MERCANTILE BANK CORP 10-K

Item 9A. Controls and Procedures.   As of December 31, 2021, an evaluation was performed under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of December 31, 2021.   There have been no significant changes in our internal control over financial reporting during the quarter ended December 31, 2021, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.   Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.   Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2021. This evaluation was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2021. Refer to page F-33 for management’s report.   Our independent registered public accounting firm has issued an audit report on our internal control over financial reporting which is included in this Annual Report.   Item 9B. Other Information.   None   PART III   Item 10. Directors, Executive Officers and Corporate Governance.   The information presented under the captions “Election of Directors,” “Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance – Code of Ethics” in the definitive Proxy Statement of Mercantile Bank Corporation for our May 26, 2022 Annual Meeting of Shareholders (the “Proxy Statement”), a copy of which will be filed with the Securities and Exchange Commission before April 30, 2022, is incorporated here by reference.   Item 11. Executive Compensation.   The information presented under the captions “Executive Compensation,” “Corporate Governance – Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the Proxy Statement is incorporated here by reference.   Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.   The information presented under the caption “Stock Ownership of Certain Beneficial Owners and Management” in the Proxy Statement is incorporated here by reference.   24 Table of Contents   Equity Compensation Plan Information   The following table summarizes information, as of December 31, 2021, relating to compensation plans under which equity securities are authorized for issuance.   Plan Category   Number of securities to be issued upon exercise of outstanding options, warrants and rights     Weighted- average exercise price of outstanding options, warrants and rights     Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))         (a)     (b)     (c)     Equity compensation plans approved by security holders     7,700     $ 34.89       187,000 (1)                               Equity compensation plans not approved by security holders     0       0       0                                 Total     7,700     $ 34.89       187,000       (1) These securities are available under the Stock Incentive Plan of 2020. Incentive awards may include, but are not limited to, stock options, restricted stock, stock appreciation rights and stock awards.   Item 13. Certain Relationships and Related Transactions, and Director Independence.   The information presented under the captions “Transactions with Related Persons” and “Corporate Governance – Director Independence” in the Proxy Statement is incorporated here by reference.   Item 14. Principal Accountant Fees and Services.   The information presented under the caption “Principal Accountant Fees and Services” in the Proxy Statement is incorporated here by reference.   25 Table of Contents   PART IV   Item 15. Exhibits and Financial Statement Schedules   (a) (1)     Financial Statements. The following financial statements and reports of the independent registered public accounting firm of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:   Reports of Independent Registered Public Accounting Firm   Consolidated Balance Sheets --- December 31, 2021 and 2020   Consolidated Statements of Income for each of the three years in the period ended December 31, 2021   Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2021   Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2021   Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2021   Notes to Consolidated Financial Statements   The Consolidated Financial Statements, the Notes to Consolidated Financial Statements, and the Reports of Independent Registered Public Accounting Firm listed above are incorporated by reference in Item 8 of this report.     (2) Financial Statement Schedules   Not applicable   (b)     Exhibits:   The Exhibit Index immediately preceding the Signatures Page hereto is incorporated by reference under this item.   (c)     Financial Statements Not Included In Annual Report   Not applicable   Item 16. Form 10-K Summary   None   26 Table of Contents   MERCANTILE BANK CORPORATION   FINANCIAL INFORMATION December 31, 2021 and 2020       F-1 Table of Contents    MERCANTILE BANK CORPORATION   FINANCIAL INFORMATION December 31, 2021 and 2020   CONTENTS     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS F-3     REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (PCAOB ID 243 ) F-30     REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING   F-33     CONSOLIDATED FINANCIAL STATEMENTS       CONSOLIDATED BALANCE SHEETS F-34     CONSOLIDATED STATEMENTS OF INCOME F-35     CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME F-36     CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F-37     CONSOLIDATED STATEMENTS OF CASH FLOWS F-40     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-42     F-2 Table of Contents   MANAGEMENT ’ S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   FORWARD-LOOKING STATEMENTS   The following discussion and other portions of this Annual Report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “is likely,” “plans,” “projects,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.   Future Factors include, among others, 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; market volatility; demand for products and services; the degree of competition by traditional and non-traditional financial service companies; changes in banking regulation or actions by bank regulators; changes in prices, levies, and assessments; the impact of technological advances; potential cyber-attacks, information security breaches and other criminal activities on our computer systems; litigation liabilities; governmental and regulatory policy changes; 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, 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   Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) is based on Mercantile Bank Corporation’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and actual results could differ from those estimates. We have reviewed the analyses with the Audit Committee of our Board of Directors.   Allowance For Loan Losses : The allowance for loan losses (“allowance”) is maintained at a level we believe is adequate to absorb probable incurred losses identified and inherent in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Loan losses are charged against the allowance when we believe the uncollectability of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. Loans made under the Paycheck Protection Program are fully guaranteed by the Small Business Administration; therefore, such loans do not have an associated allowance.   F-3 Table of Contents   We complete a migration analysis quarterly to assist us in determining appropriate reserve allocation factors for non-impaired loans. Our migration takes into account various time periods; however, at year-end 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. Although the migration analysis provides an accurate historical accounting of our net loan losses, it is not able to fully account for environmental factors that will also very likely impact the collectability of our loans as of any quarter-end date. Therefore, we incorporate the environmental factors as adjustments to the historical data. Environmental factors include both internal and external items. We believe the most significant internal environmental factor is our credit culture and the relative aggressiveness in assigning and revising commercial loan risk ratings, with the most significant external environmental factor being the assessment of the current economic environment and the resulting implications on our loan portfolio.   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. 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 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. Uncollectable loans are charged-off through the allowance. Recoveries of loans previously charged-off are added to the allowance. A loan is considered impaired when it is probable that contractual principal and interest payments will not be collected either for the amounts or by the dates as scheduled in the loan agreement. Impairment is evaluated on an individual loan basis. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing interest rate or at the fair value of collateral if repayment is expected solely from the collateral. The timing of obtaining outside appraisals varies, generally depending on the nature and complexity of the property being evaluated, general breadth of activity within the marketplace and the age of the most recent appraisal. For collateral dependent impaired loans, in most cases we obtain and use the “as is” value as indicated in the appraisal report, adjusting for any expected selling costs. In certain circumstances, we may internally update outside appraisals based on recent information impacting a particular or similar property, or due to identifiable trends (e.g., recent sales of similar properties) within our markets. The expected future cash flows exclude potential cash flows from certain guarantors. To the extent these guarantors are able to provide repayments, a recovery would be recorded upon receipt. Loans are evaluated for impairment when payments are delayed, typically 30 days or more, or when serious deficiencies are identified within the credit relationship. Our policy for recognizing income on impaired loans is to accrue interest unless a loan is placed on nonaccrual status. We put loans into nonaccrual status when the full collection of principal and interest is not expected.   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 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 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.   F-4 Table of Contents   Income Tax Accounting : Current income tax assets and liabilities are established for the amount of taxes payable or refundable for the current year. In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws for which the outcome may be uncertain. We periodically review and evaluate the status of our tax positions and make adjustments as necessary. Deferred income tax assets and liabilities are also established for the future tax consequences of events that have been recognized in our financial statements or tax returns. A deferred income tax asset or liability is recognized for the estimated future tax effects attributable to temporary differences that can be carried forward (used) in future years. The valuation of our net deferred income tax asset is considered critical as it requires us to make estimates based on provisions of the enacted tax laws. The assessment of the realizability of the net deferred income tax asset involves the use of estimates, assumptions, interpretations and judgments concerning accounting pronouncements, federal and state tax codes and the extent of future taxable income. There can be no assurance that future events, such as court decisions, positions of federal and state taxing authorities, and the extent of future taxable income will not differ from our current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.   Accounting guidance requires us to assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors that may impact future operating results. Significant weight is given to evidence that can be objectively verified.   Securities : Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs and other factors. Securities classified as available for sale are reported at their fair value. Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, we consider: (1) the length of time and extent that fair value has been less than carrying value; (2) the financial condition and near term prospects of the issuer; and (3) our ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Fair values for securities available for sale are generally obtained from outside sources and applied to individual securities within the portfolio. The difference between the amortized cost and the current fair value of securities is recorded as a valuation adjustment and reported in other comprehensive income.   Mortgage Servicing Rights : Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage loan prepayment speeds, the remaining life of the mortgage loan pool, delinquency rates, our cost to service loans and other factors to determine the cash flow that we will receive from servicing each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.   Goodwill : Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We may elect to perform a qualitative assessment for the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value.   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.   F-5 Table of Contents   INTRODUCTION   This Management’s Discussion and Analysis should be read in conjunction with the consolidated financial statements contained in this Annual Report. This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiary, Mercantile Bank (“our bank”), and Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank. Unless the text clearly suggests otherwise, references to “us,” “we,” “our,” or “the company” include Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.   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 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.   The following section summarizes the primary measures that directly impact us and our customers.     ● Paycheck Protection 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 provided 100% guaranteed loans to cover specific operating costs. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. 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 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.   F-6 Table of Contents     ● Troubled Debt Restructuring Relief From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. We elected to suspend GAAP principles and regulatory determinations as permitted. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022.     ● Current Expected Credit Loss Methodology Delay Financial institutions are 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 National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022.   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. For commercial borrowers, we offered 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments. 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 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 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 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. 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.   F-7 Table of Contents   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   Our total assets increased $820 million during 2021, and totaled $5.26 billion as of December 31, 2021. Total loans increased $260 million, interest-earning deposits were up $353 million and securities available for sale increased $205 million. 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 Average earning assets equaled 93.9% of average total assets during 2021, compared to 93.5% during 2020. The loan portfolio continued to comprise a majority of earning assets, followed by interest-earning deposits and securities. Average total loans equaled 73.7% of average earning assets during 2021, compared to 81.9% in 2020, while average interest-earning deposits and average securities comprised 14.9% and 11.4% of average earning assets during 2021 and 9.2% and 8.9% during 2020, respectively.   F-8 Table of Contents   Our loan portfolio has historically been primarily comprised of commercial loans. Commercial loans increased $156 million during 2021, and at December 31, 2021 totaled $2.95 billion, or 85.4% of our loan portfolio. As of December 31, 2020, the commercial loan portfolio comprised 87.5% of total loans. The increase in commercial loans reflects 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. 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 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. 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 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.   F-9 Table of Contents   The following table summarizes our loan portfolio:       12/31/21     12/31/20     12/31/19     12/31/18     12/31/17   Commercial:                                         Commercial & Industrial *   $ 1,137,419,000     $ 1,145,423,000     $ 846,551,000     $ 822,723,000     $ 753,764,000   Land Development & Construction     43,239,000       55,055,000       56,119,000       44,885,000       29,873,000   Owner Occupied Commercial Real Estate     565,758,000       529,953,000       579,003,000       548,619,000       526,328,000   Non-Owner Occupied Commercial Real Estate     1,027,415,000       917,436,000       835,346,000       816,282,000       791,685,000   Multi-Family & Residential Rental     176,593,000       146,095,000       124,525,000       127,597,000       101,918,000   Total Commercial     2,950,424,000       2,793,962,000       2,441,544,000       2,360,106,000       2,203,568,000                                             Retail:                                         1-4 Family Mortgages     442,547,000       337,888,000       334,771,000       307,540,000       254,559,000   Home Equity & Other Consumer Loans     60,488,000       61,620,000       75,374,000       85,439,000       100,425,000   Total Retail     503,035,000       399,508,000       410,145,000       392,979,000       354,984,000                                             Total Loans   $ 3,453,459,000     $ 3,193,470,000     $ 2,851,689,000     $ 2,753,085,000     $ 2,558,552,000     (*) 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 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.       Less Than     One Through     More Than               One Year     Five Years     Five Years     Total                                     Construction and land development   $ 60,436,000     $ 139,781,000     $ 106,976,000     $ 307,193,000   Real estate - residential properties     42,264,000       112,963,000       309,114,000       464,341,000   Real estate - multi-family properties     24,181,000       20,868,000       57,363,000       102,412,000   Real estate - commercial properties     409,129,000       796,853,000       224,031,000       1,430,013,000   Commercial and industrial     662,221,000       368,338,000       103,655,000       1,134,214,000   Consumer     1,735,000       12,958,000       593,000       15,286,000   Total loans   $ 1,199,966,000     $ 1,451,761,000     $ 801,732,000     $ 3,453,459,000                                     Fixed rate loans   $ 530,975,000     $ 1,356,949,000     $ 579,573,000     $ 2,467,497,000   Floating rate loans     668,991,000       94,812,000       222,159,000       985,962,000   Total loans   $ 1,199,966,000     $ 1,451,761,000     $ 801,732,000     $ 3,453,459,000     F-10 Table of Contents   Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to provide effective loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur quickly because of changing economic conditions. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on the internal loan watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on impaired loans, as well as on foreclosed and repossessed assets, are reviewed periodically; however, we have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions.   Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $2.5 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 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.   The following tables provide a breakdown of nonperforming assets by property type:   NONPERFORMING LOANS                                                 12/31/21     12/31/20     12/31/19     12/31/18     12/31/17   Residential Real Estate:                                         Land Development   $ 32,000     $ 35,000     $ 34,000     $ 0     $ 0   Construction     0       0       0       0       0   Owner Occupied / Rental     1,768,000       2,519,000       2,104,000       3,157,000       3,381,000         1,800,000       2,554,000       2,138,000       3,157,000       3,381,000                                             Commercial Real Estate:                                         Land Development     0       0       0       0       35,000   Construction     0       0       0       0       0   Owner Occupied     0       619,000       134,000       950,000       2,241,000   Non-Owner Occupied     0       22,000       0       0       0         0       641,000       134,000       950,000       2,276,000                                             Non-Real Estate:                                         Commercial Assets     662,000       172,000       0       17,000       1,444,000   Consumer Assets     6,000       17,000       12,000       17,000       42,000         668,000       189,000       12,000       34,000       1,486,000                                             Total   $ 2,468,000     $ 3,384,000     $ 2,284,000     $ 4,141,000     $ 7,143,000     F-11 Table of Contents   OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS                                                 12/31/21     12/31/20     12/31/19     12/31/18     12/31/17   Residential Real Estate:                                         Land Development   $ 0     $ 0     $ 0     $ 0     $ 0   Construction     0       0       0       0       0   Owner Occupied / Rental     0       88,000       260,000       398,000       193,000         0       88,000       260,000       398,000       193,000                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     0       613,000       192,000       413,000       2,031,000   Non-Owner Occupied     0       0       0       0       36,000         0       613,000       192,000       413,000       2,067,000                                             Non-Real Estate:                                         Commercial Assets     0       0       0       0       0   Consumer Assets     0       0       0       0       0         0       0       0       0       0                                             Total   $ 0     $ 701,000     $ 452,000     $ 811,000     $ 2,260,000     The following tables provide a reconciliation of nonperforming assets:   NONPERFORMING LOANS RECONCILIATION                                                 2021     2020     2019     2018     2017                                             Beginning balance   $ 3,384,000     $ 2,284,000     $ 4,141,000     $ 7,143,000     $ 5,939,000   Additions     1,187,000       3,361,000       698,000       2,909,000       7,604,000   Returns to performing status     (165,000 )     (105,000 )     (126,000 )     (175,000 )     (232,000 ) Principal payments     (1,711,000 )     (1,701,000 )     (2,140,000 )     (5,028,000 )     (4,234,000 ) Loan charge-offs     (227,000 )     (455,000 )     (289,000 )     (708,000 )     (1,934,000 )                                           Total   $ 2,468,000     $ 3,384,000     $ 2,284,000     $ 4,141,000     $ 7,143,000     OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION                                                 2021     2020     2019     2018     2017                                             Beginning balance   $ 701,000     $ 452,000     $ 811,000     $ 2,260,000     $ 469,000   Additions     30,000       758,000       462,000       1,114,000       4,401,000   Sale proceeds     (397,000 )     (485,000 )     (792,000 )     (2,380,000 )     (677,000 ) Valuation write-downs     (334,000 )     (24,000 )     (29,000 )     (183,000 )     (1,933,000 )                                           Total   $ 0     $ 701,000     $ 452,000     $ 811,000     $ 2,260,000     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% 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.   F-12 Table of Contents     The following table summarizes changes in the allowance for the past five years. For the years 2019, 2018, and 2017, presented loan and allowance data are reflective of only originated loans and the allowance for originated loans. We terminated the application of purchase accounting associated with our merger with Firstbank effective January 1, 2020.       2021     2020     2019     2018     2017                                             Loans outstanding at year-end   $ 3,453,459,000     $ 3,193,470,000     $ 2,609,747,000     $ 2,451,324,000     $ 2,167,404,000                                             Daily average balance of loans outstanding during the year   $ 3,324,612,000     $ 3,190,742,000     $ 2,575,819,000     $ 2,291,901,000     $ 2,052,534,000                                             Balance of allowance for loans at beginning of year (*)   $ 37,967,000     $ 23,889,000     $ 21,554,000     $ 19,133,000     $ 17,868,000                                             Loans charged-off:                                         Commercial, financial and agricultural     (909,000 )     (614,000 )     (455,000 )     (367,000 )     (2,272,000 ) Construction and land development     0       0       0       (61,000 )     (20,000 ) Residential real estate     (92,000 )     (129,000 )     (361,000 )     (551,000 )     (687,000 ) Instalment loans to individuals     (43,000 )     (96,000 )     (67,000 )     (210,000 )     (204,000 ) Total charge-offs     (1,044,000 )     (839,000 )     (883,000 )     (1,189,000 )     (3,183,000 )                                           Recoveries of previously charged-off loans:                                         Commercial, financial and agricultural     1,537,000       488,000       302,000       1,757,000       1,445,000   Construction and land development     92,000       0       24,000       832,000       129,000   Residential real estate     1,036,000       314,000       239,000       531,000       131,000   Instalment loans to individuals     75,000       65,000       63,000       90,000       102,000   Total recoveries     2,740,000       867,000       628,000       3,210,000       1,807,000                                             Net loan (charge-offs) recoveries     1,696,000       28,000       (255,000 )     2,021,000       (1,376,000 )                                           Provision for loan losses     (4,300,000 )     14,050,000       1,867,000       400,000       2,641,000                                             Balance of allowance for loans at end of year   $ 35,363,000     $ 37,967,000     $ 23,166,000     $ 21,554,000     $ 19,133,000                                             Ratio of net loan (charge-offs) recoveries to average loans outstanding during the year     0.05 %     0.01 %     (0.01 )%     (0.09 )%     (0.07 )%                                           Ratio of allowance to loans outstanding at year-end     1.02 %     1.18 %     0.89 %     0.88 %     0.88 %   (*) For the December 31, 2020 column, the balance of allowance for loans at beginning of year includes the December 31, 2019 balance of the allowance for acquired loans.   F-13 Table of Contents   The following table illustrates the breakdown of the allowance for loans balance by loan type (dollars in thousands) and of the total loan portfolio (in percentages). For the years 2019, 2018, and 2017, presented loan and allowance data are reflective of only originated loans and the allowance for originated loans. We terminated the application of purchase accounting associated with our merger with Firstbank effective January 1, 2020.       12/31/21     12/31/20     12/31/19     12/31/18     12/31/17       Amount     Loan Portfolio     Amount     Loan Portfolio     Amount     Loan Portfolio     Amount     Loan Portfolio     Amount     Loan Portfolio                                                                                     Commercial, financial and agricultural   $ 30,224       77.3 %   $ 33,235       79.6 %   $ 20,599       76.0 %   $ 19,228       86.7 %   $ 15,616       77.8 % Construction and land development     2,324       8.9       813       7.2       340       9.0       270       2.0       1,260       7.6   Residential real estate     2,524       13.4       3,595       12.7       1,863       14.2       1,778       10.0       1,758       13.3   Instalment loans to individuals     246       0.4       265       0.5       294       0.8       234       1.3       406       1.3   Unallocated     45       0.0       59       0.0       70       0.0       44       0.0       93       0.0   Total   $ 35,363       100.0 %   $ 37,967       100.0 %   $ 23,166       100.0 %   $ 21,554       100.0 %   $ 19,133       100.0 %   The following table depicts the ratio of our allowance to nonperforming loans:       12/31/21     12/31/20     12/31/19     12/31/18     12/31/17   Ratio of allowance to nonperforming loans     1,432.9 %     1,122.0 %     1,045.9 %     540.4 %     273.0 %   The increasing trend of the ratio of our allowance to nonperforming loans over the past several years generally reflects the combined impact of an increased allowance balance and reduction in nonperforming loans.   In each accounting period, we adjust the allowance to the amount we believe is necessary to maintain the allowance at an adequate level. Through the loan review and credit departments, we establish specific portions of the allowance based on specifically identifiable problem loans. The evaluation of the allowance is further based on, but not limited to, consideration of the internally prepared Allowance Analysis, loan loss migration analysis, composition of the loan portfolio, third party analysis of the loan administration processes and portfolio, and general economic conditions.   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. 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.   F-14 Table of Contents   The Allowance Analysis applies reserve allocation factors to non-impaired outstanding loan balances, the result of which is combined with specific reserves to calculate an overall allowance amount. For non-impaired commercial loans, reserve allocation factors are based on the loan ratings as determined by our standardized grade paradigms and by loan purpose. Our commercial loan portfolio is segregated into five classes: 1) commercial and industrial loans; 2) vacant land, land development and residential construction loans; 3) owner occupied real estate loans; 4) non-owner occupied real estate loans; and 5) multi-family and residential rental property loans. The reserve allocation factors are primarily based on the historical trends of net loan charge-offs through a migration analysis whereby net loan losses are tracked via assigned grades over various time periods, with adjustments made for environmental factors reflecting the current status of, or recent changes in, items such as: lending policies and procedures; economic conditions; nature and volume of the loan portfolio; experience, ability and depth of management and lending staff; volume and severity of past due, nonaccrual and adversely classified loans; effectiveness of the loan review program; value of underlying collateral; lending concentrations; and other external factors, including competition and regulatory environment.   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. 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 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.   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. 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.   Adjustments for specific lending relationships, particularly impaired loans, are made on a case-by-case basis. Non-impaired retail loan reserve allocations are determined in a similar fashion as those for non-impaired commercial loans, except that retail loans are segmented by type of credit and not a grading system. We regularly review the Allowance Analysis and make adjustments periodically based upon identifiable trends and experience.   A migration analysis is completed quarterly to assist us in determining appropriate reserve allocation factors for non-impaired loans. Our migration takes into account various time periods; however, at year-end 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. We continue to actively monitor our loan portfolio and assess reserve allocation factors in light of the Coronavirus Pandemic and its impact on the U.S. economic environment and our borrowers in particular.   Although the migration analysis provides an accurate historical accounting of our net loan losses, it is not able to fully account for environmental factors that will also very likely impact the collectability of our loans as of any quarter-end date. Therefore, we incorporate the environmental factors as adjustments to the historical data. Environmental factors include both internal and external items. We believe the most significant internal environmental factor is our credit culture and the relative aggressiveness in assigning and revising commercial loan risk ratings, with the most significant external environmental factor being the assessment of the current economic environment and the resulting implications on our loan portfolio.   F-15 Table of Contents   The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and the timeliness of scheduled payments. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers, and we have a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.   The allowance for loans equaled $35.4 million as of December 31, 2021, or 1.0% of total loans outstanding. The allowance for loans equaled 1.2% of total loans at year-end 2020. As of December 31, 2021, the allowance for loans was comprised of $34.9 million in general reserves relating to non-impaired loans and $0.5 million in specific allocations on other loans, primarily accruing loans designated as troubled debt restructurings.   Although we believe the allowance is adequate to absorb losses as they arise, there can be no assurance that we will not sustain losses in any given period that could be substantial in relation to, or greater than, the size of the allowance. Troubled debt restructurings totaled $17.5 million at December 31, 2021, consisting of $0.8 million that are on nonaccrual status and $16.7 million that are on accrual status. The latter, while considered and accounted for as impaired loans in accordance with accounting guidelines, is not included in our nonperforming loan totals. Impaired loans with an aggregate carrying value of $0.5 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:       12/31/21     12/31/20     12/31/19     12/31/18     12/31/17                                             Performing   $ 16,728,000     $ 23,133,000     $ 11,788,000     $ 19,223,000     $ 6,128,000   Nonperforming     746,000       510,000       353,000       229,000       2,434,000                                             Total   $ 17,474,000     $ 23,643,000     $ 12,141,000     $ 19,452,000     $ 8,562,000     Securities available for sale increased $205 million during 2021, totaling $593 million as of December 31, 2021. The securities portfolio equaled 11.4% of average earning assets during 2021, compared to 8.9% during 2020. 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, 2021, the securities portfolio was comprised of U.S. Government agency bonds (66%), municipal bonds (27%) and U.S. 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, 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. In addition, the securities portfolio serves a primary interest rate risk management function.   F-16 Table of Contents   The following table reflects the composition of the securities portfolio:       12/31/21     12/31/20     12/31/19       Carrying             Carrying             Carrying               Value     Percent     Value     Percent     Value     Percent                                                     U.S. Government agency debt obligations   $ 390,371,000       65.9 %   $ 242,141,000       62.5 %   $ 186,410,000       55.7 %                                                   Mortgage-backed securities     41,803,000       7.0       24,890,000       6.4       42,470,000       12.7                                                     Municipal general obligations     137,594,000       23.2       107,824,000       27.9       101,079,000       30.2                                                     Municipal revenue bonds     22,475,000       3.8       11,992,000       3.1       4,196,000       1.3                                                     Other investments     500,000       0.1       500,000       0.1       500,000       0.1                                                     Totals   $ 592,743,000       100.0 %   $ 387,347,000       100.0 %   $ 334,655,000       100.0 %   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 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. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies and municipal bonds are determined on a monthly basis with the assistance of a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes and issuer spreads. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines. Reference is made to Note 17 of the Notes to Consolidated Financial Statements for additional information.   The following table shows by class of maturities as of December 31, 2021, the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities:       Carrying     Average       Value     Yield   Obligations of U.S. Government agencies:                 One year or less   $ 89,000       2.06 % Over one through five years     137,646,000       0.61   Over five through ten years     208,258,000       1.30   Over ten years     44,378,000       1.80         390,371,000       1.11   Obligations of states and political subdivisions:                 One year or less     11,370,000       1.92   Over one through five years     47,142,000       2.03   Over five through ten years     77,351,000       2.36   Over ten years     24,206,000       2.35         160,069,000       2.23                     Mortgage-backed securities     41,803,000       1.85   Other investments     500,000       3.75                     Totals   $ 592,743,000       1.47 %   F-17 Table of Contents   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 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.   Source of Funds Total deposits increased $672 million during 2021, totaling $4.08 billion as of December 31, 2021. 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 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 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. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.   F-18 Table of Contents   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. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. 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’ equity increased $15.0 million during 2021, totaling $457 million as of December 31, 2021. Positively impacting shareholders’ equity was net income of $59.0 million, while negatively affecting shareholders’ 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. 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 FOR THE YEARS ENDED DECEMBER 31, 2021 and 2020   Summary 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. 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.   F-19 Table of Contents   The following table shows some of the key performance and equity ratios for the years ended December 31, 2021 and 2020:       2021     2020   Return on average assets     1.23 %     1.07 % Return on average shareholders’ equity     13.11 %     10.32 % Average shareholders’ equity to average assets     9.38 %     10.34 %   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 $144 million and $19.4 million during 2021, respectively, providing for net interest income of $124 million. 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 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 $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. 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 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’ equity during 2021, 2020 and 2019. The subsequent table also depicts the dollar amount of change in interest income and interest expense of interest-earning assets and interest-bearing liabilities, respectively, segregated between change due to volume and change due to rate. 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 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.   F-20 Table of Contents   (Dollars in thousands)   Years ended December 31,       2 0 2 1     2 0 2 0     2 0 1 9       Average Balance     Interest     Average Rate     Average Balance     Interest     Average Rate     Average Balance     Interest     Average Rate   Taxable securities   $ 390,720     $ 5,127       1.31 %   $ 236,097     $ 7,740       3.28 %   $ 259,221     $ 7,919       3.05 % Tax-exempt securities     122,748       2,626       2.14       106,935       2,538       2.37       100,291       2,471       2.46   Total securities     513,468       7,753       1.51       343,032       10,278       3.00       359,512       10,390       2.89                                                                             Loans     3,324,611       135,048       4.06       3,167,065       137,399       4.34       2,844,606       145,816       5.13   Interest-earning deposits     671,351       933       0.14       356,501       876       0.25       114,527       2,371       2.07   Total earning assets     4,509,430       143,734       3.19       3,866,598       148,553       3.84       3,318,645       158,577       4.78                                                                             Allowance for loan losses     (38,003 )                     (30,164 )                     (23,914 )                 Cash and due from banks     69,084                       58,345                       53,151                   Other non-earning assets     260,623                       238,789                       213,763                                                                                             Total assets   $ 4,801,134                     $ 4,133,568                     $ 3,561,645                                                                                             Interest-bearing checking accounts   $ 498,119     $ 1,469       0.29 %   $ 392,053     $ 1,263       0.32 %   $ 315,735     $ 529       0.17 % Savings deposits     378,312       146       0.04       297,825       185       0.06       276,852       319       0.12   Money market accounts     756,715       1,617       0.21       542,967       1,968       0.36       485,044       5,664       1.17   Time deposits     472,925       5,882       1.24       590,421       11,568       1.96       644,904       14,752       2.29   Total interest-bearing deposits     2,106,071       9,114       0.43       1,823,266       14,984       0.82       1,722,535       21,264       1.23                                                                             Short-term borrowings     158,855       170       0.11       137,658       173       0.13       106,630       295       0.28   Federal Home Loan Bank advances     392,575       8,177       2.08       386,896       8,571       2.22       369,688       8,977       2.43   Other borrowings     52,984       1,971       3.72       49,792       2,339       4.70       49,427       3,267       6.61   Total interest-bearing liabilities     2,710,485       19,432       0.72       2,397,612       26,067       1.09       2,248,280       33,803       1.50                                                                             Checking accounts     1,620,480                       1,291,542                       902,180                   Other liabilities     19,998                       16,909                       16,272                   Total liabilities     4,350,963                       3,706,063                       3,166,732                   Average equity     450,171                       427,505                       394,913                   Total liabilities and equity   $ 4,801,134                     $ 4,133,568                     $ 3,561,645                                                                                             Net interest income           $ 124,302                     $ 122,486                     $ 124,774           Rate spread                     2.47 %                     2.75 %                     3.28 % Net interest margin                     2.76 %                     3.17 %                     3.76 %   F-21 Table of Contents       Years ended December 31,       2021 over 2020     2020 over 2019       Total     Volume     Rate     Total     Volume     Rate   Increase (decrease) in interest income                                                 Taxable securities   $ (2,613,000 )   $ 3,482,000     $ (6,095,000 )   $ (179,000 )   $ (735,000 )   $ 556,000   Tax exempt securities     88,000       353,000       (265,000 )     67,000       160,000       (93,000 ) Loans     (2,351,000 )     6,644,000       (8,995,000 )     (8,417,000 )     15,451,000       (23,868,000 ) Interest-earning deposit balances     57,000       548,000       (491,000 )     (1,495,000 )     1,894,000       (3,389,000 )                                                   Net change in tax-equivalent interest income     (4,819,000 )     11,027,000       (16,846,000 )     (10,024,000 )     16,770,000       (26,794,000 )                                                   Increase (decrease) in interest expense                                                 Interest-bearing demand deposits     206,000       320,000       (114,000 )     734,000       152,000       582,000   Savings deposits     (39,000 )     42,000       (81,000 )     (134,000 )     23,000       (157,000 ) Money market accounts     (351,000 )     619,000       (970,000 )     (3,696,000 )     607,000       (4,303,000 ) Time deposits     (5,686,000 )     (2,006,000 )     (3,680,000 )     (3,184,000 )     (1,180,000 )     (2,004,000 ) Short-term borrowings     (3,000 )     25,000       (28,000 )     (122,000 )     70,000       (192,000 ) Federal Home Loan Bank advances     (394,000 )     124,000       (518,000 )     (406,000 )     405,000       (811,000 ) Other borrowings     (368,000 )     143,000       (511,000 )     (928,000 )     24,000       (952,000 ) Net change in interest expense     (6,635,000 )     (733,000 )     (5,902,000 )     (7,736,000 )     101,000       (7,837,000 )                                                   Net change in tax-equivalent net interest income   $ 1,816,000     $ 11,760,000     $ (9,944,000 )   $ (2,288,000 )   $ 16,669,000     $ 18,957,000     Interest income is primarily generated from the loan portfolio, and to a significantly lesser degree, from securities and other interest-earning assets. Interest income decreased $4.8 million during 2021 from that earned in 2020, totaling $144 million in 2021 compared to $149 million in the previous year. 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. 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 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.   Interest income generated from the loan portfolio decreased $2.4 million in 2021 compared to the level earned in 2020; 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 4.09% 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.   F-22 Table of Contents   Interest income generated from the securities portfolio decreased $2.5 million in 2021 compared to the level earned in 2020; 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 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 $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 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%.   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.   A lower average rate paid on interest-bearing non-time deposits during 2021 resulted in a $1.2 million decrease in interest expense, while a $400 million increase in the average balance of these deposits equated to a $1.0 million increase in interest expense. 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. 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 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.   F-23 Table of Contents   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.   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. 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.   Noninterest Income Noninterest income during 2021 was $56.2 million, compared to $45.2 million during 2020. 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 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 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 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.   F-24 Table of Contents   Federal Income Tax Expense During 2021, we recorded income before federal income tax of $73.7 million and a federal income tax expense of $14.7 million, compared to income before federal income tax of $54.8 million and a federal income tax expense of $10.7 million during 2020. The increase in federal income tax expense in 2021 compared to 2020 resulted from the higher level of income before federal income tax. Our effective tax rate was 19.9% during 2021, compared to 19.5% during 2020.   CAPITAL RESOURCES   Shareholders’ equity increased $15.0 million during 2021, totaling $457 million as of December 31, 2021. Positively impacting shareholders’ equity was net income of $59.0 million, while negatively affecting shareholders’ 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. 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. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. As of December 31, 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 $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.”   We maintain a stock repurchase program, which is discussed in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in this Annual Report.   LIQUIDITY   Liquidity is measured by our ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-earning deposit balances. Asset and liability management is the process of managing the balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.   To assist in providing needed funds, we 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 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. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.   F-25 Table of Contents   Information regarding our repurchase agreements as of December 31, 2021 and during 2021 is as follows:   Outstanding balance at December 31, 2021   $ 197,463,000   Weighted average interest rate at December 31, 2021     0.11 % Maximum daily balance twelve months ended December 31, 2021   $ 209,093,000   Average daily balance for twelve months ended December 31, 2021   $ 158,855,000   Weighted average interest rate for twelve months ended December 31, 2021     0.11 %   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. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. Our borrowing line of credit at year-end 2021 totaled $889 million, with remaining availability based on collateral of $509 million.   We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. These lines of credit were not accessed during 2021. 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 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:       One Year     One to     Three to     Over               or Less     Three Years     Five Years     Five Years     Total                                             Deposits without a stated maturity   $ 3,651,296,000     $ 0     $ 0     $ 0     $ 3,651,296,000   Certificates of deposit     260,501,000       112,619,000       58,777,000       0       431,897,000   Short-term borrowings     197,463,000       0       0       0       197,463,000   Federal Home Loan Bank advances     94,000,000       160,000,000       80,000,000       40,000,000       374,000,000   Subordinated debentures     0       0       0       48,244,000       48,244,000   Subordinated notes     0       0       0       73,646,000       73,646,000   Other borrowed money     0       0       0       1,234,000       1,234,000   Property leases     785,000       1,365,000       273,000       1,158,000       3,581,000     In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. At December 31, 2021, we had a total of $1.53 billion in unfunded loan commitments and $33.1 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.32 billion were commitments available as lines of credit to be drawn at any time as customers’ 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 liquidity management.   F-26 Table of Contents   The following table depicts our loan commitments at the end of the past three years:       12/31/21     12/31/20     12/31/19                             Commercial unused lines of credit   $ 1,098,951,000     $ 1,019,496,000     $ 776,493,000   Unused lines of credit secured by 1-4 family residential properties     64,313,000       59,396,000       60,858,000   Credit card unused lines of credit     92,146,000       72,495,000       58,199,000   Other consumer unused lines of credit     64,876,000       30,707,000       18,135,000   Commitments to make loans     212,476,000       227,558,000       101,961,000   Standby letters of credit     33,109,000       20,543,000       22,798,000                             Total   $ 1,565,871,000     $ 1,430,195,000     $ 1,038,444,000     We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, economic or market conditions, reductions in earnings performance, declining capital levels or situations beyond our control could cause liquidity challenges. While we believe it is unlikely that a funding crisis of any significant degree is likely to materialize, we have developed a comprehensive contingency funding plan that provides a framework for meeting liquidity disruptions.   MARKET RISK ANALYSIS   Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates is assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates. We derive our income primarily from the excess of interest collected on interest-earning assets over the interest paid on interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness.   Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk, we assess the existing and potential future effects of changes in interest rates on our financial condition, including capital adequacy, earnings, liquidity and asset quality.   We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest-sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to the net interest margin during periods of changing market interest rates.   F-27 Table of Contents   The following table depicts our GAP position as of December 31, 2021:       Within     Three to     One to     After               Three     Twelve     Five     Five               Months     Months     Years     Years     Total   Assets:                                         Commercial loans (1)   $ 780,257,000     $ 375,710,000     $ 1,325,840,000     $ 492,025,000     $ 2,973,832,000   Residential real estate loans     20,790,000       21,474,000       112,963,000       309,114,000       464,341,000   Consumer loans     1,066,000       669,000       12,958,000       593,000       15,286,000   Securities (2)     21,432,000       9,362,000       197,824,000       382,127,000       610,745,000   Interest-earning deposits     914,005,000       750,000       1,000,000       0       915,755,000   Allowance for loan losses     0       0       0       0       (35,363,000 ) Other assets     0       0       0       0       313,153,000   Total assets     1,737,550,000       407,965,000       1,650,585,000       1,183,859,000     $ 5,257,749,000                                             Liabilities:                                         Interest-bearing checking     538,838,000       0       0       0       538,838,000   Savings deposits     394,330,000       0       0       0       394,330,000   Money market accounts     1,040,176,000       0       0       0       1,040,176,000   Time deposits under $100,000     23,735,000       58,190,000       50,851,000       0       132,776,000   Time deposits $100,000 & over     68,887,000       109,689,000       120,545,000       0       299,121,000   Short-term borrowings     197,463,000       0       0       0       197,463,000   Federal Home Loan Bank advances     20,000,000       74,000,000       240,000,000       40,000,000       374,000,000   Other borrowed money     49,479,000       0       0       73,646,000       123,125,000   Noninterest-bearing checking     0       0       0       0       1,677,952,000   Other liabilities     0       0       0       0       23,409,000   Total liabilities     2,332,908,000       241,879,000       411,396,000       113,646,000       4,801,190,000   Shareholders' equity     0       0       0       0       456,559,000   Total liabilities & shareholders' equity     2,332,908,000       241,879,000       411,396,000       113,646,000     $ 5,257,749,000   Net asset (liability) GAP   $ (595,358,000 )   $ 166,086,000     $ 1,239,189,000     $ 1,070,213,000           Cumulative GAP   $ (595,358,000 )   $ (429,272,000 )   $ 809,917,000     $ 1,880,130,000                                                     Percent of cumulative GAP to total assets     (11.3 %)     (8.2 %)     15.4 %     35.8 %           (1)  Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency. (2)  Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2021.   The second interest rate risk measurement used is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, it serves as our primary interest rate risk measurement technique. The simulation model assesses the direction and magnitude of variations in net interest income resulting from potential changes in market interest rates.   Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest-sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment; therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions and our strategies, among other factors.   F-28 Table of Contents   We conducted multiple simulations as of December 31, 2021, in which it was assumed that changes in market interest rates occurred ranging from up 400 basis points to down 100 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $126 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of December 31, 2021. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.       Dollar Change     Percent Change       In Net     In Net   Interest Rate Scenario   Interest Income     Interest Income                     Interest rates down 100 basis points   $ 2,700,000       2.1 % Interest rates up 100 basis points     8,300,000       6.6   Interest rates up 200 basis points     16,600,000       13.2   Interest rates up 300 basis points     24,900,000       19.8   Interest rates up 400 basis points     33,200,000       26.3     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: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; level of nonperforming assets; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors.   F-29 Table of Contents   REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   Shareholders and Board of Directors Mercantile Bank Corporation Grand Rapids, Michigan   Opinion on the Consolidated Financial Statements   We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.   We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 4, 2022 expressed an unqualified opinion thereon.   Basis for Opinion   These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.   We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.   Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.   Critical Audit Matter   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) 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. The calculation of this qualitative general reserve adjustment involves estimates and assumptions by management based on the qualitative environmental factors.   F-30 Table of Contents   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 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 BDO USA, LLP   We have served as the Company’s auditor since 2006.   Grand Rapids, Michigan March 4, 2022   F-31 Table of Contents   REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   Shareholders and Board of Directors Mercantile Bank Corporation Grand Rapids, Michigan   Opinion on Internal Control over Financial Reporting   We have audited Mercantile Bank Corporation’s (the “Company’s”) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria.   We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated March 4, 2022 expressed an unqualified opinion thereon.   Basis for Opinion   The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report by Mercantile Bank Corporation’s Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.   We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.   Definition and Limitations of Internal Control over Financial Reporting   A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.   Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.   /s/ BDO USA, LLP BDO USA, LLP Grand Rapids, Michigan March 4, 2022   F-32 Table of Contents   REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING   Management is responsible for establishing and maintaining an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.   Management assessed the Company’s system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles as of December 31, 2021. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2021, Mercantile Bank Corporation maintained an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles based on those criteria.   The Company’s independent auditors have issued an audit report on the effectiveness of the Company’s internal control over financial reporting as found on page F-32.   Mercantile Bank Corporation   /s/ Robert B. Kaminski, Jr. Robert B. Kaminski, Jr. President and Chief Executive Officer   /s/ Charles E. Christmas Charles E. Christmas Executive Vice President, Chief Financial Officer and Treasurer   F-33 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 2021 and 2020         2021     2020   ASSETS                 Cash and due from banks   $ 59,405,000     $ 62,832,000   Interest-earning deposits     915,755,000       563,174,000   Total cash and cash equivalents     975,160,000       626,006,000                     Securities available for sale     592,743,000       387,347,000   Federal Home Loan Bank stock     18,002,000       18,002,000   Mortgage loans held for sale     16,117,000       22,888,000                     Loans     3,453,459,000       3,193,470,000   Allowance for loan losses     ( 35,363,000 )     ( 37,967,000 ) Loans, net     3,418,096,000       3,155,503,000                     Premises and equipment, net     57,298,000       58,959,000   Bank owned life insurance     75,242,000       72,131,000   Goodwill     49,473,000       49,473,000   Core deposit intangible, net     1,351,000       2,436,000   Other assets     54,267,000       44,599,000                     Total assets   $ 5,257,749,000     $ 4,437,344,000                     LIABILITIES AND SHAREHOLDERS' EQUITY                 Deposits                 Noninterest-bearing   $ 1,677,952,000     $ 1,433,403,000   Interest-bearing     2,405,241,000       1,978,150,000   Total deposits     4,083,193,000       3,411,553,000                     Securities sold under agreements to repurchase     197,463,000       118,365,000   Federal Home Loan Bank advances     374,000,000       394,000,000   Subordinated debentures     48,244,000       47,563,000   Subordinated notes     73,646,000       0   Accrued interest and other liabilities     24,644,000       24,309,000   Total liabilities     4,801,190,000       3,995,790,000                     Commitments and contingent liabilities (Note 13)                                       Shareholders' equity                 Preferred stock, no par value; 1,000,000 shares authorized; 0 shares outstanding at December 31, 2021 and December 31, 2020     0       0   Common stock, no par value; 40,000,000 shares authorized; 15,839,944 shares outstanding at December 31, 2021 and 16,330,476 shares outstanding at December 31, 2020     285,752,000       302,029,000   Retained earnings     174,536,000       134,039,000   Accumulated other comprehensive gain/(loss)     ( 3,729,000 )     5,486,000   Total shareholders’ equity     456,559,000       441,554,000                     Total liabilities and shareholders’ equity   $ 5,257,749,000     $ 4,437,344,000     See accompanying notes to consolidated financial statements.   F-34 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2021, 2020 and 2019         2021     2020     2019   Interest income                         Loans, including fees   $ 135,048,000     $ 137,399,000     $ 145,816,000   Securities, taxable     5,127,000       7,740,000       7,919,000   Securities, tax-exempt     2,386,000       2,298,000       2,231,000   Other interest-earning assets     933,000       876,000       2,371,000   Total interest income     143,494,000       148,313,000       158,337,000                             Interest expense                         Deposits     9,114,000       14,984,000       21,264,000   Short-term borrowings     170,000       173,000       295,000   Federal Home Loan Bank advances     8,177,000       8,571,000       8,977,000   Subordinated debentures and other borrowings     1,971,000       2,339,000       3,267,000   Total interest expense     19,432,000       26,067,000       33,803,000                             Net interest income     124,062,000       122,246,000       124,534,000                             Provision (benefit) for loan losses     ( 4,300,000 )     14,050,000       1,750,000                             Net interest income after provision for loan losses     128,362,000       108,196,000       122,784,000                             Noninterest income                         Service charges on deposit and sweep accounts     5,078,000       4,578,000       4,584,000   Mortgage banking activities     29,959,000       29,346,000       8,485,000   Credit and debit card fees     7,516,000       5,973,000       5,925,000   Interest rate swap program fees     6,862,000       932,000       0   Payroll processing     1,815,000       1,745,000       1,626,000   Earnings on bank owned life insurance     1,164,000       1,214,000       3,886,000   Gain on sale of branch     1,058,000       0       0   Other income     2,768,000       1,384,000       2,450,000   Total noninterest income     56,220,000       45,172,000       26,956,000                             Noninterest expense                         Salaries and benefits     66,447,000       59,799,000       53,833,000   Occupancy     8,088,000       7,950,000       7,061,000   Furniture and equipment rent, depreciation and maintenance     3,654,000       3,350,000       2,583,000   Data processing     11,104,000       10,440,000       9,235,000   Advertising     1,175,000       1,292,000       1,446,000   FDIC insurance costs     1,820,000       1,138,000       225,000   Charitable foundation contributions     4,020,000       0       0   Other expense     14,558,000       14,551,000       14,897,000   Total noninterest expenses     110,866,000       98,520,000       89,280,000                             Income before federal income tax expense     73,716,000       54,848,000       60,460,000                             Federal income tax expense     14,695,000       10,710,000       11,004,000                             Net income   $ 59,021,000     $ 44,138,000     $ 49,456,000                             Earnings per common share:                         Basic   $ 3.69     $ 2.71     $ 3.01   Diluted   $ 3.69     $ 2.71     $ 3.01     See accompanying notes to consolidated financial statements.   F-35 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years ended December 31, 2021, 2020 and 2019         2021     2020     2019                             Net income   $ 59,021,000     $ 44,138,000     $ 49,456,000                             Other comprehensive income (loss):                         Unrealized holding gains (losses) on securities available for sale     ( 11,664,000 )     2,268,000       15,106,000   Total other comprehensive income (loss)     ( 11,664,000 )     2,268,000       15,106,000   Tax effect of unrealized holding gains (losses) on securities available for sale     2,449,000       ( 477,000 )     ( 3,172,000 ) Total tax effect of other comprehensive income (loss)     2,449,000       ( 477,000 )     ( 3,172,000 ) Other comprehensive income (loss), net of tax effect     ( 9,215,000 )     1,791,000       11,934,000                             Comprehensive income   $ 49,806,000     $ 45,929,000     $ 61,390,000     See accompanying notes to consolidated financial statements.   F-36 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY Years ended December 31, 2021, 2020 and 2019                                 Accumulated Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income/(Loss)     Equity                                             Balances, January 1, 2019   $ 0     $ 308,005     $ 75,483     $ ( 8,239 )   $ 375,249                                             Employee stock purchase plan ( 1,507 shares)             50                       50                                             Dividend reinvestment plan ( 21,503 shares)             729                       729                                             Stock option exercises ( 8,200 shares)             128                       128                                             Stock grants to directors for retainer fees ( 11,905 shares)             375                       375                                             Stock-based compensation expense             2,931                       2,931                                             Share repurchase program ( 233,300 shares)             ( 7,183 )                     ( 7,183 )                                           Cash dividends ($ 1.06 per common share)                     ( 17,108 )             ( 17,108 )                                           Net income for 2019                 49,456             49,456                                             Change in net unrealized gain/(loss) on securities available for sale, net of tax effect                             11,934       11,934                                             Balances, December 31, 2019   $ 0     $ 305,035     $ 107,831     $ 3,695     $ 416,561     See accompanying notes to consolidated financial statements.   F-37 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) Years ended December 31, 2021, 2020 and 2019                                 Accumulated Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income/(Loss)     Equity                                             Balances, January 1, 2020   $ 0     $ 305,035     $ 107,831     $ 3,695     $ 416,561                                             Employee stock purchase plan ( 2,264 shares)             49                       49                                             Dividend reinvestment plan ( 35,479 shares)             814                       814                                             Stock option exercises, net ( 753 shares)             3                       3                                             Stock grants to directors for retainer fees ( 17,716 shares)             394                       394                                             Stock-based compensation expense             2,325                       2,325                                             Share repurchase program ( 236,393 shares)             ( 6,591 )                     ( 6,591 )                                           Cash dividends ($ 1.12 per common share)                     ( 17,930 )             ( 17,930 )                                           Net income for 2020                     44,138               44,138                                             Change in net unrealized gain/(loss) on securities available for sale, net of tax effect                             1,791       1,791                                             Balances, December 31, 2020   $ 0     $ 302,029     $ 134,039     $ 5,486     $ 441,554     See accompanying notes to consolidated financial statements.   F-38 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) Years ended December 31, 2021, 2020 and 2019                                 Accumulated Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income/(Loss)     Equity                                             Balances, January 1, 2021   $ 0     $ 302,029     $ 134,039     $ 5,486     $ 441,554                                             Employee stock purchase plan ( 1,481 shares)           48                   48                                             Dividend reinvestment plan ( 27,562 shares)           877                   877                                             Stock option exercises, net ( 2,000 shares)           50                   50                                             Stock grants to directors for retainer fees ( 10,489 shares)           344                   344                                             Stock-based compensation expense           3,784                   3,784                                             Share repurchase program ( 683,191 shares)           ( 21,380 )                 ( 21,380 )                                           Cash dividends ($ 1.18 per common share)                 ( 18,524 )           ( 18,524 )                                           Net income for 2021                 59,021             59,021                                             Change in net unrealized gain/(loss) on securities available for sale, net of tax effect                             ( 9,215 )     ( 9,215 )                                           Balances, December 31, 2021   $ 0     $ 285,752     $ 174,536     $ ( 3,729 )   $ 456,559     See accompanying notes to consolidated financial statements.   F-39 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2021, 2020 and 2019         2021     2020     2019   Cash flows from operating activities                         Net income   $ 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     ( 135,000 )     ( 449,000 )     ( 686,000 ) 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     ( 649,245,000 )     ( 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     ( 78,000 )     ( 325,000 )     ( 254,000 ) Net gain from sale and write-downs on former bank premises     ( 140,000 )     ( 27,000 )     ( 436,000 ) 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 )     0       0   Net change in:                         Accrued interest receivable     1,528,000       ( 917,000 )     ( 48,000 ) Other assets     ( 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                         Purchases of securities available for sale     ( 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     0       0       ( 1,980,000 ) Loan originations and payments, net     ( 267,899,000 )     ( 341,461,000 )     ( 99,620,000 ) Purchases of bank owned life insurance     ( 2,000,000 )     ( 700,000 )     ( 4,500,000 ) Proceeds from bank owned life insurance cash value release and death benefits     0       0       7,708,000   Net cash transferred in branch sale     ( 2,679,000 )     0       0   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     ( 495,507,000 )     ( 398,806,000 )     ( 92,838,000 )                           Cash flows from financing activities                         Net (decrease) increase in time 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       ( 844,000 ) Proceeds from Federal Home Loan Bank advances     0       60,000,000       44,000,000   Maturities of Federal Home Loan Bank advances     ( 20,000,000 )     ( 20,000,000 )     ( 40,000,000 ) Net proceeds from subordinated notes issuance     73,635,000       0       0   Proceeds from stock option exercises, net of cashless exercises     50,000       3,000       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.   F-40 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years ended December 31, 2021, 2020 and 2019         2021     2020     2019                             Net change in cash and cash equivalents     349,154,000       392,275,000       158,377,000   Cash and cash equivalents at beginning of period     626,006,000       233,731,000       75,354,000   Cash and cash equivalents at end of period   $ 975,160,000     $ 626,006,000     $ 233,731,000                             Supplemental disclosures of cash flows information                         Cash paid during the year for:                         Interest   $ 20,352,000     $ 27,703,000     $ 32,103,000   Federal income taxes     17,550,000       10,950,000       11,975,000   Noncash financing and investing activities:                         Transfers from loans to foreclosed assets     30,000       146,000       337,000   Transfers from bank premises to other real estate owned     0       613,000       258,000     See accompanying notes to consolidated financial statements.   F-41 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021     NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   Principles of Consolidation : The consolidated financial statements include the accounts of Mercantile Bank Corporation (“Mercantile”) and its subsidiary, Mercantile Bank (“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: Mercantile Bank Capital Trust I, Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III and Firstbank Capital Trust IV (“our trusts”). Our trusts were formed to issue trust preferred securities. We issued subordinated debentures to our trusts in return for the proceeds raised from the issuance of the trust preferred securities. Our trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as liabilities.   Nature of Operations : Mercantile was incorporated on July  15, 1997 to establish and own the bank based in Grand Rapids, Michigan. Our bank began operations on December  15, 1997. We completed the merger of Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $ 1.5 billion in total assets and 46 branch locations, into Mercantile as of June 1, 2014.   Our bank is a community-based financial institution. Our bank’s primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial loans, residential mortgage loans, and instalment loans. Substantially all loans are secured by specific items of collateral including business assets, real estate or consumer assets. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by commercial or residential real estate. We have no material foreign loans or significant overdraft balances. Our bank’s loan accounts and retail deposits are primarily with customers located in the communities in which we have bank office locations. As an alternative source of funds, our bank has also issued certificates of deposit to depositors outside of its primary market areas. Substantially all revenues are derived from banking products and services and investment securities. While we monitor the revenue streams of the various products and services offered, we manage our business on the basis of one operating segment, banking.   Our insurance company acquired an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent. To date, we have not provided the insurance products noted above and currently have no plans to do so.   We have evaluated subsequent events for potential recognition and/or disclosure through the date these financial statements were issued.   Use of Estimates : To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses and the fair values of financial instruments are particularly subject to change.   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.   (Continued)   F- 42 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)   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 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.   The following section summarizes the primary measures that directly impact us and our customers.     ● Paycheck Protection Program The 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 provided 100% guaranteed loans to cover specific operating costs. PPP loans are eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. 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 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 From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid- 19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. We elected to suspend GAAP principles and regulatory determinations as permitted. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022.     ● Current Expected Credit Loss Methodology Delay Financial institutions are 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 National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022.   (Continued)   F- 43 Table of Contents   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. For commercial borrowers, we offered 90 -day ( three payments) interest only amendments as well as 90 -day ( three payments) principal and interest payment deferments. 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 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 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 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 : Cash and cash equivalents include cash on hand, demand deposits with other financial institutions, short-term investments (including securities with daily put provisions) and federal funds sold. Cash flows are reported net for customer loan and deposit transactions, interest-earning time deposits with other financial institutions and short-term borrowings with maturities of 90 days or less.   Securities : Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold prior to maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. 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. Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.   Declines in the fair value of debt securities below their amortized cost that are other-than-temporary impairment (“OTTI”) are reflected in earnings or other comprehensive income, as appropriate. For those debt securities whose fair value is less than their amortized cost, we consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and whether we expect to recover the entire amortized cost of the security based on our assessment of the issuer’s financial condition. In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies, and whether downgrades by bond rating agencies have occurred. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1 ) OTTI related to credit loss, which must be recognized in the income statement, and 2 ) OTTI related to other factors, such as liquidity conditions in the market or changes in market interest rates, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.   (Continued)   F- 44 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)   Loans : Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. Net unamortized deferred loan fees amounted to $ 2.5 million and $ 4.4 million, respectively, at December 31, 2021 and 2020.   Interest income on commercial loans and mortgage loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than when they are 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal and interest is considered doubtful.   All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.   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 : Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related mortgage loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower.   Year-end mortgage loans held for sale, included in total loans in the Consolidated Balance Sheets, were as follows:       2021     2020   Mortgage loans held for sale   $ 16,117,000     $ 22,888,000   Less: Allowance to adjust to lower of cost or market     0       0   Mortgage loans held for sale, net   $ 16,117,000     $ 22,888,000     Mortgage Loan Derivatives : We enter into forward contracts and interest rate lock commitments in the ordinary course of business, which are accounted for as derivatives. The derivatives are not designated as hedges and are carried at fair value. The net gain or loss on derivatives is included in mortgage banking activities in the 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 : Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.   (Continued)   F- 45 Table of Contents   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. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage loan servicing rights is netted against mortgage loan servicing income and recorded in mortgage banking activities in the Consolidated Statements of Income.   Troubled Debt Restructurings : A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.   In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans. Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described below under “Allowance for Loan Losses.” Certain loans modified as troubled debt restructurings may have been previously measured for impairment and included in the allowance under a general allowance methodology (i.e., pooling). In these circumstances, the allowance may be impacted to the extent there is a difference in the results obtained by the initial measurement methodology and the methodology applied to reflect a troubled debt restructuring. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.   The federal banking agencies issued an “ 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. This guidance encourages financial institutions to work prudently with borrowers that are or may be unable to meet their contractual obligations because of the effects of the Coronavirus Pandemic. Pursuant to the guidance, the federal banking agencies concluded, in consultation with FASB staff, that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current prior to any relief are not troubled debt restructurings. This guidance complements Section 4013 of the CARES Act, which specified that Coronavirus-related modifications made on loans that were current as of December 31, 2019 and that occur between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency declared by President Trump on March 13, 2020 ( the “National Emergency”) or December 31, 2020, as applicable, are not troubled debt restructurings. As part of the Consolidated Appropriations Act that was enacted in late 2020, this guidance was extended to January 1, 2022.   (Continued)   F- 46 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)   Allowance for Loan Losses : The allowance for loan losses (“allowance”) is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when we believe the uncollectability of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. We estimate the allowance balance required using past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. We estimate credit losses based on individual loans determined to be impaired and on all other loans grouped on similar risk characteristics. Our historical loss component is based on historical loss experience by credit risk grade for commercial loans and payment status for mortgage and consumer loans. Loans are pooled based on similar risk characteristics supported by observable data. The historical loss experience component of the allowance represents the results of migration analysis of historical net charge-offs for portfolios of loans, including groups of commercial loans within each credit risk grade. For measuring loss exposure in a pool of loans, the historical net charge-off or migration experience is utilized to estimate expected future losses to be realized from the pool of loans. These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative environmental factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, competition, increasing interest rates, external factors, Coronavirus Pandemic environment, and other considerations. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.   A loan is considered impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status and collateral value. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of delay, the reasons for delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, 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. 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, 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.   (Continued)   F- 47 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)   Transfers of Financial Assets : Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: ( 1 ) the assets have been isolated from our bank and put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, ( 2 ) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and ( 3 ) our bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Our transfers of financial assets are generally limited to commercial loan participations sold and residential mortgage loans sold in the secondary market.   Premises and Equipment : Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 33 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur and major improvements are capitalized. Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable based on future undiscounted cash flows. If impaired, the assets are recorded at the lower of carrying value or fair value.    Foreclosed Assets: Assets acquired through or in lieu of foreclosure are initially recorded at their estimated fair value net of estimated selling costs, establishing a new cost basis. If fair value subsequently declines, a valuation allowance is recorded through noninterest expense, as are collection and operating costs after acquisition. Foreclosed assets, included in other assets in the Consolidated Balance Sheets, totaled $ 0 and $ 0.7 million as of December 31, 2021 and 2020, respectively.   Bank Owned Life Insurance: Our bank has purchased life insurance policies on certain key officers. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.   Goodwill and Core Deposit Intangible : Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. A more frequent assessment is performed should events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We may elect to perform a qualitative assessment for the annual impairment test. If the qualitative assessment indicates it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or if we elect not to perform a qualitative assessment, then we would be required to perform a quantitative test for goodwill impairment. If the estimated fair value of the reporting unit is less than the carrying value, goodwill is impaired and is written down to its estimated fair value.   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.   The core deposit intangible that arose from the merger with Firstbank was initially measured at fair value and is being amortized into noninterest expense over a ten -year period using the sum-of-the-years-digits methodology.   Repurchase Agreements : Our bank sells certain securities under agreements to repurchase. The agreements are treated as collateralized financing transactions, with the obligations to repurchase the securities sold reflected as liabilities and the securities underlying the agreements remaining in assets in the Consolidated Balance Sheets.   (Continued)   F- 48 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)   Financial Instruments and Loan Commitments : Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit, that are considered financial guarantees are recorded at fair value. Reserves for unfunded commitments are recorded as an other liability on our Consolidated Balance Sheets.   Stock-Based Compensation : Compensation cost for equity-based awards is measured on the grant date based on the fair value of the award at that date, and is recognized over the requisite service period, net of estimated forfeitures. Fair value of stock option awards is estimated using a closed option valuation (Black-Scholes) model. Fair value of restricted stock awards is based upon the quoted market price of the common stock on the date of grant.   Revenue from Contracts with Customers : We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606” ). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. No revenue has been recognized in the current reporting period that results from performance obligations satisfied in previous periods.   Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary.   We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.   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:       2021     2020     2019                             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.   (Continued)   F- 49 Table of Contents   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 : Advertising costs are expensed as incurred.   Income Taxes : Income tax expense is the total of the current year income tax due or refundable, the change in deferred income tax assets and liabilities, and any adjustments related to unrecognized tax benefits. Deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates applicable to future years. A valuation allowance, if needed, reduces deferred income tax assets to the amount expected to be realized.   Fair Values of Financial Instruments : Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments.   Earnings Per Share : Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans using the treasury stock method. Our unvested stock awards, which contain non-forfeitable rights to dividends whether paid or unpaid (i.e., participating securities), are included in the number of shares outstanding for both basic and diluted earnings per share calculations. In the event of a net loss, our unvested stock awards are excluded from the calculations of both basic and diluted earnings per share.   Comprehensive Income : Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale.   Derivatives : Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have historically generally consisted of interest rate swap agreements that qualified for hedge accounting. We do not use derivatives for trading purposes.   (Continued)   F- 50 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)   Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.   If designated as a hedge, we formally document the relationship between the derivative instrument and the hedged item, as well as the risk-management objective and the strategy for undertaking the hedge transaction. This documentation includes linking cash flow hedges to specific assets on the balance sheet. If designated as a hedge, we also formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivative instrument that is used is highly effective in offsetting changes in cash flows of the hedged items. Ineffective hedge gains and losses are recognized immediately in current earnings as noninterest income or expense.   We discontinue hedge accounting when we determine the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or terminates, or treatment of the derivatives as a hedge is no longer appropriate or intended. We had no derivative instruments designated as hedges as of December 31, 2021 and 2020.   Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. We do not believe there are any such matters outstanding that would have a material effect on the financial statements.   Reclassifications: Certain items in the prior years’ financial statements have been reclassified to conform to the current year presentation.   Accounting Standards Updates : In June 2016, the FASB issued ASU No. 2016 - 13, Measurement of Credit Losses on Financial Instruments . This ASU (as subsequently amended by ASU 2018 - 19 ) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the CECL model, will apply to: (i) financial assets subject to credit losses and measured at amortized cost, and (ii) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans, and expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019. 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. 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 updated with no economic forecast consensus. 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. 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.   (Continued)   F- 51 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021     NOTE 2 – SECURITIES   The amortized cost and fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:       Amortized Cost     Gross Unrealized Gains     Gross Unrealized Losses     Fair Value   2021                                 U.S. Government agency debt obligations   $ 398,874,000     $ 266,000     $ ( 8,769,000 )   $ 390,371,000   Mortgage-backed securities     41,906,000       549,000       ( 652,000 )     41,803,000   Municipal general obligation bonds     133,894,000       4,092,000       ( 392,000 )     137,594,000   Municipal revenue bonds     22,289,000       331,000       ( 145,000 )     22,475,000   Other investments     500,000       0       0       500,000       $ 597,463,000     $ 5,238,000     $ ( 9,958,000 )   $ 592,743,000   2020                                 U.S. Government agency debt obligations   $ 242,522,000     $ 516,000     $ ( 897,000 )   $ 242,141,000   Mortgage-backed securities     23,869,000       1,021,000       0       24,890,000   Municipal general obligation bonds     101,991,000       5,833,000       0       107,824,000   Municipal revenue bonds     11,521,000       473,000       ( 2,000 )     11,992,000   Other investments     500,000       0       0       500,000       $ 380,403,000     $ 7,843,000     $ ( 899,000 )   $ 387,347,000     Securities with unrealized losses at year-end 2021 and 2020, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:       Less than 12 Months     12 Months or More     Total   Description of Securities   Fair Value     Unrealized Loss     Fair Value     Unrealized Loss     Fair Value     Unrealized Loss   2021                                                 U.S. Government agency debt obligations   $ 274,287,000     $ 5,274,000     $ 110,053,000     $ 3,495,000     $ 384,340,000     $ 8,769,000   Mortgage-backed securities     23,184,000       652,000       24,000       0       23,208,000       652,000   Municipal general obligation bonds     40,748,000       392,000       0       0       40,748,000       392,000   Municipal revenue bonds     12,843,000       137,000       414,000       8,000       13,257,000       145,000   Other investments     0       0       0       0       0       0       $ 351,062,000     $ 6,455,000     $ 110,491,000     $ 3,503,000     $ 461,553,000     $ 9,958,000   2020                                                 U.S. Government agency debt obligations   $ 118,650,000     $ 897,000     $ 0     $ 0     $ 118,650,000     $ 897,000   Mortgage-backed securities     0       0       0       0       0       0   Municipal general obligation bonds     0       0       0       0       0       0   Municipal revenue bonds     423,000       2,000       0       0       423,000       2,000   Other investments     0       0       0       0       0       0       $ 119,073,000     $ 899,000     $ 0     $ 0     $ 119,073,000     $ 899,000     (Continued)   F- 52 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 2 – SECURITIES (Continued)   We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.   At December 31, 2021, 333 debt securities with fair values totaling $ 462 million had unrealized losses aggregating $ 10.0 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary.   The amortized cost and fair values of debt securities at December 31, 2021, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.       Weighted Average Yield     Amortized Cost     Fair Value   Due in one year or less     1.92 %   $ 11,406,000     $ 11,458,000   Due from one to five years     0.96       185,889,000       184,788,000   Due from five to ten years     1.56       288,599,000       285,609,000   Due after ten years     1.99       69,163,000       68,585,000   Mortgage-backed securities     1.85       41,906,000       41,803,000   Other investments     3.75       500,000       500,000         1.45 %   $ 597,463,000     $ 592,743,000     No securities were sold during the last three years.   Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $ 155 million and $ 109 million at December 31, 2021 and December 31, 2020, respectively, with estimated market values of $ 158 million and $ 116 million at the respective dates. Securities issued by all other states and their political subdivisions had a combined amortized cost of $ 1.7 million and $ 4.1 million at December 31, 2021 and December 31, 2020, respectively, with estimated market values of $ 1.7 million and $ 4.2 million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies and the State of Michigan and all its political subdivisions, did not exceed 10% of shareholders’ equity.   The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $ 197 million and $ 118 million at December 31, 2021 and 2020, respectively. Investments in FHLBI stock are restricted and may only be resold to, or redeemed by, the issuer.   (Continued)   F- 53 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021     NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES   Loans originated for investment are stated at their principal amount outstanding adjusted for partial charge-offs, the allowance, and net deferred loan fees and costs. Interest income on loans is accrued over the term of the loans primarily using the simple interest method based on the principal balance outstanding. Interest is not accrued on loans where collectability is uncertain. Accrued interest is included in other assets in the Consolidated Balance Sheets. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.   Year-end loans disaggregated by class of loan within the loan portfolio segments were as follows:       December 31, 2021     December 31, 2020     Percent Increase       Balance     %     Balance     %     (Decrease)                                             Commercial:                                         Commercial and industrial (1)   $ 1,137,419,000       32.9 %   $ 1,145,423,000       35.9 %     ( 0.7 %) Vacant land, land development, and residential construction     43,239,000       1.3       55,055,000       1.7       ( 21.5 ) Real estate – owner occupied     565,758,000       16.4       529,953,000       16.6       6.8   Real estate – non-owner occupied     1,027,415,000       29.7       917,436,000       28.7       12.0   Real estate – multi-family and residential rental     176,593,000       5.1       146,095,000       4.6       20.9   Total commercial     2,950,424,000       85.4       2,793,962,000       87.5       5.6                                             Retail:                                         Home equity and other     60,488,000       1.8       61,620,000       1.9       ( 1.8 ) 1-4 family mortgages     442,547,000       12.8       337,888,000       10.6       31.0   Total retail     503,035,000       14.6       399,508,000       12.5       25.9                                             Total loans   $ 3,453,459,000       100.0 %   $ 3,193,470,000       100.0 %     8.1 %   ( 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:       2021     2020               Percentage             Percentage       Balance     of Loan Portfolio     Balance     of Loan Portfolio   Commercial real estate loans to lessors of non-residential buildings   $ 737,589,000       21.4 %   $ 649,162,000       20.3 %   (Continued)   F- 54 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Year-end nonperforming loans were as follows:       2021     2020                     Loans past due 90 days or more still accruing interest   $ 155,000     $ 0   Nonaccrual loans     2,313,000       3,384,000   Total nonperforming loans   $ 2,468,000     $ 3,384,000     The recorded principal balance of nonperforming loans was as follows:        December 31, 2021     December 31, 2020   Commercial:                 Commercial and industrial   $ 663,000     $ 172,000   Vacant land, land development, and residential construction     0       0   Real estate – owner occupied     0       619,000   Real estate – non-owner occupied     0       22,000   Real estate – multi-family and residential rental     0       0   Total commercial     663,000       813,000                     Retail:                 Home equity and other     119,000       242,000   1-4 family mortgages     1,686,000       2,329,000   Total retail     1,805,000       2,571,000                     Total nonperforming loans   $ 2,468,000     $ 3,384,000     (Continued)   F- 55 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021    NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   An age analysis of past due loans is as follows as of December 31, 2021:       30 – 59 Days Past Due     60 – 89 Days Past Due     Greater Than 89 Days Past Due     Total Past Due     Current     Total Loans     Recorded Balance > 89 Days and Accruing                                                             Commercial:                                                         Commercial and industrial   $ 14,000     $ 0     $ 193,000     $ 207,000     $ 1,137,212,000     $ 1,137,419,000     $ 155,000   Vacant land, land development, and residential construction     13,000       0       0       13,000       43,226,000       43,239,000       0   Real estate – owner occupied     0       0       0       0       565,758,000       565,758,000       0   Real estate – non-owner occupied     0       0       0       0       1,027,415,000       1,027,415,000       0   Real estate – multi-family and residential rental     0       0       0       0       176,593,000       176,593,000       0   Total commercial     27,000       0       193,000       220,000       2,950,204,000       2,950,424,000       155,000                                                             Retail:                                                         Home equity and other     132,000       2,000       20,000       154,000       60,334,000       60,488,000       0   1- 4 family mortgages     1,265,000       241,000       82,000       1,588,000       440,959,000       442,547,000       0   Total retail     1,397,000       243,000       102,000       1,742,000       501,293,000       503,035,000       0                                                             Total past due loans   $ 1,424,000     $ 243,000     $ 295,000     $ 1,962,000     $ 3,451,497,000     $ 3,453,459,000     $ 155,000     (Continued)   F- 56 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   An age analysis of past due loans is as follows as of December 31, 2020:       30 – 59 Days Past Due     60 – 89 Days Past Due     Greater Than 89 Days Past Due     Total Past Due     Current     Total Loans     Recorded Balance > 89 Days and Accruing                                                             Commercial:                                                         Commercial and industrial   $ 261,000     $ 172,000     $ 0     $ 433,000     $ 1,144,990,000     $ 1,145,423,000     $ 0   Vacant land, land development, and residential construction     0       0       0       0       55,055,000       55,055,000       0   Real estate – owner occupied     0       197,000       421,000       618,000       529,335,000       529,953,000       0   Real estate – non-owner occupied     0       0       23,000       23,000       917,413,000       917,436,000       0   Real estate – multi-family and residential rental     0       0       0       0       146,095,000       146,095,000       0   Total commercial     261,000       369,000       444,000       1,074,000       2,792,888,000       2,793,962,000       0                                                             Retail:                                                         Home equity and other     112,000       65,000       54,000       231,000       61,389,000       61,620,000       0   1- 4 family mortgages     1,147,000       247,000       342,000       1,736,000       336,152,000       337,888,000       0   Total retail     1,259,000       312,000       396,000       1,967,000       397,541,000       399,508,000       0                                                             Total past due loans   $ 1,520,000     $ 681,000     $ 840,000     $ 3,041,000     $ 3,190,429,000     $ 3,193,470,000     $ 0     (Continued)   F- 57 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Impaired loans with no related allowance recorded were as follows as of December 31, 2021:       Unpaid Contractual Principal Balance     Recorded Principal Balance   Related Allowance   Year-To-Date Average Recorded Principal Balance   With no related allowance recorded:                           Commercial:                           Commercial and industrial   $ 2,893,000     $ 2,818,000       $ 3,632,000   Vacant land, land development and residential construction     0       0         0   Real estate – owner occupied     9,674,000       9,674,000         12,634,000   Real estate – non-owner occupied     0       0         131,000   Real estate – multi-family and residential rental     91,000       91,000         37,000   Total commercial     12,658,000       12,583,000         16,434,000   Retail:                           Home equity and other     1,173,000       1,107,000         1,096,000   1-4 family mortgages     3,166,000       2,025,000         2,327,000   Total retail     4,339,000       3,132,000         3,423,000                               Total with no related allowance recorded   $ 16,997,000     $ 15,715,000       $ 19,857,000     (Continued)   F- 58 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2021:       Unpaid Contractual Principal Balance     Recorded Principal Balance     Related Allowance     Year-To-Date Average Recorded Principal Balance   With an allowance recorded:                                 Commercial:                                 Commercial and industrial   $ 2,192,000     $ 2,192,000     $ 266,000     $ 1,732,000   Vacant land, land development and residential construction     0       0       0       0   Real estate – owner occupied     761,000       761,000       84,000       803,000   Real estate – non-owner occupied     146,000       146,000       4,000       154,000   Real estate – multi-family and residential rental     0       0       0       0   Total commercial     3,099,000       3,099,000       354,000       2,689,000   Retail:                                 Home equity and other     160,000       140,000       123,000       214,000   1-4 family mortgages     412,000       412,000       69,000       537,000   Total retail     572,000       552,000       192,000       751,000                                     Total with an allowance recorded   $ 3,671,000     $ 3,651,000     $ 546,000     $ 3,440,000                                     Total impaired loans:                                 Commercial   $ 15,757,000     $ 15,682,000     $ 354,000     $ 19,123,000   Retail     4,911,000       3,684,000       192,000       4,174,000   Total impaired loans   $ 20,668,000     $ 19,366,000     $ 546,000     $ 23,297,000     (Continued)   F- 59 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Impaired loans with no related allowance recorded were as follows as of December 31, 2020:        Unpaid Contractual Principal Balance     Recorded Principal Balance   Related Allowance   Year-To-Date Average Recorded Principal Balance   With no related allowance recorded:                           Commercial:                           Commercial and industrial   $ 6,242,000     $ 6,242,000       $ 7,874,000   Vacant land, land development and residential construction     0       0         187,000   Real estate – owner occupied     14,782,000       14,593,000         5,361,000   Real estate – non-owner occupied     341,000       341,000         227,000   Real estate – multi-family and residential rental     0       0         3,000   Total commercial     21,365,000       21,176,000         13,652,000   Retail:                           Home equity and other     1,072,000       987,000         1,216,000   1-4 family mortgages     4,455,000       2,575,000         2,447,000   Total retail     5,527,000       3,562,000         3,663,000                               Total with no related allowance recorded   $ 26,892,000     $ 24,738,000       $ 17,315,000     (Continued)   F- 60 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2020:       Unpaid Contractual Principal Balance     Recorded Principal Balance     Related Allowance     Year-To-Date Average Recorded Principal Balance   With an allowance recorded:                                 Commercial:                                 Commercial and industrial   $ 343,000     $ 343,000     $ 53,000     $ 971,000   Vacant land, land development and residential construction     0       0       0       77,000   Real estate – owner occupied     763,000       734,000       77,000       578,000   Real estate – non-owner occupied     162,000       162,000       8,000       100,000   Real estate – multi-family and residential rental     0       0       0       0   Total commercial     1,268,000       1,239,000       138,000       1,726,000   Retail:                                 Home equity and other     300,000       283,000       241,000       421,000   1-4 family mortgages     698,000       698,000       172,000       595,000   Total retail     998,000       981,000       413,000       1,016,000                                     Total with an allowance recorded   $ 2,266,000     $ 2,220,000     $ 551,000     $ 2,742,000                                     Total impaired loans:                                 Commercial   $ 22,633,000     $ 22,415,000     $ 138,000     $ 15,378,000   Retail     6,525,000       4,543,000       413,000       4,679,000   Total impaired loans   $ 29,158,000     $ 26,958,000     $ 551,000     $ 20,057,000     Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated fair value. 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.   (Continued)   F- 61 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Credit Quality Indicators. We utilize a comprehensive grading system for our commercial loans. All commercial loans are graded on a ten grade rating system. The rating system utilizes standardized grade paradigms that analyze several critical factors such as cash flow, operating performance, financial condition, collateral, industry condition and management. All commercial loans are graded at inception and reviewed and, if appropriate, re-graded at various intervals thereafter. The risk assessment for retail loans is primarily based on the type of collateral.   Loans by credit quality indicators were as follows as of December 31, 2021:   Commercial credit exposure – credit risk profiled by internal credit risk grades:       Commercial and Industrial     Commercial Vacant Land, Land Development, and Residential Construction     Commercial Real Estate - Owner Occupied     Commercial Real Estate - Non-Owner Occupied     Commercial Real Estate - Multi-Family and Residential Rental                                             Internal credit risk grade groupings:                                         Grades 1 – 4 (1)   $ 729,224,000     $ 28,390,000     $ 346,082,000     $ 503,482,000     $ 119,473,000   Grades 5 – 7     398,378,000       14,730,000       208,060,000       511,280,000       56,968,000   Grades 8 – 9     9,817,000       119,000       11,616,000       12,653,000       152,000   Total commercial   $ 1,137,419,000     $ 43,239,000     $ 565,758,000     $ 1,027,415,000     $ 176,593,000     Retail credit exposure – credit risk profiled by collateral type:       Retail Home Equity and Other     Retail 1-4 Family Mortgages                     Performing     60,369,000       440,861,000   Nonperforming     119,000       1,686,000   Total retail   $ 60,488,000     $ 442,547,000       ( 1 ) Included in Commercial and Industrial Loans Grades 1 –  4 are $ 40.1 million of loans originated under the Paycheck Protection Program.   (Continued)   F- 62 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Loans by credit quality indicators were as follows as of December 31, 2020:   Commercial credit exposure – credit risk profiled by internal credit risk grades:       Commercial and Industrial     Commercial Vacant Land, Land Development, and Residential Construction     Commercial Real Estate - Owner Occupied     Commercial Real Estate - Non-Owner Occupied     Commercial Real Estate - Multi-Family and Residential Rental                                             Internal credit risk grade groupings:                                         Grades 1 – 4 (1)   $ 828,706,000     $ 22,547,000     $ 315,134,000     $ 396,700,000     $ 91,711,000   Grades 5 – 7     306,614,000       32,398,000       185,541,000       520,395,000       54,111,000   Grades 8 – 9     10,103,000       110,000       29,278,000       341,000       273,000   Total commercial   $ 1,145,423,000     $ 55,055,000     $ 529,953,000     $ 917,436,000     $ 146,095,000     Retail credit exposure – credit risk profiled by collateral type:       Retail Home Equity and Other     Retail 1-4 Family Mortgages                     Performing     61,378,000       335,559,000   Nonperforming     242,000       2,329,000   Total retail   $ 61,620,000     $ 337,888,000       ( 1 ) Included in Commercial and Industrial Loans Grades 1 –  4 are $ 365 million of loans originated under the Paycheck Protection Program.   (Continued)   F- 63 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   All commercial loans are graded using the following criteria:     Grade 1. “Exceptional”  Loans with this rating contain very little, if any, risk.     Grade 2. “Outstanding”  Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.     Grade 3. “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.     Grade 4. “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.     Grade 5. “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.     Grade 6. “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.     Grade 7. “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.     Grade 8. “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.     Grade 9. “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.     Grade 10. “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. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.   (Continued)   F- 64 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   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     1 – 4 family mortgages     Unallocated     Total   Allowance for loan losses:                                                                         Beginning balance   $ 9,424     $ 679     $ 8,246     $ 13,611     $ 1,819     $ 889     $ 3,240     $ 59     $ 37,967   Provision for loan losses     2,030       ( 618 )     ( 3,308 )     ( 310 )     ( 150 )     ( 301 )     ( 1,629 )     ( 14 )     ( 4,300 ) Charge-offs     ( 882 )     ( 15 )     ( 12 )     0       0       ( 43 )     ( 92 )     0       ( 1,044 ) Recoveries     210       374       1,119       0       26       81       930       0       2,740   Ending balance   $ 10,782     $ 420     $ 6,045     $ 13,301     $ 1,695     $ 626     $ 2,449     $ 45     $ 35,363                                                                             Ending balance: individually evaluated for impairment   $ 266     $ 0     $ 84     $ 0     $ 4     $ 123     $ 69     $ 0     $ 546                                                                             Ending balance: collectively evaluated for impairment   $ 10,516     $ 420     $ 5,961     $ 13,301     $ 1,691     $ 503     $ 2,380     $ 45     $ 34,817                                                                             Total loans (*):                                                                         Ending balance   $ 1,097,309     $ 43,239     $ 565,758     $ 1,027,415     $ 176,593     $ 60,488     $ 442,547             $ 3,413,349                                                                             Ending balance: individually evaluated for impairment   $ 5,010     $ 0     $ 10,435     $ 146     $ 91     $ 1,247     $ 2,437             $ 19,366                                                                             Ending balance: collectively evaluated for impairment   $ 1,092,299     $ 43,239     $ 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.   (Continued)   F- 65     MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – 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 (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     1 – 4 family mortgages     Unallocated     Total   Allowance for loan losses:                                                                         Beginning balance   $ 6,659     $ 466     $ 6,291     $ 6,761     $ 893     $ 861       1,888     $ 70     $ 23,889   Provision for loan losses     2,921       289       1,881       6,837       907       58       1,168       ( 11 )     14,050   Charge-offs     ( 247 )     ( 113 )     ( 235 )     0       ( 18 )     ( 96 )     ( 129 )     0       ( 838 ) Recoveries     91       37       309       13       37       66       313       0       866   Ending balance   $ 9,424     $ 679     $ 8,246     $ 13,611     $ 1,819     $ 889     $ 3,240     $ 59     $ 37,967                                                                             Ending balance: individually evaluated for impairment   $ 53     $ 0     $ 77     $ 8     $ 0     $ 241     $ 172     $ 0     $ 551                                                                             Ending balance: collectively evaluated for impairment   $ 9,371     $ 679     $ 8,169     $ 13,603     $ 1,819     $ 648     $ 3,068     $ 59     $ 37,416                                                                             Total loans (*):                                                                         Ending balance   $ 780,164     $ 55,055     $ 529,953     $ 917,436     $ 146,095     $ 61,620     $ 337,888             $ 2,828,211                                                                             Ending balance: individually evaluated for impairment   $ 6,585     $ 0     $ 15,327     $ 503     $ 0     $ 1,270     $ 3,273             $ 26,958                                                                             Ending balance: collectively evaluated for impairment   $ 773,579     $ 55,055     $ 514,626     $ 916,933     $ 146,095     $ 60,350     $ 334,615             $ 2,801,253     (*) Excludes $365 million in loans originated under the Paycheck Protection Program.   (Continued)   F- 66     MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – 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 (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     1 – 4 family mortgages     Unallocated     Total   Allowance for loan losses:                                                                         Beginning balance   $ 6,168     $ 337     $ 5,866     $ 6,408     $ 840     $ 883       1,834     $ 44     $ 22,380   Provision for loan losses     764       105       331       342       36       ( 19 )     165       26       1,750   Charge-offs     ( 393 )     ( 12 )     ( 48 )     ( 2 )     0       ( 66 )     ( 362 )     0       ( 883 ) Recoveries     120       36       142       13       17       63       251       0       642   Ending balance   $ 6,659     $ 466     $ 6,291     $ 6,761     $ 893     $ 861     $ 1,888     $ 70     $ 23,889                                                                             Ending balance: individually evaluated for impairment   $ 202     $ 0     $ 982     $ 0     $ 0     $ 356     $ 83     $ 0     $ 1,623                                                                             Ending balance: collectively evaluated for impairment   $ 6,457     $ 466     $ 5,309     $ 6,761     $ 893     $ 505     $ 1,805     $ 70     $ 22,266                                                                             Total loans:                                                                         Ending balance   $ 846,551     $ 56,119     $ 579,003     $ 835,346     $ 124,525     $ 75,374     $ 339,749             $ 2,856,667                                                                             Ending balance: individually evaluated for impairment   $ 8,587     $ 85     $ 1,745     $ 178     $ 9     $ 1,694     $ 2,324             $ 14,622                                                                             Ending balance: collectively evaluated for impairment   $ 837,964     $ 56,034     $ 577,258     $ 835,168     $ 124,516     $ 73,680     $ 337,425             $ 2,842,045     (Continued)   F- 67 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Loans modified as troubled debt restructurings during the year-ended December 31, 2021 were as follows:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     10     $ 3,017,000     $ 3,016,000   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     1       692,000       692,000   Real estate – non-owner occupied     0       0       0   Real estate – multi-family and residential rental     1       93,000       93,000   Total commercial     12       3,802,000       3,801,000                             Retail:                         Home equity and other     4       485,000       482,000   1-4 family mortgages     2       46,000       46,000   Total retail     6       531,000       528,000                             Total     18     $ 4,333,000     $ 4,329,000     Loans modified as troubled debt restructurings during the year-ended December 31, 2020 were as follows:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     13     $ 6,914,000     $ 7,717,000   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     8       14,663,000       14,663,000   Real estate – non-owner occupied     2       319,000       318,000   Real estate – multi-family and residential rental     0       0       0   Total commercial     23       21,896,000       22,698,000                             Retail:                         Home equity and other     16       451,000       452,000   1-4 family mortgages     6       151,000       148,000   Total retail     22       602,000       600,000                             Total     45     $ 22,498,000     $ 23,298,000     (Continued)   F- 68 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2021 ( amounts as of period end):       Number of Contracts     Recorded Principal Balance   Commercial:                 Commercial and industrial     0     $ 0   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     0       0   Retail:                 Home equity and other     0       0   1-4 family mortgages     0       0   Total retail     0       0                     Total     0     $ 0     The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2020 ( amounts as of period end):       Number of Contracts     Recorded Principal Balance   Commercial:                 Commercial and industrial     0     $ 0   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     0       0                     Retail:                 Home equity and other     0       0   1-4 family mortgages     0       0   Total retail     0       0                     Total     0     $ 0     (Continued)   F- 69 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2021 is as follows:       Commercial and     Commercial Vacant Land, Land Development, and Residential     Commercial Real Estate - Owner     Commercial Real Estate - Non-Owner     Commercial Real Estate - Multi-Family and Residential       Industrial     Construction     Occupied     Occupied     Rental                                             Commercial Loan Portfolio:                                         Beginning Balance   $ 6,414,000     $ 0     $ 14,797,000     $ 480,000     $ 0   Charge-Offs     ( 17,000 )     0       0       0       0   Payments     ( 4,278,000 )     0       ( 5,048,000 )     ( 334,000 )     ( 1,000 ) Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     2,854,000       0       686,000       0       92,000   Ending Balance   $ 4,973,000     $ 0     $ 10,435,000     $ 146,000     $ 91,000         Retail Home Equity and Other     Retail 1-4 Family Mortgages                     Retail Loan Portfolio:                 Beginning Balance   $ 1,146,000     $ 806,000   Charge-Offs     0       0   Payments     ( 426,000 )     ( 224,000 ) Transfers to ORE     0       0   Net Additions/Deletions     482,000       45,000   Ending Balance   $ 1,202,000     $ 627,000     (Continued)   F- 70 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2020 is as follows:       Commercial and     Commercial Vacant Land, Land Development, and Residential     Commercial Real Estate - Owner     Commercial Real Estate - Non-Owner     Commercial Real Estate - Multi-Family and Residential       Industrial     Construction     Occupied     Occupied     Rental                                             Commercial Loan Portfolio:                                         Beginning Balance   $ 8,587,000     $ 85,000     $ 1,145,000     $ 178,000     $ 7,000   Charge-Offs     0       0       0       0       0   Payments     ( 11,260,000 )     ( 85,000 )     ( 3,765,000 )     ( 585,000 )     ( 7,000 ) Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     9,087,000       0       17,417,000       887,000       0   Ending Balance   $ 6,414,000     $ 0     $ 14,797,000     $ 480,000     $ 0         Retail Home Equity and Other     Retail 1-4 Family Mortgages                     Retail Loan Portfolio:                 Beginning Balance   $ 1,415,000     $ 724,000   Charge-Offs     0       0   Payments     ( 881,000 )     ( 68,000 ) Transfers to ORE     0       0   Net Additions/Deletions     612,000       150,000   Ending Balance   $ 1,146,000     $ 806,000     (Continued)   F- 71 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2019 is as follows:       Commercial and Industrial     Commercial Vacant Land, Land Development, and Residential Construction     Commercial Real Estate - Owner Occupied     Commercial Real Estate - Non-Owner Occupied     Commercial Real Estate - Multi-Family and Residential Rental                                             Commercial Loan Portfolio:                                         Beginning Balance   $ 14,138,000     $ 0     $ 3,100,000     $ 210,000     $ 24,000   Charge-Offs     0       0       0       0       0   Payments     ( 20,364,000 )     ( 2,000 )     ( 3,820,000 )     ( 32,000 )     ( 17,000 ) Transfers to ORE     0       0       ( 97,000 )     0       0   Net Additions/Deletions     14,813,000       87,000       1,962,000       0       0   Ending Balance   $ 8,587,000     $ 85,000     $ 1,145,000     $ 178,000     $ 7,000         Retail Home Equity and Other     Retail 1-4 Family Mortgages                     Retail Loan Portfolio:                 Beginning Balance   $ 1,402,000     $ 578,000   Charge-Offs     ( 18,000 )     0   Payments     ( 272,000 )     ( 162,000 ) Transfers to ORE     0       0   Net Additions/Deletions     303,000       308,000   Ending Balance   $ 1,415,000     $ 724,000     (Continued)   F- 72 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)   The allowance related to loans categorized as troubled debt restructurings was as follows:       December 31, 2021     December 31, 2020   Commercial:                 Commercial and industrial   $ 266,000     $ 53,000   Vacant land, land development, and residential construction     0       0   Real estate – owner occupied     84,000       59,000   Real estate – non-owner occupied     5,000       8,000   Real estate – multi-family and residential rental     0       0   Total commercial     355,000       120,000                     Retail:                 Home equity and other     95,000       202,000   1-4 family mortgages     69,000       145,000   Total retail     164,000       347,000                     Total related allowance   $ 519,000     $ 467,000     In general, our policy dictates that a renewal or modification of an 8 - or 9 -rated commercial loan meets the criteria of a troubled debt restructuring, although we review and consider all renewed and modified loans as part of our troubled debt restructuring assessment procedures. Loan relationships rated 8 contain significant financial weaknesses, resulting in a distinct possibility of loss, while relationships rated 9 reflect vital financial weaknesses, resulting in a highly questionable ability on our part to collect principal. We believe borrowers warranting such ratings would have difficulty obtaining financing from other market participants. Thus, due to the lack of comparable market rates for loans with similar risk characteristics, we believe 8 - or 9 -rated loans renewed or modified were done so at below market rates. Loans that are identified as troubled debt restructurings are considered impaired and are individually evaluated for impairment when assessing these credits in our allowance for loan losses calculation.       NOTE 4 - PREMISES AND EQUIPMENT, NET   Year-end premises and equipment were as follows:       2021     2020                     Land and improvements   $ 15,111,000     $ 16,533,000   Buildings     56,168,000       56,114,000   Furniture and equipment     22,974,000       21,522,000         94,253,000       94,169,000   Less: accumulated depreciation     36,955,000       35,210,000                     Total premises and equipment   $ 57,298,000     $ 58,959,000     Depreciation expense totaled $ 5.8 million in 2021, $ 5.2 million in 2020, and $ 3.9 million in 2019.   (Continued)   F- 73 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   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. 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.       NOTE 5 – MORTGAGE LOAN SERVICING   Mortgage loans serviced for others are not reported as assets in the Consolidated Balance Sheets. The year-end aggregate unpaid principal balances of mortgage loans serviced for others were as follows:       2021     2020                     Mortgage loan portfolios serviced for:                 Federal Home Loan Mortgage Corporation   $ 1,320,550,000     $ 1,030,211,000   Federal Home Loan Bank     23,505,000       8,717,000   Total mortgage loans serviced for others   $ 1,344,055,000     $ 1,038,928,000     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.   (Continued)   F- 74 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 5 – MORTGAGE LOAN SERVICING  (Continued)   Activity for capitalized mortgage loan servicing rights during 2021 and 2020 was as follows:       2021     2020                     Balance at beginning of year   $ 8,189,000     $ 4,652,000   Additions     7,711,000       6,467,000   Amortized to expense     ( 3,652,000 )     ( 2,930,000 )                   Balance at end of year   $ 12,248,000     $ 8,189,000     We determined that no valuation allowance was necessary as of December 31, 2021 or December 31, 2020. The estimated fair value of mortgage servicing rights was $ 15.4 million and $ 10.0 million as of December 31, 2021 and December 31, 2020, respectively. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. During 2021, fair value was determined using a discount rate of 8.0 %, a weighted average constant prepayment rate of 7.4 %, depending on the stratification of the specific right, and a weighted average delinquency rate of 0.25 %. During 2020, fair value was determined using a discount rate of 7.75 %, a weighted average constant prepayment rate of 14.0 %, depending on the stratification of the specific right, and a weighted average delinquency rate of 0.40 %.   The weighted average amortization period was 8.5 years and 6.1 years as of December 31, 2021 and December 31, 2020, respectively. Forecasted amortization as of December 31, 2021 is as follows:   2022   $ 1,186,000   2023     992,000   2024     814,000   2025     654,000   2026     516,000   Thereafter     8,086,000         NOTE 6 – CORE DEPOSIT INTANGIBLE ASSET, NET   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. As of December 31, 2020, the accumulated amortization on core deposit intangible assets was $ 15.1 million, providing for a net carry balance of $ 2.4 million.   The scheduled amortization expense on core deposit intangible assets in future periods is:   2022   $ 768,000   2023     450,000   2024     133,000     (Continued)     F- 75 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021     NOTE 7 – DEPOSITS   Deposits at year-end are summarized as follows:     December 31, 2021     December 31, 2020     Percent Increase       Balance     %     Balance     %     (Decrease)                                             Noninterest-bearing checking   $ 1,677,952,000       41.1 %   $ 1,433,403,000       42.0 %     17.1 % Interest-bearing checking     538,838,000       13.2       473,053,000       13.9       13.9   Money market     1,040,176,000       25.5       611,912,000       17.9       70.0   Savings     394,330,000       9.7       338,070,000       9.9       16.6   Time, under $100,000     132,776,000       3.2       165,548,000       4.9       ( 19.8 ) Time, $100,000 and over     275,208,000       6.7       342,633,000       10.0       ( 19.7 ) Total local deposits     4,059,280,000       99.4       3,364,619,000       98.6       20.6                                             Out-of-area time, $100,000 and over     23,913,000       0.6       46,934,000       1.4       ( 49.0 )                                           Total deposits   $ 4,083,193,000       100.0 %   $ 3,411,553,000       100.0 %     19.7 %   Out-of-area time deposits consist of deposits obtained from depositors outside of our primary market areas exclusively through deposit brokers.   The following table depicts the maturity distribution for time deposits at year-end:       2021     2020                     In one year or less   $ 260,501,000     $ 327,246,000   In one to two years     78,024,000       139,801,000   In two to three years     34,595,000       39,801,000   In three to four years     7,863,000       25,577,000   In four to five years     50,914,000       22,690,000                     Total certificates of deposit   $ 431,897,000     $ 555,115,000     The following table depicts the maturity distribution for time deposits with balances of $100,000 or more at year-end:       2021     2020                     Up to three months   $ 68,887,000     $ 79,500,000   Three months to six months     53,077,000       79,373,000   Six months to twelve months     56,612,000       77,363,000   Over twelve months     120,545,000       153,331,000                     Total certificates of deposit   $ 299,121,000     $ 389,567,000     Total time deposits of more than $250,000 totaled $ 207 million and $ 272 million at year-end 2021 and 2020, respectively.   (Continued)   F- 76 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021     NOTE 8 – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE   Information regarding securities sold under agreements to repurchase at year-end is summarized below:       2021     2020                     Outstanding balance at year-end   $ 197,463,000     $ 118,365,000   Weighted average interest rate at year-end     0.11 %     0.12 %                   Average daily balance during the year   $ 158,855,000     $ 132,880,000   Weighted average interest rate during the year     0.11 %     0.12 %                   Maximum daily balance during the year   $ 209,093,000     $ 173,186,000     Securities sold under agreements to repurchase (“repurchase agreements”) generally have original maturities of less than one year. Repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the repurchase agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank. Repurchase agreements are offered principally to certain large deposit customers. Repurchase agreements are secured by securities with an aggregate fair value equal to the aggregate outstanding balance.       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 %.   Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. Our borrowing line of credit as of December 31, 2021 totaled $ 889 million, with remaining availability based on collateral of $ 509 million.   Scheduled maturities as of December 31, 2021:   2022   $ 94,000,000   2023     80,000,000   2024     80,000,000   2025     50,000,000   2026     30,000,000   2027     40,000,000     (Continued)   F- 77 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021     NOTE 10 - FEDERAL INCOME TAXES   The consolidated income tax expense is as follows:        2021     2020     2019                             Current expense   $ 12,675,000     $ 14,945,000     $ 10,978,000   Deferred expense     2,020,000       ( 4,141,000 )     26,000   Change in valuation allowance     0       ( 94,000 )     0   Tax expense   $ 14,695,000     $ 10,710,000     $ 11,004,000     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:       2021     2020     2019                             Tax at statutory rate   $ 15,481,000     $ 11,518,000     $ 12,697,000   Increase (decrease) from                         Tax-exempt interest     ( 658,000 )     ( 681,000 )     ( 644,000 ) Bank owned life insurance     ( 233,000 )     ( 238,000 )     ( 804,000 ) Change in valuation allowance     0       ( 94,000 )     0   Other     105,000       205,000       ( 245,000 ) Tax expense   $ 14,695,000     $ 10,710,000     $ 11,004,000     The statutory tax rate was 21 % for 2021, 2020 and 2019.   Significant components of deferred tax assets and liabilities as of December 31, 2021 and 2020 are as follows:       2021     2020   Deferred income tax assets                 Allowance for loan losses   $ 7,426,000     $ 7,973,000   Deferred compensation     259,000       511,000   Stock compensation     941,000       541,000   Nonaccrual loan interest income     159,000       211,000   Deferred loan fees     520,000       924,000   Unrealized loss on securities     991,000       0   Fair value write-downs on foreclosed properties     0       537,000   Other     1,344,000       938,000   Deferred tax asset     11,640,000       11,635,000                     Deferred income tax liabilities                 Depreciation     1,168,000       1,175,000   Prepaid expenses     416,000       297,000   Core deposit intangible     276,000       498,000   Mortgage loan servicing rights     2,572,000       1,720,000   Unrealized gain on securities     0       1,458,000   Business combination adjustments     2,013,000       2,142,000   Other     942,000       521,000   Deferred tax liability     7,387,000       7,811,000                     Total net deferred tax asset   $ 4,253,000     $ 3,824,000     (Continued)   F- 78 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2021   NOTE 10 - FEDERAL INCOME TAXES (Continued)   A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized. 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. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income tax accounts; no such accruals existed at any time during 2021 or 2020. Our U.S. federal income tax returns are no longer subject to examination for all years before 2018.       NOTE 11 – STOCK-BASED COMPENSATION   Stock-based compensation plans are used to provide directors and employees with an increased incentive to contribute to our long-term performance and growth, to align the interests of directors and employees with the interests of our shareholders through the opportunity for increased stock ownership and to attract and retain directors and employees. During 2014 and 2015, stock option and restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2006. During the years 2016 through 2019, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2016. 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 and 2021 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. The Stock Incentive Plan of 2016 was effectively replaced with the Stock Incentive Plan of 2020 that was approved by shareholders in May, 2020.   Under the Stock Incentive Plan of 2006, the Stock Incentive Plan of 2016 and the Stock Incentive Plan of 2020, incentive awards may include, but are not limited to, stock options, restricted stock, stock appreciation rights and stock awards. Incentive awards that are stock options or stock appreciation rights are granted with an exercise price not less than the closing price of our common stock on the date of grant. Price, vesting and expiration date parameters are determined by Mercantile’s Compensation Committee on a grant-by-grant basis. No payments are required from employees for restricted stock awards. The restricted stock awards granted during the years 2014 through 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 Firstbank Corporation 2006 Stock Compensation Plan. In general, stock option grants for 50 shares or less fully vested after one year from date of grant, while stock option grants for more than 50 shares vested over a five -year period at 20 % of the grant per annum starting one year from date of grant. The stock option grants expire ten years from date of grant. There were approximately 282,200 Mercantile stock options issued as a result of the merger, with about 258,400 of the stock option grants fully vested and exercisable on the date of merger. The remaining 23,800 stock option grants vested during 2015.   (Continued)   F- 79 Table of Contents   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:       2021     2020     2019       Shares     Weighted Average Fair Value     Shares     Weighted Average Fair Value     Shares     Weighted Average Fair Value                                                     Nonvested at beginning of year     262,336     $ 29.42       262,260     $ 34.91       262,967     $ 33.97   Granted     163,000       33.68       121,518       24.65       84,596       35.29   Vested     ( 59,772 )     31.82       ( 85,445 )     37.08       ( 81,772 )     32.19   Forfeited     ( 11,873 )     29.54       ( 35,997 )     33.71       ( 3,531 )     34.85   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:       2021     2020     2019       Shares     Weighted Average Exercise Price     Shares     Weighted Average Exercise Price     Shares     Weighted Average Exercise Price                                                     Outstanding at beginning of year     9,700     $ 32.83       10,700     $ 30.25       18,900     $ 23.92   Granted     0     NA       0     NA       0     NA   Exercised     ( 2,000 )     24.91       ( 1,000 )     5.19       ( 8,200 )     15.69   Forfeited or expired     0     NA       0     NA       0     NA   Outstanding at end of year     7,700     $ 34.89       9,700     $ 32.83       10,700     $ 30.25   Options exercisable at year-end     7,700     $ 34.89       9,700     $ 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.   (Continued)   F- 80 Table of Contents   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:           Outstanding     Exercisable                   Weighted Average     Weighted             Weighted   Range of           Remaining     Average             Average   Exercise           Contractual     Exercise             Exercise   Prices   Number     Life (Years)     Price     Number     Price                                                 $27.00 - $ 28.00     1,200       0.9     $ 27.66       1,200       27.66   $36.00 - $ 37.00     6,500       1.9       36.22       6,500       36.22   Outstanding at year end     7,700       1.7     $ 34.89       7,700       34.89     Information related to options outstanding at year-end 2021, 2020 and 2019 is as follows:       2021     2020     2019                             Minimum exercise price   $ 27.66     $ 22.15     $ 5.19   Maximum exercise price     36.22       36.22       36.22   Average remaining option term (years)     1.7       2.4       3.2     Information related to stock option grants and exercises during 2021, 2020 and 2019 is as follows:       2021     2020     2019                             Aggregate intrinsic value of stock options exercised   $ 13,000     $ 17,000     $ 157,000   Cash received from stock option exercises     50,000       3,000       126,000   Tax benefit realized from stock option exercises     0       0       0   Weighted average per share fair value of stock options granted   NA     NA     NA     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.   (Continued)   F- 81 Table of Contents   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.       2021     2020                     Beginning balance   $ 108,042,000     $ 104,043,000   New loans     2,542,000       13,823,000   Repayments     ( 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.   (Continued)   F- 82 Table of Contents   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:       2021     2020                     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.   (Continued)   F- 83 Table of Contents   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.       2021     2020       Contract     Carrying     Contract     Carrying       Amount     Value     Amount     Value                                     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.   (Continued)   F- 84 Table of Contents   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 Location   Fair Value                       Derivative Assets                   Interest rate swaps   $ 279,419,000   Other Assets   $ 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 Location   Fair Value                       Derivative Assets                   Interest rate swaps   $ 33,731,000   Other Assets   $ 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. 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 $ 1.0 million as of December 31, 2020. 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.   (Continued)   F- 85 Table of Contents   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):       Level in     2021     2020       Fair Value     Carrying     Fair     Carrying     Fair       Hierarchy     Amount     Value     Amount     Value   Financial assets                                         Cash   Level 1     $ 17,872     $ 17,872     $ 16,953     $ 16,953   Cash equivalents   Level 1       957,288       957,288       609,053       609,053   Securities available for sale   (1)       592,743       592,743       387,347       387,347   Federal Home Loan Bank stock   (2)       18,002       18,002       18,002       18,002   Loans, net   Level 3       3,418,096       3,498,345       3,155,503       3,294,522   Loans held for sale   Level 2       16,117       16,707       22,888       24,029   Mortgage servicing rights   Level 2       12,248       15,445       8,189       10,006   Accrued interest receivable   Level 2       9,311       9,311       10,861       10,861   Interest rate swaps   Level 2       4,609       4,609       1,003       1,003                                            Financial liabilities                                        Deposits   Level 2       4,083,193       4,028,249       3,411,553       3,397,768   Securities sold under agreements to repurchase   Level 2       197,463       197,463       118,365       118,365   Federal Home Loan Bank advances   Level 2       374,000       384,927       394,000       410,881   Subordinated debentures   Level 2       48,244       48,284       47,563       47,574   Subordinated notes   Level 2       73,646       73,646       0       0   Accrued interest payable   Level 2       1,393       1,393       2,313       2,313   Interest rate swaps   Level 2       4,857       4,857