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, 2002 [ ] 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) 5650 BYRON CENTER AVENUE SW, WYOMING, MI 49509 (Address of principal executive offices) (616) 406-3777 (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 9, 2002, there were 5,148,342 shares of Common Stock outstanding.
MERCANTILE BANK CORPORATION INDEX <TABLE> <CAPTION> PART I. Financial Information Page No. --------------------- -------- <S> <C> Item 1. Financial Statements Consolidated Balance Sheets - March 31, 2002 (Unaudited) and December 31, 2001................................... 3 Consolidated Statements of Income and Comprehensive Income - Three Months Ended March 31, 2002 (Unaudited) and March 31, 2001 (Unaudited)......................................................... 4 Consolidated Statement of Changes in Shareholders' Equity - Three Months Ended March 31, 2002 (Unaudited) and March 31, 2001 (Unaudited)........................................................ 5 Consolidated Statements of Cash Flows - Three Months Ended March 31, 2002 (Unaudited) and March 31, 2001 (Unaudited)......................................................... 6 Notes to 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>
MERCANTILE BANK CORPORATION CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> March 31, December 31, 2002 2001 ---- ---- (Unaudited) <S> <C> <C> ASSETS Cash and due from banks $ 15,305,000 $ 14,467,000 Short-term investments 183,000 171,000 Federal funds sold 1,500,000 5,300,000 --------------- ---------------- Total cash and cash equivalents 16,988,000 19,938,000 Securities available for sale 48,067,000 52,054,000 Securities held to maturity (fair value of $28,309,000 at March 31, 2002 and $26,183,000 at December 31, 2001) 28,049,000 25,979,000 Federal Home Loan Bank stock 785,000 785,000 Total loans 621,301,000 587,248,000 Allowance for loan and lease losses (8,925,000) (8,494,000) --------------- ---------------- Total loans, net 612,376,000 578,754,000 Premises and equipment, net 9,967,000 9,557,000 Accrued interest receivable 3,171,000 2,811,000 Other assets 8,653,000 8,804,000 --------------- ---------------- Total assets $ 728,056,000 $ 698,682,000 =============== ================ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest-bearing $ 39,771,000 $ 43,162,000 Interest-bearing 556,205,000 525,915,000 --------------- ---------------- Total deposits 595,976,000 569,077,000 Securities sold under agreements to repurchase 37,273,000 36,485,000 Other borrowed money 406,000 239,000 Accrued expenses and other liabilities 5,630,000 5,418,000 Guaranteed preferred beneficial interests in the Corporation's subordinated debentures 16,000,000 16,000,000 --------------- ---------------- Total liabilities 655,285,000 627,219,000 Shareholders' equity Preferred stock, no par value; 1,000,000 shares authorized, none issued Common stock, no par value: 9,000,000 shares authorized; 5,148,342 shares outstanding at March 31, 2002 and 5,147,791 shares outstanding at December 31, 2001 69,397,000 69,406,000 Retained earnings 3,253,000 1,649,000 Accumulated other comprehensive income 121,000 408,000 --------------- ---------------- Total shareholders' equity 72,771,000 71,463,000 --------------- ---------------- Total liabilities and shareholders' equity $ 728,056,000 $ 698,682,000 =============== ================ </TABLE> See accompanying notes to consolidated financial statements. 3.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) <TABLE> <CAPTION> Three Months Three Months Ended Ended March 31, March 31, 2002 2001 ---- ---- <S> <C> <C> Interest income Loans, including fees $ 9,907,000 $ 9,576,000 Investment securities 1,097,000 1,060,000 Federal funds sold 35,000 218,000 Short-term investments 1,000 1,000 -------------- --------------- Total interest income 11,040,000 10,855,000 Interest expense Deposits 5,409,000 6,665,000 Short-term borrowings 201,000 335,000 Long-term borrowings 396,000 393,000 -------------- --------------- Total interest expense 6,006,000 7,393,000 -------------- --------------- NET INTEREST INCOME 5,034,000 3,462,000 Provision for loan and lease losses 460,000 450,000 -------------- --------------- NET INTEREST INCOME AFTER PROVISIONS FOR LOAN AND LEASE LOSSES 4,574,000 3,012,000 Noninterest income Service charges on accounts 194,000 102,000 Net gain on sales of securities 149,000 100,000 Other income 226,000 207,000 -------------- --------------- Total noninterest income 569,000 409,000 Noninterest expense Salaries and benefits 1,678,000 1,244,000 Occupancy 265,000 128,000 Furniture and equipment 173,000 107,000 Other expense 749,000 594,000 -------------- --------------- Total noninterest expenses 2,865,000 2,073,000 -------------- --------------- INCOME BEFORE FEDERAL INCOME TAX EXPENSE 2,278,000 1,348,000 Federal income tax expense 674,000 433,000 -------------- --------------- NET INCOME $ 1,604,000 $ 915,000 ============== =============== COMPREHENSIVE INCOME $ 1,317,000 $ 1,136,000 ============== =============== Basic earnings per share $ 0.31 $ 0.33 ============== =============== Diluted earnings per share $ 0.31 $ 0.32 ============== =============== Average basic shares outstanding 5,148,128 2,809,861 ============== =============== Average diluted shares outstanding 5,234,129 2,850,964 ============== =============== </TABLE> See accompanying notes to consolidated financial statements. 4.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS 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, 2001 $ 29,936,000 $ 1,629,000 $ 290,000 $ 31,855,000 Comprehensive income: Net income for the period from January 1, 2001 through March 31, 2001 915,000 915,000 Change in net unrealized gain (loss) on securities available for sale, net of reclassifications and tax effect 221,000 221,000 ---------------- Total comprehensive income 1,136,000 Common stock sale, February 21, 2001 1,006,000 1,006,000 Common stock sale, March 22, 2001 5,833,000 5,833,000 ---------------- --------------- ----------- ---------------- BALANCE, MARCH 31, 2001 $ 36,775,000 $ 2,544,000 $ 511,000 $ 39,830,000 ================ =============== =========== ================ BALANCE, JANUARY 1, 2002 $ 69,406,000 $ 1,649,000 $ 408,000 $ 71,463,000 Comprehensive income: Net income for the period from January 1, 2002 through March 31, 2002 1,604,000 1,604,000 Change in net unrealized gain (loss) on securities available for sale, net of reclassifications and tax effect (287,000) (287,000) ---------------- Total comprehensive income 1,317,000 Stock option exercise 6,000 6,000 Issuance costs from December 2001 common stock sale (15,000) (15,000) ---------------- --------------- ----------- ---------------- BALANCE, MARCH 31, 2002 $ 69,397,000 $ 3,253,000 $ 121,000 $ 72,771,000 ================ =============== =========== ================ </TABLE> See accompanying notes to consolidated financial statements. 5.
MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <TABLE> <CAPTION> Three Months Three Months Ended Ended March 31, March 31, 2002 2001 ---- ---- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,604,000 $ 915,000 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization 301,000 62,000 Provision for loan and lease losses 460,000 450,000 Net gain on sale of securities (149,000) (100,000) Net change in: Accrued interest receivable (360,000) (171,000) Other assets 262,000 (221,000) Accrued expenses and other liabilities 212,000 388,000 --------------- ---------------- Net cash from operating activities 2,330,000 1,323,000 CASH FLOWS FROM INVESTING ACTIVITIES Loan originations and payments, net (34,082,000) (29,911,000) Purchases of: Securities available for sale (11,877,000) (10,363,000) Securities held to maturity (2,071,000) (1,098,000) Premises and equipment (627,000) (748,000) Proceeds from: Sales of available for sale securities 10,572,000 5,362,000 Maturities, calls and repayments of available for sale securities 4,960,000 4,597,000 --------------- ---------------- Net cash from investing activities (33,125,000) (32,161,000) CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits 26,899,000 41,353,000 Net proceeds from sale of common stock 0 6,839,000 Stock option exercise 6,000 0 Issuance costs of prior period common stock sale (15,000) 0 Net increase in other borrowed money 167,000 38,000 Net increase (decrease) in securities sold under agreements to repurchase 788,000 (2,099,000) --------------- ---------------- Net cash from financing activities 27,845,000 46,131,000 --------------- ---------------- Net change in cash and cash equivalents (2,950,000) 15,293,000 Cash and cash equivalents at beginning of period 19,938,000 18,102,000 --------------- ---------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 16,988,000 $ 33,395,000 =============== ================ Supplemental disclosures of cash flow information Cash paid during the period for: Interest $ 5,462,000 $ 7,175,000 Federal income tax 0 196,000 </TABLE> See accompanying notes to consolidated financial statements. 6.
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION: The unaudited financial statements for the three months ended March 31, 2002 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank of West Michigan ("our bank"), our bank's two wholly-owned subsidiaries, Mercantile Bank Mortgage Company ("our mortgage company") and Mercantile BIDCO, Inc. ("our BIDCO"), and our subsidiary MBWM Capital Trust I ("the trust"). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Item 303(b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended March 31, 2002 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2001. 2. LOANS Our total loans at March 31, 2002 were $621.3 million compared to $587.2 million at December 31, 2001, an increase of $34.1 million, or 5.8%. The components of our outstanding balances at March 31, 2002 and December 31, 2001, and percentage increase in loans from the end of 2001 to the end of the first quarter 2002 are as follows: <TABLE> <CAPTION> Percent March 31, 2002 December 31, 2001 Increase/ Balance % Balance % (Decrease) ------- - ------- - ---------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Real Estate: Construction and land development $ 77,329 12.4% $ 62,710 10.6% 23.3% Secured by 1 - 4 family properties 40,735 6.6 41,028 7.0 (0.7) Secured by multi- family properties 1,761 0.3 1,107 0.2 59.1 Secured by nonfarm nonresidential properties 285,566 46.0 269,855 46.0 5.8 Commercial 209,101 33.6 205,839 35.1 1.6 Consumer 6,809 1.1 6,709 1.1 1.5 ----------- -------- ----------- ------- ------- $ 621,301 100.0% $ 587,248 100.0% 5.8% =========== ======== =========== ======= ======= </TABLE> (Continued) 7.
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 3. ALLOWANCE FOR LOAN AND LEASE LOSSES The following is a summary of the activity in our allowance for loan and lease losses account for the three months ended March 31: <TABLE> <CAPTION> 2002 2001 ---- ---- <S> <C> <C> Balance at January 1 $ 8,494,000 $ 6,302,000 Charge-offs (93,000) (20,000) Recoveries 64,000 33,000 Provision for loan and lease losses 460,000 450,000 -------------- --------------- Balance at March 31 $ 8,925,000 $ 6,765,000 ============== =============== </TABLE> 4. PREMISES AND EQUIPMENT, NET Premises and equipment are comprised of the following: <TABLE> <CAPTION> March 31, December 31, 2002 2001 ---- ---- <S> <C> <C> Land and improvements $ 1,979,000 $ 1,970,000 Buildings and leasehold improvements 5,982,000 5,975,000 Furniture and equipment 3,730,000 3,119,000 -------------- --------------- 11,691,000 11,064,000 Less accumulated depreciation 1,723,000 1,507,000 -------------- --------------- Premises and equipment, net $ 9,967,000 $ 9,557,000 ============== =============== </TABLE> Depreciation expense for the first quarter 2002 amounted to $216,000. (Continued) 8.
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 5. DEPOSITS Our total deposits at March 31, 2002 were $596.0 million compared to $569.1 million at December 31, 2001, an increase of $26.9 million, or 4.7%. The components of our outstanding balances at March 31, 2002 and December 31, 2001, and percentage increase in deposits from the end of 2001 to the end of the first quarter 2002 are as follows: <TABLE> <CAPTION> Percent March 31, 2002 December 31, 2001 Increase/ Balance % Balance % (Decrease) ------- - ------- - ---------- (dollars in thousands) <S> <C> <C> <C> <C> <C> Noninterest-bearing demand $ 39,771 6.7% $ 43,162 7.6% (7.9)% Interest-bearing checking 21,344 3.6 22,188 3.9 (3.8) Money market 6,085 1.0 5,578 1.0 9.1 Savings 50,055 8.4 47,157 8.3 6.1 Time, under $100,000 6,637 1.1 6,144 1.1 8.0 Time, $100,000 and over 53,294 8.9 52,601 9.2 1.3 ----------- -------- ----------- ------- ------- 177,186 29.7 176,830 31.1 0.2 Out-of-area time, under $100,000 83,474 14.0 83,789 14.7 (0.4) Out-of-area time, $100,000 and over 335,316 56.3 308,458 54.2 8.7 ----------- -------- ----------- ------- ------- 418,790 70.3 392,247 68.9 6.8 ----------- -------- ----------- ------- ------- Total deposits $ 595,976 100.0% $ 569,077 100.0% 4.7% =========== ======== =========== ======= ======= </TABLE> 6. SHORT-TERM BORROWINGS Information relating to our securities sold under agreements to repurchase follows: <TABLE> <CAPTION> March 31, December 31, 2002 2001 ---- ---- <S> <C> <C> Outstanding balance at end of period $ 37,273,000 $ 36,485,000 Average interest rate at end of period 2.21% 2.21% Average balance during the period $ 36,465,000 $ 34,596,000 Average interest rate during the period 2.21% 3.42% Maximum month end balance during the period $ 37,273,000 $ 40,587,000 </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 our 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.
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 7. COMMITMENTS AND OFF-BALANCE SHEET RISK Our bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of 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 bank's maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, property and equipment, is generally obtained based on management's credit assessment of the borrower. A summary of the notional or contractual amounts of our financial instruments with off-balance sheet risk at March 31, 2002 and December 31, 2001 follows: <TABLE> <CAPTION> March 31, December 31, 2002 2001 ---- ---- <S> <C> <C> Commercial unused lines of credit $ 110,896,000 $ 110,787,000 Unused lines of credit secured by 1 - 4 family residential properties 10,356,000 8,181,000 Credit card unused lines of credit 5,231,000 6,212,000 Other consumer unused lines of credit 3,793,000 3,965,000 Commitments to make loans 36,018,000 25,966,000 Standby letters of credit 38,922,000 36,377,000 --------------- ---------------- $ 205,216,000 $ 191,488,000 =============== ================ </TABLE> 8. REGULATORY MATTERS We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements. (Continued) 10.
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. Our 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, 2002 -------------- Total capital (to risk weighted assets) Consolidated $ 97,471 13.8% $ 56,447 8.0% $ 70,559 10.0% Bank 94,712 13.5 56,318 8.0 70,397 10.0 Tier 1 capital (to risk weighted assets) Consolidated 88,650 12.6 28,228 4.0 42,342 6.0 Bank 85,911 12.2 28,164 4.0 42,246 6.0 Tier 1 capital (to average assets) Consolidated 88,650 12.3 28,807 4.0 36,009 5.0 Bank 85,911 12.0 28,722 4.0 35,902 5.0 December 31, 2001 ----------------- Total capital (to risk weighted assets) Consolidated $ 95,430 14.3% $ 53,584 8.0% $ 66,980 10.0% Bank 92,683 13.9 53,404 8.0 66,754 10.0 Tier 1 capital (to risk weighted assets) Consolidated 87,057 13.0 26,797 4.0 40,195 6.0 Bank 84,337 12.6 26,708 4.0 40,062 6.0 Tier 1 capital (to average assets) Consolidated 87,057 13.0 26,786 4.0 33,482 5.0 Bank 84,337 12.6 26,722 4.0 33,403 5.0 </TABLE> We were categorized as well capitalized at March 31, 2002 and year-end 2001. (Continued) 11.
MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The trust 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 the trust to purchase an equivalent amount of subordinated debentures from the company. The trust preferred securities carry a fixed rate of 9.60%, have a stated maturity of 30 years, and, in effect, are guaranteed by the company. 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 company's capital levels as of March 31, 2002 include an adjustment for the 1.6 million trust preferred securities issued by the trust subject to certain limitations. Federal Reserve guidelines limit the amount of trust preferred securities which can be included in our Tier 1 capital to 25% of total Tier 1 capital. As of March 31, 2002, the entire $16.0 million of the trust preferred securities were included as Tier 1 capital. Our and our bank's ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. We declared a 5% stock dividend on January 7, 2002, that was paid on February 1, 2002 to record holders as of January 18, 2002. We have not paid cash dividends on our common stock since our formation in 1997, and we currently have no intention of doing so in the foreseeable future. 9. NEW ACCOUNTING PRONOUNCEMENTS A new accounting standard dealing with asset retirement obligations will apply for 2003. We do not believe this standard will have a material effect on our financial position or results of operations. Effective January 1, 2002, we adopted a new standard issued by the FASB on impairment and disposal of long-lived assets. We do not believe this standard will have a material effect on our financial position or results of operations. 12.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 our company. 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. 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 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 and its consolidated subsidiaries, Mercantile Bank of West Michigan ("our bank"), our bank's two wholly-owned subsidiaries Mercantile Bank Mortgage Company ("our mortgage company") and Mercantile BIDCO, Inc. ("our BIDCO"), and our subsidiary MBWM Capital Trust I ("the trust"), at March 31, 2002 to December 31, 2001 and the results of operations for the three months ended March 31, 2002 and March 31, 2001. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included herein. Unless the text clearly suggests otherwise, references in this report to "us," "we," "our" or "the company" include Mercantile Bank Corporation and its consolidated subsidiaries referred to above. During the first quarter of 2002, we were engaged in preliminary discussions with a few unaffiliated financial institutions to explore the possibility of an acquisition by us. To date the discussions have been exploratory in nature and no likely acquisition candidate has been identified. We expect that such discussions may occur from time-to-time with these or other financial institutions in future periods. FINANCIAL CONDITION During the first three months of 2002, assets increased from $698.7 million on December 31, 2001, to $728.1 million on March 31, 2002. This represents a total increase in assets of $29.4 million, or 4.2%. The asset growth was comprised primarily of a $33.6 million increase in net loans. The increase in net loans was primarily funded by $26.9 million growth in deposits, a $3.8 million decline in federal funds sold, a $1.9 million decline in securities and a $1.3 million increase in shareholders' equity. 13.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Commercial loans increased by $34.2 million, or 6.3%, during the first three months of 2002, and at March 31, 2002 totaled $573.8 million, or 92.3% of the total loan portfolio. The continued significant concentration of the loan portfolio in commercial loans and the rapid growth of this portion of business is consistent with our stated strategy of focusing a substantial amount of efforts on "wholesale" banking. Corporate and business lending continues to be an area of expertise of our senior management team, and our eight commercial lenders have over 110 years of combined commercial lending experience. Of each of the loan categories that we originate, commercial loans are the most efficiently originated and managed, thus reducing overhead costs by necessitating the attention of fewer employees. Our commercial lending business generates the greatest amount of local deposits, and it is virtually the only source of significant demand deposits. Residential mortgage loans declined by $0.3 million and consumer loans increased by $0.1 million during the first three months of 2002. The decline in residential mortgage loans was due primarily to the completion of homes in our construction portfolio, and the referral to other unaffiliated parties of the conventional residential mortgage loans used to pay off the construction loans. As of March 31, 2002, residential mortgage loans and consumer loans totaled a combined $47.5 million, or 7.7% of the total loan portfolio. Although the residential mortgage loan and consumer loan portfolios are expected to increase in future periods, given our 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 our loan portfolio remains strong. Net loan charge-offs during the first three months of 2002 totaled $29,000, or less than 0.01% of average total loans. Past due loans and nonaccrual loans at March 31, 2002 totaled $646,000, or only 0.10% of period-ending total loans. We believe we have 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 our market area. The remaining portion is comprised of commercial loans participated with certain unaffiliated commercial banks outside of the immediate area, which are underwritten using the same underwriting criteria as though our bank was the originating bank. Deposits increased $26.9 million during the first three months of 2002, totaling $596.0 million at March 31, 2002. Local deposits increased $0.4 million, or 0.2%, while out-of-area deposits increased $26.5 million, or 6.8%. As a percent of total deposits, local deposits decreased from 31.1% on December 31, 2001, to 29.7% at March 31, 2002. Noninterest-bearing demand deposits, comprising 6.7% of total deposits, decreased $3.4 million during the first three months of 2002. Savings deposits (8.4% of total deposits) increased $2.9 million and money market deposit accounts (1.0% of total deposits) increased by $0.5 million during the first three months of 2002, while interest-bearing checking accounts (3.6% of total deposits) decreased by $0.8 million. Local certificates of deposit, comprising 10.0% of total deposits, increased by $1.2 million during the first three months of 2002. The decline in noninterest-bearing demand deposits and interest-bearing checking accounts during the first quarter of 2002 is believed to be primarily seasonal in nature due to business customers making federal income tax payments, paying employee bonuses and other business purposes. No significant local deposit accounts were closed during the quarter. 14.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Out-of-area deposits totaled $418.8 million, or 70.3% of total deposits, as of March 31, 2002. Out-of-area deposits consist of certificates of deposit primarily 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 our 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 sufficient level of funds. During the first three months of 2002 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 our development, the longer-term funding strategy is to increase local deposits and lower the reliance on out-of-area deposits. 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") increased by $0.8 million during the first three months of 2002. As part of our 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 our business checking deposit accounts. 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 monies are used to fund loan requests, meet deposit withdrawals, maintain reserve requirements, and support our operations. 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. Our 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, we have regularly obtained certificates of deposit from customers outside of the market area and placed by deposit brokers for a fee, as well as certificates of deposit obtained from the deposit owners directly. As of March 31, 2002, out-of-area deposits totaled $418.8 million, or 66.1% of combined deposits and repurchase agreements, compared to $392.2 million, or 64.8% of combined deposits and repurchase agreements, as of December 31, 2001. Reliance on out-of-area deposits is expected to be ongoing due to our planned future growth. 15.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Our 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 and our bank was generally in a federal funds sold position during the first quarter of 2002. The average balance of federal funds purchased during the first three months of 2002 equaled $0.4 million, compared to an $8.4 million average federal funds sold position. As a member of the Federal Home Loan Bank of Indianapolis ("FHLBI"), our bank has access to the FHLBI's borrowing programs. Based on ownership of FHLBI stock and available collateral at March 31, 2002, our bank could borrow up to approximately $20.0 million. Our bank has yet to use its established borrowing line at the FHLBI. Subsequent to March 31, 2002, the FHLBI announced a new borrowing program that allows its members to pledge commercial real estate loans for advances. Subject to meeting certain financial condition and capital requirements, members will be permitted to borrow up to $1 for every $3 of eligible commercial real estate loans. Using commercial real estate loan balances as of March 31, 2002, under this new program our bank would be able to borrow an additional $90.0 million. It is expected that this new borrowing program will be available for our use by June 30, 2002. The company has been extended a $5.0 million unsecured line of credit from a correspondent bank. Proceeds from the credit facility may be used for working capital, investment in our bank or acquisition of financial institutions. The line of credit, which has yet to be utilized, matures on February 28, 2003. In addition to typical loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of March 31, 2002, our bank had a total of $166.3 million in unfunded loan commitments and $38.9 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $130.3 million were commitments available as lines of credit to be drawn at any time as customers' cash needs vary, and $36.0 million were for loan commitments scheduled to close and become funded within the next three months. We monitor fluctuations in loan balances and commitment levels, and include such data in managing overall liquidity. CAPITAL RESOURCES Shareholders' equity is a noninterest-bearing source of funds that provides support for asset growth. Shareholders' equity increased by $1.3 million during the first three months of 2002, from $71.5 million on December 31, 2001, to $72.8 million at March 31, 2002. The increase is attributable to net income of $1.6 million recorded during the first quarter of 2002. Shareholders' equity was negatively impacted during the first quarter of 2002 by a $0.3 million mark-to-market adjustment for available for sale securities as defined in SFAS No. 115. The adjustment was due to the increase in the interest rate environment during the first three months of 2002. In September 1999 the company, through the trust, issued 1.6 million shares of trust preferred securities at $10.00 per share. Substantially all of the net proceeds were contributed to our bank as capital and were used to support 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 capital for purposes of calculating regulatory capital ratios. At March 31, 2002, the entire $16.0 million of trust preferred securities were included as Tier 1 capital. 16.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We are subject to regulatory capital requirements primarily administered by federal banking regulatory agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Since our bank commenced operations, both the company and our bank have been categorized as "Well Capitalized," the highest classification contained within the banking regulations. The capital ratios of the company and our bank as of March 31, 2002 and December 31, 2001 are disclosed under Note 8 of the Notes to Consolidated Financial Statements. 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. We declared a 5% stock dividend on January 7, 2002, which was paid on February 1, 2002 to record holders as of January 18, 2002. We have not paid cash dividends on our common stock since our formation in 1997, and we currently have no intention of doing so in the foreseeable future. RESULTS OF OPERATIONS Net income for the first quarter of 2002 was $1.6 million ($0.31 per basic and diluted share), which represents a 75.3% increase over net income of $0.9 million ($0.33 per basic share and $0.32 per diluted share) recorded during the first quarter of 2001. The 6.1% decline in basic earnings per share and the 3.1% decline in diluted earnings per share is due to the dilution impact of the common stock sales completed during 2001. Average basic and diluted shares outstanding during the first quarter of 2002 were up 83.2% and 83.6% over the levels during the same time period in 2001, respectively. The improvement in net income was primarily the result of an increase in net interest income, higher noninterest income and greater employee efficiency. Interest income during the first quarter of 2002 was $11.0 million, an increase of 1.7% over the $10.9 million earned during the first quarter of 2001. The growth in interest income is primarily attributable to an increase in earning assets. During the first three months of 2002 earning assets averaged $692.2 million, a level significantly higher than the average earning assets of $521.5 million during the same time period in 2001. Increase in total loans and securities accounted for all of the growth in average earning assets. Negatively impacting the growth in interest income was the decline in yield on earning assets. During the first three months of 2002 and 2001, earning assets had a weighted average rate (tax equivalent-adjusted basis) of 6.55% and 8.51%, respectively. The decrease in weighted average yield was primarily due to the overall decline in market interest rates since the beginning of 2001, in part evidenced by the 475 basis point drop in the prime rate since January 3, 2001. Interest expense during the first quarter of 2002 was $6.0 million, a decrease of 18.8% from the $7.4 million expensed during the first quarter of 2001. The decrease in interest expense is primarily attributable to a decline in market interest rates and increase in shareholders' equity, which more than offset the increase in interest-bearing liabilities necessitated by the growth in assets. During the first three months of 2002 interest-bearing liabilities averaged $604.0 million, a level substantially higher than average interest-bearing liabilities of $469.7 million during the same time period in 2001. Increase in interest-bearing deposits accounted for 95.3% of the growth in average interest-bearing liabilities. Positively impacting interest expense was the substantial decline in the cost of interest-bearing liabilities. During the first three months of 2002 and 2001, interest-bearing liabilities had a weighted average rate of 4.03% and 6.38%, respectively. The decrease was primarily due to the aforementioned overall decline in market interest rates since the beginning of 2001. Also positively impacting interest expense was the growth in shareholders' equity, which increased from an average balance of $33.6 million during the first quarter of 2001 to $72.4 million during the first quarter of 2002 due to common stock sales and net income. 17.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net interest income during the first quarter of 2002 was $5.0 million, an increase of 45.4% over the $3.5 million earned during the first quarter of 2001. The increase in net interest income was due to the growth in earning assets and improved net interest margin. The net interest margin increased from 2.76% during the first three months of 2001 to 3.03% during the first three months of 2002, primarily reflecting the overall positive impact of the decreasing interest rate environment since the beginning of 2001 and common stock sales completed during 2001. The following table sets forth certain information relating to our consolidated average interest earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the first quarter of 2002 and 2001. 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%. <TABLE> <CAPTION> Quarters ended March 31, ---------------------2 0 0 2--------------- --------------------2 0 0 1--------------- Average Average Average Average Balance Interest Rate Balance Interest Rate ------- -------- ---- ------- -------- ---- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Loans $ 606,065 $ 9,907 6.63 $ 442,647 $ 9,576 8.77% Investment securities 77,538 1,236 6.46 62,622 1,143 7.30 Federal funds sold 8,424 35 1.69 16,096 218 5.43 Short term investments 194 1 1.25 110 1 4.44 -------------- ------------ ------- -------------- ------------- ------- Total interest - earning assets 692,221 11,179 6.55 521,475 10,938 8.51 Allowance for loan losses (8,751) (6,536) Other assets 36,696 22,047 -------------- -------------- Total assets $ 720,166 $ 536,986 ============== ============== Interest-bearing deposits $ 550,840 $ 5,409 3.98 $ 422,824 $ 6,665 6.39% Short-term borrowings 36,880 201 2.21 30,853 335 4.41 Long-term borrowings 16,309 396 9.73 16,057 393 9.81 -------------- ------------ ------- -------------- ------------- ------- Total interest-bearing liabilities 604,029 6,006 4.03 469,734 7,393 6.38 Noninterest-bearing deposits 38,874 26,637 Other liabilities 4,888 7,004 Shareholders' equity 72,375 33,611 -------------- ------------ ------- -------------- ------------- ------- Total liabilities and shareholders' equity $ 720,166 $ 536,986 ============== ============== Net interest income $ 5,173 $ 3,545 ============ ============= Net interest rate spread 2.52% 2.13% Net interest spread on average assets 2.91 2.68 Net interest margin on earning assets 3.03 2.76 </TABLE> 18.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Provisions to the allowance for loan and lease losses during the first quarter of 2002 were $460,000, compared to the $450,000 that was expensed during the first quarter of 2001. Net loan charge-offs of $29,000 were recorded during the first three months of 2002, compared to a net recovery of $13,000 during the same time period in 2001. The allowance for loan and lease losses as a percentage of total loans outstanding as of March 31, 2002 was 1.44%, compared to 1.45% at December 31, 2001. In each accounting period, the allowance for loan and lease losses is adjusted to the amount believed necessary to maintain the allowance for loan and lease losses at adequate levels. Through the loan review and credit departments, we attempt to allocate specific portions of the allowance for loan and lease losses based on specifically identifiable problem loans. The evaluation of the allowance for loan and lease 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, the rapid loan growth since our inception is taken into account. The Reserve Analysis, used since the inception of our 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 our comprehensive loan rating paradigm that is administered by our 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 15 years. The Reserve Analysis is reviewed regularly 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 quarter of 2002 was $420,000, an increase of $111,000, or 35.9%, over the amount earned during the same period in 2001. Service charge income on deposit and repurchase agreements increased $92,000 (90.2%) during the first quarter of 2002 over that earned in the comparable time period in 2001 due primarily to new accounts opened during the last 12 months and a reduction of the earnings credit rate. Reflecting the declining interest rate environment and resulting increase in residential mortgage loan refinancings, fees earned on referring residential mortgage loan applicants to various third parties increased $15,000 (18.3%). Noninterest income related to the cash surrender value of bank owned life insurance policies ("BOLI") totaled $45,000 during the first quarter of 2002. Purchased at various intervals during mid-2001, the BOLI policies represent a combination of whole life and term life insurance and were purchased as part of our non-qualified deferred compensation program. Letter of credit fees declined $72,000 during the first three months of 2002 when compared to the first three months of 2001, reflecting the reduction in letter of credit issuances and resulting origination fees. As part of our interest rate risk management program, during the first quarter of 2002 we sold ten mortgage-backed securities with an aggregate par value of $10.2 million, resulting in a net gain of $149,000. The underlying mortgage loans of the mortgage-backed securities generally had 25 to 30 years to final maturity and exhibited a relatively high level of extension risk in an increasing interest rate environment. The proceeds of the sold bonds were re-invested into five mortgage-backed securities, the underlying mortgage loans of which have 10 to 15 years to final maturity and would expect to have a much lower level of extension risk in a rising interest rate environment when compared to the bonds that were sold. As a result of this bond swap transaction, we would expect a higher level of principal payments if a rising interest rate environment occurs than we would have otherwise received, providing a higher level of funds that could be re-invested in the higher interest rate environment. 19.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Noninterest expense during the first quarter of 2002 was $2.9 million, an increase of 38.2% over the $2.1 million expensed during the first quarter of 2001. An increase in all major overhead cost categories was recorded, but was primarily related to employee salaries and benefits and the opening of our new administration and combination branch/operations center in the latter part of 2001. The increase in employee salaries and benefits primarily resulted from the hiring of additional staff and merit annual pay raises. The level of full-time equivalent employees increased from 73 at the end of the first quarter in 2001 to 101 at the end of the first quarter in 2002, an increase of 38.4%. Occupancy and furniture and equipment costs increased from $235,000 during the first quarter of 2001 to $438,000 during the first quarter of 2002, or 86.4%. A vast majority of this increase is related to our new facilities that opened in September and October of 2001. 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 a result of our growth and the realization of operating efficiencies. Monitoring and controlling noninterest costs, while at the same time providing high quality service to customers, is a key component to our business strategy. The efficiency ratio, computed by dividing noninterest expenses by net interest income plus noninterest income, was 51.1% during the first three months of 2002, a 4.5% improvement from the 53.5% during the first three months of 2001. Although noninterest expenses increased by $0.8 million during the first three months of 2002 over the amount expensed during the first three months of 2001, net revenues (net interest income plus noninterest income) increased at a substantially higher level of $1.7 million during the same time period, leading to an improved efficiency ratio and overall profitability. Federal income tax expense was $674,000 during the first three months of 2002, a significant increase over the $433,000 expensed in the first three months of 2001. The increase was primarily due to the increase in net income before federal income tax. During the first three months of 2002, net income before federal income tax was $2.3 million, a significant increase over the $1.3 million recorded during the first three months of 2001. 20.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates. We derive our income primarily from the excess of interest collected on our interest-earning assets over the interest paid on our interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness. Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal 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 our net interest margin during periods of changing market interest rates. The following table depicts our GAP position as of March 31, 2002 (dollars in thousands): 21.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS <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 $ 243,647 $ 26,115 $ 299,568 $ 4,427 $ 573,757 Residential real estate loans 15,167 1,275 14,562 9,731 40,735 Consumer loans 1,738 1,147 3,854 70 6,809 Investment securities (1) 1,488 1,657 33,909 39,847 76,901 Federal funds sold 1,500 1,500 Short-term investments 183 183 Allowance for loan and lease losses (8,925) (8,925) Other assets 37,096 37,096 ----------- ----------- ----------- ----------- ----------- Total Assets 263,723 30,194 351,893 82,246 728,056 Liabilities: Interest-bearing checking 21,344 21,344 Savings 50,055 50,055 Money market accounts 6,085 6,085 Time deposits less than $100,000 24,286 38,951 26,874 90,111 Time deposits $100,000 and over 110,755 139,031 138,824 388,610 Short-term borrowings 37,273 37,273 Long-term borrowings 406 16,000 16,406 Noninterest-bearing checking 39,771 39,771 Other liabilities 5,630 5,630 ----------- ----------- ----------- ----------- ----------- Total Liabilities 250,204 177,982 165,698 61,401 655,285 Shareholders' Equity 72,771 72,771 ----------- ----------- ----------- ----------- ----------- Total Sources of Funds 250,204 177,982 165,698 134,172 728,056 ----------- ----------- ----------- ----------- ----------- Net asset (liability) GAP $ 13,519 $ (147,788) $ 186,195 $ (51,926) =========== =========== =========== =========== Cumulative GAP $ 13,519 $ (134,269) $ 51,926 =========== =========== =========== Percent of cumulative GAP to total assets 1.9% (18.4)% 7.1% =========== =========== =========== </TABLE> (1) Mortgage-backed securities are categorized by expected final maturities based upon prepayment trends as of March 31, 2002 The second interest rate risk measurement we use is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, 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. 22.
MERCANTILE BANK CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We conducted multiple simulations as of March 31, 2002, whereby it was assumed that a simultaneous, instant and sustained change in market interest rates occurred. The following table reflects the suggested impact on our 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 $ 734,000 3.3% Interest rates down 100 basis points 949,000 4.2 No change in interest rates 1,049,000 4.7 Interest rates up 100 basis points 1,404,000 6.2 Interest rates up 200 basis points 1,765,000 7.8 </TABLE> The increase in our net interest income under all interest rate scenarios reflects the expected repricing of local and out-of-area certificates of deposit during the next twelve months. Unlike interest rates on our floating rate loans that declined throughout 2001 as the prime rate declined, our certificates of deposit have fixed interest rates and only reprice at maturity. Throughout most of the remainder of 2002 we have a large volume of certificates of deposit that will mature and are expected to be refinanced at lower interest rates. 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.
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. From time to time, we may be involved in various legal proceedings that are incidental to our business. In our opinion, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate. ITEM 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: EXHIBIT NO. EXHIBIT DESCRIPTION 3.1 Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Registration Statement on Form SB-2 (Commission File no. 333-33081) that became effective on October 23, 1997 3.2 Our bylaws are incorporated by reference to Exhibit 3.2 of our 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 24.
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 9, 2002. 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.
EXHIBIT INDEX EXHIBIT NO. EXHIBIT DESCRIPTION 3.1 Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our Registration Statement on Form SB-2 (Commission File no. 333-33081) that became effective on October 23, 1997 3.2 Our bylaws are incorporated by reference to Exhibit 3.2 of our 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 26.