demand deposits, securities sold under agreements to repurchase, and variable rate loans and deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans and deposits and for variable rate loans and deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. 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. Fair value of subordinated debentures and Federal Home Loan Bank advances is based on current rates for similar financing. Fair value of the interest rate swap is determined primarily utilizing market-consensus forecasted yield curves. Fair value of off-balance sheet items is estimated to be nominal.

   

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 18 – 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, municipal general obligation and revenue bonds, and mutual funds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information becomes known which necessitates an impairment. There was no such impairment as of December 31, 2017 or 2016. We have no Level 1 securities available for sale.

  

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 18 – 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, 2017 and 2016, we determined that the fair value of our mortgage loans held for sale approximated the recorded cost of $2.6 million and $1.0 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. The interest rate swap agreement is measured at fair value on a recurring basis. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves, and accordingly, the interest rate swap agreement is classified as Level 2.

 

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, 2017 are as follows:

 

		Total				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government agency debt obligations		$	169,700,000			$	0			$	169,700,000			$	0
Mortgage-backed securities			38,792,000				0				38,792,000				0
Municipal general obligation bonds			121,293,000				0				116,102,000				5,191,000
Municipal revenue bonds			3,978,000				0				3,978,000				0
Other investments			1,981,000				0				1,981,000				0
Derivatives
Interest rate swap agreement			(2,000	)			0				(2,000	)			0
Total		$	335,742,000			$	0			$	330,551,000			$	5,191,000

 

There were no transfers in or out of Level 1, Level 2 or Level 3 during 2017. The $1.2 million reduction in Level 3 municipal general obligation bonds during 2017 reflects the scheduled maturities of such bonds. 

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 18 – FAIR VALUE MEASUREMENTS (Continued)

The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 are as follows:

 

		Total				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government agency debt obligations		$	152,040,000			$	0			$	152,040,000			$	0
Mortgage-backed securities			47,392,000				0				47,392,000				0
Municipal general obligation bonds			119,047,000				0				112,648,000				6,399,000
Municipal revenue bonds			7,631,000				0				7,631,000				0
Other investments			1,950,000				0				1,950,000				0
Derivatives
Interest rate swap agreement			(84,000	)			0				(84,000	)			0
Total		$	327,976,000			$	0			$	321,577,000			$	6,399,000

 

There were no transfers in or out of Level 1, Level 2 or Level 3 during 2016. The $2.0 million reduction in Level 3 municipal general obligation bonds during 2016 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, 2017 are as follows:

 

						Quoted Prices
						in Active				Significant
						Markets for				Other				Significant
						Identical				Observable				Unobservable
						Assets				Inputs				Inputs
		Total				(Level 1)				(Level 2)				(Level 3)
Impaired loans		$	5,836,000			$	0			$	0			$	5,836,000
Foreclosed assets			2,260,000				0				0				2,260,000
Total		$	8,096,000			$	0			$	0			$	8,096,000

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 18 – FAIR VALUE MEASUREMENTS (Continued)

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2016 are as follows:

 

						Quoted Prices
						in Active				Significant
						Markets for				Other				Significant
						Identical				Observable				Unobservable
						Assets				Inputs				Inputs
		Total				(Level 1)				(Level 2)				(Level 3)
Impaired loans		$	9,896,000			$	0			$	0			$	9,896,000
Foreclosed assets			469,000				0				0				469,000
Total		$	10,365,000			$	0			$	0			$	10,365,000

 

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 19 – EARNINGS PER SHARE

 

The factors used in the earnings per share computation follow:

		2017				2016				2015
Basic
Net income attributable to common shares		$	31,274,000			$	31,913,000			$	27,020,000
Weighted average common shares outstanding			16,478,968				16,292,086				16,609,263
Basic earnings per common share		$	1.90			$	1.96			$	1.63
Diluted
Net income attributable to common shares		$	31,274,000			$	31,913,000			$	27,020,000
Weighted average common shares outstanding for basic earnings per common share			16,478,968				16,292,086				16,609,263
Add: Dilutive effects of share-based awards			10,102				18,644				32,877
Average shares and dilutive potential common shares			16,489,070				16,310,730				16,642,140
Diluted earnings per common share		$	1.90			$	1.96			$	1.62

 

Stock options for approximately 7,000, 11,000 and 40,000 shares of common stock were antidilutive and were not included in determining dilutive earnings per share in 2017, 2016 and 2015, respectively.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 20 – 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 the 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, 2017:

 

		Preferred Securities
Trust Name		Outstanding			Interest Rate		Maturity Date
Mercantile Bank Capital Trust I		$	21,000,000		3 Month Libor + 218 bps		September 16, 2034
Firstbank Capital Trust I		$	10,000,000		3 Month Libor + 199 bps		October 18, 2034
Firstbank Capital Trust II		$	10,000,000		3 Month Libor + 127 bps		April 7, 2036
Firstbank Capital Trust III		$	7,500,000		3 Month Libor + 135 bps		July 30, 2037
Firstbank Capital Trust IV		$	7,500,000		3 Month Libor + 135 bps		July 30, 2037

  

 

NOTE 21 - 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.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 21 - 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 2017 and 2016, 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, 2017 that we believe have changed our Bank’s categorization.

 

Our actual capital levels (dollars in thousands) and minimum required levels were:

 

		Actual								Minimum Required for Capital Adequacy Purposes								Minimum Required to be Well Capitalized Under Prompt Corrective Action Regulations
		Amount				Ratio				Amount				Ratio				Amount				Ratio
2017
Total capital (to risk weighted assets)
Consolidated		$	379,417				12.9	%		$	235,723				8.0	%		NA				NA
Bank			371,346				12.6				235,515				8.0				294,393				10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated			359,915				12.2				176,792				6.0			NA				NA
Bank			351,844				12.0				176,636				6.0				235,515				8.0
Common equity (to risk weighted assets)
Consolidated			316,472				10.7				132,594				4.5			NA				NA
Bank			351,844				12.0				132,477				4.5				191,356				6.5
Tier 1 capital (to average assets)
Consolidated			359,915				11.3				127,782				4.0			NA				NA
Bank			351,844				11.0				127,698				4.0				159,623				5.0

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 21 - REGULATORY MATTERS (Continued)

		Actual								Minimum Required for Capital Adequacy Purposes								Minimum Required to be Well Capitalized Under Prompt Corrective Action Regulations
		Amount				Ratio				Amount				Ratio				Amount				Ratio
2016
Total capital (to risk weighted assets)
Consolidated		$	354,278				13.1	%		$	215,819				8.0	%		NA				NA
Bank			353,243				13.1				215,605				8.0				269,506				10.0	%
Tier 1 capital (to risk weighted assets)
Consolidated			336,316				12.5				161,864				6.0			NA				NA
Bank			335,282				12.4				161,704				6.0				215,605				8.0
Common equity (to risk weighted assets)
Consolidated			293,555				10.9				121,398				4.5			NA				NA
Bank			335,282				12.4				121,278				4.5				175,179				6.5
Tier 1 capital (to average assets)
Consolidated			336,316				11.2				120,486				4.0			NA				NA
Bank			335,282				11.1				120,383				4.0				150,479				5.0

 

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 is being phased in over three years beginning in 2016. The capital buffer requirement effectively raises 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, 2017, our bank would meet all capital adequacy requirements under the Basel III capital rules on a fully phased-in basis as if all such requirements were currently in effect.

 

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 2017, under the most restrictive of these regulations, our Bank could distribute approximately $42.6 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 12, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.18 per share that was paid on March 22, 2017 to shareholders of record as of March 10, 2017. On April 13, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.18 per share that was paid on June 21, 2017 to shareholders of record as of June 9, 2017. On July 13, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.19 per share that was paid on September 20, 2017 to shareholders of record as of September 8, 2017. On October 12, 2017, our Board of Directors declared a cash dividend on our common stock in the amount of $0.19 per share that was paid on December 20, 2017 to shareholders of record as of December 8, 2017.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 21 - REGULATORY MATTERS (Continued)

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 will be paid on March 21, 2018 to shareholders of record as of March 9, 2018.

 

On January 30, 2015, we announced that our Board of Directors had authorized a new 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. On April 19, 2016, we announced a $15.0 million expansion of the stock repurchase plan. Since inception, we have purchased a total of 956,419 shares at a total price of $19.5 million, at an average price per share of $20.38; no shares were purchased under the authorized plan during 2017. 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, which would also likely be funded from cash dividends paid to us from our Bank.

 

Our consolidated capital levels as of December 31, 2017 and 2016 include $43.4 million and $42.8 million, respectively, of trust preferred securities subject to certain limitations. Under applicable Federal Reserve guidelines, the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate amount of restricted core elements that may be included in 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, 2017 and 2016, all $43.4 million and $42.8 million, respectively, of the trust preferred securities were included as Tier 1 capital of Mercantile.

   

NOTE 22 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

At December 31, 2017, accumulated other comprehensive income, net of tax effects (as applicable), consisted of a net unrealized loss on available for sale securities of $4.9 million and the fair value of an interest rate swap of less than negative $0.1 million. At December 31, 2016, accumulated other comprehensive income, net of tax effects (as applicable), consisted of a net unrealized loss on available for sale securities of $5.5 million and the fair value of an interest rate swap of negative $0.1 million. At December 31, 2015, accumulated other comprehensive income, net of tax effects (as applicable), consisted of a net unrealized gain on available for sale securities of $1.4 million and the fair value of an interest rate swap of negative $0.2 million.  

 

NOTE 23 - QUARTERLY FINANCIAL DATA (Unaudited)

  

		Interest				Net Interest				Net				Earnings per Share
		Income				Income				Income				Basic				Diluted
2017
First quarter		$	28,704,000			$	25,509,000			$	7,615,000			$	0.46			$	0.46
Second quarter			30,903,000				27,193,000				7,343,000				0.45				0.45
Third quarter			33,034,000				28,644,000				8,337,000				0.51				0.51
Fourth quarter			32,902,000				28,402,000				7,979,000				0.48				0.48
2016
First quarter		$	28,889,000			$	25,882,000			$	8,549,000			$	0.52			$	0.52
Second quarter			30,147,000				27,100,000				7,434,000				0.46				0.46
Third quarter			29,706,000				26,450,000				7,845,000				0.48				0.48
Fourth quarter			29,715,000				26,435,000				8,085,000				0.49				0.49

 

Net income for the fourth quarter of 2017 was impacted by $1.3 million in federal income tax expense to revalue net deferred tax assets relating to the federal tax law change.

 

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 24 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)

CONDENSED FINANCIAL STATEMENTS

 

CONDENSED BALANCE SHEETS

 

		2017				2016
ASSETS
Cash and cash equivalents		$	9,704,000			$	4,257,000
Investment in bank subsidiary			383,941,000				365,291,000
Other assets			20,435,000				20,665,000
Total assets		$	414,080,000			$	390,213,000
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities		$	2,693,000			$	4,567,000
Subordinated debentures			45,517,000				44,835,000
Shareholders’ equity			365,870,000				340,811,000
Total liabilities and shareholders’ equity		$	414,080,000			$	390,213,000

 

 

CONDENSED STATEMENTS OF INCOME

 

		2017				2016				2015
Income
Interest and dividends from subsidiaries		$	16,203,000			$	32,521,000			$	24,166,000
Total income			16,203,000				32,521,000				24,166,000
Expenses
Interest expense			2,496,000				2,490,000				2,569,000
Other operating expenses			3,651,000				2,953,000				2,276,000
Total expenses			6,147,000				5,443,000				4,845,000
Income before income tax benefit and equity in undistributed net income of subsidiary			10,056,000				27,078,000				19,321,000
Federal income tax benefit			(4,060,000	)			(836,000	)			(2,051,000	)
Equity in undistributed net income of subsidiary			17,158,000				3,999,000				5,648,000
Net income		$	31,274,000			$	31,913,000			$	27,020,000
Comprehensive income		$	32,821,000			$	25,069,000			$	28,267,000

   

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(Continued)

 

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2017

 

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NOTE 24 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)

CONDENSED FINANCIAL STATEMENTS (Continued)

  

CONDENSED STATEMENTS OF CASH FLOWS

 

		2017				2016				2015
Cash flows from operating activities
Net income		$	31,274,000			$	31,913,000			$	27,020,000
Adjustments to reconcile net income to net cash from operating activities:
Equity in undistributed net income of subsidiary			(17,158,000	)			(3,999,000	)			(5,648,000	)
Stock-based compensation expense			1,981,000				1,459,000				684,000
Stock grants to directors for retainer fees			363,000				327,000				403,000
Gain on trust preferred securities repurchase			0				(2,970,000	)			0
Change in other assets			(230,000	)			387,000				11,000
Change in other liabilities			(677,000	)			78,000				4,717,000
Net cash from operating activities			15,553,000				27,195,000				27,187,000
Cash flows from investing activities
Net capital investment into subsidiaries			0				0				0
Net cash for investing activities			0				0				0
Cash flows from financing activities
Stock option exercises, net of cashless exercises			318,000				978,000				891,000
Employee stock purchase plan			46,000				36,000				44,000
Dividend reinvestment plan			1,576,000				1,601,000				655,000
Repurchase of common shares			0				(3,732,000	)			(15,762,000	)
Cash dividends on common stock			(12,046,000	)			(18,731,000	)			(9,516,000	)
Repurchase of trust preferred securities			0				(8,030,000	)			0
Net cash for financing activities			(10,106,000	)			(27,878,000	)			(23,688,000	)
Net change in cash and cash equivalents			5,447,000				(683,000	)			3,499,000
Cash and cash equivalents at beginning of period			4,257,000				4,940,000				1,441,000
Cash and cash equivalents at end of period		$	9,704,000			$	4,257,000			$	4,940,000

 

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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 5, 2018.

 

		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 5, 2018.

 

 

/s/ David M. Cassard David M. Cassard, Director	/s/ Robert B. Kaminski, Jr. Robert B. Kaminski, Jr. Director, President and Chief Executive Officer (principal executive officer)
/s/ Edward J. Clark Edward J. Clark, Director	/s/ Michael H. Price Michael H. Price, Executive Chairman of the Board
/s/ Michelle L. Eldridge Michelle L. Eldridge, Director	/s/ Thomas R. Sullivan Thomas R. Sullivan, Director
/s/ Jeff A. Gardner Jeff A. Gardner, Director	/s/ Charles E. Christmas Charles E. Christmas, Executive Vice President, Chief Financial Officer and Treasurer (principal financial and accounting officer)

 

 /s/ Edward B. Grant

Edward B. Grant, Director

 

 

EXHIBIT INDEX

   

Exhibit No.	EXHIBIT DESCRIPTION
2.1	Agreement and Plan of Merger dated August 14, 2013, incorporated by reference to exhibit 2.1 to our Current Report on Form 8-K filed August 15, 2013
2.2	First Amendment to Merger Agreement dated February 20, 2014, incorporated by reference to exhibit 10.1 to our Current Report on Form 8-K filed February 21, 2014
3.1	Our Articles of Incorporation are incorporated by reference to exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2009
3.2	Our Amended and Restated By-laws dated as of February 26, 2014 are incorporated by reference to exhibit 3.1 to our Current Report on Form 8-K filed February 26, 2015
4.1	Instruments defining the Rights of Security Holders – reference is made to Exhibits 3.1 and 3.2. In accordance with Regulation S-K Item 601(b)(4), Mercantile Bank Corporation is not filing copies of instruments defining the rights of holders of long-term debt because none of those instruments authorizes debt in excess of 10% of the total assets of Mercantile Bank Corporation and its subsidiaries on a consolidated basis. Mercantile Bank Corporation hereby agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.
10.1	Form of Mercantile Bank of Michigan Split Dollar Agreement that has been entered into between our bank and each of Michael H. Price, Robert B. Kaminski, Jr., Charles E. Christmas, and certain other officers of our bank is incorporated by reference to exhibit 10.33 of our Form 10-K for the year ended December 31, 2005*
10.2	Amendment and Restatement of Stock Incentive Plan of 2006 dated November 18, 2008 is incorporated by reference to exhibit 10.39 of our Form 10-K for the year ended December 31, 2008*
10.3	Form of Notice of Grant of Incentive Stock Option and Stock Option Agreement for incentive stock options granted after 2006 under our Stock Incentive Plan of 2006 is incorporated by reference to exhibit 10.41 of our Form 10-K for the year ended December 31, 2007*
10.4	Form of Restricted Stock Award Agreement Notification of Award and Terms and Conditions of Award for restricted stock granted after 2006 under our Stock Incentive Plan of 2006 is incorporated by reference to exhibit 10.43 of our Form 10-K for the year ended December 31, 2007*
10.5	Mercantile Bank Corporation Employee Stock Purchase Plan of 2014 is incorporated by reference to exhibit 4(b) of our Registration Statement on Form S-8 that became effective on June 27, 2014
10.6	Employment Agreement dated as of November 13, 2014, effective as of December 31, 2014, among the company, our bank and Michael H. Price, incorporated by reference to exhibit 10.12 of our Form 10-K filed March 3, 2015*
10.7	Employment Agreement dated as of November 13, 2014, effective as of December 31, 2014, among the company, our bank and Robert B. Kaminski, Jr., incorporated by reference to exhibit 10.13 of our Form 10-K filed March 3, 2015*
10.8	Employment Agreement dated as of November 13, 2014, effective as of December 31, 2014, among the company, our bank and Charles E. Christmas, incorporated by reference to exhibit 10.14 of our Form 10-K filed March 3, 2015*
10.9	Mercantile Bank of Michigan Amended and Restated Deferred Compensation Plan dated as of November 13, 2014, effective on January 1, 2015, incorporated by reference to exhibit 10.15 of our Form 10-K filed March 3, 2015*

 

 

Exhibit No.	EXHIBIT DESCRIPTION
10.10	Amendment to Employment Agreement of Michael H. Price, dated May 28, 2015, incorporated by reference to exhibit 10.1 of our Form 8-K filed May 28, 2015*
10.11	Amendment to Employment Agreement of Robert B. Kaminski, Jr., dated May 28, 2015, incorporated by reference to exhibit 10.2 of our Form 8-K filed May 28, 2015*
10.12	2015 Mercantile Executive Officer Bonus Plan, incorporated by reference to exhibit 10.3 of our Form 8-K filed May 28, 2015*
10.13	First Amendment to Employment Agreement of Charles E. Christmas, dated November 19, 2015, incorporated by reference to exhibit 10.1 of our Form 8-K filed November 19, 2015*
10.14	Change in Control Agreement among the Company, the Bank and Michael H. Price, dated November 19, 2015, incorporated by reference to exhibit 10.2 of our Form 8-K filed November 19, 2015*
10.15	Change in Control Agreement among the Company, the Bank and Robert B. Kaminski, Jr., dated November 19, 2015, incorporated by reference to exhibit 10.3 of our Form 8-K filed November 19, 2015*
10.16	Change in Control Agreement among the Company, the Bank and Charles E. Christmas, dated November 19, 2015, incorporated by reference to exhibit 10.4 of our Form 8-K filed November 19, 2015*
10.17	2016 Mercantile Executive Officer Bonus Plan, incorporated by reference to exhibit 10.1 of our Form 8-K filed June 10, 2016*
10.18	2016 Mercantile General Counsel Bonus Plan, incorporated by reference to exhibit 10.2 of our Form 8-K filed June 10, 2016*
10.19	Second Amendment to Employment Agreement of Michael H. Price dated July 14, 2016, incorporated by reference to exhibit 10.1 of our Form 8-K filed July 19, 2016*
10.20	First Amendment to Change in Control Agreement among Mercantile, the Bank and Michael H. Price, dated July 14, 2016, incorporated by reference to exhibit 10.2 of our Form 8-K filed July 19, 2016*
10.21	Form of Restricted Stock Award Agreement, incorporated by reference to exhibit 10.1 of our Form 8-K filed November 18, 2016*
10.22	Form of Stock Option Agreement, incorporated by reference to exhibit 10.2 of our Form 8-K filed November 18, 2016*
10.23	Second Amendment to Employment Agreement of Robert B. Kaminski, Jr. effective January 1, 2017, incorporated by reference to exhibit 10.1 of our Form 8-K filed January 3, 2017*
10.24	Amended and Restated Employment Agreement of Robert T. Worthington effective January 1, 2017, incorporated by reference to exhibit 10.2 of our Form 8-K filed January 3, 2017*
10.25	Employment Agreement among Mercantile, the Bank and Raymond E. Reitsma effective January 1, 2016, incorporated by reference to exhibit 10.3 of our Form 8-K filed January 3, 2017*
10.26	First Amendment to Employment Agreement of Raymond E. Reitsma effective January 1, 2017, incorporated by reference to exhibit 10.4 of our Form 8-K filed January 3, 2017*
10.27	2017 Mercantile Executive Officer Bonus Plan, incorporated by reference to exhibit 10.1 of our Form 8-K filed May 26, 2017*
10.28	Director Fee Summary*

 

 

Exhibit No.	EXHIBIT DESCRIPTION
21	Subsidiaries of the company
23	Consent of BDO USA, LLP
31	Rule 13a-14(a) Certifications
32.1	Section 1350 Chief Executive Officer Certification
32.2	Section 1350 Chief Financial Officer Certification

 

101

The following information from Mercantile’s Annual Report on Form 10-K for the year ended December 31, 2017, 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.