1 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission File No. 000-26719 MERCANTILE BANK CORPORATION (Exact name of small business issuer as specified in its charter) Michigan 38-3360865 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 216 NORTH DIVISION AVENUE, GRAND RAPIDS, MICHIGAN 49503 (Address of principal executive offices) (616) 242-9000 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ---- ---- At May 11, 2001, there were 3,112,702 shares of Common Stock outstanding
2 MERCANTILE BANK CORPORATION INDEX <TABLE> <CAPTION> PART 1. Financial Information Page No. --------------------- -------- <S> <C> <C> Item I. Financial Statements Consolidated Balance Sheets - March 31, 2001 (Unaudited) and December 31, 2000.................... 3 Consolidated Statements of Income - Three Months Ended March 31, 2001 (Unaudited) and March 31, 2000 (Unaudited).......................................... 4 Consolidated Statement of Changes in Shareholders Equity - Three Months Ended March 31, 2001 (Unaudited) and March 31, 2000 (Unaudited)......................................... 5 Consolidated Statements of Cash Flows - Three Months Ended March 31, 2001 (Unaudited) and March 31, 2000 (Unaudited).......................................... 6 Notes to Condensed Consolidated Financial Statements (Unaudited)........ 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 13 Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 21 PART II. Other Information ----------------- Item 1. Legal Proceedings.............................................. 24 Item 2. Changes in Securities and Use of Proceeds...................... 24 Item 3. Defaults upon Senior Securities................................ 24 Item 4. Submission of Matters to a Vote of Security Holders............ 24 Item 5. Other Information.............................................. 24 Item 6. Exhibits and Reports on Form 8-K............................... 24 Signatures.............................................................. 25 </TABLE>
3 MERCANTILE BANK CORPORATION CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> March 31, December 31, 2001 2000 ---- ---- (Unaudited) <S> <C> <C> ASSETS Cash and due from banks $ 12,769,843 $ 11,692,825 Short-term investments 125,443 108,846 Federal funds sold 20,500,000 6,300,000 ------------- ------------- Total cash and cash equivalents 33,395,286 18,101,671 Securities available for sale 46,059,876 45,147,493 Securities held to maturity (fair value of $16,322,090 at March 31, 2001 and $14,942,311 at December 31, 2000) 15,621,562 14,524,341 Federal Home Loan Bank stock 784,900 784,900 Total loans 459,728,059 429,804,105 Allowance for loan losses (6,765,031) (6,301,805) -------------- -------------- Loans, net 452,963,028 423,502,300 Premises and equipment - net 4,757,974 4,119,385 Accrued interest receivable 2,929,030 2,758,054 Other assets 3,890,446 3,808,218 ------------- ------------- Total assets $ 560,402,102 $ 512,746,362 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest-bearing $ 35,399,078 $ 27,368,257 Interest-bearing 431,693,981 398,372,056 ------------- ------------- Total deposits 467,093,059 425,740,313 Securities sold under agreements to repurchase 30,052,599 32,151,391 Other borrowed money 94,657 56,510 Accrued expenses and other liabilities 7,331,719 6,944,262 Guaranteed preferred beneficial interests in the Corporation's subordinated debentures 16,000,000 16,000,000 ------------- ------------- Total liabilities 520,572,034 480,892,476 Shareholders' equity Preferred stock, no par value; 1,000,000 shares authorized, none issued Common stock, no par value: 9,000,000 shares authorized; 3,112,702 shares outstanding at March 31, 2001 and 2,596,102 shares outstanding at December 31, 2000 36,774,913 29,935,401 Retained earnings 2,543,728 1,628,277 Accumulated other comprehensive income 511,427 290,208 ------------- ------------- Total shareholders' equity 39,830,068 31,853,886 ------------- ------------- Total liabilities and shareholders' equity $ 560,402,102 $ 512,746,362 ============= ============= </TABLE> See accompanying notes to condensed consolidated financial statements. 3.
4 MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME <TABLE> <CAPTION> Three Months Three Months Ended Ended March 31, March 31, 2001 2000 ---- ---- (Unaudited) (Unaudited) <S> <C> <C> Interest income Loans, including fees $ 9,575,628 $ 7,050,132 Investment securities 1,060,140 686,889 Federal funds sold 218,444 124,488 Short term investments 1,204 2,672 ------------ ------------ Total interest income 10,855,416 7,864,181 Interest expense Deposits 6,664,541 4,412,279 Short term borrowings 335,621 261,874 Long term borrowings 393,511 392,614 ------------ ------------ Total interest expense 7,393,673 5,066,767 ------------ ------------ NET INTEREST INCOME 3,461,743 2,797,414 Provision for loan losses 450,000 585,000 ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,011,743 2,212,414 Noninterest income Service charges on accounts 102,486 75,226 Net gain on sales of securities 99,594 0 Other income 207,257 148,132 ------------ ------------ Total noninterest income 409,337 223,358 Noninterest expense Salaries and benefits 1,243,788 938,424 Occupancy 127,800 126,080 Furniture and equipment 106,852 105,011 Other expense 594,189 540,965 ------------ ------------ Total noninterest expenses 2,072,629 1,710,480 ------------ ------------ INCOME BEFORE FEDERAL INCOME TAX EXPENSE 1,348,451 725,292 Federal income tax expense 433,000 225,000 ------------ ------------ NET INCOME $ 915,451 $ 500,292 ============ ============ COMPREHENSIVE INCOME $ 1,136,670 $ 417,674 ============ ============ Basic earnings per share $ 0.34 $ 0.19 ============ ============ Diluted earnings per share $ 0.34 $ 0.19 ============ ============ Average shares outstanding 2,676,058 2,596,102 ============ ============ </TABLE> See accompanying notes to condensed consolidated financial statements. 4.
5 MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) <TABLE> <CAPTION> Accumulated Other Total Common Retained Comprehensive Shareholders' Stock Earnings Income Equity ----- -------- ------ ------ <S> <C> <C> <C> <C> BALANCE, JANUARY 1, 2000 $ 28,181,798 $ 587,639 $(801,568) $ 27,967,869 Comprehensive income: Net income for the period from January 1, 2000 through March 31, 2000 500,292 500,292 Change in net unrealized gain (loss) on securities available for sale, net of tax effect (82,618) (82,618) -------------- Total comprehensive income 417,674 ------------- ----------- --------- ------------- BALANCE, MARCH 31, 2000 $ 28,181,798 $ 1,087,931 $(884,186) $ 28,385,543 ============= =========== ========== ============= BALANCE, JANUARY 1, 2001 $ 29,935,401 $ 1,628,277 $ 290,208 $ 31,853,886 Comprehensive income: Net income for the period from January 1, 2001 through March 31, 2001 915,451 915,451 Change in net unrealized gain (loss) on securities available for sale, net of tax effect 221,219 221,219 ------------- Total comprehensive income 1,136,670 Common stock sale, February 21, 2001 1,006,250 1,006,250 Common stock sale, March 22, 2001 5,833,262 5,833,262 ------------- ----------- --------- ------------- BALANCE, MARCH 31, 2001 $ 36,774,913 $ 2,543,728 $ 511,427 $ 39,830,068 ============= =========== ========= ============= </TABLE> See accompanying notes to condensed consolidated financial statements. 5.
6 MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS <TABLE> <CAPTION> Three Months Three Months Ended Ended March 31, March 31, 2001 2000 ---- ---- (Unaudited) (Unaudited) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 915,451 $ 500,292 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization 61,774 148,011 Provision for loan losses 450,000 585,000 Net gain on sales of available for sale securities (99,594) 0 Net change in: Accrued interest receivable (170,976) (392,604) Other assets (220,693) (314,485) Accrued expenses and other liabilities 387,457 1,100,799 ------------- ------------- Net cash from operating activities 1,323,419 1,627,013 CASH FLOWS FROM INVESTING ACTIVITIES Net increase in loans (29,910,728) (39,966,725) Purchase of: Securities available for sale (10,362,999) (4,798,750) Securities held to maturity (1,098,104) (1,353,880) Premises and equipment (748,065) (74,938) Proceeds from: Sales of available for sale securities 5,361,961 0 Maturities, calls and repayments of available for sale securities 4,596,518 1,398,101 ------------- ------------- Net cash used in investing activities (32,161,417) (44,796,192) CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 41,352,746 39,619,793 Net proceeds from sale of common stock 6,839,512 0 Net increase in other borrowed money 38,147 236 Net increase (decrease) in securities sold under agreements to repurchase (2,098,792) 563,398 -------------- ------------- Net cash from financing activities 46,131,613 40,183,427 ------------- ------------- Net change in cash and cash equivalents 15,293,615 (2,985,752) Cash and cash equivalents at beginning of period 18,101,671 13,650,356 ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 33,395,286 $ 10,664,604 ============= ============= Supplemental disclosures of cash flow information Cash paid during the period for: Interest $ 7,175,330 $ 4,143,027 Federal income tax 196,110 0 </TABLE> See accompanying notes to condensed consolidated financial statements. 6.
7 MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION: The unaudited financial statements for the three months ended March 31, 2001 include the consolidated results of operations of Mercantile Bank Corporation ("Mercantile") and its wholly-owned subsidiaries, Mercantile Bank of West Michigan ("Bank") and MBWM Capital Trust I ("Capital Trust"), and of Mercantile Bank Mortgage Company ("Mortgage Company"), a wholly-owned subsidiary of the Bank. These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by generally accepted accounting principles for a complete presentation of Mercantile's financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended March 31, 2001 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in Mercantile's annual report on Form 10-K for the year ended December 31, 2000. 2. LOANS Total loans at March 31, 2001 were $459.7 million compared to $429.8 million at December 31, 2000, an increase of $29.9 million, or 7.0%. The components of the outstanding balances and percentage increase in loans from the end of 2000 to the end of the first quarter 2001 are as follows: <TABLE> <CAPTION> Percent March 31, 2001 December 31, 2000 Increase/ Balance % Balance % (Decrease) ------- - ------- - ---------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Real Estate: Construction and land development $ 39,171 8.5% $ 38,815 9.0% 0.9% Secured by 1 - 4 family properties 34,609 7.5 33,709 7.8 2.7 Secured by multi- family properties 2,073 0.5 2,127 0.5 (2.5) Secured by nonfarm nonresidential properties 212,704 46.3 197,018 45.9 8.0 Commercial 163,900 35.6 151,344 35.2 8.3 Consumer 7,271 1.6 6,791 1.6 7.1 --------- ------ --------- ------ ------- $ 459,728 100.0% $ 429,804 100.0% 7.0% ========= ====== ========= ====== ======= </TABLE> (Continued) 7.
8 MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 3. ALLOWANCE FOR LOAN LOSSES The following is a summary of the activity in the allowance for loan losses account for the three months ended March 31: <TABLE> <CAPTION> 2001 2000 ---- ---- <S> <C> <C> Balance at January 1 $ 6,301,805 $ 4,620,469 Charge-offs (20,000) (21,781) Recoveries 33,226 4,200 Provision for loan losses 450,000 585,000 ------------ ------------ Balance at March 31 $ 6,765,031 $ 5,187,888 ============ ============ </TABLE> 4. PREMISES AND EQUIPMENT - NET Premises and equipment are comprised of the following: <TABLE> <CAPTION> March 31, December 31, 2001 2000 ---- ---- <S> <C> <C> Land and improvements $ 1,134,548 $ 1,134,548 Buildings and leasehold improvements 2,133,426 2,128,353 Construction in process 815,597 220,797 Furniture and equipment 1,734,814 1,586,621 ------------ ------------ 5,818,385 5,070,319 Less accumulated depreciation 1,060,411 950,934 ------------ ------------ Premises and equipment, net $ 4,757,974 $ 4,119,385 ============ ============ </TABLE> Depreciation expense for the first quarter 2001 amounted to $109,477. The "construction in process" caption represents the monies capitalized thus far for the construction of two new facilities, both of which are being constructed on a 4-acre parcel of land located in the City of Wyoming, a southwest suburb of Grand Rapids. The land, which was acquired in 2000, is carried under the caption "land and improvements". The larger of the two buildings, a two-story facility with approximately 25,000 square feet of usable space, will serve as the new location for the operations and accounting departments and will include a full service branch. The other building, a single-story facility with approximately 7,000 square feet of usable space, will accommodate the administration function. Both facilities are expected to be available for use starting in August 2001. The cost of the facilities, including furniture and equipment but excluding the purchase price of the land, is expected to total approximately $5.1 million (Continued) 8.
9 MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 5. DEPOSITS Total deposits at March 31, 2001 were $467.1 million compared to $425.7 million at December 31, 2000, an increase of $41.4 million, or 9.7%. The components of the outstanding balances and percentage increase in deposits from the end of 2000 to the end of the first quarter 2001 are as follows: <TABLE> <CAPTION> Percent March 31, 2001 December 31, 2000 Increase/ Balance % Balance % (Decrease) ------- - ------- - ---------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Noninterest-bearing demand $ 35,399 7.6% $ 27,368 6.4% 29.3% Interest-bearing checking 12,006 2.6 12,968 3.1 (7.4) Money market 5,724 1.2 5,196 1.2 10.2 Savings 37,194 8.0 36,331 8.6 2.4 Time, under $100,000 6,527 1.4 6,165 1.4 5.9 Time, $100,000 and over 47,760 10.2 38,682 9.1 23.5 --------- ------ --------- ------ ------- 144,610 31.0 126,710 29.8 14.1 Out-of-area time, under $100,000 67,226 14.4 55,260 13.0 21.7 Out-of-area time, $100,000 and over 255,257 54.6 243,770 57.2 4.7 --------- ------ --------- ------ ------- 322,483 69.0 299,030 70.2 7.8 --------- ------ --------- ------ ------- Total deposits $ 467,093 100.0% $ 425,740 100.0% 9.7% ========= ====== ========= ====== ======= </TABLE> 6. BORROWINGS Information relating to securities sold under agreements to repurchase follows: <TABLE> <CAPTION> March 31, December 31, 2001 2000 ---- ---- <S> <C> <C> Outstanding balance at end of period $30,052,599 $32,151,391 Average interest rate at end of period 4.10% 4.63% Average balance during the period $30,852,726 $29,190,780 Average interest rate during the period 4.41% 4.66% Maximum month end balance during the period $32,612,510 $35,473,498 </TABLE> 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 agreements are recorded as assets of the Bank and are primarily held in safekeeping by correspondent banks. Repurchase agreements are offered principally to certain large deposit customers as deposit equivalent investments. (Continued) 9.
10 MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 7. COMMITMENTS AND OFF-BALANCE SHEET RISK The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by the 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. The Bank's maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, property and equipment, is generally obtained based on management's credit assessment of the borrower. A summary of the notional or contractual amounts of financial instruments with off-balance sheet risk at March 31, 2001 and December 31, 2000 follows: <TABLE> <CAPTION> March 31, December 31, 2001 2000 ---- ---- <S> <C> <C> Commercial unused lines of credit $ 90,881,022 $ 87,121,094 Unused lines of credit secured by 1 - 4 family residential properties 8,129,167 7,641,057 Credit card unused lines of credit 5,147,372 4,578,325 Other consumer unused lines of credit 1,881,654 2,062,084 Commitments to make loans 25,976,500 20,110,500 Standby letters of credit 38,273,657 36,889,288 ------------- ------------- $ 170,289,372 $ 158,402,348 ============= ============= </TABLE> 8. REGULATORY MATTERS Mercantile and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. (Continued) 10.
11 MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 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 adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. Actual capital levels (dollars in thousands) and minimum required levels were: <TABLE> <CAPTION> Minimum Required to be Well Minimum Required Capitalized Under for Capital Prompt Corrective Actual Adequacy Purposes Action Regulations ------ ----------------- ------------------ Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> March 31, 2001 -------------- Total capital (to risk weighted assets) Consolidated $ 61,902 11.8% $ 42,117 8.0% $ 52,646 10.0% Bank 59,549 11.4 41,957 8.0 52,446 10.0 Tier 1 capital (to risk weighted assets) Consolidated 52,425 10.0 21,066 4.0 31,599 6.0 Bank 52,991 10.1 20,987 4.0 31,481 6.0 Tier 1 capital (to average assets) Consolidated 52,425 9.8 21,480 4.0 26,850 5.0 Bank 52,991 9.9 21,402 4.0 26,752 5.0 December 31, 2000 ----------------- Total capital (to risk weighted assets) Consolidated $ 53,685 11.0% $ 39,163 8.0% $ 48,953 10.0% Bank 51,596 10.6 39,017 8.0 48,771 10.0 Tier 1 capital (to risk weighted assets) Consolidated 42,085 8.6 19,589 4.0 29,383 6.0 Bank 45,497 9.3 19,517 4.0 29,275 6.0 Tier 1 capital (to average assets) Consolidated 42,085 8.6 19,601 4.0 24,502 5.0 Bank 45,497 9.3 19,528 4.0 24,410 5.0 </TABLE> Mercantile and the Bank were categorized as well capitalized at March 31, 2001 and year-end 2000. (Continued) 11.
12 MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) During the first quarter of 2001 Mercantile sold a combined 516,600 shares of common stock in two private placement offerings, raising $6.8 million in net proceeds. Mercantile contributed substantially all of the net proceeds to the Bank as capital. Capital Trust, a business trust subsidiary of Mercantile, sold 1.6 million Cumulative Preferred Securities ("trust preferred securities") at $10.00 per trust preferred security in a September 1999 offering. The proceeds from the sale were used by Capital Trust to purchase an equivalent amount of subordinated debentures from Mercantile. The trust preferred securities carry a fixed rate of 9.60%, have a stated maturity of 30 years, and, in effect, are guaranteed by Mercantile. The securities are redeemable at par after 5 years. Distributions on the trust preferred securities are payable quarterly on January 15, April 15, July 15, and October 15. The first distribution was paid on October 15, 1999. Under certain circumstances, distributions may be deferred for up to 20 calendar quarters. However, during any such deferrals, interest accrues on any unpaid distributions at the rate of 9.60% per annum. The capital levels of Mercantile as of March 31, 2001 include an adjustment for the 1.6 million trust preferred securities issued by Capital Trust subject to certain limitations. Federal Reserve guidelines limit the amount of trust preferred securities which can be included in Tier 1 capital of Mercantile to 25% of total Tier 1 capital. As of March 31, 2001, approximately $13.1 million of the $16.0 million of the trust preferred securities were included as Tier 1 capital with the remaining $2.9 million included as Tier 2 capital, a component of risk-based capital. The ability of Mercantile to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. Mercantile declared a 5% stock dividend on January 10, 2001, that was paid on February 1, 2001 to record holders as of January 19, 2001. Mercantile has not paid cash dividends on its common stock since its formation in 1997, and currently has no intention of doing so in the foreseeable future. 12.
13 MERCANTILE BANK CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about Mercantile. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "projects," 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. Mercantile undertakes 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 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; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of contingencies; trends in customer behavior as well as their ability to repay loans; and changes in the national and local economy. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement. INTRODUCTION The following discussion compares the financial condition of Mercantile Bank Corporation ("Mercantile") and its wholly owned subsidiaries, Mercantile Bank of West Michigan ("Bank") and MBWM Capital Trust I ("Capital Trust"), and of Mercantile Bank Mortgage Company ("Mortgage Company"), a wholly-owned subsidiary of the Bank, at March 31, 2001 to December 31, 2000 and the results of operations for the three months ended March 31, 2001 and March 31, 2000. This discussion should be read in conjunction with the interim consolidated condensed financial statements and footnotes included herein. Mercantile's election to become a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board regulations was effective March 23, 2000. At the present time Mercantile has no plans to engage in any of the expanded activities permitted under the new regulations. During the past year, Mercantile was engaged in preliminary discussions with several non-affiliated financial institutions to explore the possibility of an acquisition by Mercantile. To date the discussions have been exploratory in nature and no likely acquisition candidate has been identified. Mercantile expects that such discussions may occur from time-to-time with these or other financial institutions in future periods. 13.
14 MERCANTILE BANK CORPORATION FINANCIAL CONDITION During the first three months of 2001, assets increased from $512.7 million on December 31, 2000, to $560.4 million on March 31, 2001. This represents a total increase in assets of $47.7 million, or 9.3%. The asset growth was comprised primarily of a $29.5 million increase in net loans, an increase of $15.3 million in cash and cash equivalents and an increase of $2.0 million in investment securities. The increase in assets was primarily funded by a $41.4 million growth in deposits and a $7.9 million increase in shareholders' equity. The increase in cash and cash equivalents was primarily due to an increase of $14.2 million in federal funds sold. Approximately $10.0 million of the March 31, 2001, federal funds sold position were used to fund out-of-area certificates of deposit maturities during the initial part of April 2001. Commercial loans increased by $28.5 million, or 7.3%, during the first three months of 2001. At March 31, 2001, commercial loans totaled $417.8 million, and comprised 90.9% of total loans. The significant concentration in commercial loans and the rapid growth of this portion of business is in keeping with the strategy of focusing a substantial amount of efforts on "wholesale" banking. Corporate and business lending is an area of expertise of the senior management team, and the eight commercial lenders have over 110 years of combined commercial lending experience. Commercial loans are also the assets most easily originated and managed by the fewest number of staff, thus reducing overhead through necessitating fewer full-time equivalents (FTE's)/$million in assets. It is also the commercial sector of our business that generates the greatest amount of local deposits, and it is virtually the only source of significant demand deposits. Residential mortgage loans and consumer loans increased by $0.9 million and $0.5 million, respectively, during the first three months of 2001. As of March 31, 2001, these loan types totaled a combined $41.9 million, or 9.1% of total loans. Although the residential mortgage loan and consumer loan portfolios are expected to increase in future periods, given the wholesale banking strategy the commercial sector of the lending efforts and resultant assets are expected to remain the dominant loan portfolio category. The quality of the loan portfolio remains strong. Gross loan charge-offs during the first three months of 2001 totaled $20,000, or less than 0.01% of average total loans. Recoveries on prior loan charge-offs totaled $33,000 during the first three months of 2001, resulting in a net recovery position for the period. Past due loans at March 31, 2001 totaled $174,000, or only 0.04% of period-ending total loans. Management believes it has instilled a very strong credit culture within the lending departments as it pertains to the underwriting and administration processes, which in part is reflected in the loan charge-off and delinquency ratios. Over 98% of the loan portfolio consists of loans extended directly to companies and individuals doing business and residing within the Bank's market area. The remaining portion is comprised of commercial loans participated with certain non-affiliated commercial banks outside of the immediate area, which are underwritten using the same underwriting criteria as though Mercantile was the originating bank. Deposits increased $41.4 million during the first three months of 2001, totaling $467.1 million at March 31, 2001. Local deposits increased $17.9 million, while out-of-area deposits increased $23.5 million. As a percent of total deposits, local deposits increased from 29.8% on December 31, 2000, to 31.0% at March 31, 2001. Noninterest-bearing demand deposits, comprising 7.6% of total deposits, increased $8.0 million during the first three months of 2001. Savings deposits (8.0% of total deposits) increased $0.9 million and money market deposit accounts (1.2% of total deposits) increased by $0.5 million during the first three months of 2001, while interest-bearing checking accounts (2.6% of total deposits) decreased by $1.0 million. Local certificates of deposit, comprising 11.6% of total deposits, increased by $9.4 million during the first three months of 2001. 14.
15 MERCANTILE BANK CORPORATION Out-of-area deposits totaled $322.5 million, or 69.0% of total deposits, as of March 31, 2001. Out-of-area deposits consist of certificates of deposit generally obtained from depositors located outside the market area and placed by deposit brokers for a fee, but also include certificates of deposit obtained from the deposit owners directly. Out-of-area deposits are utilized to support asset growth, and are generally a lower cost source of funds when compared to the interest rates that would have to be offered in the local market to generate a commensurate level of funds. During the first three months of 2001 rates paid on new out-of-area certificates of deposit were very similar to rates paid on new certificates of deposit issued to local customers. In addition, the overhead costs associated with the out-of-area deposits are considerably less than the overhead costs that would be incurred to administer a similar level of local deposits. While the business plan anticipated the reliance on out-of-area deposits in the early stages of the Bank's development, the longer-term strategy for funding is to increase local deposits and lower the reliance on out-of-area deposits. However, although local deposits have and are expected to increase as new business, governmental and consumer deposit relationships are established and as existing customers increase their deposit accounts, the relatively high reliance on out-of-area deposits will likely remain. Securities sold under agreements to repurchase ("repurchase agreements") decreased by $2.1 million during the first three months of 2001. Part of the Bank's sweep account program, collected funds from certain business noninterest-bearing checking accounts are invested into over-night interest-bearing repurchase agreements. Although not considered a deposit account and therefore not afforded federal deposit insurance, the repurchase agreements have characteristics very similar to that of business checking deposit accounts. The decline in repurchase agreements is believed to be seasonal in nature due to business customers paying bonuses to business owners, federal income tax payments, and other business purposes. LIQUIDITY Liquidity is measured by the ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment of loans and investment securities. These monies are used to fund loan requests, meet deposit withdrawals, maintain reserve requirements, and pay for general operating expenses. Liquidity is primarily achieved through the growth of deposits (both local and out-of-area) and liquid assets such as securities available for sale, matured securities, and federal funds sold. 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. The Bank's liquidity strategy is to fund loan growth with deposits and repurchase agreements and to maintain an adequate level of short- and medium-term investments to meet typical daily loan and deposit activity. Although deposit and repurchase agreement growth from depositors located in the market area have consistently increased, the growth has not been sufficient to meet the substantial loan growth and provide monies for additional investing activities. To assist in providing the additional needed funds the Bank has regularly obtained certificates of deposit from customers outside of the market area. As of March 31, 2001, out-of-area deposits totaled approximately $322.5 million, or 64.9% of combined deposits and repurchase agreements, compared to the $299.0 million, or 65.3% of combined deposits and repurchase agreements, as of December 31, 2000. Reliance on out-of-area deposits is expected to be ongoing due to the planned future growth. 15.
16 MERCANTILE BANK CORPORATION The Bank has the ability to borrow money on a daily basis through correspondent banks via established federal funds purchased lines; however, this is viewed as only a secondary and temporary source of funds. The federal funds purchased lines were not utilized at any time during the first three months of 2001. The federal funds sold position averaged $16.1 million during the first three months of 2001. In addition, as a member of the Federal Home Loan Bank of Indianapolis ("FHLBI"), the Bank has access to the FHLBI's borrowing programs. Based on ownership of FHLBI stock and available collateral at March 31, 2001, the Bank could borrow up to approximately $20.0 million. The Bank has yet to use its established borrowing line at the FHLBI. Mercantile has been extended a $10.0 million unsecured line of credit from a correspondent bank. Proceeds from the credit facility may be used for working capital, investment in the Bank or acquisition of financial institutions. The line of credit matures on February 27, 2002. In addition to typical loan funding and deposit flow, the Bank also needs to maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of March 31, 2001, Mercantile had a total of $132.0 million in unfunded loan commitments and $38.3 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $106.0 million were commitments available as lines of credit to be drawn at any time as customers' cash needs vary, and $26.0 million were for loan commitments scheduled to close and become funded within the next three months. Mercantile monitors fluctuations in loan balances and commitment levels, and includes such data in its overall liquidity management. CAPITAL RESOURCES Shareholders' equity is a noninterest-bearing source of funds that provides support for asset growth. Shareholders' equity increased by $7.9 million during the first three months of 2001, from $31.9 million on December 31, 2000, to $39.8 million at March 31, 2001. The increase is primarily attributable to the sale of common stock and net income. Mercantile sold a combined 516,600 shares of common stock in two private placement offerings, raising $6.8 million in net proceeds. Mercantile contributed substantially all of the net proceeds to the Bank as capital. Net income equaled $0.9 million during the first three months of 2001. In addition, shareholders' equity was positively impacted during the first quarter of 2001 by a $0.2 million mark-to-market adjustment for available for sale securities as defined in SFAS No. 115. The adjustment was due to the decline in the interest rate environment during the first three months of 2001. In September 1999 Mercantile, through its wholly-owned business trust subsidiary Capital Trust, issued 1.6 million shares of trust preferred stock at $10.00 per share. Substantially all of the net proceeds were ultimately contributed to the Bank as capital and were used to support anticipated growth in assets, fund investments in loans and securities, and for general corporate purposes. Although not part of shareholder's equity, subject to certain limitations the trust preferred securities are considered a component of Mercantile's capital structure for purposes of calculating regulatory capital ratios. At March 31, 2000, $13.1 million of the $16.0 million was considered Tier 1 capital, with the remaining amount included as Tier 2 capital. The amount includable as Tier 1 capital is expected to gradually increase in future periods as shareholders' equity increases from anticipated net income from operations. Mercantile and the Bank are subject to regulatory capital requirements administered by the State of Michigan 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. Since the Bank began operations, both Mercantile and the Bank have been categorized as "Well Capitalized," the highest classification contained within the banking regulations. The capital ratios of Mercantile and the Bank as of March 31, 2001 and December 31, 2000 are disclosed under Note 8 of the Notes to Consolidated Financial Statements. 16.
17 MERCANTILE BANK CORPORATION The ability of Mercantile and the Bank to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. Mercantile declared a 5% stock dividend on January 10, 2001, which was paid on February 1, 2001 to record holders as of January 19, 2001. Mercantile has not paid cash dividends on its common stock since its formation in 1997, and currently has no intention of doing so in the foreseeable future. RESULTS OF OPERATIONS Net income for the first three months of 2001 was $915,451 ($0.34 per basic and diluted share), which represents an 83.0% increase over net income of $500,292 ($0.19 per basic and diluted share) recorded during the first three months of 2000. The improvement in net income was primarily the result of an increase in net interest income, a reduction of provisions to the allowance for loan losses, increased noninterest income and greater employee efficiency. Interest income during the first three months of 2001 was $10,855,416, a substantial increase over the $7,864,181 earned during the first three months of 2000. The growth in interest income is primarily attributable to an increase in earning assets. During the first three months of 2001 earning assets averaged $521.5 million, a level significantly higher than the average earning assets of $383.6 million during the same time period in 2000. Increase in total loans and investment securities accounted for 80.9% and 13.9% of the growth in average earning assets, respectively. Also adding to the growth in interest income is the increase in the yield on earning assets. During the first three months of 2001 and 2000, earning assets had a weighted average rate (tax equivalent-adjusted basis) of 8.51% and 8.38%, respectively. The increase was primarily due to an overall increase of market interest rates during most of 2000. However, the significant decline in market interest rates that have occurred since the latter part of 2000 has substantially impacted the yield on earning assets. As a result, a significant decline in the yield on earning assets is expected so long as market interest rates remain at current levels or continue to decline further. Interest expense during the first three months of 2001 was $7,393,673, a significant increase over the $5,066,767 expensed during the first three months of 2000. The growth in interest expense is primarily attributable to the growth in assets, which necessitated an increase in funding liabilities. During the first three months of 2001 interest-bearing liabilities averaged $469.7 million, a level substantially higher than average interest-bearing funds of $343.3 million during the same time period in 2000. Increase in interest-bearing deposits accounted for 95.2% of the growth in average interest-bearing liabilities. Also adding to the growth in interest expense is the increase in the cost of interest-bearing liabilities. During the first three months of 2001 and 2000, interest-bearing liabilities had a weighted average rate of 6.38% and 5.92%, respectively. The increase was primarily due to the aforementioned overall increase in market interest rates during most of 2000. However, the aforementioned significant decline in market interest rates that have occurred since the latter part of 2000 has substantially impacted the cost of interest-bearing liabilities. As a result, a significant decline in the cost of interest-bearing liabilities is expected so long as market interest rates remain at current levels or continue to decline further. Net interest income during the first three months of 2001 was $3,461,743, a significant increase over the $2,797,414 earned during the first three months of 2000. The increase in net interest income was due to the growth in earning assets, which more than offset the negative impact of a lower net interest margin. The net interest margin declined from 2.97% during the first three months of 2000 to 2.76% during the first three months of 2001, primarily reflecting the impact of the increasing interest rate environment during much of 2000 and the declining interest rate environment during the first quarter of 2001. However, the current declining interest rate environment, while having a negative impact in the first part of 2001, is expected to have a positive impact on the net interest margin through at least most of the second part of 2001 and into early 2002. 17.
18 MERCANTILE BANK CORPORATION During the first part of 2000 market interest rates were on a rapidly increasing trend and remained relatively high throughout the year. Although the prime rate increased during this time period, rates paid on local and out-of-area certificates of deposit increased at a quicker rate and at a higher magnitude, which when combined with a higher volume of certificates of deposits repricing than floating and fixed rate loans, caused the net interest margin to gradually decline throughout 2000. The net interest margin was 2.97%, 2.95%, 2.90% and 2.83% in the first, second, third and fourth quarters of 2000, respectively. During the first three months of 2001 market interest rates have been on a rapidly declining trend, as evidenced by the 150 basis point drop in the prime rate. Although the interest rates paid on local and out-of-area certificates of deposit declined in a similar manner to the decline in the prime rate, a much higher volume of loans repriced during the first quarter than certificates of deposit, leading to a further decline in the net interest margin. However, as a significant volume of local and out-of-area certificates of deposit continue to reprice to much lower rates throughout the remainder of 2001 and into 2002, the net interest margin is expected to improve. This expectation is further supported by the results of the net interest income simulation analysis, as presented and discussed under the heading "Item 3 Quantitative and Qualitative Disclosures About Market Risk" starting on page 21. In addition to providing interest income and secondary liquidity, the investment portfolio plays an integral role in managing the net interest margin. During the relatively high interest rate environment in 2000, the Bank purchased four $1 million heavily discounted U.S. Government-Sponsored Agency callable bonds. A major factor in purchasing the bonds was the expectation that the bonds would likely be called by the issuer in a declining interest rate environment, resulting in the remaining discount being immediately accreted into interest income and at least partially offsetting the short term negative impact a declining interest rate environment would have on the net interest margin. With interest rates declining during the first quarter of 2001, two of the bonds were called by the issuer and the combined unaccreted discount of $71,808 was immediately taken into interest income. Of the remaining two bonds, one was not initially callable until June 2001, and although immediately callable by the issuer, interest rates had not declined to a level where the other bond was going to be called by the issuer. In that net interest margin management was a major factor in purchasing the bonds, it was decided to sell the remaining two bonds, and an aggregate profit of $97,289 was recorded. Although accounting standards require the gains on the sales of securities to be recorded as noninterest income, if the resulting gains were allowed to be recorded as interest income, and thereby paralleling management's intent, the net interest margin for the first three months of 2001 would have been 2.83%, unchanged from the fourth quarter of 2000 level. The following table sets forth certain information relating to Mercantile's consolidated average interest earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the first quarter of 2001 and 2000. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. For tax-exempt securities interest income and yield have been computed on a tax equivalent basis using a marginal tax rate of 34%. 18.
19 MERCANTILE BANK CORPORATION <TABLE> <CAPTION> Quarters ended March 31, -----------------2 0 0 1----------- ----------------2 0 0 0----------- Average Average Average Average Balance Interest Rate Balance Interest Rate ------- -------- ---- ------- -------- ---- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Loans $ 442,647 $ 9,576 8.77% $ 331,065 $ 7,050 8.54% Investment securities 62,622 1,143 7.30 43,451 734 6.76 Federal funds sold 16,096 218 5.43 8,801 124 5.60 Short term investments 110 1 4.44 237 3 4.57 ----------- --------- ------- ------------ ---------- ------- Total interest - earning assets 521,475 10,938 8.51 383,554 7,911 8.38 Allowance for loan losses (6,536) (4,934) Other assets 22,047 16,941 ------------ ------------ Total assets $ 536,986 $ 395,561 ============ ============ Interest-bearing deposits $ 422,824 $ 6,664 6.39% $ 302,425 $ 4,412 5.85% Short term borrowings 30,853 336 4.41 24,845 262 4.23 Long term borrowings 16,057 393 9.81 16,014 393 9.81 ------------ ---------- ------- ------------ ---------- ------ Total interest-bearing liabilities 469,734 7,393 6.38 343,284 5,067 5.92 Noninterest-bearing deposits 26,637 21,116 Other liabilities 7,004 3,055 Shareholders' equity 33,611 28,106 ------------ ---------- ------- ------------ ---------- ------ Total liabilities and shareholders' equity $ 536,986 $ 395,561 ============ ============ Net interest income $ 3,545 $ 2,844 ========== ========== Net interest rate spread 2.13% 2.46% Net interest spread on average assets 2.69 2.88 Net interest margin on earning assets 2.76 2.97 </TABLE> Provisions to the allowance for loan losses during the first three months of 2001 were $450,000, a decrease from the $585,000 expensed during the first three months of 2000. The decline reflects the lower volume of loan growth during the first three months of 2001 when compared to the first three months of 2000. Net loan recoveries of $13,226 were recorded during the first three months of 2001, compared to a net loan loss of $17,581 during the same time period in 2000. The allowance for loan losses as a percentage of total loans outstanding as of March 31, 2001 was 1.47%, unchanged from the level at December 31, 2000. In each accounting period, the allowance for loan losses is adjusted to the amount believed necessary to maintain the allowance at adequate levels. Through the loan review and credit department, management attempts to allocate specific portions of the allowance for loan losses based on specifically identifiable problem loans. The evaluation of the allowance for loan losses is further based on, although not limited to, consideration of the internally prepared Loan Loss Reserve Analysis ("Reserve Analysis"), composition of the loan portfolio, third party analysis of the loan administration processes and loan portfolio and general economic conditions. In addition, Mercantile's status as a de novo banking organization and the rapid loan growth since inception is taken into account. 19.
20 MERCANTILE BANK CORPORATION The Reserve Analysis, used since the inception of the Bank and completed monthly, applies reserve allocation factors to outstanding loan balances to calculate an overall allowance dollar amount. For commercial loans, which continue to comprise a vast majority of total loans, reserve allocation factors are based upon the loan ratings as determined by Mercantile's comprehensive loan rating paradigm that is administered by the loan review function. For retail loans reserve allocation factors are based upon the type of credit. The reserve allocation factors are based on the experience of senior management making similar loans in the same community over the past 12 years. The Reserve Analysis is under regular review by senior management and the Board of Directors and is adjusted periodically based upon identifiable trends and experience. Noninterest income, excluding the net gains on sales of securities, during the first three months of 2001 was $309,743, a significant increase of $86,385, or 38.7%, over the amount earned during the same period in 2000. Service charge income on deposit and repurchase agreements increased $27,260 (36.2%) during the first quarter of 2001 over that earned in the comparable time period in 2000 due primarily to new accounts opened during the last 12 months. Also the result of additional new accounts, credit and debit card fees increased $6,480 (22.3%). Reflecting declining interest rates and the resulting increase in residential mortgage loan refinancings, fees earned on referring residential mortgage loan applicants to various third parties increased $54,072 (197.7%). Letter of credit fees remained virtually unchanged during the first three months of 2001 when compared to the first three months of 2000 at $73,619. Noninterest expense during the first three months of 2001 was $2,072,629, a significant increase over the $1,710,480 expensed during the first three months of 2000. An increase in salaries and benefits, as well as general overhead costs, was recorded. The increases in salaries and benefits primarily resulted from the hiring of additional staff and annual pay increases. General overhead costs have also increased, reflecting the additional expenses required to administer the significantly increased asset base. While the dollar volume of noninterest costs has increased, as a percent of average assets the level has substantially declined as Mercantile has grown and operating efficiencies have been realized. During the first three months of 2001, noninterest costs equaled 1.57% of average assets, a 10.3% decline from the 1.75% level in the first three months of 2000. Monitoring and controlling noninterest costs, while at the same time providing high quality service to customers, is an integral part of Mercantile's business strategy. The efficiency ratio, computed by dividing noninterest expenses by net interest income plus noninterest income, was 53.5% during the first three months of 2001. This compares favorably to the efficiency ratio of 56.6% during the first three months of 2000. Although noninterest expenses increased by 21.2% during the first three months of 2001 over the amount expensed during the first three months of 2000, net revenues (net interest income plus noninterest income) increased at a substantially higher rate of 28.1% during the same time period, leading to an improved efficiency ratio and overall profitability. Federal income tax expense was $433,000 during the first three months of 2001, a significant increase over the $225,000 expensed in the first three months of 2000. The increase was primarily due to the increase in net income before federal income tax. During the first three months of 2001, net income before federal income tax was $1,348,451, a significant increase over the $725,292 recorded during the first three months of 2000. 20.
21 MERCANTILE BANK CORPORATION ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Mercantile's primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of Mercantile's transactions are denominated in U.S. dollars with no specific foreign exchange exposure. Mercantile has only limited agricultural-related loan assets and therefore has no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be insignificant. Interest rate risk is the exposure of Mercantile's financial condition to adverse movements in interest rates. Mercantile derives its income primarily from the excess of interest collected on its interest-earning assets over the interest paid on its interest-bearing liabilities. The rates of interest Mercantile earns on its assets and owes on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, Mercantile is exposed to lower profitability if it 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 Mercantile's earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to Mercantile's 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. Mercantile's 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 Mercantile assesses the existing and potential future effects of changes in interest rates on its financial condition, including capital adequacy, earnings, liquidity and asset quality. There are two interest rate risk measurement techniques used by Mercantile. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest-sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to the net interest margin during periods of changing market interest rates. The following table depicts Mercantile's GAP position as of March 31, 2001 (dollars in thousands): 21.
22 MERCANTILE BANK CORPORATION <TABLE> <CAPTION> Within Three to One to After Three Twelve Five Five Months Months Years Years Total ------ ------ ----- ----- ----- <S> <C> <C> <C> <C> <C> Assets: Commercial loans $ 168,972 $ 6,688 $ 230,986 $ 11,202 $ 417,848 Residential real estate loans 10,988 1,345 15,522 6,754 34,609 Consumer loans 1,770 980 4,350 171 7,271 Investment securities (1) 887 504 19,685 41,391 62,467 Federal funds sold 20,500 20,500 Short term investments 125 125 Allowance for loan losses (6,765) (6,765) Other assets 24,347 24,347 --------- --------- --------- --------- --------- Total Assets 203,242 9,517 270,543 77,100 560,402 Liabilities: Interest-bearing checking 12,006 12,006 Savings 37,194 37,194 Money market accounts 5,724 5,724 Time deposits < $100,000 21,121 40,715 11,917 73,753 Time deposits $100,000 and over 84,759 174,267 43,991 303,017 Short term borrowings 30,052 30,052 Long term borrowings 95 16,000 16,095 Noninterest-bearing checking 35,399 35,399 Other liabilities 7,332 7,332 --------- --------- --------- --------- --------- Total Liabilities 190,951 214,982 55,908 58,731 520,572 Shareholders' Equity 39,830 39,830 --------- --------- --------- --------- --------- Total Sources of Funds 190,951 214,982 55,908 98,561 560,402 --------- --------- --------- --------- --------- Net asset (liability) GAP $ 12,291 $(205,465) $ 214,635 $ (21,461) ========= ========== ========= ========== Cumulative GAP $ 12,291 $(193,174) $ 21,461 ========= ========== ========= Percent of cumulative GAP to total assets 2.2% (34.5)% 3.8% ========= ========== ========= </TABLE> (1) Mortgage-backed securities are categorized by expected final maturities based upon prepayment trends as of March 31, 2001 The second interest rate risk measurement used is commonly referred to as net interest income simulation analysis. Mercantile believes that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, serves as the primary interest rate risk measurement technique used by Mercantile. 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 Mercantile's strategies, among other factors. 22.
23 MERCANTILE BANK CORPORATION Mercantile conducted multiple simulations as of March 31, 2001, whereby it was assumed that a simultaneous, instant and sustained change in market interest rates occurred. The following table reflects the suggested impact on net interest income over the next twelve months, which are well within the policy parameters established to manage and monitor interest rate risk. <TABLE> <CAPTION> Dollar Change In Percent Change In Interest Rate Scenario Net Interest Income Net Interest Income ---------------------- ------------------- ------------------- <S> <C> <C> Interest rates down 200 basis points $2,594,102 14.0% Interest rates down 100 basis points 2,403,651 13.0 No change in interest rates 2,208,706 11.9 Interest rates up 100 basis points 2,192,716 11.8 Interest rates up 200 basis points 2,177,754 11.7 </TABLE> 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; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors. 23.
24 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. From time to time, Mercantile may be involved in various legal proceedings that are incidental to its business. In the opinion of management, Mercantile is not a party to any current legal proceedings that are material to the financial condition of Mercantile, either individually or in the aggregate. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. ITEM 5. OTHER INFORMATION. Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: <TABLE> <CAPTION> EXHIBIT NO. EXHIBIT DESCRIPTION ----------- ------------------- <C> <C> 3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Corporation's Registration Statement on Form SB-2 (Commission File no. 333-33081) that became effective on October 23, 1997 3.2 Bylaws of the Corporation are incorporated by reference to exhibit 3.2 of the Corporation's Registration Statement on Form SB-2 (Commission File No. 333-33081) that became effective on October 23, 1997 11 Statement re Computation of Per Share Earnings </TABLE> 24.
25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on May 11, 2001. MERCANTILE BANK CORPORATION By: /s/ Gerald R. Johnson Jr. --------------------------------------- Gerald R. Johnson, Jr. Chairman of the Board and Chief Executive Officer (Principal Executive Officer) By: /s/ Michael H. Price ------------------------------- Michael H. Price President and Chief Operating Officer By: /s/ Charles E. Christmas -------------------------------------- Charles E. Christmas Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) 25.
26 EXHIBIT INDEX <TABLE> <CAPTION> EXHIBIT NO. EXHIBIT DESCRIPTION - ---------- ------------------- <S> <C> 3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of the Corporation's Registration Statement on Form SB-2 (Commission File no. 333-33081) that became effective on October 23, 1997 3.2 Bylaws of the Corporation are incorporated by reference to exhibit 3.2 of the Corporation's Registration Statement on Form SB-2 (Commission File No. 333-33081) that became effective on October 23, 1997 11 Statement re Computation of Per Share Earnings </TABLE> 26.