What changed in this filing

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Item 9A. Controls and Procedures

2022-03-04 compared with 2021-03-05 · 1041 added, 734 removed, 2613 unchanged (40% of the section changed)

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Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2021.

Refer to page F-38 for management’s report.

Refer to page F-33 for management’s report.

Our independent registered public accounting firm has issued an audit report on our internal control over financial reporting which is included in this Annual Report.

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December 31, 2021 and 2020

SELECTED FINANCIAL DATA

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (PCAOB ID 243 )

REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SELECTED FINANCIAL DATA

Consolidated Results of Operations:

(Dollars in thousands except per share data)

Interest income

Interest expense

Net interest income

Provision for loan losses

Noninterest income

Noninterest expense

Income before income tax expense

Income tax expense

Consolidated Balance Sheet Data:

Cash and cash equivalents

Allowance for loan losses

Bank owned life insurance

Securities sold under agreements to repurchase

Federal Home Loan Bank advances

Subordinated debentures

Shareholders’

Consolidated Financial Ratios:

Return on average assets

Return on average shareholders’

Average shareholders’

equity to average assets

Nonperforming loans to total loans

Allowance for loan losses to total loans *

Tier 1 leverage capital

Common equity risk-based capital

Tier 1 risk-based capital

Total risk-based capital

Per Common Share Data:

Book value per share at end of period

Dividends declared

Dividend payout ratio

(*) Excludes Paycheck Protection Program Loans

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

MANAGEMENT ’

S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

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Future Factors include, among others, adverse changes in interest rates and interest rate relationships;

increasing rates of inflation and slower growth rates;

significant declines in the value of commercial real estate;

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demand for products and services;

the degree of competition by traditional and non-traditional competitors;

the degree of competition by traditional and non-traditional financial service companies;

changes in banking regulation or actions by bank regulators;

our participation in the PayCheck Protection Program administered by the Small Business Administration;

changes in the method of determining Libor, or the replacement of Libor with an alternative reference rate;

changes in tax laws;

changes in prices, levies, and assessments;

the impact of technological advances;

risks associated with cyber-attacks, information security breaches and other criminal activities on our computer systems;

potential cyber-attacks, information security breaches and other criminal activities on our computer systems;

litigation liabilities;

governmental and regulatory policy changes;

the outcomes of contingencies;

the outcomes of existing or future contingencies;

trends in customer behavior as well as their ability to repay loans;

changes in local real estate values;

damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, the failure to meet client expectations and other facts;

changes in the national and local economies, including the significant disruption to financial market and other economic activity caused by the outbreak of Covid-19;

and other risk factors described in Item 1A of this Annual Report.

damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, and the failure to meet client expectations and other facts;

adoption of SOFR and changes in the method of determining SOFR;

direct and indirect climate change matters;

changes in the national and local economies, including the ongoing disruption to financial market and other economic activity caused by the Coronavirus Pandemic;

and other factors described in Item 1A of this Annual Report.

These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.

Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”

in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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Our migration takes into account various time periods;

however, at year-end 2020, we placed most weight on the period starting December 31, 2010 through December 31, 2020.

however, at year-end 2021, we placed most weight on the period starting January 1, 2011 through December 31, 2021.

We believe this period represents an appropriate range of economic conditions, and that it provides for an appropriate basis in determining reserve allocation factors given current economic conditions and the general market consensus of economic conditions in the near future.

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We established a Covid-19 reserve allocation factor to address the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio during the second quarter of 2020.

The creation of this factor reflected our belief that the traditional nine environmental factors did not sufficiently capture and address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic, which include unprecedented federal government stimulus and interventions, statewide mandatory closures of nonessential businesses and periodic changes to such and our ability to provide payment deferral programs to commercial and retail borrowers without the interjection of troubled debt restructuring accounting rules.

The creation of this factor reflected our belief that the traditional nine environmental factors did not sufficiently capture and address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic, which included unprecedented federal government stimulus and interventions, statewide mandatory closures of nonessential businesses and periodic changes to such and our ability to provide payment deferral programs to commercial and retail borrowers without the interjection of troubled debt restructuring accounting rules.

We review a myriad of items when assessing this new environmental factor, including virus infection rates, economic outlooks, employment data, business closures, foreclosures, payment deferments and government-sponsored stimulus programs.

The Covid-19 reserve factor resulted in a $5.3 million increase to the allowance as of December 31, 2020.

The Covid-19 reserve factor resulted in a $5.3 million increase to the allowance during 2020, which increased to $6.5 million as of December 31, 2021 given the significant core commercial loan and residential mortgage loan growth during the year.

The allowance is increased through a provision charged to operating expense.

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Financial institutions were not required to comply with the Current Expected Credit Loss (“CECL”) methodology requirements from the enactment date of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020.

The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for an extension of the required CECL adoption date to January 1, 2022, which is the date we expect to adopt.

The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022.

An economic forecast is a key component of the CECL methodology.

As we continue to experience an unprecedented economic environment whereby a sizable portion of the economy has been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus has been provided to businesses, individuals and state and local governments and financial institutions have offered businesses and individuals payment relief options, economic forecasts are regularly revised with no economic forecast consensus.

Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.

As we continued to experience an unprecedented economic environment whereby a sizable portion of the economy had been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus was provided to businesses, individuals and state and local governments and financial institutions offered businesses and individuals payment relief options, economic forecasts were regularly revised with no economic forecast consensus.

Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL until January 1, 2022, and continued to use our incurred loan loss reserve model as permitted through December 31, 2021.

Income Tax Accounting :

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Any impairment of a grouping is reported as a valuation allowance.

Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets.

Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified.

A more frequent assessment is performed if conditions in the market place or changes in the company’s organizational structure occur.

Due to current stressed economic and market conditions, we assessed goodwill for impairment as of March 31, 2020, June 30, 2020, September 30, 2020, and October 1, 2020.

For March 31, 2020, we used a discounted income approach and a market valuation model, which compared the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill had been impaired.

Using this quantitative methodology, we determined goodwill was not impaired as of March 31, 2020.

For June 30, 2020, September 30, 2020, and October 1, 2020, we used the Step 0 methodology for which we assessed the macro and microeconomic conditions, industry and market conditions, financial performance, and our underlying stock performance.

We concluded it was more likely than not our fair value was greater than its carrying amount at the end of each period;

A more frequent assessment is performed should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable.

We may elect to perform a qualitative assessment for the annual impairment test.

If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment.

If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value.

We performed a qualitative assessment as of October 1, 2021 for which we evaluated the macro and microeconomic conditions, industry and market conditions, financial performance, and our underlying stock performance.

We concluded it was more likely than not our fair value was greater than its carrying amount at the end of the period;

therefore, no further testing was required.

Due to stressed economic and market conditions throughout 2020, we assessed goodwill for impairment as of March 31, 2020, June 30, 2020, September 30, 2020, and October 1, 2020.

No impairments were recorded in 2021 or 2020.

This Management’s Discussion and Analysis should be read in conjunction with the consolidated financial statements contained in this Annual Report.

This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiary, Mercantile Bank of Michigan (“our bank”), and of Mercantile Bank Real Estate Co., L.L.C.

(“our real estate company”) and Mercantile Insurance Center, Inc.

(“our insurance company”), subsidiaries of our bank.

This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiary, Mercantile Bank (“our bank”), and Mercantile Insurance Center, Inc.

(“our insurance company”), a subsidiary of our bank.

Unless the text clearly suggests otherwise, references to “us,”

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include Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.

C ORONAVIRUS PANDEMIC

economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”).

While the economic fallout has stabilized somewhat, there remains a significant amount of stress and uncertainty across national and global economies.

This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances.

CORONAVIRUS PANDEMIC

There remains a significant amount of stress and uncertainty across national and global economies due to the ongoing pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”).

This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances, including supply chain disruptions and inflationary pressures.

The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations.

We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income.

We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have had a negative impact on our net interest income and net income.

Additionally, the consequences of the unprecedented economic impact of the Coronavirus Pandemic may produce declining asset quality, reflected by a higher level of loan delinquencies and loan charge-offs, as well as downgrades of commercial lending relationships, which may necessitate additional provisions for our allowance and reduced net income.

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Paycheck Protection Program

The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program.

The Paycheck Protection Program (“PPP”) reflected a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program.

The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors.

The PPP provides 100% guaranteed loans to cover specific operating costs, with the maximum loan size capped at the lesser of 250% of the average monthly payroll costs or $10.0 million.

The PPP provided 100% guaranteed loans to cover specific operating costs.

PPP loans are eligible to be forgiven based upon certain criteria.

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Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan.

The loan tenor is 24 months for loans originated prior to June 5, 2020 and 60 months for loans originated on or after June 5, 2020.

Loans originated prior to June 5, 2020 can be modified to a tenor of 60 months upon the mutual agreement of the lender and borrower.

We have not modified the maturity date of any loans made prior to June 5, 2020.

The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee ranging from 1% to 5% of the loan amount paid by the Small Business Administration.

The loan origination fees, net of the direct origination costs, have totaled approximately $15.0 million and are being accreted into interest income on loans using the level yield methodology.

The program was originally scheduled to end on June 30, 2020, but was subsequently modified to end on August 8, 2020.

Participation in the PPP has had a significant impact on the composition of our loan and deposit portfolios and our net interest income starting during the second quarter of 2020, which is expected to remain well into 2021.

We originated approximately 2,200 loans aggregating $554 million under the PPP, with no customer payments but $189 million in forgiveness transactions on approximately 900 PPP loans recorded through December 31, 2020.

Under the CARES Act, a PPP loan is assigned a risk weight of 0% under the risk-based capital rules of the federal banking agencies.

On April 9, 2020, the federal banking agencies issued an interim final rule allowing financial institutions to exclude PPP loans from the average asset calculation to the degree the PPP loans are financed through the Paycheck Protection Program Lending Facility (“PPPLF”) for the Tier 1 Leverage Capital Ratio.

The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee from the Small Business Administration.

The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology.

The program ended on August 8, 2020.

We originated approximately 2,200 loans aggregating $554 million.

As of December 31, 2021, we recorded forgiveness transactions on all but ten loans aggregating $1.3 million.

Net loan origination fees of $3.7 million were recorded during 2021.

The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in Second Draw PPP loans (“Second Draw”).

The program ended on May 31, 2021.

Under the Second Draw, we originated approximately 1,200 loans aggregating $208 million.

As of December 31, 2021, we recorded forgiveness transactions on about 1,000 loans aggregating $169 million.

Net loan origination fees of $7.1 million were recorded during 2021.

Individual Economic Impact Payments

The Internal Revenue Service began making Individual Economic Impact Payments in mid-April via direct deposit or mailed checks.

Individuals with adjusted gross income of $75,000 or less received payments of $1,200, with a reduction formula for those individuals with adjusted gross income over $75,000 but less than $99,000.

Individuals with adjusted gross income of over $99,000 did not receive a payment.

Married couples filing jointly with adjusted gross income of $150,000 or less received payments of $2,400, with a reduction formula for those married couples filing jointly with adjusted gross income over $150,000 but less than $198,000.

Married couples filing jointly with adjusted gross income of over $198,000 did not receive a payment.

The Internal Revenue Service has made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks.

In general, and subject to adjusted gross income limitations, qualifying individuals have received payments of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.

Troubled Debt Restructuring Relief

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Under the latter program, borrowers were extended a 12-month single payment note at 0% interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments.

The single payment notes receive a loan grade equal to the loan grade of each respective borrowing relationship.

The single payment notes received a loan grade equal to the loan grade of each respective borrowing relationship.

Certain of our commercial loan borrowers subsequently requested and received an additional 90-day (three payments) interest only amendment or 90-day (three payments) principal and interest payment deferment.

Under the latter program, the amount equal to the three payments was added to the original deferment note which has nine months remaining to maturity;

however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.

At the peak of activity in mid-July, nearly 750 borrowers with loan balances aggregating $719 million were participating in the commercial loan deferment program.

However, as of December 31, 2020, only 19 borrowers with loan balances aggregating $8.0 million remained in the commercial loan deferment program.

Under the latter program, the amount equal to the three payments was added to the original deferment note which had nine months remaining to maturity;

however, the original 0% interest rate was modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.

At the peak of activity in mid-2020, nearly 750 borrowers with loan balances aggregating $719 million participated in the commercial loan deferment program.

As of December 31, 2021, we had no loans in the commercial loan deferment program.

For retail borrowers, we offered 90-day (three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan.

As of June 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $23.8 million.

These payment deferral transactions largely applied to the borrowers’

April, May and June loan payments.

As of December 31, 2020, only 14 borrowers with loan balances aggregating $1.8 million remained in the retail loan payment deferment program.

In April, 2020, the Federal Reserve initiated the PPPLF, which is designed to facilitate lending by financial institutions to small businesses under the PPP.

Only PPP loans are eligible to serve as collateral for the PPPLF, with each dollar of PPP loans providing one dollar of advance availability.

The maturity date of an extension of credit under the PPPLF will equal the maturity date of the pool of PPP loans pledged to secure the extension of credit.

Any principal payments received by the financial institution on the PPP loans, such as PPP loan forgiveness payments from the Small Business Administration or principal payments from the borrower after the initial six-month deferment period, must be used to pay down the PPPLF advance by the same dollar amount, maintaining the dollar-for-dollar advance amount and PPP aggregate loan balance relationship.

The interest rate on PPPLF advances is fixed at 0.35%.

No PPPLF advances could be obtained after September 30, 2020.

We obtained a PPPLF advance in the amount of $43.7 million in late April 2020 and paid it off in full in early June 2020.

As of December 31, 2020, we had no advances outstanding under the PPPLF.

SUBSEQUENT EVENTS

On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law.

This $900 billion Coronavirus Pandemic relief package includes $284 billion in aid for small businesses through a second round of forgivable loans through the PPP.

In general, the framework of loans originated under the second round are similar to that of the initial round.

As of February 26, 2021, we had originated about 900 loans aggregating $181 million in second round PPP loans.

We originated approximately 2,200 loans aggregating $554 million under the initial round of the PPP.

As of December 31, 2020, we had received no customer payments but had received $189 million in forgiveness payments from the Small Business Administration on about 900 PPP loans.

As of February 26, 2021, we had received no customer payments but had received $266 million in forgiveness payments from the Small Business Administration on approximately 1,400 loans.

As part of our bank’s branch rationalization efforts, we recently announced that our bank and Lake Trust Credit Union have entered into an agreement for the sale of our banking office located in Hastings, Michigan, with the sale expected to be consummated by March 31, 2021.

The agreement includes the 4,300 square-foot facility, all associated assets and approximately $16 million in deposits.

As of September 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $23.8 million.

As of December 31, 2021, only eight borrowers with loan balances aggregating $0.4 million remained in the retail loan payment deferment program.

FINANCIAL OVERVIEW

We recorded net income of $59.0 million, or $3.69 per basic and diluted share, for 2021, compared to net income of $44.1 million, or $2.71 per basic and diluted share, for 2020.

The net impact of a gain on the sale of a former branch facility and write-downs of former branch facilities decreased net income during 2020 by approximately $1.1 million, or $0.07 per diluted share.

Bank owned life insurance claims and the net impact of gains and losses on sales and write-downs of former branch facilities increased net income during 2019 by approximately $2.7 million, or $0.16 per diluted share.

Excluding the impacts of these transactions, diluted earnings per share decreased $0.07, or 2.5%, during 2020 compared to 2019.

The lower level of net income during 2020 compared to 2019 resulted from higher provision expense and noninterest expense and decreased net interest income, which more than offset increased noninterest income.

The loan loss reserve build during 2020, which primarily reflected increased allocations associated with changes in certain environmental factors and an allocation related to a newly-created Covid-19 pandemic environmental factor, was viewed as a precautionary measure to guard against any potential deterioration in the quality of the loan portfolio stemming from the pandemic and associated weakened economic conditions.

The higher level of noninterest expense mainly reflected increased compensation, occupancy, furniture and equipment, and Federal Deposit Insurance Corporation (“FDIC”) insurance premium costs, along with increased write-downs of former branch facilities.

The decline in net interest income depicted a lower yield on earning assets, which more than offset the positive impact of growth in earning assets.

The improved noninterest income primarily reflected increased mortgage banking income.

We believe the overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.11% of total loans as of December 31, 2020.

Gross loan charge-offs during 2020 totaled $0.8 million, while recoveries of prior period loan charge-offs totaled $0.9 million, providing for net loan recoveries of $0.1 million, or 0.01% of average total loans.

We continue our collection efforts on charged-off loans, and expect to record recoveries in future periods;

however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries.

Accruing loans past due 30 to 89 days remain very low.

Commercial loans increased $352 million during 2020, and at December 31, 2020 totaled $2.79 billion, or 86.9% of our loan portfolio.

As of December 31, 2019, the commercial loan portfolio comprised 85.5% of total loans.

The increase in commercial loans during 2020 primarily reflects activity under the PPP.

Originations of PPP loans, primarily during the second quarter and to a lesser degree the third quarter, totaled $554 million.

We started to receive PPP loan forgiveness payments from the Small Business Administration during the fourth quarter, totaling $189 million through year-end 2020 and providing for a net balance of $365 million at December 31, 2020.

Excluding PPP loans, our commercial and industrial loan segment declined $66.1 million during 2020, in large part reflecting a reduction in lines of credit during the second quarter.

Non-owner occupied commercial real estate (“CRE”) loans increased $82.1 million and multi-family and residential rental loans grew $21.6 million, while owner-occupied CRE loans declined $49.1 million.

We believe our loan portfolio remains well diversified.

As a percentage of total commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 60.0% as of December 31, 2020, compared to 58.4% at December 31, 2019.

The current commercial loan pipeline remains strong, and at year-end 2020, we had almost $100 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

We experienced significant deposit growth during 2020, primarily reflecting federal government stimulus payments and reduced business and consumer investing and spending, along with PPP loan proceeds being deposited into customers’

accounts at the time the loans were originated and remaining on deposit at year-end 2020.

Local deposits increased $808 million during 2020, in large part comprised of a $508 million increase in noninterest-bearing checking accounts.

In addition, interest-bearing checking accounts were up $141 million, money market deposits grew $103 million and savings deposits increased $68.8 million.

Brokered deposits declined $86.5 million, comprising 1.4% of total deposits at December 31, 2020 compared to 5.0% at year-end 2019.

We recorded a loan loss provision expense of $14.1 million during 2020, a substantial increase over the $1.8 million recorded during 2019.

Approximately 80% of the provision expense recorded during 2020 is reflective of increased allocations associated with qualitative factors, namely economic conditions, loan review and value of underlying collateral dependent commercial loans, as well as the creation of a Coronavirus Pandemic environmental factor (“Covid-19 factor”).

The Covid-19 factor, developed during the second quarter, is designed to address the unique challenges and economic uncertainty resulting from the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio.

The provision expense recorded during 2020 also reflects the downgrading of certain non-impaired commercial loan relationships, most of which occurred during the third quarter.

Noninterest income during 2020 was $45.2 million, compared to $27.0 million in 2019.

The significant growth primarily reflects increased mortgage banking income stemming from a sizeable upturn in refinance activity spurred by a decrease in residential mortgage loan interest rates, an increase in purchase activity, and the continuing success of strategic initiatives that have been implemented over the past several years to gain market share and increase production.

Mortgage banking income totaled $29.3 million in 2020, compared to $8.5 million during 2019.

Noninterest expense totaled $98.5 million during 2020, compared to $89.3 million in 2019.

The higher level of expense primarily resulted from increased compensation costs, mainly reflecting higher residential mortgage lender commissions and related incentives, as well as annual merit pay increases and a larger bonus accrual.

Occupancy and equipment and furniture costs were up $1.7 million on a combined basis in 2020 compared to 2019, mainly reflecting the late 2019 completion of our main office expansion.

Costs and a charitable contribution related to the formation and initial funding of The Mercantile Bank Foundation decreased net income during 2021 by $3.2 million, or $0.20 per diluted share.

Excluding these costs, diluted earnings per share increased $1.18, or over 43%, during 2021 compared to 2020.

Commercial loans increased $156 million during 2021, reflecting the combined net growth of core commercial loans and net activity under the PPP.

Core commercial loans increased $481 million, or almost 20% during 2021, while PPP loans declined $325 million, comprised of $209 million in Second Draw PPP loans extended and $534 million in forgiveness transactions.

As a percentage of total core commercial loans, commercial and industrial loans and owner occupied commercial real estate (“CRE”) loans combined equaled 57.1% at December 31, 2021, compared to 53.9% at year-end 2020.

The new commercial loan pipeline remains strong, and at December 31, 2021, we had $182 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

The overall quality of our loan portfolio remains strong, with nonperforming loans equaling 0.07% of total loans as of December 31, 2021.

Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties at year-end 2021.

Gross loan charge-offs totaled $1.0 million during 2021, while recoveries of prior period loan charge-offs totaled $2.7 million, providing for net loan recoveries of $1.7 million, or 0.05% for the year.

We recorded a negative loan loss provision expense of $4.3 million during 2021, compared to a provision expense of $14.1 million during 2020.

The negative provision expense recorded during 2021 primarily reflects reduced allowance allocations associated with the economic and business conditions environmental factor, depicting improvement in both current and forecasted economic conditions, and the recording of net loan recoveries, which combined more than offset required allowance allocations necessitated by the strong net core commercial loan growth.

The economic and business conditions environmental factor was upgraded during both the second and fourth quarters of 2021, resulting in an aggregate allowance reduction of $7.3 million related to these factors.

The relatively large provision expense recorded during 2020 primarily reflected the onset of stressed conditions related to the Coronavirus Pandemic, including two separate downgrades of the economic and business conditions environmental factor, the introduction of the Covid-19 pandemic environmental factor to address the unique challenges and uncertainties associated with the Coronavirus Pandemic, and certain commercial loan downgrades.

Interest-earning balances, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity.

During 2021, the average balance of these funds equaled $671 million, or 14.9% of average earning assets, compared to $357 million, or 9.2% of average earning assets, during 2020.

Typically, we maintain our interest-earning balances at approximately $75 million, or about 2% of average earning assets.

The elevated levels during 2021 and 2020 primarily reflect increased local deposits stemming from federal government stimulus programs and reduced business and consumer investing and spending.

The excess level of interest-earning balances had a negative impact of approximately 40 basis points on our 2021 net interest margin.

Total deposits increased $672 million during 2021, and are up $1.4 billion since year-end 2019, equating to growth rates of almost 20% and over 51%, respectively.

Growth in noninterest-bearing checking accounts comprised about 38% of the growth in 2021, and approximately 54% of the growth since year-end 2019.

Net interest income increased $1.8 million during 2021 compared to 2020.

Both interest income and interest expense were impacted during 2021 by the Federal Open Market Committee’s (“FOMC”) federal funds rate cuts totaling 150 basis points in March 2020 and a historically low interest rate environment since that time;

however, growth in earning assets, especially core commercial loans, and income associated with the PPP, has provided for the increase in net interest income.

Interest income declined $4.8 million during 2021 compared to 2020, while interest expense was down $6.6 million during the same time periods.

Noninterest income was $56.2 million during 2021, compared to $45.2 million during 2020.

The improved level mainly resulted from ongoing strength in our mortgage banking function and fee income generated from a commercial lending interest rate swap program that was introduced in late 2020.

In addition, a gain of $1.1 million was recognized from the sale of a branch during 2021.

Noninterest expense was $111 million during 2021, compared to $98.5 million during 2020.

Growth in salary expense, in large part reflecting merit and market adjustments, totaled $2.4 million in 2021.

Expense associated with our bonus and stock-based compensation programs increased $2.8 million in 2021, primarily reflecting the strong 2021 operating performance.

Health insurance costs were up $1.1 million in 2021, generally reflecting the Coronavirus Pandemic environment.

FINANCIAL CONDITION

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Total loans increased $260 million, interest-earning deposits were up $353 million and securities available for sale increased $205 million.

Total deposits increased $721 million and FHLBI advances were up $40.0 million.

Local deposit growth exceeded net loan growth, with the excess funds maintained with the Federal Reserve Bank of Chicago.

Total deposits increased $672 million, securities sold under agreements to repurchase (“sweep accounts”) were up $79.1 million, and net proceeds from the issuance of subordinated notes totaled $73.6 million.

In large part, increased local deposits exceeded growth in the loan and securities portfolios, with the excess funds maintained with the Federal Reserve Bank of Chicago.

Earning Assets

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As of December 31, 2020, the commercial loan portfolio comprised 87.5% of total loans.

The increase in commercial loans during 2020 primarily reflects activity under the PPP.

Originations of PPP loans, primarily during the second quarter and to a lesser degree during the third quarter, totaled $554 million.

We started to receive PPP loan forgiveness payments from the Small Business Administration during the fourth quarter, totaling $189 million through year-end 2020, and providing for a net balance of $365 million as of December 31, 2020.

Excluding PPP loans, our commercial and industrial loan segment declined $66.1 million during 2020, in large part reflecting a reduction in lines of credit during the second quarter.

Non-owner occupied CRE loans increased $82.1 million and multi-family and residential rental loans grew $21.6 million, while owner-occupied CRE loans declined $49.1 million.

We believe our loan portfolio remains well diversified.

As a percentage of total commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 60.0% as of December 31, 2020, compared to 58.4% at December 31, 2019.

As of December 31, 2020, availability on commercial construction and development loans that are in the construction phase totaled almost $100 million, with most of the funds expected to be drawn over the next 12 to 18 months.

Our current pipeline reports indicate strong commercial loan funding opportunities in future periods, including $228 million in new lending commitments.

The increase in commercial loans reflects the combined net growth of core commercial loans and net activity under the PPP.

Core commercial and industrial loans increased $317 million, non-owner occupied CRE loans grew $110 million, owner occupied CRE loans were up $35.8 million and multi-family and residential rental loans increased $30.5 million, while vacant land, land development and residential construction loans declined $11.8 million.

As a percentage of total core commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 57.1% at December 31, 2021, compared to 53.9% at year-end 2020.

We believe our commercial loan portfolio remains well diversified.

As of December 31, 2021, availability on commercial construction and development loans that are in the construction phase totaled $182 million, with most of the funds expected to be drawn over the next 12 to 18 months.

Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including $212 million in new lending commitments, a majority of which we expect to be accepted and funded over the next 12 to 18 months.

Our commercial lenders also report additional opportunities they are currently discussing with existing borrowers and potential new customers.

We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio.

Usage of existing commercial lines of credit was relatively stable during the last six months of 2020, after having declined by about $110 million during the second quarter largely reflecting the Coronavirus Pandemic and associated weakened economic conditions.

Usage of existing commercial lines of credit was relatively stable during 2021 at approximately 40%, compared to our historical average of about 50% prior to the Coronavirus Pandemic.

Residential mortgage loans increased $105 million during 2021, totaling $443 million, or 12.8% of total loans, at December 31, 2021.

We originated $864 million in residential mortgage loans during 2020, compared to $369 million in 2019.

The 135% increase is primarily attributable to a sizeable upturn in refinance activity spurred by a decrease in residential mortgage loan interest rates, an increase in purchase activity, and the continuing success of strategic initiatives that have been implemented over the past several years to gain market share and increase production.

Almost 66% of the residential mortgage loans originated during 2020 consisted of refinance transactions, compared to about 50% during 2019.

Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $672 million during 2020, or almost 78% of the total residential mortgage loans originated.

As of December 31, 2020, the residential mortgage portfolio comprised 10.6% of total loans.

Activity within the residential mortgage loan function remained very active throughout 2021, primarily reflecting refinance transactions spurred by low residential mortgage loan rates, strength in home purchase activity, and the continuing success of strategic initiatives that have been implemented over the past several years to gain market share and increase production.

We originated $952 million in residential mortgage loans during 2021, compared to $864 million in 2020, an increase of over 10%.

The production composition during 2021 was split almost evenly between refinance and purchase transactions, compared to 2020 when approximately 66% of production was comprised of refinance transactions.

Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $644 million during 2021, or about 68% of the total residential mortgage loans originated, compared to approximately 78% in 2020.

Residential mortgage loans originated not sold are generally comprised of adjustable rate residential mortgage loans.

We are very pleased with the results of our strategic initiatives associated with the growth of our residential mortgage banking operation over the past few years, and remain optimistic that origination volumes will continue to be solid in future periods.

Other consumer-related loans declined $13.8 million during 2020, and at December 31, 2020 totaled $61.6 million, or 1.9% of the loan portfolio.

Other consumer-related loans equaled 2.6% of total loans as of December 31, 2019.

We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed origination volumes.

We remain pleased with the results of our strategic initiatives associated with the growth of our residential mortgage banking operation over the past few years, and remain optimistic that origination volumes will continue to be solid in future periods.

Other consumer-related loans declined $1.1 million during 2021, and at December 31, 2021 totaled $60.5 million, or 1.8% of total loans.

As of December 31, 2020, the other consumer-related loan portfolio comprised 1.9% of total loans.

We expect this loan portfolio segment to decline in dollar amount and as a percent of total loans in future periods as scheduled principal payments exceed origination volumes.

The following table summarizes our loan portfolio:

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1,137,419,000

1,145,423,000

Land Development & Construction

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Non-Owner Occupied Commercial Real Estate

1,027,415,000

Multi-Family & Residential Rental

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2,558,552,000

(*) For December 31, 2020, includes $365 million in loans originated under the Paycheck Protection Program.

(*) For December 31, 2021, and December 31, 2020, includes $40.1 million and $365 million in loans originated under the Paycheck Protection Program, respectively.

The following table presents total loans outstanding as of December 31, 2021, according to scheduled repayments of principal on fixed rate loans and repricing frequency on variable rate loans.

Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.

Floating rate commercial loans that are currently at interest rate floors, representing approximately 50% of total commercial loans at year-end 2021, are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.

Construction and land development

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1,451,761,000

3,453,459,000

Fixed rate loans

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1,451,761,000

3,453,459,000

Our credit policies establish guidelines to manage credit risk and asset quality.

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Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $2.5 million (0.1% of total assets) as of December 31, 2021, compared to $4.1 million (0.1% of total assets) as of December 31, 2020.

The volume of nonperforming assets has remained low over the past several years.

The volume of nonperforming assets has remained under 0.3% of total assets since year-end 2015, and under 0.1% over the past three years.

Given the low level of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with a relatively steady level of watch list credits and what we believe are strong credit administration practices, we are pleased with the overall quality of the loan portfolio.

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Valuation write-downs

We continue our collection efforts on charged-off loans, and expect to record recoveries in future periods;

however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries.

Accruing loans past due 30 to 89 days remain very low.

The following table summarizes changes in the allowance for the past five years.

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The evaluation of the allowance is further based on, but not limited to, consideration of the internally prepared Allowance Analysis, loan loss migration analysis, composition of the loan portfolio, third party analysis of the loan administration processes and portfolio, and general economic conditions.

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020.

The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for an extension of the required CECL adoption date to January 1, 2022, which is the date we plan to adopt.

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020.

The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022.

An economic forecast is a key component of the CECL methodology.

Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.

The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan balances, the result of which is combined with specific reserves to calculate an overall allowance amount.

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We established a Covid-19 reserve allocation factor to address the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio during the second quarter of 2020.

The creation of this factor reflected our belief that the traditional nine environmental factors did not sufficiently capture and address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic, which included unprecedented federal government stimulus and interventions, statewide mandatory closures of nonessential businesses and periodic changes to such and our ability to provide payment deferral programs to commercial and retail borrowers without the interjection of troubled debt restructuring accounting rules.

The Covid-19 reserve factor resulted in a $5.3 million increase to the allowance as of December 31, 2020.

We recorded a negative loan loss provision expense of $4.3 million during 2021, compared to a provision expense of $14.1 million during 2020.

The economic and business conditions environmental factor was upgraded during both the second and fourth quarters of 2021, resulting in an aggregate allowance reduction of $7.3 million.

Adjustments for specific lending relationships, particularly impaired loans, are made on a case-by-case basis.

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Our migration takes into account various time periods;

however, at year-end 2020 we placed most weight on the period starting December 31, 2010 through December 31, 2020.

however, at year-end 2021 we placed most weight on the period starting January 1, 2011 through December 31, 2021.

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We believe the most significant internal environmental factor is our credit culture and the relative aggressiveness in assigning and revising commercial loan risk ratings, with the most significant external environmental factor being the assessment of the current economic environment and the resulting implications on our loan portfolio.

Approximately 80% of the provision expense recorded during 2020 is reflective of increased allocations associated with qualitative factors, with the remainder primarily reflecting the downgrading of certain non-impaired commercial loan relationships.

During the first quarter, we changed the trend rating on the economic and business conditions environmental factor from slightly deteriorating to severely deteriorating due to the initial and expected stressed economic environment resulting from the Coronavirus Pandemic.

This modification impacted all loan portfolio segments, adding $4.0 million to the required allowance during the quarter.

Also during the first quarter, we improved the trend rating on the lending policies environmental factor from slightly deteriorating to relatively stable to reflect the duration since the Firstbank merger in 2014 and recent loan policy enhancements.

This modification impacted all loan portfolio segments, subtracting $3.0 million from the required allowance level.

In addition, during the first quarter we improved the trend rating on the changes in the experience, ability, and depth of lending management and staff environmental factor from slightly deteriorating to relatively stable to reflect the duration since personnel changes were made as part of the Firstbank merger and personnel changes necessitated by the retirement of our former CEO about two years ago.

This modification impacted the commercial loan portfolio segment, subtracting $2.0 million from the required allowance.

During the second quarter, we changed the impact rating of the economic and business conditions environmental factor from moderate to high due to the ongoing and expected stressed economic environment resulting from the Coronavirus Pandemic.

This modification impacted all loan portfolio segments, adding $4.0 million to the required allowance level.

We also established the Covid-19 factor to address the Coronavirus Pandemic and its potential impact on the collectability of the loan portfolio.

Impacting all loan portfolio segments, the establishment of the Covid-19 factor added $3.9 million to the required allowance level.

During the third quarter, we completed a comprehensive review of risk ratings assigned to many commercial loan relationships, especially those operating in lines of business that were hardest hit by the Coronavirus Pandemic.

The review resulted in loan rating downgrades of 159 of the reviewed relationships (eight of which were moved to the watch list), and an increase to the required allowance of approximately $3.0 million.

During the fourth quarter, we made further changes to several environmental factors, including loan review, value of underlying collateral dependent commercial loans and the Covid-19 factor.

For the loan review environmental factor, we lowered the trend from slightly deteriorating to moderately deteriorating to reflect a reduction in the level of commercial loans being review by our loan review function, in large part reflecting personnel within that department spending a significant amount of time administering our PPP activities.

This change impacted the commercial loan portfolio segment, and increased the required allowance by $0.7 million.

We lowered the trend rating of the value of underlying collateral dependent commercial loans from relatively stable to slightly deteriorating to reflect valuation softness we have noticed in our larger markets.

Impacting only the owner-occupied CRE and non-owner occupied CRE portfolio segments, this change increased the required allowance by $1.7 million.

Reflecting the ongoing uncertainty associated with the Coronavirus Pandemic, including increased infections and the apparently slow roll-out of the vaccine, we lowered the impact rating on the Covid-19 factor from moderate to moderate-to-high.

This change impacted all loan portfolio segments, and added $1.4 million to the required allowance level.

The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and the timeliness of scheduled payments.

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The latter, while considered and accounted for as impaired loans in accordance with accounting guidelines, is not included in our nonperforming loan totals.

Impaired loans with an aggregate carrying value of $1.3 million as of December 31, 2020 had been subject to previous partial charge-offs aggregating $1.2 million.

Those partial charge-offs were recorded as follows:

$0.2 million in 2020, less than $0.1 million in 2019, 2018, 2017, 2015, 2014, 2013, 2012 and 2010, $0.1 million in 2016 and $0.3 million in 2011.

As of December 31, 2020, specific reserves allocated to impaired loans that had been subject to a previous partial charge-off totaled less than $0.1 million.

Impaired loans with an aggregate carrying value of $0.5 million as of December 31, 2021 had been subject to previous partial charge-offs aggregating $0.5 million over the past eleven years.

As of December 31, 2021, there were no specific reserves allocated to impaired loans that had been subject to a previous partial charge-off.

The following table provides a breakdown of our loans categorized as troubled debt restructurings:

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The securities portfolio equaled 11.4% of average earning assets during 2021, compared to 8.9% during 2020.

During 2020, purchases of U.S.

Government agency bonds totaled $345 million, in part reflecting the reinvestment of funds from $289 million in called U.S.

Government agency bonds and $17.7 million in principal paydowns on U.S.

Government agency issued or guaranteed mortgage-backed securities.

Municipal bond purchases aggregated $24.8 million, with municipal bond maturities and calls totaling $12.9 million.

Purchases of U.S.

Government agency bonds totaled $218 million during 2021, in part reflecting the reinvestment of proceeds from called U.S.

Government agency bonds that totaled $61.9 million.

Purchases of U.S.

Government agency guaranteed mortgage-backed securities totaled $28.8 million during 2021, consisting of investments in Community Reinvestment Act-qualified securities, in part reflecting the reinvestment of $10.5 million from principal paydowns on U.S.

Government agency guaranteed mortgage-backed securities.

Purchases of municipal bonds totaled $51.8 million during 2021;

proceeds from matured and called municipal bonds totaled $8.0 million.

No bonds were sold during 2021.

At December 31, 2020, the securities portfolio was primarily comprised of U.S.

At December 31, 2021, the securities portfolio was comprised of U.S.

Government agency bonds (66%), municipal bonds (27%) and U.S.

Government agency issued or guaranteed mortgage-backed securities (6%).

Government agency guaranteed mortgage-backed securities (7%).

All of our securities are currently designated as available for sale, and therefore are stated at fair value.

The fair value of securities designated as available for sale at December 31, 2020 totaled $387 million, including a net unrealized gain of $6.9 million.

The fair value of securities designated as available for sale at December 31, 2021 totaled $593 million, including a net unrealized loss of $4.7 million.

We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations.

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Other investments

FHLBI stock totaled $18.0 million as of December 31, 2020, unchanged from the balance at December 31, 2019.

Federal Home Loan Bank of Indianapolis (“FHLBI”) stock totaled $18.0 million as of December 31, 2021, unchanged from the balance at December 31, 2020.

Our investment in FHLBI stock is necessary to engage in their advance and other financing programs.

We continue to receive regular quarterly cash dividends, and we expect a cash dividend will continue in future quarterly periods.

We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.

Market values on our U.S.

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Reference is made to Note 17 of the Notes to Consolidated Financial Statements for additional information.

The following table shows by class of maturities as of December 31, 2020, the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities: 

The following table shows by class of maturities as of December 31, 2021, the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities:

Obligations of U.S.

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Other investments

Interest-earning deposit balances, primarily consisting of excess funds deposited with the Federal Reserve Bank of Chicago and a correspondent bank, are used to manage daily liquidity needs and interest rate sensitivity.

The average balance of these funds equaled $357 million, or 9.2% of average earning assets during 2020, compared to a more typical $115 million, or 3.4%, during 2019.

The higher level during 2020 reflects increased local deposit balances, primarily a product of federal government stimulus programs as well as lower business and individual investing and spending.

We anticipate the level of interest-earning deposit balances to remain elevated throughout at least a majority of 2021 given the conditions associated with the Coronavirus Pandemic.

Interest-earning deposit balances, primarily consisting of funds deposited with the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity.

The average balance of these funds equaled $671 million, or 14.9% of average earning assets, during 2021, compared to $357 million, or 9.2% of average earning assets, during 2020, and a more typical $115 million, or 3.5% of average earning assets, during 2019.

The elevated level during 2021 and 2020 primarily reflects increased local deposits stemming from federal government stimulus programs and reduced business and consumer investing and spending.

Although we expect the level of interest-earning deposit balances to gradually decline during 2022, the level will likely remain elevated throughout the year and into 2023.

Non-Earning Assets

Cash and due from bank balances averaged 1.4% of total assets during 2020, similar to the average level during 2019, and no significant changes are expected in future periods.

Net premises and equipment increased $1.6 million during 2020, equaling $59.0 million as of December 31, 2020, or 1.3% of total assets.

Net purchases during 2020 totaled $9.0 million, in large part reflecting the construction and opening of a new regional banking center in Mt.

Pleasant, Michigan and a new banking facility in Clare, Michigan.

Depreciation expense during 2020 totaled $5.2 million.

Banking facility closures resulted in a $2.2 million reduction in net premises and equipment during 2020.

Foreclosed and repossessed assets totaled $0.7 million at December 31, 2020, compared to $0.5 million at December 31, 2019.

Almost the entire balance at year-end 2020 consisted of properties that were former banking office facilities that were closed during 2020.

Cash and due from bank balances averaged 1.4% of total assets during 2021, similar to the average levels during 2020, and no significant changes are expected in future periods.

Net premises and equipment declined $1.7 million during 2021, equaling $57.3 million as of December 31, 2021, or 1.1% of total assets.

Increases were recorded during 2021 from remodeling and new lease activities, while declines of a similar total were recorded from the sales of a branch facility (along with the associated loans and deposits) and former branch offices, along with depreciation expense.

We had no foreclosed or repossessed assets at December 31, 2021, compared to $0.7 million at December 31, 2020.

Although we expect periodic transfers from loans to foreclosed and repossessed assets in future periods reflecting our collection efforts on certain impaired lending relationships, we believe the strong quality of our loan portfolio will limit any overall increase in, and average balance of, this nonperforming asset category.

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Total deposits increased $672 million during 2021, totaling $4.08 billion as of December 31, 2021.

Local deposits increased $808 million, while out-of-area deposits decreased $86.5 million during 2020.

Local deposits increased $695 million, while out-of-area deposits decreased $23.0 million.

As a percent of total deposits, out-of-area deposits declined from 1.4% at December 31, 2020 to 0.6% as of year-end 2021.

FHLBI advances increased $40.0 million during 2020, totaling $394 million as of December 31, 2020.

Noninterest-bearing checking accounts increased $508 million during 2020, while interest-bearing checking accounts and money market deposit accounts increased $141 million and $103 million, respectively.

The increases in these transactional deposit products largely reflect federal government stimulus, especially the PPP, as well as lower business investing and spending.

Savings deposits were up $68.8 million during 2020, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending.

Local time deposits decreased $12.8 million, generally reflecting the maturities of certain time deposits that were not renewed as we did not aggressively seek to renew these time deposits that were opened as part of a special time deposit campaign we ran during the early part of 2019, which more than offset new time deposits from several municipal deposit customers.

The reduction in out-of-area deposits during 2020 reflects maturities not replaced as the funds were no longer needed.

FHLBI advances decreased $20.0 million during 2021, totaling $374 million as of December 31, 2021.

Noninterest-bearing checking accounts and interest-bearing checking accounts increased $245 million and $65.8 million, respectively, during 2021, in large part reflecting federal government stimulus programs, especially the PPP, as well as lower business investing and spending.

Money market deposit accounts grew $428 million during 2021, of which $314 million was during the last two quarters.

A portion of the growth reflects federal government stimulus programs and lower business and consumer investing and spending;

however, we believe a large portion of the growth during the third and fourth quarters, consisting of large additional deposits by several existing account holders, are temporary and will be withdrawn over the next three months to six months.

Savings deposits increased $56.3 million, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending.

Local time deposits decreased $100 million during 2021, in large part reflecting the maturity and withdrawal of funds from certain municipal customers and time deposits that were opened as part of a special time deposit campaign we ran in early 2019.

The $23.0 million reduction in out-of-area time deposits during 2021 reflects maturities that were not replaced as the funds were no longer needed.

Total local deposits have increased $1.50 billion since December 31, 2019.

Noninterest-bearing checking accounts have grown $753 million during this time period, while interest-bearing checking accounts and money market deposit accounts are up $206 million and $531 million, respectively.

The increases in these transactional deposit products largely reflect federal government stimulus programs, especially the PPP, as well as lower business investing and spending.

Deposit growth associated with new commercial lending relationships has also been notable.

Savings deposits are up $125 million over the past two years, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending.

Sweep accounts increased $79.1 million during 2021, totaling $197 million as of December 31, 2021.

The average balance of sweep accounts equaled $133 million during 2020.

The aggregate balance of this funding type can be subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that many of the customers maintain.

The average balance of sweep accounts equaled $159 million during 2021, with a high balance of $209 million and a low balance of $113 million.

Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements.

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All of our repurchase agreements are accounted for as secured borrowings.

FHLBI advances increased $40.0 million during 2020, reflecting new advances obtained primarily to replace advance maturities and manage interest rate risk.

FHLBI advances totaled $394 million as of December 31, 2020.

In June 2020, we executed a blend and extend transaction with the FHLBI to extend the duration of the FHLBI advance portfolio as part of our interest rate risk management program.

We prepaid seven advances aggregating $70.0 million with maturities ranging from August 2020 through October 2021 and fixed interest rates from 1.36% to 2.84% and averaging 1.97%, using the proceeds from seven new advances aggregating $70.0 million with maturities ranging from June 2024 through June 2027 and fixed interest rates from 0.55% to 1.18% and averaging 0.84%.

Prepayment fees totaling $0.9 million were embedded into the fixed rates on the newly obtained advances, equating to 0.22% of the 0.84% average rate of the new advances.

FHLBI advances declined $20.0 million during 2021, reflecting maturities that were not replaced as the funds were no longer needed.

FHLBI advances aggregated $374 million as of December 31, 2021.

FHLBI advances are primarily used to assist in funding loan demand, as well as playing an integral role in our interest rate risk management program.

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Our borrowing line of credit at year-end 2021 totaled $889 million, with remaining availability based on collateral of $509 million.

On December 15, 2021, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $75.0 million in aggregate principal amount of its 3.25% fixed-to-floating rate subordinated notes (“Notes”).

The Notes have a stated maturity of January 30, 2032, are redeemable by us at our option, in whole or in part, on or after January 30, 2027 on any interest payment date at a redemption price of 100% of the principal amount of the Notes being redeemed.

The Notes are not subject to redemption at the option of the holder.

The Notes will bear interest at a fixed rate of 3.25% per year until January 29, 2027.

Commencing on January 30, 2027 and through the stated maturity date of January 30, 2032, the interest rate will reset quarterly at a variable rate equal to the then-current Three-Month Term SOFR plus 212 basis points.

On December 15, 2021, we injected $70.0 million of the issuance proceeds to our bank as an increase to equity capital.

On January 14, 2022, we issued an additional $15.0 million of its Notes to certain institutional accredited investors, reflecting an expansion of the $75.0 million issuance completed on December 15, 2021.

The additional $15.0 million issuance was completed on the same terms as the prior offering and under the existing indenture.

On January 14, 2022, we injected $15.0 million of the issuance proceeds to our bank as an increase to equity capital.

Shareholders’

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equity was net income of $59.0 million, while negatively affecting shareholders’

equity were cash dividends on our common stock totaling $17.9 million.

equity were cash dividends on our common stock totaling $18.5 million and share repurchases aggregating $21.4 million.

Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’

equity by a total of $5.1 million.

Share repurchases reduced shareholders’

equity by $6.6 million during 2020.

Positively impacting shareholders’

equity during 2020 was a $1.8 million after-tax increase in the market value of available for sale securities.

Negatively impacting shareholders’

equity during 2021 was a $9.2 million after-tax decline in the market value of available for sale securities.

RESULTS OF OPERATIONS

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We recorded net income of $59.0 million, or $3.69 per basic and diluted share, for 2021, compared to net income of $44.1 million, or $2.71 per basic and diluted share, for 2020.

Excluding the impacts of these transactions, diluted earnings per share decreased $0.07, or 2.5%, during 2020 compared to 2019.

The higher level of noninterest expense mainly reflected increased compensation, occupancy, furniture and equipment, and FDIC insurance premium costs, along with increased write-downs of former branch facilities.

The decline in net interest income depicted a lower yield on earning assets, which more than offset the positive impact of growth in earning assets.

The improved noninterest income primarily reflected increased mortgage banking income.

Costs and a charitable contribution related to the formation and initial funding of The Mercantile Bank Foundation decreased net income during 2021 by approximately $3.2 million, or $0.20 per diluted share.

Excluding the impacts of these transactions, diluted earnings per share increased $1.18, or 43.5%, during 2021 compared to 2020.

The higher level of net income during 2021 compared to 2020 resulted from a lower provision for loan losses and increased noninterest income and net interest income, which more than offset higher noninterest expense.

A negative loan loss provision expense was recorded during 2021, primarily reflecting reduced allocations associated with the economic and business conditions environmental factor and the recording of net loan recoveries during the year.

Growth in noninterest income during 2021 mainly reflected an increased level of fee income generated from an interest rate swap program that was introduced during the fourth quarter of 2020.

Increases in all other key fee income categories also contributed to the higher level of noninterest income.

The increase in net interest income during 2021 resulted from the positive impact of earning asset growth, which more than offset the negative impact of a lower net interest margin.

Noninterest expense increased in 2021 compared to 2020 primarily due to higher compensation costs and the previously mentioned formation expenses and initial funding contribution associated with The Mercantile Bank Foundation.

The following table shows some of the key performance and equity ratios for the years ended December 31, 2021 and 2020:

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During 2020, interest income and interest expense equaled $149 million and $26.1 million, respectively, providing for net interest income of $122 million.

In comparing 2020 with 2019, interest income decreased 6.3%, interest expense was down 22.9%, and net interest income declined 1.8%.

In comparing 2021 with 2020, interest income decreased 3.2%, interest expense was down 25.5%, and net interest income increased 1.5%.

The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources;

however, factors such as types and levels of assets and liabilities, the interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact net interest income as well as the net interest margin.

The $2.3 million decrease in net interest income in 2020 compared to 2019 resulted from a lower net interest margin, which more than offset an increased level of average earning assets.

The $1.8 million increase in net interest income in 2021 compared to 2020 resulted from a higher level of average earning assets, which more than offset a decreased net interest margin.

During 2021, the net interest margin equaled 2.76%, down from 3.17% during 2020 due to a lower yield on average earning assets, which more than offset a reduction in the cost of funds.

The lower yield on average earning assets mainly resulted from a decreased yield on commercial loans, primarily reflecting reduced interest rates on variable-rate loans stemming from the Federal Open Market Committee (“FOMC”) significantly lowering the targeted federal funds rate by a total of 225 basis points during the last six months of 2019 and the first three months of 2020.

The decreased cost of funds mainly reflected lower interest rates paid on local deposit accounts and borrowings, reflecting the declining interest rate environment.

A change in funding mix, consisting of an increase in lower-cost non-time deposits as a percentage of total funding sources, also contributed to the decreased cost of funds.

During 2021, earning assets averaged $4.51 billion, representing an increase of $643 million, or 16.6%, from the $3.87 billion average during 2020.

Average loans increased $338 million, and average interest-earning deposits were up $242 million, while average securities decreased $16.5 million.

The increase in average loans primarily depicted PPP loan originations of approximately $554 million during 2020;

PPP loans averaged approximately $370 million during the year.

Average interest-earning deposits increased $315 million, average securities were up $170 million, and average loans increased $158 million.

The decreased yield on average earning assets mainly resulted from a change in earning asset mix, reflecting an increase in low-yielding interest-earning deposits.

A significant volume of excess on-balance sheet liquidity, which initially surfaced in the second quarter of 2020 as a result of the Covid-19 environment and persisted during the remainder of 2020 and full year 2021, negatively impacted the yield on average earning assets by 46 basis points and 27 basis points during 2021 and 2020, respectively, and the net interest margin by 39 basis points and 22 basis points during the respective periods.

The excess funds, consisting primarily of low-yielding deposits with the Federal Reserve Bank of Chicago, are mainly a product of continuing local deposit growth and PPP loan forgiveness activities.

Lower yields on commercial loans and securities also contributed to the decreased yield on average earning assets.

The reduced yield on commercial loans primarily resulted from lower interest rates on variable-rate commercial loans resulting from the FOMC significantly decreasing the targeted federal funds rate by 150 basis points in March of 2020, along with the origination of new loans and renewal of maturing loans in the lower interest rate environment.

The decreased yield on securities mainly depicted a lower level of accelerated discount accretion on called U.S.

Government agency bonds and reduced yields on newly purchased agency bonds, reflecting the declining interest rate environment.

The cost of funds declined from 0.67% during 2020 to 0.43% during 2021, primarily due to a change in funding mix, consisting of an increase in lower-costing non-time deposits as a percentage of total funding sources, and decreased rates paid on local time deposits, reflecting the declining interest rate environment.

The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets, liabilities and shareholders’

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Tax-exempt securities interest income and yield for 2021, 2020 and 2019 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%.

Securities interest income was increased by $0.2 million in both 2020 and 2019, and $0.3 million in 2018, for this non-GAAP, but industry standard, adjustment.

Securities interest income was increased by $0.2 million in 2021, 2020 and 2019 for this non-GAAP, but industry standard, adjustment.

These adjustments equated to one basis point increases in our net interest margin during all three years.

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The decrease in interest income is attributable to a lower yield on average earning assets, which more than offset the positive impact of an increased level of average earning assets.

The lower yield on average earning assets mainly resulted from a change in earning asset mix.

During 2021 and 2020, earning assets had an average yield (tax equivalent-adjusted basis) of 3.19% and 3.84%, respectively.

A change in earning asset mix and a decreased yield on interest-earning deposits also contributed to the lower yield on average earning assets.

On average, lower-yielding interest-earning deposits represented 14.9% of earning assets during 2021, up from 9.2% during 2020, while higher-yielding loans represented 73.7% of earning assets during 2021, down from 81.9% during 2020.

The significant increase in interest-earning deposits during 2020 primarily reflected increased local deposits stemming from federal government stimulus programs as well as lower business and consumer investing and spending.

The yield on interest-earning deposits was 0.25% during 2020, down from 2.07% during 2019, mainly reflecting the decreased interest rate environment.

The significant increase in interest-earning deposits during 2021 primarily reflected ongoing local deposit growth stemming from federal government stimulus programs and lower business and consumer investing and spending and PPP loan forgiveness activities, which outpaced loan growth and an expanded securities portfolio.

A decreased yield on commercial loans, primarily reflecting reduced interest rates on variable-rate loans stemming from FOMC rate cuts and the lower interest rate environment, and a decreased yield on securities, mainly reflecting a reduced level of accelerated discount accretion on called U.S.

Government agency bonds and the lower interest rate environment, also contributed to the decreased yield on average earning assets.

Accelerated discount accretion on called U.S.

Government agency bonds totaling $3.0 million was recorded as interest income during 2020;

accelerated discount accretion totaled less than $0.1 million during 2021.

The accelerated discount accretion positively impacted the yield on average earning assets during 2020 by eight basis points.

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a decrease in loan yield from 4.34% in 2020 to 4.06% in 2021 resulted in a $9.0 million decline in interest income, while growth in the loan portfolio during 2021 resulted in a $6.6 million increase in interest income.

The lower yield on loans mainly resulted from a decreased yield on commercial loans, which equaled 4.35% during 2020, down from 5.21% during 2019 primarily due to the aforementioned FOMC rate cuts during the last six months of 2019 and first three months of 2020.

The lower yield on loans mainly resulted from a decreased yield on commercial loans, which equaled 4.09% during 2021, down from 4.35% during 2020 primarily due to the aforementioned FOMC rate cuts during March of 2020 and the lower interest rate environment.

Interest income generated from the securities portfolio decreased $2.5 million in 2021 compared to the level earned in 2020;

a decrease in the average balance of the securities portfolio during 2020 resulted in a reduction in interest income of $0.6 million, while an increase in the yield on securities from 2.89% during 2019 to 3.00% during 2020 resulted in a $0.5 million increase in interest income.

The increased yield on securities mainly reflected $3.0 million in accelerated discount accretion on called U.S.

Government agency bonds being recorded as interest income during 2020;

accelerated discount accretion totaled $0.3 million during 2019.

Interest income on interest-earning deposits decreased $1.5 million in 2020 compared to the level earned in 2019;

a decline in the yield on interest-earning deposits, reflecting the decreased interest rate environment, resulted in a $3.4 million reduction in interest income, while growth in these balances resulted in a $1.9 million increase in interest income.

The increase in average interest-earning deposits during 2020 primarily stemmed from growth in local deposits.

Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from borrowed funds.

a decrease in the yield on securities from 3.00% during 2020 to 1.51% during 2021 resulted in a $6.3 million reduction in interest income, while growth in the average balance of the securities portfolio during 2021 resulted in an increase in interest income of $3.8 million.

The decreased yield on securities mainly reflected a lower level of accelerated discount accretion on called U.S.

Government agency bonds being recorded as interest income during 2021 and the decreased interest rate environment.

Interest income on interest-earning deposits was up slightly in 2021 compared to the level earned in 2020 as an increase in interest income stemming from growth in these balances was substantially offset by a decrease in interest income resulting from a lower yield on these balances, reflecting the decreased interest rate environment.

The increase in average interest-earning deposits during 2021 primarily resulted from continuing local deposit growth and PPP loan forgiveness activities.

Interest expense is generated from interest-bearing deposits and borrowed funds.

Interest expense decreased $6.6 million during 2021 from that expensed in 2020, totaling $19.4 million in 2021 compared to $26.0 million in the previous year.

The decrease in interest expense resulted from a lower cost of funds, which more than offset an increase in the average balance of interest-bearing liabilities.

The decrease in interest expense largely resulted from a lower cost of funds.

During 2021 and 2020, interest-bearing liabilities had a weighted average rate of 0.72% and 1.09%, respectively;

a decrease in interest expense of $7.8 million was recorded during 2020 due to the lower cost of funds.

Average interest-bearing liabilities were $2.40 billion during 2020, up $149 million, or 6.6%, from the $2.25 billion average during 2019;

the growth in average interest-bearing liabilities resulted in an increase in interest expense of $0.1 million.

The lower average cost of interest-bearing liabilities resulted from decreased costs of local deposits and borrowings and a change in funding mix.

a decrease in interest expense of $5.9 million was recorded during 2021 due to the reduced cost of funds.

The lower average cost of interest-bearing liabilities mainly resulted from decreased costs of local deposits and borrowings and a change in funding mix.

The cost of time deposits declined from 1.96% during 2020 to 1.24% during 2021 primarily due to lower rates paid on local time deposits, depicting the decreased interest rate environment, and a change in composition, mainly reflecting a decline in higher-cost brokered funds.

The cost of interest-bearing non-time deposit accounts decreased from 0.28% during 2020 to 0.20% during 2021, primarily reflecting lower interest rates paid on money market accounts;

the reduced interest rates mainly reflected the decreased interest rate environment.

The cost of time deposits declined from 2.29% during 2019 to 1.96% during 2020 due to lower rates paid on local time deposits, depicting the decreased interest rate environment, and a change in composition, mainly reflecting a decline in higher-cost brokered funds.

The cost of borrowed funds decreased from 2.39% during 2019 to 1.93% during 2020, mainly reflecting lower costs of subordinated debentures and FHLBI advances, along with a change in borrowing mix.

The cost of subordinated debentures was 4.80% during 2020, down from 6.77% during 2019 due to decreases in the 90-Day Libor Rate.

The cost of FHLBI advances was 2.22% during 2020, down from 2.43% during 2019, primarily reflecting the declining interest rate environment and the impact of a blend and extend transaction that was executed in June 2020.

The cost of borrowed funds decreased from 1.93% during 2020 to 1.71% during 2021, mainly reflecting lower costs of FHLBI advances and subordinated debentures, along with a change in borrowing mix.

The cost of FHLBI advances was 2.08% during 2021, down from 2.22% during 2020, primarily reflecting the impact of a blend and extend transaction that was executed in June of 2020 and the declining interest rate environment.

The blend and extend transaction with the FHLBI, which extended the duration of our FHLBI advance portfolio as part of our interest rate risk management program, consisted of us prepaying seven advances aggregating $70.0 million with maturities ranging from August 2020 through October 2021 and fixed interest rates from 1.36% to 2.84% and averaging 1.97%, using the proceeds from seven new advances aggregating $70.0 million with maturities ranging from June 2024 through June 2027 and fixed interest rates from 0.55% to 1.18% and averaging 0.84%.

Average lower-cost sweep accounts represented 23.1% and 20.0% of average total borrowings during 2020 and 2019, respectively, while average higher-cost FHLBI advances represented 67.4% and 70.3% of average total borrowings during the respective time periods.

The cost of subordinated debentures was 3.80% during 2021, down from 4.80% during 2020 due to decreases in the 90-Day Libor Rate.

Average lower-cost sweep accounts represented 26.3% and 23.1% of average total borrowings during 2021 and 2020, respectively, while average higher-cost FHLBI advances represented 65.0% and 67.4% of average total borrowings during the respective periods.

A change in funding mix, consisting of an increase in average lower-cost interest-bearing non-time deposits and a decrease in average higher-cost time deposits as a percentage of average total interest-bearing liabilities, also contributed to the lower weighted average cost of interest-bearing liabilities during 2021 compared to 2020.

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A lower average rate paid on time deposits during 2021 resulted in a $3.7 million decrease in interest expense, while a $117 million decrease in the average balance of time deposits equated to a $2.0 million reduction in interest expense.

A decreased average rate paid on short-term borrowings, which are comprised almost entirely of sweep accounts, during 2020 resulted in a $0.2 million decline in interest expense, while a $31.0 million increase in the average balance of these borrowings resulted in a $0.1 million increase in interest expense.

Interest expense related to short-term borrowings, which are comprised entirely of sweep accounts, during 2021 remained virtually unchanged compared to the prior year as a lower level of expense resulting from a slight decrease in the average rate paid on these funds was substantially offset by a higher level of expense stemming from an increase in the average balance of these funds.

A lower average rate paid on average FHLBI advances during 2021 resulted in a $0.5 million reduction in interest expense, while a $5.7 million increase in the average balance of advances resulted in a $0.1 million increase in interest expense.

A slight increase in average other borrowings during 2020 resulted in a nominal increase in interest expense, while a decreased average rate paid on the borrowings resulted in a $1.0 million decline in interest expense.

P rovision for Loan Losses

A loan loss provision expense of $14.1 million was recorded in 2020, compared to a provision expense of $1.8 million recorded in 2019.

Approximately 80% of the provision expense recorded during 2020 consisted of increased allocations associated with existing environmental factors, including economic and business conditions, loan review, and value of underlying collateral dependent loans, and an allocation stemming from the creation of a Covid-19 pandemic environmental factor.

A decreased average rate paid on other borrowings during 2021 resulted in a $0.5 million decline in interest expense, while a $3.2 million increase in average other borrowings equated to a $0.1 million increase in interest expense.

Provision for Loan Losses

A negative loan loss provision expense of $4.3 million was recorded in 2021, compared to a provision expense of $14.1 million recorded in 2020.

The negative provision expense recorded during 2021 mainly reflected reduced allocations associated with the economic and business conditions environmental factor, depicting improvement in both current and forecasted economic conditions, and the recording of net loan recoveries during the year, which more than offset required reserve allocations necessitated by net growth in core commercial loans.

Approximately 80% of the provision expense recorded during 2020 consisted of increased allocations associated with existing environmental factors, including economic and business conditions, loan review, and value of underlying collateral dependent commercial loans, and an allocation stemming from the creation of a Covid-19 pandemic environmental factor.

The Covid-19 pandemic environmental factor, developed during the second quarter of 2020, is designed to address the unique challenges and economic uncertainty resulting from the pandemic and its potential impact on the collectability of the loan portfolio.

The provision expense recorded during 2020 also reflected the downgrading of certain non-impaired commercial loan relationships, most of which occurred during the third quarter.

The provision expense recorded during 2019 primarily reflected ongoing net loan growth, as well as an increased allocation related to a change in the nature and volume of the consumer mortgage loan portfolio environmental factor.

During 2021, loan charge-offs totaled $1.0 million, while recoveries of prior-period loan charge-offs equaled $2.7 million, providing for net loan recoveries of $1.7 million, or 0.05% of average total loans.

During 2020, recoveries of prior-period loan charge-offs totaling $0.9 million slightly exceeded loan charge-offs, providing for a nominal level of net loan recoveries.

During 2019, loan charge-offs totaled $0.9 million, while recoveries of prior-period loan charge-offs equaled $0.7 million, providing for net loan charge-offs of $0.2 million, or an annualized 0.01% of average total loans.

The allowance for loans, as a percentage of total loans, was 1.0% as of December 31, 2021, and 1.2% as of December 31, 2020.

Excluding PPP loans, the allowance for loans represented 1.3% of total loans as of December 31, 2020.

Noninterest Income

Noninterest income during 2021 was $56.2 million, compared to $45.2 million during 2020.

 Noninterest income during 2019 included bank owned life insurance claims totaling $2.6 million and gains on the sales of former branch facilities totaling $0.8 million.

Excluding these transactions, noninterest income increased $21.7 million, or 92.1%, during 2020 compared to 2019.

 The improved level of noninterest income primarily resulted from increased mortgage banking income stemming from a sizeable upturn in refinance activity spurred by a decrease in residential mortgage loan interest rates, a higher level of purchase activity, the continuing success of strategic initiatives that were implemented to gain market share, and an increase in the percentage of originated loans being sold.

Mortgage banking income totaled $29.3 million during 2020, representing an increase of $20.9 million, or nearly 246%, from the $8.5 million earned during 2019.

We originated $864 million in residential mortgage loans during 2020, which was approximately 135% higher than originations during 2019.

Almost 66% of the residential mortgage loans originated during 2020 consisted of refinance transactions, compared to approximately 50% during 2019.

Noninterest income during 2021 included a $1.1 million gain on the sale of a branch facility, a $0.6 million recovery of loan collection costs, and $0.5 million in gains on the sales of former branch facilities.

Excluding the impacts of these transactions, noninterest income increased $8.9 million, or 19.8%, during 2021 compared to 2020.

The higher level of noninterest income primarily resulted from increased fee income generated from an interest rate swap program that was implemented during the fourth quarter of 2020.

The interest rate swap program provides certain commercial borrowers with a longer-term fixed-rate option and assists Mercantile in managing associated longer-term interest rate risk.

Growth in credit and debit card income, mortgage banking income, service charges on accounts, and payroll processing fees also contributed to the increased level of noninterest income.

Mortgage banking income remained robust in 2021 as ongoing strength in purchase mortgage originations and a higher gain on sale rate more than offset the negative impacts of a decline in refinance activity and a reduced mortgage loan sold percentage.

Residential mortgage loan originations totaled $952 million during 2021, approximately 10% higher than originations during 2020.

Purchase transactions totaled $494 million during 2021, compared to $297 million during 2020, representing an increase of $197 million, or approximately 66%.

Refinance transactions totaled $458 million during 2021, compared to $567 million during 2020, representing a decrease of $109 million, or approximately 19%.

Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $644 million, or approximately 68% of total mortgage loans originated, during 2021.

During 2019, residential mortgage loans originated for sale totaled $257 million, or nearly 70% of total mortgage loans originated.

Fee income generated from an interest rate swap program that was implemented during the fourth quarter of 2020 and growth in payroll processing fees also contributed to the improved noninterest income during 2020.

The interest rate swap program provides certain commercial borrowers with a longer-term fixed-rate option and assists us in managing associated longer-term interest rate risk.

Service charges on accounts and credit and debit card income during 2020, which were negatively impacted by Covid-19 pandemic-related events, including business shutdowns and stay-at-home orders, approximated 2019 levels.

During 2020, residential mortgage loans originated for sale totaled $672 million, or approximately 78% of total mortgage loans originated.

Noninterest Expense

Noninterest expense totaled $111 million during 2021, compared to $98.5 million during 2020.

Overhead costs during 2020 included write-downs of former branch facilities totaling $1.4 million, while overhead costs during 2019 included a loss on the sale of a former branch facility of $0.5 million and a write-down of a former branch facility of $0.1 million.

Overhead costs during 2021 included expenses and a charitable contribution associated with the formation and initial funding of The Mercantile Bank Foundation totaling $4.0 million and net losses on sales and write-downs of former branch facilities aggregating $0.6 million, while overhead costs during the prior year included write-downs of former branch facilities totaling $1.4 million.

Excluding these transactions, noninterest expense increased $9.2 million, or 9.5%, during 2021 compared to 2020.

The higher level of expense primarily resulted from increased salary and benefit costs, which were up a combined $6.0 million in 2020 compared to 2019.

The increased salary expense mainly reflected higher residential mortgage lender commissions and related incentives, as well as annual employee merit pay increases and a larger bonus accrual, while the increased benefit expense primarily reflected higher insurance costs.

The higher level of commissions and associated incentives primarily depicted the significant increase in residential mortgage loan originations during 2020.

Occupancy and equipment and furniture costs were up $1.7 million on a combined basis during 2020 compared to 2019, mainly reflecting increased depreciation expense associated with an expansion of our main office that was completed during the latter part of 2019.

Data processing costs increased $1.2 million during 2020 compared to 2019, primarily depicting growth in transaction volume, new product offerings, and stay-at-home efforts and activities, including providing employees with access to work computers while working remotely.

FDIC insurance premiums increased $0.9 million in 2020 compared to 2019, mainly reflecting deposit insurance assessment credits being applied against regular assessments during 2019.

As part of a branch network efficiency plan, we closed three branches during the fourth quarter of 2020.

As a result of these branch network efficiency actions, we recorded pre-tax charges of $0.3 million for severance-related payments and $1.4 million for valuation adjustments during 2020.

Annual pre-tax savings of approximately $0.7 million are anticipated as a result of these actions.

Federal Income Tax Expense

During 2020, we recorded income before federal income tax of $54.8 million and a federal income tax expense of $10.7 million, compared to income before federal income tax of $60.5 million and a federal income tax expense of $11.0 million during 2019.

The decrease in federal income tax expense in 2020 compared to 2019 resulted from the lower level of income before federal income tax.

Our effective tax rate was 19.5% during 2020, compared to 18.2% during 2019.

The aforementioned nontaxable bank owned life insurance claims positively impacted the effective tax rate in 2019.

RESULTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 201 9 and 201 8

We recorded net income of $49.5 million, or $3.01 per basic and diluted share, for 2019, compared to net income of $42.0 million, or $2.53 per basic and diluted share, for 2018.

Bank owned life insurance claims and the net impact of gains and losses on sales and write-downs of former branch facilities increased reported net income during 2019 by approximately $2.7 million, or $0.16 per diluted share.

Interest income related to purchased loan accounting entries increased net income during 2019 by $1.1 million, or $0.07 per diluted share, and net income during 2018 by $3.2 million, or $0.19 per diluted share.

Excluding the impacts of these transactions, diluted earnings per share increased $0.44, or 18.8%, during 2019 compared to 2018.

Our earnings performance in 2019 benefited from increased net interest income and noninterest income, which more than offset increased provision expense and noninterest expense.

The improved net interest income resulted from a higher level of earning assets.

Noninterest income during 2019 included bank owned life insurance claims and gains on the sales of former branch facilities, while noninterest income during 2018 included a one-time accounting adjustment related to mortgage banking activities.

In addition to increasing in 2019 compared to 2018 on a reported basis, noninterest income also grew after excluding the impacts of these transactions.

Growth in noninterest income primarily resulted from increased mortgage banking activity income;

increases in credit and debit card income, service charges on accounts, and payroll processing revenue also contributed to the improved level of noninterest income.

The amount of provision expense necessitated by net loan growth during 2018 was partially mitigated by net loan recoveries being recorded during the period, resulting in a lower provision expense during 2018 compared to 2019.

The higher level of noninterest expense primarily reflects increased salary costs.

The following table shows some of the key performance and equity ratios for the years ended December 31, 2019 and 2018:

Return on average assets

Return on average shareholders’

Average shareholders’

equity to average assets

Net Interest Income

Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings.

Interest income (adjusted for tax-exempt income) and interest expense totaled $159 million and $33.8 million during 2019, respectively, providing for net interest income of $125 million.

During 2018, interest income and interest expense equaled $142 million and $21.9 million, respectively, providing for net interest income of $120 million.

In comparing 2019 with 2018, interest income increased 11.5%, interest expense was up 54.4%, and net interest income increased 3.7%.

The $4.4 million increase in net interest income in 2019 compared to 2018 resulted from an increased level of average earning assets, which more than offset a lower net interest margin.

During 2019, earning assets averaged $3.33 billion, or $285 million higher than average earning assets during 2018.

Average loans increased $224 million, average interest-earning deposits increased $45.0 million, and average securities increased $15.6 million.

During 2019, the net interest margin equaled 3.75%, down from 3.96% during 2018 due to a higher cost of funds, which more than offset an increased yield on average earning assets.

The higher cost of funds primarily resulted from increased costs of time deposits and borrowed funds and a change in funding mix.

The improved yield on average earning assets mainly resulted from an increased yield on commercial loans, primarily reflecting higher interest rates on variable-rate loans stemming from the FOMC raising the targeted federal funds rate by 25 basis points on four occasions during 2018.

The positive impact of these rate increases more than offset the negative impact of decreased interest rates on variable-rate commercial loans resulting from the FOMC lowering the targeted federal funds rate by 25 basis points on three occasions during the last six months of 2019.

Interest income is primarily generated from the loan portfolio, and to a significantly lesser degree, from securities and other interest-earning assets.

Interest income increased $16.3 million during 2019 from that earned in 2018, totaling $159 million in 2019 compared to $142 million in the previous year.

The increase in interest income is attributable to an increased level of, and a higher yield on, average earning assets.

During 2019 and 2018, earning assets had an average yield (tax equivalent-adjusted basis) of 4.77% and 4.68%, respectively.

Increased yields on securities and interest-earning deposit balances also contributed to the higher yield on average earning assets.

Interest income generated from the loan portfolio increased $14.1 million in 2019 compared to the level earned in 2018;

growth in the loan portfolio during 2019 resulted in an $11.4 million increase in interest income, while an increase in loan yield from 5.01% in 2018 to 5.11% in 2019 resulted in a $2.7 million increase in interest income.

The higher yield on loans mainly resulted from an increased yield on commercial loans.

The yield on commercial loans equaled 5.21% during 2019, up from 5.11% during 2018 primarily due to the FOMC rate hikes in 2018.

Interest income related to purchased loan accounting entries totaled $1.4 million in 2019, compared to $4.0 million in 2018.

Interest income generated from the securities portfolio increased $1.1 million in 2019 compared to the level earned in 2018;

an increase in the yield on securities from 2.69% during 2018 to 2.89% during 2019 resulted in a $0.6 million increase in interest income, while an increase in the average balance of the securities portfolio resulted in an increase in interest income of $0.5 million.

The increased yield on securities mainly reflects $0.3 million in accelerated discount accretion on called U.S.

Government agency bonds being recorded as interest income during 2019;

no accelerated discount accretion was recorded during 2018.

Interest income on interest-earning deposits increased $1.1 million in 2019 compared to the level earned in 2018;

a higher average balance of interest-earning deposits resulted in a $0.9 million increase in interest income, while an increase in the yield on these balances resulted in a $0.2 million increase in interest income.

The growth in average interest-earning deposits during 2019 primarily stemmed from certain deposit-gathering initiatives, an increase in wholesale funds, and several large commercial loan paydowns.

Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from borrowed funds.

Interest expense increased $11.9 million during 2019 from that expensed in 2018, totaling $33.8 million in 2019 compared to $21.9 million in the previous year.

The increase in interest expense resulted from an increase in the average balance of interest-bearing liabilities and a higher cost of funds.

Average interest-bearing liabilities were $2.25 billion during 2019, up $225 million, or 11.1%, from the $2.02 billion average during 2018;

the growth in average interest-bearing liabilities resulted in an increase in interest expense of $6.2 million.

During 2019 and 2018, interest-bearing liabilities had a weighted average rate of 1.50% and 1.08%, respectively;

an increase in interest expense of $5.7 million was recorded during 2019 due to the higher cost of funds.

The higher average cost of interest-bearing liabilities mainly resulted from increased costs of time deposits and borrowed funds and a change in funding mix.

The cost of time deposits increased from 1.59% during 2018 to 2.29% during 2019 due to higher rates being paid on each category of time deposits, primarily reflecting the rising interest rate environment during 2018.

A higher-costing time deposit special campaign, which was introduced in mid-first quarter 2019 and ended in early April 2019, also contributed to the increased cost of time deposits.

The cost of borrowed funds increased from 2.06% during 2018 to 2.39% during 2019, mainly reflecting a higher cost of FHLBI advances, which equaled 2.43% and 1.94% during 2019 and 2018, respectively.

The higher cost of FHLBI advances primarily reflects the rising interest rate environment during 2018 and the lengthening of the average weighted maturity of the advance portfolio.

Longer-term FHLBI advances totaling $194 million were obtained during the last eight months of 2018 and first month of 2019 to meet various funding needs.

Average higher-costing time deposits and borrowed funds represented 28.7% and 23.4%, respectively, of average interest-bearing liabilities during 2019, compared to 23.7% and 19.3%, respectively, during 2018.

Increased reliance on more costly wholesale funds during 2019, most of which occurred in late 2018 and January 2019, was necessitated by various funding requirements, including ongoing loan growth and seasonal deposit withdrawals by certain business customers for bonus and tax payments.

Average lower-costing interest-bearing non-time deposits represented 47.9% of average interest-bearing liabilities during 2019, down from 57.0% during 2018.

A higher average rate paid on interest-bearing non-time deposits during 2019 resulted in a $0.3 million increase in interest expense, while a $76.8 million decrease in the average balance of these deposits equated to a nominal decrease in interest expense.

A $4.0 million increase in interest expense during 2019 resulted from a higher average rate paid on time deposits.

Average time deposits increased $166 million during 2019;

the increased average balance equated to an increase in interest expense of $3.1 million.

Slight increases in the average balance of, and average rate paid on, short-term borrowings, comprised almost entirely of sweep accounts, resulted in nominal increases in interest expense during 2019.

Average FHLBI advances increased $131 million during 2019, resulting in a $3.0 million increase in interest expense, while a higher average rate paid on the advances resulted in a $1.3 million increase in interest expense.

A $0.4 million increase in average other borrowings resulted in a nominal increase in interest expense, while a higher average rate paid on the borrowings resulted in a $0.1 million increase in interest expense.

Net interest income and the net interest margin during 2019 and 2018 were affected by purchase accounting accretion and amortization associated with fair value measurements.

Increases in interest income on loans totaling $1.4 million and $4.0 million were recorded during 2019 and 2018, respectively.

Purchased loan accretion amounts vary from period to period as a result of periodic cash flow re-estimations, loan payoffs, and payment performance.

Provision for Loan Losses

A loan loss provision expense of $1.8 million was recorded in 2019, compared to a provision expense of $1.1 million recorded in 2018.

The provision expense recorded during both 2019 and 2018 mainly reflected ongoing net loan growth.

In addition, the provision expense recorded during 2019 depicted an increased allocation related to a change in the nature and volume of the consumer mortgage loan portfolio environmental factor, while the provision expense recorded during 2018 reflected increased allocations related to changes in the competition, economic conditions, and concentrations environmental factors.

The amount of provision expense necessitated by net loan growth and environmental factor changes during 2018 was partially mitigated by net loan recoveries being recorded during the period.

Net loan charge-offs of $0.2 million were recorded during 2019, while net loan recoveries of $1.8 million were recorded during 2018.

The allowance for originated loans, as a percentage of total originated loans, was 0.9% as of both December 31, 2019 and December 31, 2018.

Our allowance for acquired loans totaled $0.7 million and $0.8 million as of December 31, 2019 and December 31, 2018, respectively.

Noninterest Income

Noninterest income was $27.0 million during 2019, compared to $19.0 million during 2018.

Noninterest income during 2019 included bank owned life insurance claims totaling $2.6 million and gains on the sales of former branch facilities totaling $0.8 million, while noninterest income during 2018 included a one-time $0.9 million accounting adjustment related to mortgage banking activities in prior years.

Excluding these transactions, noninterest income increased $5.4 million, or 29.9%, during 2019 compared to 2018.

 The improved level of noninterest income in 2019 compared to 2018 primarily resulted from increased mortgage banking activity income stemming from the success of continuing strategic initiatives designed to increase market presence, along with a higher level of refinance activity resulting from a decrease in residential mortgage loan interest rates and a higher percentage of originated loans being sold.

 Growth in credit and debit card income, service charges on accounts, and payroll processing fees also contributed to the improved level of noninterest income in 2019.

Noninterest Expense

Noninterest expense during 2019 was $89.3 million, an increase of $3.1 million, or 3.6%, from the $86.2 million expensed during 2018.

The higher level of expense primarily resulted from increased salary costs, mainly reflecting annual employee merit pay increases, higher residential mortgage loan lender commissions, and increased stock-based compensation expense.

Pay increases for all hourly employees, which went into effect on April 1, 2018, also contributed to the higher level of salary costs during 2019.

Data processing costs were up $0.7 million during 2019 compared to 2018 primarily due to increases in debit and credit card and internet banking expenses stemming from growth in transaction volume and new product offerings, along with increased software amortization expense mainly resulting from the implementation of certain software solutions.

Occupancy and furniture and equipment costs increased $0.5 million on a combined basis in 2019 compared to 2018 mainly due to higher depreciation expense, in large part stemming from an expansion of our main office and equipment purchases.

FDIC deposit insurance premiums were down $0.7 million in 2019 compared to 2018 as a result of deposit insurance credits being applied against regular assessments.

The higher level of expense primarily resulted from increased compensation costs, mainly reflecting increased regular salary expense largely stemming from annual employee merit pay increases, higher stock-based compensation expense, an increased bonus accrual, larger signing bonus payments, and increased residential mortgage lender commissions and related incentives.

FDIC deposit insurance premiums increased $0.7 million in 2021 compared to 2020, mainly reflecting an increased assessment base and rate.

Health insurance costs were up $1.1 million in 2021 compared to 2020 mainly due to a higher level of claims, a large portion of which resulted from the treatment of Covid-19 related medical conditions.

Data processing costs increased $0.7 million in 2021 compared to 2020, in large part reflecting higher credit and debit card and software maintenance expenses.

Federal Income Tax Expense

2 unchanged sentences

Our effective tax rate was 19.9% during 2021, compared to 19.5% during 2020.

The aforementioned nontaxable bank owned life insurance claims positively impacted the effective tax rate in 2019.

CAPITAL RESOURCES

3 unchanged sentences

equity was net income of $59.0 million, while negatively affecting shareholders’

equity were cash dividends on our common stock totaling $17.9 million.

equity were cash dividends on our common stock totaling $18.5 million and share repurchases aggregating $21.4 million.

Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’

equity by a total of $5.1 million.

Share repurchases reduced shareholders’

equity by $6.6 million during 2020.

Positively impacting shareholders’

equity during 2020 was a $1.8 million after-tax increase in the market value of available for sale securities.

Negatively impacting shareholders’

equity during 2021 was a $9.2 million after-tax decline in the market value of available for sale securities.

We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies.

1 unchanged sentence

As of December 31, 2021, our bank’s total risk-based capital ratio was 13.6%, compared to 13.5% at December 31, 2020.

Our bank’s total regulatory capital increased $32.3 million during 2020, primarily reflecting the net impact of net income totaling $49.6 million, an increase in the allowance of $14.1 million and cash dividends paid to Mercantile Bank Corporation aggregating $32.5 million.

Our bank’s total risk-based capital ratio was also impacted by a $114 million increase in total risk-weighted assets.

Our bank’s total regulatory capital increased $94.6 million during 2021, primarily reflecting the net impact of net income totaling $65.1 million, a $70.0 million equity capital injection from us in association with the $75.0 million issuance of subordinated notes and cash dividends paid to us aggregating $39.0 million.

Our bank’s total risk-based capital ratio was also impacted by a $659 million increase in total risk-weighted assets, in large part reflecting growth in core commercial loans, residential mortgage loans and securities.

As of December 31, 2021, our bank’s total regulatory capital equaled $552 million, or $147 million in excess of the amount necessary to attain the 10.0% minimum total risk-based capital ratio, which is among the requirements to be categorized as “well capitalized.”

5 unchanged sentences

Asset and liability management is the process of managing the balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.

To assist in providing needed funds, we regularly obtained monies from wholesale funding sources.

Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $441 million, or 11.2% of combined deposits and borrowed funds as of December 31, 2020, compared to $487 million, or 15.5% of combined deposits and borrowed funds, as of December 31, 2019.

To assist in providing needed funds, we have regularly obtained monies from wholesale funding sources.

Wholesale funds, comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $398 million, or 8.5% of combined deposits and borrowed funds as of December 31, 2021, compared to $441 million, or 11.2% of combined deposits and borrowed funds, as of December 31, 2020.

Sweep accounts increased $79.1 million during 2021, totaling $197 million as of December 31, 2021.

The average balance of sweep accounts equaled $133 million during 2020.

The average balance of sweep accounts equaled $159 million during 2021, with a high balance of $209 million and a low balance of $113 million.

Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements.

7 unchanged sentences

Weighted average interest rate for twelve months ended December 31, 2021

FHLBI advances increased $40.0 million during 2020, reflecting new advances obtained primarily to replace advance maturities and manage interest rate risk.

FHLBI advances totaled $394 million as of December 31, 2020.

In June 2020, we executed a blend and extend transaction with the FHLBI to extend the duration of the FHLBI advance portfolio as part of our interest rate risk management program.

Prepayment fees totaling $0.9 million were embedded into the fixed rates on the newly obtained advances, equating to 0.22% of the 0.84% average rate of the new advances.

FHLBI advances declined $20.0 million during 2021, reflecting maturities that were not replaced as the funds were no longer needed.

FHLBI advances aggregated $374 million as of December 31, 2021.

FHLBI advances are primarily used to assist in funding loan demand, as well as playing an integral role in our interest rate risk management program.

3 unchanged sentences

These lines of credit were not accessed during 2021.

In contrast, our interest-earning deposit accounts at the Federal Reserve Bank of Chicago and a correspondent bank averaged $352 million during 2020.

In contrast, our interest-earning deposit account at the Federal Reserve Bank of Chicago averaged $633 million during 2021.

We have a line of credit through the Discount Window of the Federal Reserve Bank of Chicago.

Using certain municipal bonds as collateral, we could have borrowed up to $34.1 million at December 31, 2021.

We did not utilize this line of credit during the past ten years, and do not plan to access this line of credit in future periods.

We did not utilize this line of credit in over ten years, and do not plan to access this line of credit in future periods.

The following table reflects, as of December 31, 2021, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

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Subordinated debentures

Subordinated notes

Other borrowed money

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cash needs vary, and $212 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months.

We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.

We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our liquidity management.

The following table depicts our loan commitments at the end of the past three years:

1 unchanged sentence

1,098,951,000

1,019,496,000

Unused lines of credit secured by 1-4 family residential properties

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Money market accounts

1,040,176,000

Time deposits under $100,000

15 unchanged sentences

1,239,189,000

1,070,213,000

Cumulative GAP

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Percent of cumulative GAP to total assets

 Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using  maturity date and not repricing frequency.

 Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.

 Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2021.

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Interest rates up 400 basis points

The resulting estimates have been significantly impacted by the current interest rate and economic environment, as adjustments have been made to critical model inputs with regards to traditional interest rate relationships.

This is especially important as it relates to floating rate commercial loans and out-of-area deposits, which comprise a sizable portion of our balance sheet.

The resulting estimates have been significantly impacted by the current interest rate and economic environments, as adjustments have been made to critical model inputs with regards to traditional interest rate relationships.

This is especially important as it relates to floating rate commercial loans and nonmaturity deposits, which comprise a sizable portion of our balance sheet.

In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including:

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

Shareholders and Board of Directors

Mercantile Bank Corporation

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Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S.

We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S.

federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

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The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that:

(1) relate(s) to accounts or disclosures that are material to the consolidated financial statements, and (2) involved especially challenging, subjective or complex judgments. 

The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Loan Losses - General Reserve

As described in Notes 1 and 3 to the Company’s consolidated financial statements, the Company has a gross loan balance of $3,216,358,000 and related allowance for loan losses (“allowance”) balance of $37,967,000 at December 31, 2020. 

The allowance consists of loans individually and collectively evaluated for impairment. 

(1) relates to accounts or disclosures that are material to the consolidated financial statements, and (2) involved our especially challenging, subjective, or complex judgments.

The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Allowance for Loan Losses –

General Reserve

As described in Notes 1 and 3 to the Company’s consolidated financial statements, the Company has a gross loan balance of $3,453,459,000 and related allowance for loan losses (“allowance”) balance of $35,363,000 at December 31, 2021.

The allowance consists of loans individually and collectively evaluated for impairment.

Loans collectively evaluated for impairment are grouped using similar risk characteristics using historical loss experience that is adjusted for certain qualitative environmental factors.

We identified the estimation of the qualitative environmental factors as a critical audit matter. 

Management’s assumptions related to the qualitative environmental factors, such as economic trends, credit quality trends, valuation trends, and external factors, such as Covid-19, which are used to adjust the quantitative historical losses, are highly subjective and have a significant impact on the allowance. 

Auditing these assumptions involves especially challenging and subjective auditor judgment due to the extent of specialized knowledge about the industry and local economy needed to assess these assumptions.

The calculation of this qualitative general reserve adjustment involves estimates and assumptions by management based on the qualitative environmental factors.

We identified the estimation of certain qualitative environmental factors as a critical audit matter.

Management’s assumptions related to certain qualitative environmental factors, which are used to adjust the quantitative historical losses (both upwards and downwards), are highly subjective and could have a significant impact on the allowance.

Auditing these assumptions involves especially challenging and subjective auditor judgment.

The primary procedures we performed to address this critical audit matter included:

Testing the design and operating effectiveness of internal controls over:

The completeness and accuracy of the data used by management to assess the qualitative environmental factors.

Management’s monitoring review of the conclusions related to the qualitative environmental factors and the resulting adjustment to the allowance.

Evaluating the relevance and reliability of the data used by management to support their assessment of the qualitative environmental factors by comparing to source data.

Performing an independent assessment of the reasonableness of qualitative environmental factors by evaluating trends in internal and external data, including using alternative source data, evaluating the impact of Covid-19, and comparing to the conclusions reached by management.

Testing the design and operating effectiveness of internal controls over the data used by management to assess certain qualitative factors and their effect on the estimation of inherent losses within the loan portfolio.

Evaluating the reliability of the data and assumptions used by management to support their assessment of certain qualitative environmental factors by vouching to internal and external sources, including considerations of contradictory evidence.

Evaluating the reasonableness of management’s conclusion on the qualitative assessment and the resulting adjustment to the allowance.

/s/ BDO USA, LLP

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

Shareholders and Board of Directors

Mercantile Bank Corporation

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The Company’s independent auditors have issued an audit report on the effectiveness of the Company’s internal control over financial reporting as found on page F-32.

Mercantile Bank Corporation

/s/ Robert B.

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President and Chief Executive Officer

/s/ Charles E.

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18,002,000  

Mortgage loans held for sale

16,117,000  

22,888,000  

3,453,459,000  

3,193,470,000  

Allowance for loan losses

37 unchanged sentences

47,563,000  

Subordinated notes

73,646,000  

Accrued interest and other liabilities

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Accumulated other comprehensive gain/(loss)

5,486,000  

( 3,729,000 )

5,486,000  

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Net interest income

Provision for loan losses

Provision (benefit) for loan losses

Net interest income after provision for loan losses

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Credit and debit card fees

Interest rate swap program fees

Payroll processing

Earnings on bank owned life insurance

Interest rate swap program fees

Letter of credit fees

Gain on sale of branch

Total noninterest income

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FDIC insurance costs

Charitable foundation contributions

Other expense

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Unrealized holding gains (losses) on securities available for sale

Fair value of interest rate swap

Total other comprehensive income (loss)

Tax effect of unrealized holding gains (losses) on securities available for sale

Tax effect of fair value of interest rate swap

Total tax effect of other comprehensive income (loss)

3 unchanged sentences

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years ended December 31, 2021, 2020 and 2019

7 unchanged sentences

$ 375,249  

Reclassification of equity securities related to ASU 2016-01 adoption

Employee stock purchase plan ( 1,507 shares)

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Change in net unrealized gain/(loss) on securities available for sale, net of tax effect

Change in fair value of interest rate swap, net of tax effect

11,934  

Balances, December 31, 2019

2 unchanged sentences

$ 3,695  

$ 416,561  

See accompanying notes to consolidated financial statements.

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’

EQUITY (Continued)

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

Years ended December 31, 2021, 2020 and 2019

7 unchanged sentences

$ 3,695  

$ 416,561  

Employee stock purchase plan ( 2,264 shares)

Dividend reinvestment plan ( 35,479 shares)

Stock option exercises ( 8,200 shares)

Stock option exercises, net ( 753 shares)

Stock grants to directors for retainer fees ( 17,716 shares)

6 unchanged sentences

Change in net unrealized gain/(loss) on securities available for sale, net of tax effect

11,934  

Balances, December 31, 2020

5 unchanged sentences

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’

EQUITY (Continued)

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

Years ended December 31, 2021, 2020 and 2019

23 unchanged sentences

$ 456,559  

$ 441,554  

See accompanying notes to consolidated financial statements.

3 unchanged sentences

Cash flows from operating activities

$ 59,021,000  

$ 44,138,000  

$ 49,456,000  

Adjustments to reconcile net income to net cash from operating activities:

Depreciation and amortization

13,678,000  

9,425,000  

9,553,000  

Accretion of acquired loans

Provision for loan losses

( 4,300,000 )

14,050,000  

1,750,000  

Deferred income tax expense (benefit)

2,020,000  

( 4,141,000 )

26,000  

Stock-based compensation expense

3,784,000  

2,325,000  

2,931,000  

Stock grants to directors for retainer fee

344,000  

394,000  

375,000  

Proceeds from sales of mortgage loans held for sale

686,418,000  

677,634,000  

261,021,000  

Origination of mortgage loans held for sale

1 unchanged sentence

( 665,992,000 )

( 256,767,000 )

Net gain on sales of mortgage loans held for sale

( 30,402,000 )

( 29,541,000 )

( 8,108,000 )

Net gain from sales and valuation write-downs of foreclosed assets

1 unchanged sentence

Net loss from sales and disposals of premises and equipment

246,000  

1,514,000  

294,000  

Earnings on bank owned life insurance

( 1,164,000 )

( 1,214,000 )

( 3,886,000 )

Gain on sale of branch

( 1,058,000 )

Net change in:

Accrued interest receivable

1,528,000  

( 16,279,000 )

( 10,892,000 )

( 7,636,000 )

Accrued interest and other liabilities

335,000  

1,895,000  

( 2,818,000 )

Net cash from operating activities

64,573,000  

37,877,000  

44,767,000  

Cash flows from investing activities

1 unchanged sentence

( 298,708,000 )

( 369,682,000 )

( 62,084,000 )

Proceeds from maturities, calls and repayments of securities available for sale

80,432,000  

321,164,000  

79,478,000  

Purchases of Federal Home Loan Bank stock

( 1,980,000 )

Loan originations and payments, net

1 unchanged sentence

( 341,461,000 )

( 99,620,000 )

Purchases of bank owned life insurance

( 2,000,000 )

( 4,500,000 )

Proceeds from bank owned life insurance cash value release and death benefits

Purchases of premises and equipment, net

7,708,000  

Net cash transferred in branch sale

( 2,679,000 )

Net purchases of premises and equipment and lease activity

( 5,602,000 )

( 8,989,000 )

( 13,484,000 )

Proceeds from sales of former bank premises

753,000  

162,000  

854,000  

Proceeds from sales of foreclosed assets

196,000  

700,000  

790,000  

Net cash for investing activities

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( 398,806,000 )

( 92,838,000 )

Cash flows from financing activities

Net (decrease) increase in time deposits

Net (decrease) increase in all other deposits

( 120,512,000 )

( 99,294,000 )

170,921,000  

Net increase in all other deposits

806,796,000  

820,463,000  

55,755,000  

Net (decrease) increase in securities sold under agreements to repurchase

79,098,000  

15,690,000  

Proceeds from Federal Home Loan Bank advances

60,000,000  

44,000,000  

Maturities of Federal Home Loan Bank advances

( 20,000,000 )

( 40,000,000 )

Net proceeds from subordinated notes issuance

73,635,000  

Proceeds from stock option exercises, net of cashless exercises

50,000  

128,000  

Employee stock purchase plan

48,000  

49,000  

50,000  

Dividend reinvestment plan

877,000  

814,000  

729,000  

Repurchases of common stock

( 21,380,000 )

( 6,591,000 )

( 7,183,000 )

Payment of cash dividends to common shareholders

( 18,524,000 )

( 17,930,000 )

( 17,108,000 )

Net cash from financing activities

780,088,000  

753,204,000  

206,448,000  

See accompanying notes to consolidated financial statements.

3 unchanged sentences

Net change in cash and cash equivalents

( 124,747,000

Cash and cash equivalents at beginning of period

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Principles of Consolidation :

The consolidated financial statements include the accounts of Mercantile Bank Corporation (“Mercantile”) and its subsidiary, Mercantile Bank of Michigan (“our bank”), and of Mercantile Bank Real Estate Co., L.L.C.

(“our real estate company”) and Mercantile Insurance Center, Inc.

(“our insurance company”), subsidiaries of our bank, after elimination of significant intercompany transactions and accounts.

The consolidated financial statements include the accounts of Mercantile Bank Corporation (“Mercantile”) and its subsidiary, Mercantile Bank (“our bank”), and of Mercantile Insurance Center, Inc.

(“our insurance company”), a subsidiary of our bank, after elimination of significant intercompany transactions and accounts.

Mercantile has five separate business trusts:

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While we monitor the revenue streams of the various products and services offered, we manage our business on the basis of one operating segment, banking.

Our real estate company was organized on July 21, 2003, principally to develop, construct, and own a facility in downtown Grand Rapids that serves as our bank’s main office and Mercantile’s headquarters.

This facility was placed into service during the second quarter of 2005.

The facility was transferred to our bank, and our real estate company was dissolved on December 18, 2020.

Our insurance company acquired an existing shelf insurance agency effective April 15, 2002.

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The allowance for loan losses and the fair values of financial instruments are particularly subject to change.

Recent Events:

There remains a significant amount of stress and uncertainty across national and global economies due to the ongoing pandemic of coronavirus disease 2019 (“Covid- 19”

) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”).

This uncertainty is heightened as certain geographic areas continue to experience surges in Covid- 19 cases and governments at all levels continue to react to changes in circumstances, including supply chain disruptions and inflationary pressures.

MERCANTILE BANK CORPORATION

1 unchanged sentence

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Events:

economy deteriorated rapidly during the latter part of the first quarter and into the second quarter of 2020 due to the ongoing Coronavirus Pandemic.

While the economic fallout has stabilized somewhat, there remains a significant amount of stress and uncertainty across national and global economies.

This uncertainty is heightened as certain geographic areas continue to experience surges in Covid- 19 cases and governments at all levels continue to react to changes in circumstances.

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Paycheck Protection Program

The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7 (a) loan program.

The PPP reflected a substantial expansion of the Small Business Administration’s 100% guaranteed 7 (a) loan program.

The PPP provides 100% guaranteed loans to cover specific operating costs, with the maximum loan size capped at the lesser of 250% of the average monthly payroll costs or $10.0 million.

The PPP provided 100% guaranteed loans to cover specific operating costs.

PPP loans are eligible to be forgiven based upon certain criteria.

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Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan.

The loan tenor is 24 months for loans originated prior to June 5, 2020 and 60 months for loans originated on or after June 5, 2020.

Loans originated prior to June 5, 2020 can be modified to a tenor of 60 months upon the mutual agreement of the lender and borrower.

We have not modified the maturity date of any loans made prior to June 5, 2020.

The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee ranging from 1% to 5% of the loan amount paid by the Small Business Administration.

The loan origination fees, net of the direct origination costs, have totaled approximately $ 15.0 million and are being accreted into interest income on loans using the level yield methodology.

The program was originally scheduled to end on June 30, 2020, but was subsequently modified to end on August 8, 2020.

We originated approximately 2,200 loans aggregating $ 554 million under the PPP, with no customer payments but $ 189 million in forgiveness payments from the Small Business Administration on approximately 900 PPP loans recorded through December 31, 2020.

Under the CARES Act, a PPP loan is assigned a risk weight of 0% under the risk-based capital rules of the federal banking agencies.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee from the Small Business Administration.

The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology.

The program ended on August 8, 2020.

We originated approximately 2,200 loans aggregating $ 554 million.

As of December 31, 2021, we recorded forgiveness transactions on all but ten loans aggregating $ 1.3 million.

Net loan origination fees of $ 3.7 million were recorded during 2021.

The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in Second Draw PPP loans (“Second Draw”).

The program ended on May 31, 2021.

Under the Second Draw, we originated approximately 1,200 loans aggregating $ 208 million.

As of December 31, 2021, we recorded forgiveness transactions on about 1,000 loans aggregating $ 169 million.

Net loan origination fees of $ 7.1 million were recorded during 2021.

Individual Economic Impact Payments

The Internal Revenue Service began making Individual Economic Impact Payments in mid- April via direct deposit or mailed checks.

Individuals with adjusted gross income of $75,000 or less received payments of $1,200, with a reduction formula for those individuals with adjusted gross income over $75,000 but less than $99,000.

Individuals with adjusted gross income of over $99,000 did not receive a payment.

Married couples filing jointly with adjusted gross income of over $198,000 did not receive a payment.

The Internal Revenue Service has made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks.

In general, and subject to adjusted gross income limitations, qualifying individuals have received payments of $1,200 in April 2020, $600 in January 2021 and $1,400 in March 2021.

Troubled Debt Restructuring Relief

7 unchanged sentences

The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In early April 2020, in response to the early stages of the Coronavirus Pandemic and its pervasive impact across the economy and financial markets, we developed internal programs of loan payment deferments for commercial and retail borrowers.

1 unchanged sentence

Under the latter program, borrowers were extended a 12 -month single payment note at 0 % interest in an amount equal to three payments, with loan proceeds used to make the scheduled payments.

The single payment notes receive a loan grade equal to the loan grade of each respective borrowing relationship.

The single payment notes received a loan grade equal to the loan grade of each respective borrowing relationship.

Certain of our commercial loan borrowers subsequently requested and received an additional 90 -day ( three payments) interest only amendment or 90 -day ( three payments) principal and interest payment deferment.

Under the latter program, the amount equal to the three payments was added to the original deferment note which has nine months remaining to maturity;

however, the original 0% interest rate is modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.

Peak of activity in the commercial loan deferment program was in mid- July, 2020;

however, as of December 31, 2020, only 19 borrowers with loan balances aggregating $ 8.0 million remained in the commercial loan deferment program.

Under the latter program, the amount equal to the three payments was added to the original deferment note which had nine months remaining to maturity;

however, the original 0% interest rate was modified to equal the rate associated with each borrower’s traditional lending relationship with us for the remainder of the term.

At the peak of activity in mid- 2020, nearly 750 borrowers with loan balances aggregating $ 719 million participated in the commercial loan deferment program.

As of December 31, 2021, we had no loans in the commercial loan deferment program.

For retail borrowers, we offered 90 -day ( three payments) principal and interest payment deferments, with deferred amounts added to the end of the loan.

Peak of activity was in early third quarter of 2020;

however, as of December 31, 2020, only 14 borrowers with loan balances aggregating $ 1.8 million remained in the retail loan payment deferment program.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In April, 2020, the Federal Reserve initiated the PPPLF, which is designed to facilitate lending by financial institutions to small businesses under the PPP.

Only PPP loans are eligible to serve as collateral for the PPPLF, with each dollar of PPP loans providing one dollar of advance availability.

The maturity date of an extension of credit under the PPPLF will equal the maturity date of the pool of PPP loans pledged to secure the extension of credit.

Any principal payments received by the financial institution on the PPP loans, such as PPP loan forgiveness payments from the Small Business Administration or principal payments from the borrower after the initial six -month deferment period, must be used to pay down the PPPLF advance by the same dollar amount, maintaining the dollar-for-dollar advance amount and PPP aggregate loan balance relationship.

The interest rate on PPPLF advances is fixed at 0.35%.

No PPPLF advances could be obtained after September 30, 2020.

We obtained a PPPLF advance in the amount of $ 43.7 million in late April 2020 and paid it off in full in early June 2020.

As of December 31, 2020, we had no advances outstanding under the PPPLF.

As of September 30, 2020, we had processed 260 principal and interest payment deferments with loan balances totaling $ 23.8 million.

As of December 31, 2021, only eight borrowers with loan balances aggregating $ 0.4 million remained in the retail loan payment deferment program.

Cash and Cash Equivalents and Cash Flow Reporting :

4 unchanged sentences

Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Federal Home Loan Bank stock is carried at cost.

It is not practical to determine the fair value of FHLBI stock due to transferability restrictions;

therefore, its fair value is estimated at carrying value.

Interest income includes amortization of purchase premiums and accretion of discounts.

8 unchanged sentences

The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses.

6 unchanged sentences

In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal and interest is considered doubtful.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income.

1 unchanged sentence

Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Commercial Loan Participations :

As part of our credit risk administration practices and to manage exposure limits, we engage in commercial loan participations with other financial institutions from time-to-time.

In all instances, the commercial loans are participated at par with no loan yield adjustments;

therefore, no gain or loss on sale, or servicing right, is recorded.

We retain a large portion of the loan exposure and continue to service the lending relationship.

Commercial loan participations aggregated $ 24.2 million and $ 18.1 million as of December 31, 2021 and 2020, respectively.

Loans Held for Sale :

4 unchanged sentences

We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower.

Year-end mortgage loans held for sale, included in total loans in the balance sheet, were as follows:

Year-end mortgage loans held for sale, included in total loans in the Consolidated Balance Sheets, were as follows:

Mortgage loans held for sale

8 unchanged sentences

The derivatives are not designated as hedges and are carried at fair value.

The net gain or loss on derivatives is included in mortgage banking activities in the income statement.

The balance of derivatives was immaterial at December 31, 2020 and 2019.

The net gain or loss on derivatives is included in mortgage banking activities in the Consolidated Statements of Income.

The balance of mortgage loan derivatives aggregated $ 0.3 million and $ 0.5 million at December 31, 2021 and 2020, respectively.

Mortgage Banking Activities :

3 unchanged sentences

Any impairment of a grouping is reported as a valuation allowance.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Servicing fee income is recorded for fees earned for servicing mortgage loans.

7 unchanged sentences

Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans.

4 unchanged sentences

The federal banking agencies issued an “

Interagency Statement on Loan Modifications and R eporting for Financial Institutions Working with Customers Affected by the Coronavirus”

Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus ”

on March 22, 2020, which was subsequently revised on April 7, 2020.

4 unchanged sentences

As part of the Consolidated Appropriations Act that was enacted in late 2020, this guidance was extended to January 1, 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses :

4 unchanged sentences

We estimate credit losses based on individual loans determined to be impaired and on all other loans grouped on similar risk characteristics.

Our historical loss component is generally the most significant of the allowance components and is based on historical loss experience by credit risk grade for commercial loans and payment status for mortgage and consumer loans.

Our historical loss component is based on historical loss experience by credit risk grade for commercial loans and payment status for mortgage and consumer loans.

Loans are pooled based on similar risk characteristics supported by observable data.

3 unchanged sentences

Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

A loan is considered impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

3 unchanged sentences

Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, generally based on delinquency status.

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020.

The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022.

An economic forecast is a key component of the CECL methodology.

Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.

Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL, and have continued to use our incurred loan loss reserve model as permitted through December 31, 2021.

Loans made under PPP are fully guaranteed by the Small Business Administration;

therefore, such loans do not have an associated allowance.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Transfers of Financial Assets :

14 unchanged sentences

If fair value subsequently declines, a valuation allowance is recorded through noninterest expense, as are collection and operating costs after acquisition.

Foreclosed assets, included in other assets in the balance sheet, totaled $ 0.7 million and $ 0.5 million as of December 31, 2020 and 2019, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Foreclosed assets, included in other assets in the Consolidated Balance Sheets, totaled $ 0 and $ 0.7 million as of December 31, 2021 and 2020, respectively.

Bank Owned Life Insurance:

8 unchanged sentences

If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value.

In 2019, we elected to perform a qualitative assessment for our annual impairment test and concluded it was more likely than not our fair value was greater than its carrying amount;

therefore, no further testing was required.

Due to current stressed economic and market conditions, we assessed goodwill for impairment as of March 31, 2020, June 30, 2020, September 30, 2020 and October 1, 2020.

For March 31, 2020, we performed a quantitative analysis, which used a discounted income approach and a market valuation model, which compared the inherent value of our company to valuations of recent transactions in the market place to determine if our goodwill had been impaired.

Using this quantitative methodology, we determined goodwill was not impaired as of March 31, 2020.

For June 30, 2020, September 30, 2020, and October 1, 2020, we used the Step 0 qualitative methodology for which we assessed the macro and microeconomic conditions, industry and market conditions, financial performance, and our underlying stock performance.

We concluded it was more likely than not our fair value was greater than its carrying amount;

We concluded it was more likely than not our fair value was greater than its carrying amount at the end of the period;

therefore, no further testing was required.

Due to stressed economic and market conditions throughout 2020, we assessed goodwill for impairment as of March 31, 2020, June 30, 2020, September 30, 2020, and October 1, 2020.

No impairments were recorded in 2021 or 2020.

The core deposit intangible that arose from the merger with Firstbank was initially measured at fair value and is being amortized into noninterest expense over a ten -year period using the sum-of-the-years-digits methodology.

2 unchanged sentences

The agreements are treated as collateralized financing transactions, with the obligations to repurchase the securities sold reflected as liabilities and the securities underlying the agreements remaining in assets in the Consolidated Balance Sheets.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Financial Instruments and Loan Commitments :

3 unchanged sentences

Instruments, such as standby letters of credit, that are considered financial guarantees are recorded at fair value.

Reserves for unfunded commitments are recorded as an other liability on our Consolidated Balance Sheets.

Stock-Based Compensation :

7 unchanged sentences

No revenue has been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606.

2 unchanged sentences

Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

The following table depicts our sources of noninterest income presented in the Consolidated Statements of Income for the years ended December 31, 2021, 2020 and 2019 that are scoped within Topic 606:

Service charges on deposit and sweep accounts

5,078,000  

4,578,000  

4,584,000  

Credit and debit card fees

7,516,000  

5,973,000  

5,925,000  

Payroll processing

1,815,000  

1,745,000  

1,626,000  

Customer service fees

878,000  

785,000  

759,000  

Service Charges on Deposit and Sweep Accounts:

We earn fees from deposit and sweep customers for account maintenance, transaction-based and overdraft services.

Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of the month reflecting the period over which we satisfy the performance obligation.

Transaction-based fees, which includes services such as stop payment and returned item charges, are recognized at the time the transaction is executed as that is the point in time we fulfill the customer request.

Service charges on deposit and sweep accounts are withdrawn from the customer account balance.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Credit and Debit Card Fees:

We earn interchange income on our cardholder debit and credit card usage.

Interchange income is primarily comprised of fees whenever our debit and credit cards are processed through card payment networks such as Visa.

Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

Payroll Processing Fees:

We earn fees from providing payroll processing services for our commercial clients.

Fees are assessed for processing weekly or bi-weekly payroll files, reports and documents, as well as year-end tax-related files, reports and documents.

Fees are recognized and collected as payroll processing services are completed for each payroll run and year-end processing activities.

Customer Service Fees:

We earn fees by providing a variety of other services to our customers, such as wire transfers, check ordering, sale of cashier checks and money orders, and rental of safe deposit boxes.

Generally, fees are recognized and collected daily, concurrently with the point in time we fulfill the customer request.

Safe deposit box rentals are on annual contracts, with fees generally earned at the time of the contract signing or renewal.

Advertising Costs :

16 unchanged sentences

Comprehensive income consists of net income and other comprehensive income (loss).

Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale and interest rate swaps which are also recognized as a separate component of equity.

Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale.

Derivatives :

3 unchanged sentences

We do not use derivatives for trading purposes.

Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income.

They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded.

If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.

MERCANTILE BANK CORPORATION

3 unchanged sentences

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded.

If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.

If designated as a hedge, we formally document the relationship between the derivative instrument and the hedged item, as well as the risk-management objective and the strategy for undertaking the hedge transaction.

3 unchanged sentences

We discontinue hedge accounting when we determine the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or terminates, or treatment of the derivatives as a hedge is no longer appropriate or intended.

We had no derivative instruments designated as hedges as of December 31, 2021 and 2020.

Contingencies:

4 unchanged sentences

financial statements have been reclassified to conform to the current year presentation.

Subsequent Events:

On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law. 

This $900 billion Coronavirus Pandemic relief package includes $284 billion in aid for small businesses through a second round of forgivable loans through the PPP.

In general, the framework of loans originated under the second round is similar to that of the initial round. 

As of February 26, 2021, we had originated about 900 loans aggregating $ 181 million in second round PPP loans.

We originated approximately 2,200 loans aggregating $ 554 million under the initial round of the PPP. 

As of December 31, 2020, we had received no customer payments but had received $ 189 million in forgiveness payments from the Small Business Administration on about 900 PPP loans. 

As of February 26, 2021, we had received no customer payments but had received $ 266 million in forgiveness payments from the Small Business Administration on approximately 1,400 loans.

The agreement includes the 4,300 square-foot facility, all associated assets and approximately $ 16 million in deposits.

Accounting Standards Updates :

In February 2016, the FASB issued ASU 2016 - 02, Leases .

This ASU (as subsequently amended by ASU 2018 - 01, ASU 2018 - 10, ASU 2018 - 11 and ASU 2018 - 20 ) establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.

Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.

The ASU was effective for annual and interim periods beginning after December 15, 2018.

The adoption of this new standard as of January 1, 2019 resulted in the recording of a ROU asset and associated lease liability of approximately $ 1.3 million.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 –

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In June 2016, the FASB issued ASU No.

3 unchanged sentences

approach with an “expected loss”

The new model, referred to as the current expected credit loss (“CECL”) model, will apply to:

The new model, referred to as the CECL model, will apply to:

(i) financial assets subject to credit losses and measured at amortized cost, and (ii) certain off-balance sheet credit exposures.

3 unchanged sentences

This ASU is effective for interim and annual reporting periods beginning after December 15, 2019.

The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022.

Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020.

The Consolidated Appropriations Act, 2021 provided for a further extension of the required CECL adoption date to January 1, 2022.

An economic forecast is a key component of the CECL methodology.

Given the high degree of uncertainty surrounding economic forecasting, we have elected to postpone the adoption of CECL, and will continue to use our incurred loan loss reserve model as permitted.

We adopted CECL effective January 1, 2022, which we expect to result in an allowance reduction of $ 0.2 million to $ 2.0 million, of which the assumption related to the Covid- 19 environmental factor presents the most variability within this range.

The resulting impact will be an increase to the retained earnings account on our Consolidated Balance Sheet equal to the after-tax impact of the allowance balance reduction, with the tax impact portion being recorded as a deferred tax asset in other assets on our Consolidated Balance Sheet.

MERCANTILE BANK CORPORATION

60 unchanged sentences

$ 3,495,000  

$ 384,340,000  

$ 8,769,000  

Mortgage-backed securities

Municipal general obligation bonds

Municipal revenue bonds

23,184,000  

652,000  

Other investments

24,000  

1 unchanged sentence

652,000  

Municipal general obligation bonds

40,748,000  

Government agency debt obligations

392,000  

1 unchanged sentence

392,000  

Municipal revenue bonds

12,843,000  

1 unchanged sentence

414,000  

Mortgage-backed securities

13,257,000  

145,000  

Other investments

$ 351,062,000  

2 unchanged sentences

$ 3,503,000  

Municipal general obligation bonds

$ 461,553,000  

$ 9,958,000  

Government agency debt obligations

$ 118,650,000  

2 unchanged sentences

$ 897,000  

Mortgage-backed securities

Municipal general obligation bonds

Municipal revenue bonds

Other investments

423,000  

Other investments

$ 119,073,000  

95 unchanged sentences

$ 3,193,470,000  

For December 31, 2020, includes $ 365 million in loans originated under the Paycheck Protection Program.

( 1 ) For December 31, 2021, and December 31, 2020, includes $ 40.1 million and $ 365 million in loans originated under the Paycheck Protection Program, respectively.

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

Percentage of

Loan Portfolio

Commercial real estate loans to lessors of non-residential buildings

8 unchanged sentences

Loans past due 90 days or more still accruing interest

$ 155,000  

Nonaccrual loans

7 unchanged sentences

$ 663,000  

$ 172,000  

Vacant land, land development, and residential construction

2 unchanged sentences

619,000  

134,000  

Real estate –

29 unchanged sentences

$ 1,137,419,000  

Vacant land, land development, and residential construction

$ 155,000  

Vacant land, land development, and residential construction

13,000  

Real estate –

owner occupied

13,000  

1 unchanged sentence

43,239,000  

Real estate –

owner occupied

565,758,000  

4 unchanged sentences

1,027,415,000  

917,413,000  

917,436,000  

Real estate –

15 unchanged sentences

60,488,000  

61,620,000  

1- 4 family mortgages

18 unchanged sentences

$ 3,453,459,000  

$ 155,000  

MERCANTILE BANK CORPORATION

7 unchanged sentences

$ 172,000  

Vacant land, land development, and residential construction

$ 433,000  

1 unchanged sentence

$ 1,145,423,000  

Vacant land, land development, and residential construction

55,055,000  

Real estate –

4 unchanged sentences

529,335,000  

529,953,000  

Real estate –

2 unchanged sentences

23,000  

917,413,000  

917,436,000  

Real estate –

8 unchanged sentences

2,792,888,000  

2,793,962,000  

Home equity and other

31 unchanged sentences

Impaired loans with no related allowance recorded were as follows as of December 31, 2021:

Year-To-Date Average

Recorded Principal Balance

With no related allowance recorded:

4 unchanged sentences

Vacant land, land development and residential construction

187,000  

Real estate –

6 unchanged sentences

131,000  

341,000  

227,000  

Real estate –

multi-family and residential rental

91,000  

37,000  

Total commercial

23 unchanged sentences

Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2021:

Year-To-Date Average Recorded Principal Balance

With an allowance recorded:

5 unchanged sentences

Vacant land, land development and residential construction

77,000  

Real estate –

49 unchanged sentences

$ 23,297,000  

MERCANTILE BANK CORPORATION

3 unchanged sentences

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans with no related allowance recorded were as follows as of December 31, 2020: 

Year-To-Date Average

Recorded Principal Balance

With no related allowance recorded:

5 unchanged sentences

187,000  

85,000  

89,000  

Real estate –

10 unchanged sentences

multi-family and residential rental

29,000  

44,000  

Total commercial

23 unchanged sentences

Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2020:

Year-To-Date Average Recorded Principal Balance

With an allowance recorded:

5 unchanged sentences

Vacant land, land development and residential construction

77,000  

Real estate –

7 unchanged sentences

162,000  

100,000  

Real estate –

multi-family and residential rental

54,000  

Total commercial

37 unchanged sentences

Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated fair value.

Interest income recognized on accruing troubled debt restructurings totaled $ 1.3 million in 2020 and 2019, and $ 1.1 million during 2018.

Interest income recognized on accruing troubled debt restructurings totaled $ 1.5 million in 2021, and $ 1.3 million in 2020 and 2019.

Interest income recognized on nonaccrual loans totaled less than $ 0.1 million in 2021, 2020 and 2019, reflecting the collection of interest at the time of principal pay-off.

Lost interest income on nonaccrual loans totaled $ 0.1 million in 2021, $ 0.2 million in 2020, and $ 0.1 million in 2019.

MERCANTILE BANK CORPORATION

3 unchanged sentences

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Credit Quality Indicators.

47 unchanged sentences

$ 442,547,000  

Included in Commercial and Industrial Loans Grades 1 –

4 are $ 40.1 million of loans originated under the Paycheck Protection Program.

2 unchanged sentences

December 31, 2021

NO TE 3 –

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

42 unchanged sentences

$ 337,888,000  

Included in Commercial and Industrial Loans Grades 1 – 

4 are $ 365 million of loans originated under the Paycheck Protection Program.

MERCANTILE BANK CORPORATION

4 unchanged sentences

All commercial loans are graded using the following criteria:

“Exceptional”

Loans with this rating contain very little, if any, risk.

“Outstanding”

Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.

“Very Good”

Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements.

“Exceptional”  Loans with this rating contain very little, if any, risk.

“Outstanding”  Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.

“Very Good”  Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements.

These are loans for which repayment risks are acceptable.

“Good”

Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements.

“Good”  Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements.

These are loans for which repayment risks are modest.

“Acceptable”

Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements.

“Acceptable”  Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements.

These are loans for which repayment risks are satisfactory.

“Monitor”

Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses.

“Monitor”  Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses.

Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report.

“Special Mention”

Loans with this rating have potential weaknesses that deserve management’s close attention.

“Special Mention”  Loans with this rating have potential weaknesses that deserve management’s close attention.

If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

“Substandard”

Loans with this rating are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any.

“Substandard”  Loans with this rating are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any.

A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt.

They are characterized by the distinct possibility of loss if the deficiencies are not corrected.

“Doubtful”

Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.

“Loss”

Loans with this rating are considered uncollectable, and of such little value that continuance as an active asset is not warranted.

“Doubtful”  Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.

“Loss”  Loans with this rating are considered uncollectable, and of such little value that continuance as an active asset is not warranted.

The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and timeliness of scheduled payments.

8 unchanged sentences

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2020 are as follows:

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2021 are as follows (dollars in thousands):

Commercial and industrial

Commercial vacant land, land development and residential construction

Commercial real estate –

owner occupied

Commercial real estate –

non-owner occupied

Commercial real estate –

multi-family and residential rental

Home equity and other

4 family mortgages

Allowance for loan losses:

4 unchanged sentences

$ 1,819  

$ 3,240  

$ 37,967  

Provision for loan losses

5 unchanged sentences

( 1,629 )  

Ending balance

( 14 )  

2 unchanged sentences

( 12 )  

( 43 )  

( 92 )  

Ending balance

individually evaluated for impairment

$ 10,782  

1 unchanged sentence

$ 13,301  

$ 1,695  

$ 2,449  

$ 35,363  

Ending balance:

individually evaluated for impairment

Ending balance:

collectively evaluated for impairment

3 unchanged sentences

$ 1,691  

$ 2,380  

$ 34,817  

Total loans (*):

3 unchanged sentences

$ 565,758  

$ 1,027,415  

$ 176,593  

$ 60,488  

$ 442,547  

$ 3,413,349  

Ending balance:

3 unchanged sentences

$ 1,247  

$ 2,437  

$ 19,366  

Ending balance:

3 unchanged sentences

$ 555,323  

$ 1,027,269  

$ 176,502  

$ 59,241  

$ 440,110  

$ 3,393,983  

(*) Excludes $40.1 million in loans originated under the Paycheck Protection Program.

4 unchanged sentences

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2019 are as follows:

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2020 are as follows (dollars in thousands):

Commercial and industrial

Commercial vacant land, land development and residential construction

Commercial real estate –

owner occupied

Commercial real estate –

non-owner occupied

Commercial real estate –

multi-family and residential rental

Home equity and other

4 family mortgages

Allowance for loan losses:

12 unchanged sentences

( 96 )  

( 129 )  

Ending balance

3 unchanged sentences

$ 1,819  

$ 3,240  

$ 37,967  

Ending balance:

individually evaluated for impairment

Ending balance:

collectively evaluated for impairment

$ 9,371  

1 unchanged sentence

$ 13,603  

$ 1,819  

$ 3,068  

$ 37,416  

Total loans (*):

Ending balance

collectively evaluated for impairment

$ 780,164  

2 unchanged sentences

$ 917,436  

Ending balance

$ 146,095  

1 unchanged sentence

$ 337,888  

$ 2,828,211  

Ending balance:

3 unchanged sentences

$ 1,270  

$ 3,273  

$ 26,958  

Ending balance:

3 unchanged sentences

$ 514,626  

$ 916,933  

$ 146,095  

$ 60,350  

$ 334,615  

$ 2,801,253  

(*) Excludes $365 million in loans originated under the Paycheck Protection Program.

MERCANTILE BANK CORPORATION

3 unchanged sentences

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2018 are as follows:

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2019 are as follows (dollars in thousands):

Commercial and industrial

Commercial vacant land, land development and residential construction

Commercial real estate –

owner occupied

Commercial real estate –

non-owner occupied

Commercial real estate –

multi-family and residential rental

Home equity and other

4 family mortgages

Allowance for loan losses:

8 unchanged sentences

( 12 )  

( 1,450,000 )

( 48 )  

6 unchanged sentences

$ 1,888  

$ 23,889  

Ending balance:

1 unchanged sentence

$ 1,623  

$ 539,000  

$ 1,089,000  

Ending balance:

4 unchanged sentences

$ 1,805  

$ 22,266  

Ending balance

2 unchanged sentences

$ 579,003  

$ 835,346  

$ 124,525  

$ 75,374  

$ 339,749  

$ 2,856,667  

Ending balance:

3 unchanged sentences

$ 1,694  

$ 2,324  

$ 14,622  

Ending balance:

3 unchanged sentences

$ 577,258  

$ 835,168  

$ 124,516  

$ 73,680  

$ 337,425  

$ 2,842,045  

MERCANTILE BANK CORPORATION

14 unchanged sentences

non-owner occupied

319,000  

318,000  

Real estate –

multi-family and residential rental

93,000  

Total commercial

16 unchanged sentences

Vacant land, land development and residential construction

87,000  

Real estate –

4 unchanged sentences

non-owner occupied

319,000  

318,000  

Real estate –

41 unchanged sentences

Home equity and other

20,000  

1-4 family mortgages

106,000  

126,000  

$ 126,000  

MERCANTILE BANK CORPORATION

4 unchanged sentences

Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2021 is as follows:

Land Development,

and Residential

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

3 unchanged sentences

$ 480,000  

$ 178,000  

$ 7,000  

( 4,278,000 )

9 unchanged sentences

$ 146,000  

$ 91,000  

Retail Loan Portfolio:

15 unchanged sentences

Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2020 is as follows:

Land Development,

and Residential

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

4 unchanged sentences

$ 178,000  

$ 7,000  

( 11,260,000 )

9 unchanged sentences

$ 480,000  

$ 178,000  

$ 7,000  

Retail Loan Portfolio:

15 unchanged sentences

Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2019 is as follows:

Land Development,

and Residential

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

4 unchanged sentences

$ 24,000  

$ 41,000  

( 20,364,000 )

( 3,820,000 )

Transfers to ORE

2 unchanged sentences

87,000  

1,962,000  

Ending Balance

3 unchanged sentences

$ 178,000  

$ 7,000  

Retail Loan Portfolio:

64 unchanged sentences

$ 58,959,000  

Future lease payments at December 31, 2020 totaled $ 3.4 million, comprised of $ 0.6 million in one year, $ 1.2 million in one to three years, $ 0.5 million in three to five years and $ 1.1 million in over five years.

Future lease payments at December 31, 2019 totaled $ 3.8 million, comprised of $ 0.6 million in one year, $ 1.1 million in one to three years, $ 0.9 million in three to five years and $ 1.2 million in over five years.

Depreciation expense totaled $ 5.8 million in 2021, $ 5.2 million in 2020, and $ 3.9 million in 2019.

3 unchanged sentences

NOTE 4 –

PREMISES AND EQUIPMENT, NET (Continued)

We enter into facility leases in the normal course of business.

As of December 31, 2021, we were under lease contracts for ten of our branch facilities.

The leases have maturity dates ranging from June, 2022 through December, 2026, with a weighted average life of the lease term of 2.8 years as of December 31, 2021.

All of our leases have multiple three - to five -year extensions;

however, these were not factored in the lease maturities and weighted average lease term as it is not reasonably certain we will exercise the options.

Leases are classified as either operating or finance leases at the lease commencement date, with all of our current leases determined to be operating leases.

Lease expense for operating leases is recognized on a straight-line basis over the lease term.

Right-of-use assets represent our right to use an underlying asset for the lease term, while lease liabilities represent our obligation to make lease payments arising from the lease.

Right-of-use assets and lease liabilities are recognized at the lease commencement date at the estimated present value of lease payments over the lease term.

We use our incremental borrowing rate, on a collateralized basis, at lease commencement to calculate the present value of lease payments.

The weighted average discount rate for leases was 4.71 % as of December 31, 2021.

The right-of-use assets, included in premises and equipment, net on our Consolidated Balance Sheets, and the lease liabilities, included in other liabilities on our Consolidated Balance Sheets, totaled $ 2.9 million and $ 2.8 million as of December 31, 2021, respectively, and totaled $ 1.1 million and $ 0.9 million as of December 31, 2020, respectively.

As permitted by applicable accounting standards, we have elected not to recognize short-term leases with original terms of twelve months or less on our Consolidated Balance Sheet.

Total operating lease expense associated with the leases aggregated $ 0.6 million in each of 2021 and 2020, and $ 0.5 million in 2019.

Future lease payments at December 31, 2021 totaled $ 3.6 million, comprised of $ 0.8 million in one year, $ 1.4 million in one to three years, $ 0.3 million in three to five years and $ 1.1 million in over five years.

NOTE 5 –

MORTGAGE LOAN SERVICING

12 unchanged sentences

Custodial escrow balances, which are reported as deposits on the Consolidated Balance Sheets, maintained in connection with serviced loans were $ 12.1 million and $ 11.8 million as of December 31, 2021 and December 31, 2020, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 5 –

MORTGAGE LOAN SERVICING 

Activity for capitalized mortgage loan servicing rights during 2021 and 2020 was as follows:

17 unchanged sentences

Forecasted amortization as of December 31, 2021 is as follows:

$ 1,186,000  

4 unchanged sentences

8,086,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 6 –

CORE DEPOSIT INTANGIBLE ASSET, NET

The gross carrying amount of core deposit intangible assets totaled $ 17.5 million as of December 31, 2020 and December 31, 2019.

The gross carrying amount of core deposit intangible assets, included in other assets on our Consolidated Balance Sheets, totaled $ 17.5 million as of December 31, 2021 and December 31, 2020.

As of December 31, 2021, the accumulated amortization on core deposit intangible assets was $ 16.1 million, providing for a net carry balance of $ 1.4 million.

1 unchanged sentence

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

$ 1,086,000  

768,000  

450,000  

132,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 7 –

47 unchanged sentences

$ 555,115,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 7 –

DEPOSITS (Continued)

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

15 unchanged sentences

Total time deposits of more than $250,000 totaled $ 207 million and $ 272 million at year-end 2021 and 2020, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 8 –

2 unchanged sentences

Outstanding balance at year-end

$ 118,365,000  

$ 102,675,000  

Weighted average interest rate at year-end

Average daily balance during the year

$ 132,880,000  

$ 105,234,000  

Weighted average interest rate during the year

Maximum daily balance during the year

$ 173,186,000  

$ 133,411,000  

Securities sold under agreements to repurchase (“repurchase agreements”) generally have original maturities of less than one year.

3 unchanged sentences

Repurchase agreements are secured by securities with an aggregate fair value equal to the aggregate outstanding balance.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $ 374 million at December 31, 2021, and were expected to mature at varying dates from January 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 2.00 %.

Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $ 394 million at December 31, 2020, and were expected to mature at varying dates from November 2021 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 2.06 %.

FHLBI advances totaled $ 354 million at December 31, 2019, and were expected to mature at varying dates from April 2020 through June 2025, with fixed rates of interest from 1.36 % to 3.18 % and averaging 2.45 %.

In June 2020, we executed a blend and extend transaction with the FHLBI to extend the duration of the FHLBI advance portfolio as part of our interest rate risk management program.

We prepaid seven advances aggregating $ 70.0 million with maturities ranging from August 2020 through October 2021 and fixed interest rates from 1.36 % to 2.84 % and averaging 1.97 %, using the proceeds from seven new advances aggregating $ 70.0 million with maturities ranging from June 2024 through June 2027 and fixed interest rates from 0.55 % to 1.18 % and averaging 0.84 %.

Prepayment fees totaling $ 0.9 million were embedded into the fixed rates on the newly obtained advances, equating to 0.22 % of the 0.84% average rate of the new advances.

Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date.

8 unchanged sentences

40,000,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 10 - FEDERAL INCOME TAXES

The consolidated income tax expense is as follows:

Current expense

3 unchanged sentences

Deferred expense

2,020,000  

( 4,141,000 )

4 unchanged sentences

$ 11,004,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2020

NOTE 1 0 - FEDERAL INCOME TAXES (Continued)

A reconciliation of the differences between the federal income tax expense recorded and the amount computed by applying the federal statutory rate to income before income taxes is as follows:

11 unchanged sentences

$ 10,710,000  

$ 11,004,000  

The statutory tax rate was 21 % for 2021, 2020 and 2019.

16 unchanged sentences

924,000  

Capital loss carryforward

Unrealized loss on securities

991,000  

3 unchanged sentences

938,000  

683,000  

Deferred tax asset before valuation allowance

11,635,000  

7,460,000  

Valuation allowance

Deferred tax asset after valuation allowance

Deferred tax asset

11,640,000  

14 unchanged sentences

1,458,000  

982,000  

Business combination adjustments

14 unchanged sentences

A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized.

At December 31, 2019, we carried a valuation allowance of $ 0.1 million against capital loss carryforwards generated by the disposal of certain capital investments acquired in our merger with Firstbank.

The $ 0.1 million of capital loss carryforwards expired at December 31, 2020 and we no longer carry this asset or the valuation allowance against it.

We determined that no valuation allowance was required at year-end 2020 or 2021.

We had no unrecognized tax benefits at any time during 2021 or 2020 and do not anticipate any significant increase in unrecognized tax benefits during 2022.

7 unchanged sentences

During the years 2016 through 2019, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2016.

During 2020, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2020.

During 2020 and 2021, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2020.

Stock option grants were provided to certain employees during 2016 from the Stock Incentive Plan of 2016.

Stock grants to directors as retainer payments during the years 2016 through 2019 were from the Stock Incentive Plan of 2016, while stock grants to directors as retainer payments during 2020 were from the Stock Incentive Plan of 2020.

The Stock Incentive Plan of 2006 expired on January 18, 2016, and was effectively replaced with the Stock Incentive Plan of 2016 that was approved by shareholders in May, 2016.

4 unchanged sentences

No payments are required from employees for restricted stock awards.

The restricted stock awards granted during the years 2014 through 2020 fully vest after three years and, in the case of performance-based restricted stock issued to executive officers in 2018, 2019 and 2020, are subject to the attainment of pre-determined performance goals.

The restricted stock awards granted during the years 2014 through 2021 fully vest after three years and, in the case of performance-based restricted stock issued to executive officers in 2018 through 2021, are subject to the attainment of pre-determined performance goals.

The stock options granted during 2014, 2015 and 2016, which were at 110 % of the market price on the date of grant, fully vest after two years and expire after seven years.

At year-end 2021, there were approximately 187,000 shares authorized for future incentive awards.

In conjunction with the Firstbank merger, we issued Mercantile stock options in replacement of all outstanding Firstbank stock option grants that had been previously issued to Firstbank employees under the Firstbank Corporation Stock Option and Restricted Stock Plan of 1997 and the Firstban

In general, stock option grants for 50 shares or less fully vested after one year from date of grant, while stock option grants for more than 50 shares vested over a five -year period at 20 % of the grant per annum starting one year from date of grant.

The stock option grants expire ten years from date of grant.

There were approximately 282,200 Mercantile stock options issued as a result of the merger, with about 258,400 of the stock option grants fully vested and exercisable on the date of merger.

The remaining 23,800 stock option grants vested during 2015.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

A summary of restricted stock activity from grants issued during the past three years is as follows:

Nonvested at beginning of year

262,336  

$ 29.42  

262,260  

$ 34.91  

262,967  

$ 33.97  

163,000  

121,518  

84,596  

Nonvested at end of year

353,691  

$ 30.71  

262,336  

$ 29.42  

262,260  

$ 34.91  

Of the restricted stock shares granted in 2021, 2020 and 2019, a total of 22,703 shares, 31,295 shares and 23,596 shares, respectively, are performance-based awards made to our Named Executive Officers at the target level and are subject to the attainment of pre-determined performance goals.

Of the granted shares during 2021, a total of 11,454 , 23,053 and 22,836 shares reflect increases in performance-based grants to our Named Executive Officers that were awarded in 2020, 2019 and 2018, respectively.

Of the forfeited shares during 2020, a total of 13,709 shares and 14,681 shares reflect reductions in performance-based grants to our Named Executive Officers that were awarded in 2019 and 2018, respectively.

These adjustments were based on an analysis of the pre-determined performance goals taking into account actual performance since the grant date and updated forecasts for the remainder of the three -year performance period.

A summary of stock option activity during the past three years is as follows:

Outstanding at beginning of year

$ 32.83  

10,700  

$ 30.25  

18,900  

$ 23.92  

Forfeited or expired

Outstanding at end of year

$ 34.89  

$ 32.83  

10,700  

$ 30.25  

Options exercisable at year-end

$ 34.89  

$ 32.83  

10,700  

$ 30.25  

The fair value of each stock option award is estimated on the date of grant using a closed option valuation (Black-Scholes) model that uses the assumptions noted in the table below.

Expected volatilities are based on historical volatilities on our common stock.

Historical data is used to estimate stock option expense and post-vesting termination behavior.

The expected term of stock options granted is based on historical data and represents the period of time that stock options granted are expected to be outstanding, which takes into account that the stock options are not transferable.

The risk-free interest rate for the expected term of the stock option is based on the U.S.

Treasury yield curve in effect at the time of the stock option grant.

No stock option grants were made during the past three years.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

Options at year-end 2021 were as follows:

Weighted Average

- $ 28.00  

$ 27.66  

- $ 37.00  

Outstanding at year end

$ 34.89  

Information related to options outstanding at year-end 2021, 2020 and 2019 is as follows:

Minimum exercise price

$ 27.66  

$ 22.15  

$ 5.19  

Maximum exercise price

Average remaining option term (years)

Information related to stock option grants and exercises during 2021, 2020 and 2019 is as follows:

Aggregate intrinsic value of stock options exercised

$ 13,000  

$ 17,000  

$ 157,000  

Cash received from stock option exercises

50,000  

126,000  

Tax benefit realized from stock option exercises

Weighted average per share fair value of stock options granted

The aggregate intrinsic value of in-the-money stock options issued under Mercantile plans outstanding and exercisable at December 31, 2021 was less than $ 0.1 million.

Shares issued as a result of the exercise of stock option grants have been authorized and were previously unissued shares.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

On May 24, 2018, we granted about 11,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2018 through May 31, 2019.

The associated $ 0.4 million cost was expensed on a straight-line basis over the respective twelve month period.

On October 25, 2018, we granted about 1,000 shares of common stock to newly appointed Bank Board members for retainer payments for the period of October 1, 2018 through May 31, 2019.

The associated less than $ 0.1 million cost was expensed over the respective eight -month period.

On May 23, 2019, we granted about 12,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2019 through May 31, 2020.

The associated $ 0.4 million cost was expensed on a straight-line basis over the respective twelve month period.

On June 1, 2020, we granted about 16,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2020 through May 31, 2021.

The associated $ 0.3 million cost was expensed on a straight-line basis over the respective twelve month period.

On August 27, 2020, we granted about 2,000 shares of common stock to newly appointed Corporate and Bank Board members for retainer payments for the period of September 1, 2020 through May 31, 2021.

The associated less than $ 0.1 million cost was expensed over the respective nine -month period.

On May 27, 2021, we granted about 10,000 shares of common stock to our Corporate and Bank Boards of Directors for retainer payments for the period of June 1, 2021 through May 31, 2022.

The associated $ 0.3 million cost is being expensed on a straight-line basis over the respective twelve month period.

NOTE 12 –

RELATED PARTIES

Certain directors and executive officers of our bank, including their immediate families and companies in which they are principal owners, were loan customers of our bank.

At year-end 2021 and 2020, our bank had $ 104 million and $ 122 million in loan commitments to directors and executive officers, of which $ 87.7  million and $ 108 million were outstanding at year-end 2021 and 2020, respectively, as reflected in the following table.

Beginning balance

$ 108,042,000  

$ 104,043,000  

2,542,000  

13,823,000  

( 22,912,000 )

( 9,824,000 )

Ending balance

$ 87,672,000  

$ 108,042,000  

We had no PPP loans outstanding to related companies of our directors as of December 31, 2021.

PPP loans to related companies of our directors totaled $ 0.3 million as of December 31, 2020.

Related party deposits and repurchase agreements totaled $ 18.4 million and $ 19.4 million at year-end 2021 and 2020, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 13 –

COMMITMENTS AND OFF-BALANCE-SHEET RISK

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers.

These financial instruments include commitments to extend credit and standby letters of credit.

Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.

Standby letters of credit are conditional commitments issued by our bank to guarantee the performance of a customer to a third party.

Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet.

Our maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.

We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on management’s credit assessment of the borrower.

If required, estimated loss exposure resulting from these instruments is expensed and recorded as a liability.

There was no liability balance for these instruments as of December 31, 2021 and 2020.

At year-end 2021 and 2020, the rates on existing off-balance sheet instruments were substantially equivalent to current market rates, considering the underlying credit standing of the counterparties.

Our maximum exposure to credit losses for loan commitments and standby letters of credit outstanding at year-end was as follows:

Commercial unused lines of credit

$ 1,098,951,000  

$ 1,019,496,000  

Unused lines of credit secured by 1 –

4 family residential properties

64,313,000  

59,396,000  

Credit card unused lines of credit

92,146,000  

72,495,000  

Other consumer unused lines of credit

64,876,000  

30,707,000  

Commitments to make loans

212,476,000  

227,558,000  

Standby letters of credit

33,109,000  

20,543,000  

Total commitments

$ 1,565,871,000  

$ 1,430,195,000  

Commitments to make loans generally reflect our binding obligations to existing and prospective customers to extend credit, including line of credit facilities secured by accounts receivable and inventory, and term debt secured by either real estate or equipment.

In most instances, line of credit facilities are for a one -year term and have been at a floating rate tied to the Wall Street Journal Prime Rate or the 30 -Day Libor Rate.

For term debt secured by real estate, customers have been generally offered a floating rate tied to the Wall Street Journal Prime Rate or the 30 -Day Libor Rate, and a fixed rate currently ranging from 3.00 % to 5.00 %.

These credit facilities generally balloon within five years, with payments based on amortizations ranging from 10 to 20 years.

For term debt secured by non-real estate collateral, customers have been generally offered a floating rate tied to the Wall Street Journal Prime Rate or the 30 -Day Libor Rate, and a fixed rate currently ranging from 3.50 % to 5.00 %.

These credit facilities generally mature and fully amortize within three to seven years.

Effective January 1, 2022, we replaced the 30 -Day Libor Rate with the CBM Term SOFR Rate for all new floating rate commercial loan commitments.

It is expected that currently outstanding commercial loans tied to the 30 -Day Libor Rate will convert to an equivalent fallback SOFR Rate on or about June 30, 2023.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 13 –

COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)

The following instruments are considered financial guarantees under current accounting guidance.

These instruments are carried at fair value as an other liability on our Consolidated Balance Sheets.

Standby letters of credit

$ 33,109,000  

$ 212,000  

$ 20,543,000  

$ 138,000  

NOTE 14 –

BENEFIT PLANS

We have a 401 (k) benefit plan that covers substantially all of our employees.

The percent of our matching contributions to the 401 (k) benefit plan is determined annually by the Board of Directors.

The matching contribution had been 4.25 % since January 1, 2014;

effective April 1, 2018, the matching contribution was increased to 5.00 %.

Matching contributions, if made, are immediately vested.

Our 2021, 2020 and 2019 matching 401 (k) contributions charged to expense were $ 2.1 million, $ 1.9 million and $ 1.7 million, respectively.

We have a deferred compensation plan in which all persons serving on the Board of Directors may defer all or portions of their annual retainer and meeting fees, with distributions to be paid upon termination of service as a director or specific dates selected by the director.

We also have a non-qualified deferred compensation program in which selected officers may defer all or portions of salary and bonus payments.

The deferred amounts, totaling $ 1.2 million and $ 2.4 million as of December 31, 2021 and 2020, respectively, are categorized as other liabilities in the Consolidated Balance Sheets, and are paid interest at a rate equal to the Wall Street Journal Prime Rate.

Interest expense was less than $ 0.1 million during 2021, and $ 0.1 million during 2020 and 2019.

The Mercantile Bank Corporation Employee Stock Purchase Plan of 2014 is a non-compensatory plan intended to encourage full- and part-time employees of Mercantile and its subsidiaries to promote our best interests and to align employees’

interests with the interests of our shareholders by permitting employees to purchase shares of our common stock through regular payroll deductions.

Shares are purchased on the last business day of each calendar quarter at a price equal to the consolidated closing bid price of our common stock reported on The Nasdaq Stock Market.

A total of 250,000 shares of common stock may be issued under the existing plan;

however, the number of shares may be adjusted to reflect any stock dividends and other changes in our capitalization.

The number of shares issued totaled 1,481 and 2,264 in 2021 and 2020, respectively.

As of December 31, 2021, there were approximately 237,000 shares available under our current plan.

NOTE 15 –

DERIVATIVES AND HEDGING ACTIVITIES

We are exposed to certain risks arising from both business operations and economic conditions.

We principally manage the exposure to a wide variety of operational risks through core business activities.

Economic risks, including interest rate, liquidity and credit risk, are primarily administered via the amount, sources and duration of assets and liabilities.

Derivative financial instruments may also be used to assist in managing economic risks.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 15 –

DERIVATIVES AND HEDGING ACTIVITIES (Continued)

Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers.

We execute interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with correspondent banks to offset the impact of the interest rate swaps with the commercial banking customers.

The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions.

As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent banks are recognized directly to earnings.

The fair value of derivative instruments as of December 31, 2021, are reflected in the following table.

Notional Amount

Balance Sheet

Derivative Assets  

Interest rate swaps

$ 279,419,000  

$ 4,609,000  

Derivative Liabilities  

Interest rate swaps

279,419,000  

Other Liabilities

4,857,000  

The effect of interest rate swaps that are not designated as hedging instruments resulted in noninterest expense of $ 0.2 million during the year-ended December 31, 2021.

The fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $ 4.9 million as of December 31, 2021.

Cash collateral totaling $ 3.6 million was provided to the counterparty correspondent banks as of December 31, 2021.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 279 million as of December 31, 2021.

Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instrument that has been hedged.

The fair value of derivative instruments as of December 31, 2020, are reflected in the following table.

Notional Amount

Balance Sheet

Derivative Assets  

Interest rate swaps

$ 33,731,000  

$ 1,003,000  

Derivative Liabilities  

Interest rate swaps

33,731,000  

Other Liabilities

1,027,000  

The effect of interest rate swaps that are not designated as hedging instruments resulted in noninterest expense of less than $ 0.1 million during the year-ended December 31, 2020.

There were no such instruments outstanding during 2019.

Cash collateral totaling $ 1.1 million was provided to the counterparty correspondent bank as of December 31, 2020.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 33.7 million as of December 31, 2020.

Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instrument that has been hedged.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 16 –

FAIR VALUES OF FINANCIAL INSTRUMENTS

Carrying amount, estimated fair value and level within the fair value hierarchy of financial instruments were as follows at year-end (dollars in thousands):

Financial assets

$ 17,872  

$ 16,953  

Cash equivalents

957,288  

609,053  

Securities available for sale

592,743  

387,347  

Federal Home Loan Bank stock

18,002  

3,418,096  

3,498,345  

3,155,503  

3,294,522  

Loans held for sale

16,117  

16,707  

22,888  

24,029  

Mortgage servicing rights

12,248  

15,445  

10,006  

Accrued interest receivable

10,861  

Interest rate swaps

Financial liabilities

4,083,193  

4,028,249  

3,411,553  

3,397,768  

Securities sold under agreements to repurchase

197,463  

118,365  

Federal Home Loan Bank advances

374,000  

384,927  

394,000  

410,881  

Subordinated debentures

48,244  

48,284  

47,563  

47,574  

Subordinated notes

73,646  

Accrued interest payable

Interest rate swaps

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 9A. Controls and Procedures