MERCANTILE BANK CORP 10-Q

Item 1. Financial Statements CONSOLIDATED BALANCE SHEETS (Unaudited)         March 31,     December 31,       2022     2021   ASSETS                 Cash and due from banks   $ 71,480,000     $ 59,405,000   Interest-earning deposits     698,724,000       915,755,000   Total cash and cash equivalents     770,204,000       975,160,000                     Securities available for sale     605,661,000       592,743,000   Federal Home Loan Bank stock     17,721,000       18,002,000   Mortgage loans held for sale     14,746,000       16,117,000                     Loans     3,555,790,000       3,453,459,000   Allowance for credit losses     ( 35,153,000 )     ( 35,363,000 ) Loans, net     3,520,637,000       3,418,096,000                     Premises and equipment, net     56,078,000       57,298,000   Bank owned life insurance     75,508,000       75,242,000   Goodwill     49,473,000       49,473,000   Core deposit intangible, net     1,112,000       1,351,000   Other assets     64,759,000       54,267,000   Total assets   $ 5,175,899,000     $ 5,257,749,000                     LIABILITIES AND SHAREHOLDERS' EQUITY                 Deposits                 Noninterest-bearing   $ 1,686,203,000     $ 1,677,952,000   Interest-bearing     2,290,048,000       2,405,241,000   Total deposits     3,976,251,000       4,083,193,000                     Securities sold under agreements to repurchase     204,271,000       197,463,000   Federal Home Loan Bank advances     382,263,000       374,000,000   Subordinated debentures     48,415,000       48,244,000   Subordinated notes     88,428,000       73,646,000   Accrued interest and other liabilities     39,800,000       24,644,000   Total liabilities     4,739,428,000       4,801,190,000                     Commitments and contingent liabilities (Note 8)                                       Shareholders' equity                 Preferred stock, no par value; 1,000,000 shares authorized; none issued     0       0   Common stock, no par value; 40,000,000 shares authorized; 15,843,347 shares outstanding at March 31, 2022 and 15,839,944 shares outstanding at December 31, 2021     286,831,000       285,752,000   Retained earnings     181,532,000       174,536,000   Accumulated other comprehensive income (loss)     ( 31,892,000 )     ( 3,729,000 ) Total shareholders’ equity     436,471,000       456,559,000   Total liabilities and shareholders’ equity   $ 5,175,899,000     $ 5,257,749,000     See accompanying notes to consolidated financial statements.   1 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)         Three Months     Three Months       Ended     Ended       March 31,     March 31,       2022     2021   Interest income                 Loans, including fees   $ 33,251,000     $ 32,985,000   Securities, taxable     1,665,000       1,035,000   Securities, tax-exempt     600,000       597,000   Other interest-earning assets     366,000       168,000   Total interest income     35,882,000       34,785,000                     Interest expense                 Deposits     1,825,000       2,717,000   Short-term borrowings     50,000       36,000   Federal Home Loan Bank advances     1,864,000       2,027,000   Subordinated debentures and other borrowings     1,258,000       472,000   Total interest expense     4,997,000       5,252,000                     Net interest income     30,885,000       29,533,000                     Provision for credit losses     100,000       300,000                     Net interest income after provision for credit losses     30,785,000       29,233,000                     Noninterest income                 Service charges on deposit and sweep accounts     1,416,000       1,155,000   Mortgage banking income     3,281,000       8,800,000   Credit and debit card income     1,881,000       1,678,000   Interest rate swap fees     1,351,000       653,000   Payroll processing     638,000       557,000   Earnings on bank owned life insurance     287,000       277,000   Other income     423,000       343,000   Total noninterest income     9,277,000       13,463,000                     Noninterest expense                 Salaries and benefits     15,510,000       15,086,000   Occupancy     2,104,000       2,014,000   Furniture and equipment depreciation, rent and maintenance     934,000       889,000   Data processing costs     2,973,000       2,617,000   Other expense     4,221,000       4,511,000   Total noninterest expenses     25,742,000       25,117,000                     Income before federal income tax expense     14,320,000       17,579,000                     Federal income tax expense     2,828,000       3,340,000                     Net income   $ 11,492,000     $ 14,239,000                     Basic earnings per share   $ 0.73     $ 0.87   Diluted earnings per share   $ 0.73     $ 0.87   Cash dividends per share   $ 0.31     $ 0.29   Average basic shares outstanding     15,840,801       16,283,044   Average diluted shares outstanding     15,841,037       16,283,490     See accompanying notes to consolidated financial statements.   2 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)         Three Months Ended March 31, 2022     Three Months Ended March 31, 2021                     Net income   $ 11,492,000     $ 14,239,000                     Other comprehensive income (loss):                 Unrealized holding gains (losses) on securities available for sale     ( 35,650,000 )     ( 9,168,000 ) Tax effect of unrealized holding gains (losses) on securities available for sale     7,487,000       1,925,000   Other comprehensive income (loss), net of tax effect     ( 28,163,000 )     ( 7,243,000 )                   Comprehensive income (loss)   $ ( 16,671,000 )   $ 6,996,000     See accompanying notes to consolidated financial statements.   3 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)     ($ in thousands except per share amounts)   Preferred Stock     Common Stock     Retained Earnings     Accumulated Other Comprehensive Income (Loss)     Total Shareholders’ Equity                                             Balances, January 1, 2022   $ 0     $ 285,752     $ 174,536     $ ( 3,729 )   $ 456,559                                             Adoption of ASU 2016-13                     316               316                                             Employee stock purchase plan ( 281 shares)             10                       10                                             Dividend reinvestment plan ( 5,835 shares)             222                       222                                             Stock option exercises ( 1,355 shares)             36                       36                                             Stock-based compensation expense             811                       811                                             Cash dividends ( $0.31 per common share)                     ( 4,812 )             ( 4,812 )                                           Net income for the three months ended March 31, 2022                     11,492               11,492                                             Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect                             ( 28,163 )     ( 28,163 )                                           Balances, March 31, 2022   $ 0     $ 286,831     $ 181,532     $ ( 31,892 )   $ 436,471     See accompanying notes to consolidated financial statements.   4 Table of Contents   MERCANTILE BANK CORPORATION  CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) (Unaudited)     ($ in thousands except per share amounts)   Preferred Stock     Common Stock     Retained Earnings     Accumulated Other Comprehensive Income (Loss)     Total Shareholders’ Equity                                             Balances, January 1, 2021   $ 0     $ 302,029     $ 134,039     $ 5,486     $ 441,554                                             Employee stock purchase plan ( 331 shares)             11                       11                                             Dividend reinvestment plan ( 6,647 shares)             213                       213                                             Stock-based compensation expense             643                       643                                             Share repurchase program ( 118,261 shares)             ( 3,538 )                     ( 3,538 )                                           Cash dividends ( $0.29 per common share)                     ( 4,636 )             ( 4,636 )                                           Net income for the three months ended March 31, 2021                     14,239               14,239                                             Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect                             ( 7,243 )     ( 7,243 )                                           Balances, March 31, 2021   $ 0     $ 299,358     $ 143,642     $ ( 1,757 )   $ 441,243     See accompanying notes to consolidated financial statements.   5 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)         Three Months     Three Months       Ended     Ended       March 31, 2022     March 31, 2021   Cash flows from operating activities                 Net income   $ 11,492,000     $ 14,239,000   Adjustments to reconcile net income to net cash from operating activities                 Depreciation and amortization     3,458,000       3,457,000   Accretion of acquired loans     0       ( 34,000 ) Provision for credit losses     100,000       300,000   Stock-based compensation expense     811,000       643,000   Proceeds from sales of mortgage loans held for sale     79,622,000       189,018,000   Origination of mortgage loans held for sale     ( 75,046,000 )     ( 197,245,000 ) Net gain from sales of mortgage loans held for sale     ( 3,205,000 )     ( 9,182,000 ) Net gain from sales and valuation write-downs of foreclosed assets     ( 13,000 )     ( 81,000 ) Net loss from sales and valuation write-downs of former bank premises     0       250,000   Net (gain) loss from sales and write-downs of fixed assets     ( 1,000 )     312,000   Earnings on bank owned life insurance     ( 287,000 )     ( 277,000 ) Net change in:                 Accrued interest receivable     ( 1,344,000 )     ( 971,000 ) Other assets     ( 2,855,000 )     ( 1,367,000 ) Accrued interest and other liabilities     15,156,000       ( 483,000 ) Net cash from (for) operating activities     27,888,000       ( 1,421,000 )                   Cash flows from investing activities                 Loan originations and payments, net     ( 102,241,000 )     ( 180,147,000 ) Purchases of securities available for sale     ( 51,705,000 )     ( 87,307,000 ) Proceeds from maturities, calls and repayments of securities available for sale     2,854,000       30,974,000   Proceeds from sales of foreclosed assets     13,000       158,000   Proceeds from Federal Home Loan Bank stock redemption     281,000       0   Net purchases of premises and equipment and lease activity     ( 332,000 )     ( 1,603,000 ) Net cash for investing activities     ( 151,130,000 )     ( 237,925,000 )                   Cash flows from financing activities                 Net decrease in time deposits     ( 35,861,000 )     ( 51,961,000 ) Net (decrease) increase in all other deposits     ( 71,081,000 )     302,650,000   Net increase in securities sold under agreements to repurchase     6,808,000       22,945,000   Proceeds from Federal Home Loan Bank advances     28,263,000       0   Payoffs of Federal Home Loan Bank advances     ( 20,000,000 )     0   Employee stock purchase plan     10,000       11,000   Net proceeds from stock option exercises     36,000       0   Dividend reinvestment plan     222,000       213,000   Proceeds from subordinated notes issuance     14,701,000       0   Repurchases of common stock     0       ( 3,538,000 ) Payment of cash dividends to common shareholders     ( 4,812,000 )     ( 4,636,000 ) Net cash from (for) financing activities     ( 81,714,000 )     265,684,000                     Net change in cash and cash equivalents     ( 204,956,000 )     26,338,000   Cash and cash equivalents at beginning of period     975,160,000       626,006,000   Cash and cash equivalents at end of period   $ 770,204,000     $ 652,344,000     See accompanying notes to consolidated financial statements.   6 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited)         Three Months     Three Months       Ended     Ended       March 31, 2022     March 31, 2021   Supplemental disclosures of cash flows information                 Cash paid during the period for:                 Interest   $ 4,240,000     $ 5,509,000   Noncash financing and investing activities:                 Transfers from loans to assets held for sale     0       9,709,000   Transfers from bank premises to assets held for sale     0       3,450,000   Transfers from deposits to liabilities held for sale     0       17,280,000     See accompanying notes to consolidated financial statements.   7 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       1. SIGNIFICANT ACCOUNTING POLICIES   Basis of Presentation : The unaudited financial statements for the three months ended March 31, 2022 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries. These subsidiaries include Mercantile Bank (“our bank”) and our bank’s subsidiary, Mercantile Insurance Center, Inc. These consolidated financial statements have been prepared in accordance with the instructions for Form 10 -Q and Item 303 (b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended March 31, 2022 should not be considered as indicative of results for a full year. For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10 -K for the year ended December  31, 2021.   We have five separate business trusts that were formed to issue trust preferred securities. Subordinated debentures were issued to the trusts in return for the proceeds raised from the issuance of the trust preferred securities. The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as a liability.   Coronavirus Pandemic : There remains a significant amount of stress and uncertainty across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid- 19” ) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). This uncertainty is heightened as certain geographic areas continue to experience surges in Covid- 19 cases and governments at all levels continue to react to changes in circumstances, including supply chain disruptions and inflationary pressures.   The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations. We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income. 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 reduce net income.   The following section summarizes the primary measures that directly impact us and our customers.     ● Paycheck Protection Program The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7 (a) loan program. The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs. 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 paid by 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 $ 553 million. As of March 31, 2022, we recorded forgiveness transactions on all but six loans aggregating $ 0.9 million. Net loan origination fees of less than $ 0.1 million were recorded during the first quarter of 2022.   (Continued)   8 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   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 March 31, 2022, we recorded forgiveness transactions on all but 38 loans aggregating $ 11.3 million. Net loan origination fees of $ 0.8 million were recorded during the first quarter of 2022.     ● 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. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022. We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021.     ● Current Expected Credit Loss ( “ CECL ” ) Methodology Delay   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 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. We adopted the CECL methodology effective January 1, 2022.   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 and are determined using the treasury stock method. Our unvested restricted shares, which contain non-forfeitable rights to dividends whether paid or accrued (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 restricted shares are excluded from the calculation of both basic and diluted earnings per share.   Approximately 335,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2022. In addition, stock options for approximately 8,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2022. Approximately 262,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2021. In addition, stock options for approximately 3,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2021. Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2021.   (Continued)   9 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   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. As of March 31, 2022 and December 31, 2021, all of our debt securities were designated as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Federal Home Loan Bank stock is carried at cost.   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.   For available for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance. For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors. In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.   Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when we believe the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At March 31, 2022, there was no allowance for credit losses related to the available for sale debt securities portfolio. Accrued interest receivable on available for sale debt securities totaled $ 3.0 million at March 31, 2022 and was excluded from the estimate of credit losses as any accrued interest that is not expected to be collected is reversed against interest income.   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.   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.   (Continued)   10 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   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. As of March 31, 2022 and December 31, 2021, we determined that the fair value of our mortgage loans held for sale totaled $ 15.2 million and $ 16.7 million, respectively.   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 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. These mortgage banking activities are not designated as hedges and are carried at fair value. The net gain or loss on mortgage banking derivatives, which is generally nominal in dollar amount, is included in the gain on sale of loans and recorded as part of mortgage banking income. Mortgage loans serviced for others totaled approximately $ 1.36 billion and $ 1.34 billion as of March 31, 2022 and December 31, 2021, respectively.   Allowance for Credit Losses ( “ Allowance ” ) : 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, applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. 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 was 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, 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.   We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $ 0.4 million, which included a $ 0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $ 0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.   (Continued)   11 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   Accrued interest receivable for loans is included in other assets on our Consolidated Balance Sheet. We elected not to measure an allowance for accrued interest receivable and instead elected to reverse interest income on loans that are placed on nonaccrual status, which is generally when the loan becomes 90 days past due, or earlier if we believe the collection of interest is doubtful. We believe this policy results in the timely reversal of uncollectible interest.   The allowance is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged-off against the allowance when we believe the uncollectibility of a loan balance is confirmed.   The allowance is measured on a collective pool basis when similar risk characteristics exist. Loans with similar risk characteristics are grouped into homogenous segments, or pools, for analysis. Commercial loans are divided among five segments based primarily on collateral type, risk characteristics, and primary and secondary sources of repayment. These segments are then further stratified based on the commercial loan grade that is assigned using our standard loan grading paradigm. Retail loans are divided into one of two groups based on if the loan is secured by residential real estate or not.   Our loan portfolio segments as of March 31, 2022 were as follows:   o Commercial Loans   ■ Commercial and Industrial   ■ Owner Occupied Commercial Real Estate   ■ Non-Owner Occupied Commercial Real Estate   ■ Multi-Family and Residential Rental   ■ Vacant Land, Land Development and Residential Construction   o Retail Loans   ■ 1 - 4 Family Mortgages   ■ Other Consumer Loans   The “remaining life methodology” is utilized for substantially all loan pools. This non-discounted cash flow approach projects an estimated future amortized cost basis based on current loan balance and repayment terms. Our historical loss rate is then applied to future loan balances at the instrument level based on remaining contractual life adjusted for amortization, prepayment and default to develop a baseline lifetime loss. The baseline lifetime loss is adjusted for changes in macroeconomic conditions over the reasonable and supportable forecast and reversion periods via a series of macroeconomic forecast inputs, such as gross domestic product, unemployment rates, interest rates, credit spreads, stock market volatility and property price indices, to quantify the impact of current and forecasted economic conditions on expected loan performance.   We use migration to determine historical loss rates for commercial loans given the comprehensive loan grading process employed by the bank for over two decades, while an open pool approach is best suited for retail loans given the smaller dollar size of the segments. A baseline loss rate is produced at each reporting date for each loan portfolio segment using bank-specific loan charge-off and recovery data over a defined historical look-back period. The look-back period represents the number of data periods that will be used to calculate a baseline loss rate for each loan portfolio segment. We determined that the look-back period commencing on January 1, 2011 through the current reporting date was reasonable and appropriate.   (Continued)   12 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   Reasonable and supportable economic forecasts have to be incorporated in determining expected credit losses. The forecast period represents the time frame from the current period end through the point in time that we can reasonably forecast and support entity and environmental factors that are expected to impact the performance of our loan portfolio. Ideally, the economic forecast period would encompass the contractual terms of all loans; however, the ability to produce a forecast that is considered reasonable and supportable becomes more difficult or may not be possible in later periods. Subsequent to the end of the forecast period, we revert to historical loan data based on an ongoing evaluation of each economic forecast in relation to then current economic conditions as well as any developing loan loss activity and resulting historical data. As of March 31, 2022, we used a one -year reasonable and supportable economic forecast period, with a six -month straight-line reversion period.   We are not required to develop and use our own economic forecast model, and elected to utilize economic forecasts from a third -party provider that analyzes and develops forecasts of the economy for the entire United States at least quarterly. Our methodology does provide for a potential qualitative factor that can be used in the event of local or regional conditions that depart from the conditions and forecasts for the entire country.   During each reporting period, we also consider the need to adjust historical loss information to reflect the extent to which we expect current conditions and reasonable and supportable economic forecasts to differ from the conditions that existed for the period over which the historical loss information was determined. These qualitative adjustments may increase or decrease our estimate of expected future credit losses.   Traditional qualitative factors include:   o Changes in lending policies and procedures   o Changes in the nature and volume of the loan portfolio and in the terms of loans   o Changes in the experience, ability and depth of lending management and other relevant staff   o Changes in the volume and severity of past due loans, nonaccrual loans and adversely classified loans   o Changes in the quality of the loan review program   o Changes in the value of underlying collateral dependent loans   o Existence and effect of any concentrations of credit and any changes in such   o Effect of other factors such as competition and legal and regulatory requirements on the level of estimated credit losses   The estimation of future credit losses should reflect consideration of all significant factors that affect the collectibility of the loan portfolio at each evaluation date. While our methodology considers both the historical loss rates as well as the traditional qualitative factors, there may be instances or situations where additional qualitative factors need to be considered.   As of March 31, 2022, we employed two additional qualitative factors:   o The Coronavirus Pandemic Factor was established effective June 30, 2020 to address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic.   o The Historical Loss Information Factor was established effective January 1, 2022 to address the low level of loan losses during the look-back period.   Expected credit losses are estimated over the contractual terms of the loans, adjusted for expected prepayments when appropriate. The contractual term generally excludes potential extensions, renewals and modifications.   (Continued)   13 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.   Mortgage Banking Activities : Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.   Servicing fee income is recorded for fees earned for servicing mortgage loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage loan servicing rights is netted against mortgage loan servicing income and recorded in mortgage banking activities in the income statement.   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 under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.   (Continued)   14 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   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.   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 generally consisted of interest rate swap agreements that qualified for hedge accounting. We do not use derivatives for trading purposes.   Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.   If designated as a hedge, we formally document the relationship between derivatives as hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions. This documentation includes linking cash flow hedges to specific assets and liabilities 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 instruments that are used are 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 derivative as a hedge is no longer appropriate or intended. We had no derivative instruments designated as hedges as of March 31, 2022 and December 31, 2021.   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.   The core deposit intangible that arose from the Firstbank Corporation acquisition 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.   (Continued)   15 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES  (Continued)   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. Significant revenue has not 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 that are scoped within Topic 606:       Three Months Ended March 31, 2022     Three Months Ended March 31, 2021   Service charges on deposit and sweep accounts   $ 1,416,000     $ 1,155,000   Credit and debit card fees     1,881,000       1,678,000   Payroll processing     638,000       557,000   Customer service fees     242,000       223,000     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 include 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.   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, sales of cashier checks and money orders, and rentals 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.   Newly Issued Not Yet Effective Standards :  ASU No. 2022 - 02 Financial Instruments – Credit Losses (Topic 326 ): Troubled Debt Restructurings and Vintage Disclosures .  This ASU eliminates the accounting guidance for troubled debt restructurings (“TDRs”) by creditors in Subtopic 310 - 40, Receivables – Troubled Debt Restructurings by Creditors, while adding disclosures for certain loan restructurings by creditors when a borrower is experiencing financial difficulty.  This guidance requires an entity to determine whether the modification results in a new loan or a continuation of an existing loan.  Additionally, the ASU requires disclosures of current period gross charge-offs by year of origination for financing receivables.  This ASU is effective for fiscal years beginning after December 15, 2022.  We do not believe the adoption of this ASU will have a material impact on our financial results.  The required disclosures for gross charge-offs on our financial statements will be added upon adoption of this new standard.   (Continued)   16 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       2. SECURITIES   The amortized cost and estimated fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:       Amortized Cost     Gross Unrealized Gains     Gross Unrealized Losses     Fair Value   March 31, 2022                                 U.S. Government agency debt obligations   $ 442,500,000     $ 74,000     $ ( 31,996,000 )   $ 410,578,000   Mortgage-backed securities     40,215,000       123,000       ( 2,592,000 )     37,746,000   Municipal general obligation bonds     138,916,000       540,000       ( 4,785,000 )     134,671,000   Municipal revenue bonds     23,900,000       39,000       ( 1,773,000 )     22,166,000   Other investments     500,000       0       0       500,000                                         $ 646,031,000     $ 776,000     $ ( 41,146,000 )   $ 605,661,000                                     December 31, 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       Securities with unrealized losses at March 31, 2022 and December 31, 2021, 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       Fair     Unrealized     Fair     Unrealized     Fair     Unrealized       Value     Loss     Value     Loss     Value     Loss   March 31, 2022                                                 U.S. Government agency debt obligations   $ 190,990,000     $ 11,971,000     $ 215,783,000     $ 20,025,000     $ 406,773,000     $ 31,996,000   Mortgage-backed securities     26,110,000       1,783,000       6,594,000       809,000       32,704,000       2,592,000   Municipal general obligation bonds     63,139,000       3,399,000       12,600,000       1,386,000       75,739,000       4,785,000   Municipal revenue bonds     13,671,000       999,000       5,842,000       774,000       19,513,000       1,773,000                                                         $ 293,910,000     $ 18,152,000     $ 240,819,000     $ 22,994,000     $ 534,729,000     $ 41,146,000     (Continued)   17 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     2. SECURITIES (Continued)       Less than 12 Months     12 Months or More     Total       Fair Value     Unrealized Loss     Fair Value     Unrealized Loss     Fair Value     Unrealized Loss   December 31, 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                                                         $ 351,062,000     $ 6,455,000     $ 110,491,000     $ 3,503,000     $ 461,553,000     $ 9,958,000     We evaluate securities in an unrealized loss position at least quarterly. Consideration is given to the length of time and the extent to which 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 March 31, 2022, 527 debt securities with estimated fair values totaling $ 535 million had unrealized losses aggregating $ 41.1 million. At December 31, 2021, 333 debt securities with estimated 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 the 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 value of debt securities at March 31, 2022, 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.   (Continued)   18 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     2. SECURITIES (Continued)       Weighted                       Average     Amortized     Fair       Yield (%)     Cost     Value                             Due in 2022     1.98     $ 10,171,000     $ 10,171,000   Due in 2023 through 2027     1.11       263,429,000       251,105,000   Due in 2028 through 2032     1.74       295,377,000       273,366,000   Due in 2033 and beyond     2.13       36,339,000       32,773,000   Mortgage-backed securities     1.95       40,215,000       37,746,000   Other investments     3.75       500,000       500,000                             Total available for sale securities     1.52     $ 646,031,000     $ 605,661,000     Securities issued by the State of Michigan and all its political subdivisions had combined amortized costs of $ 161 million and $ 155 million at March 31, 2022 and December 31, 2021, respectively, with estimated market values of $ 155 million and $ 158 million, respectively. Securities issued by all other states and their political subdivisions had combined amortized costs of $ 1.6 million and $ 1.7 million and estimated market values of $ 1.6 million and $ 1.7 million at March 31, 2022 and December 31, 2021, 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 $ 204 million and $ 197 million at March 31, 2022 and December 31, 2021, respectively. Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.       3. LOANS AND ALLOWANCE FOR CREDIT 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 collectibility is uncertain. Accrued interest is presented separately in the consolidated balance sheet. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.   (Continued)   19 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Our total loans at March 31, 2022 were $ 3.56 billion compared to $ 3.45 billion at December 31, 2021, an increase of $ 102 million, or 3.0 %. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at March 31, 2022 and December 31, 2021, and the percentage change in loans from the end of 2021 to the end of the first quarter of 2022, are as follows:                                       Percent       March 31, 2022     December 31, 2021     Increase       Balance     %     Balance     %     (Decrease)                                             Commercial:                                         Commercial and industrial (1)   $ 1,153,814,000       32.4 %   $ 1,137,419,000       32.9 %     1.4 % Vacant land, land development, and residential construction     52,693,000       1.5       43,239,000       1.3       21.9   Real estate – owner occupied     582,732,000       16.4       565,758,000       16.4       3.0   Real estate – non-owner occupied     1,007,361,000       28.3       1,027,415,000       29.7       ( 2.0 ) Real estate – multi-family and residential rental     207,962,000       5.9       176,593,000       5.1       17.8   Total commercial     3,004,562,000       84.5       2,950,424,000       85.4       1.8                                             Retail:                                         1-4 family mortgages     522,556,000       14.7       442,547,000       12.8       18.1   Other consumer loans (2)     28,672,000       0.8       60,488,000       1.8       ( 52.6 ) Total retail     551,228,000       15.5       503,035,000       14.6       9.6                                             Total loans   $ 3,555,790,000       100.0 %   $ 3,453,459,000       100.0 %     3.0 %     ( 1 ) For March 31, 2022, and December 31, 2021, includes $ 12.2 million and $ 40.1 million in loans originated under the Paycheck Protection Program, respectively.     ( 2 ) In conjunction with the adoption of the CECL methodology effective January 1, 2022, home equity lines of credit were reclassified to 1 - 4 family mortgage loans from other consumer loans. Home equity lines of credit totaled $ 31.9 million and $ 29.5 million as of March 31, 2022 and December 31, 2021, respectively.     Nonperforming loans as of March 31, 2022 and December 31, 2021 were as follows:       March 31,     December 31,       2022     2021                     Loans past due 90 days or more still accruing interest   $ 0     $ 155,000   Nonaccrual loans     1,612,000       2,313,000                     Total nonperforming loans   $ 1,612,000     $ 2,468,000     (Continued)   20 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   The recorded principal balance of nonperforming loans was as follows:       March 31,     December 31,       2022     2021   Commercial:                 Commercial and industrial   $ 0     $ 663,000   Vacant land, land development, and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     0       663,000                     Retail:                 1-4 family mortgages     1,610,000       1,686,000   Other consumer loans     2,000       119,000   Total retail     1,612,000       1,805,000                     Total nonperforming loans   $ 1,612,000     $ 2,468,000     An age analysis of past due loans is as follows as of March 31, 2022:       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   $ 0     $ 0     $ 0     $ 0     $ 1,153,814,000     $ 1,153,814,000     $ 0   Vacant land, land development, and residential construction     0       0       0       0       52,693,000       52,693,000       0   Real estate – owner occupied     1,195,000       0       0       1,195,000       581,537,000       582,732,000       0   Real estate – non-owner occupied     0       0       0       0       1,007,361,000       1,007,361,000       0   Real estate – multi-family and residential rental     0       0       0       0       207,962,000       207,962,000       0   Total commercial     1,195,000       0       0       1,195,000       3,003,367,000       3,004,562,000       0                                                             Retail:                                                         1-4 family mortgages     567,000       89,000       154,000       810,000       521,746,000       522,556,000       0   Other consumer loans     17,000       0       0       17,000       28,655,000       28,672,000       0   Total retail     584,000       89,000       154,000       827,000       550,401,000       551,228,000       0                                                             Total past due loans   $ 1,779,000     $ 89,000     $ 154,000     $ 2,022,000     $ 3,553,768,000     $ 3,555,790,000     $ 0     (Continued)   21 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT 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)   22 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Nonaccrual loans as of March 31, 2022 were as follows:       Recorded               Principal     Related       Balance     Allowance   With no allowance recorded:                 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:                 1-4 family mortgages     1,585,000       0   Other consumer loans     2,000       0   Total retail     1,587,000       0                     Total with no allowance recorded   $ 1,587,000     $ 0                     With an allowance recorded:                 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:                 1-4 family mortgages     25,000       25,000   Other consumer loans     0       0   Total retail     25,000       25,000                     Total with an allowance recorded   $ 25,000     $ 25,000                     Total nonaccrual loans:                 Commercial   $ 0     $ 0   Retail     1,612,000       25,000   Total nonaccrual loans   $ 1,612,000     $ 25,000     No interest income was recognized on nonaccrual loans during the first quarter of 2022. Lost interest income on nonaccrual loans totaled less than $ 0.1 million during the first quarter of 2022.   (Continued)   23 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. 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 an internal watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on nonaccrual loans, as well as on foreclosed and repossessed assets, are reviewed periodically. We also 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. Under CECL for collateral dependent loans, in instances where the borrower is experiencing financial difficulties, we adopted the practical expedient to measure the allowance based on the fair value of collateral. The allowance is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral and the recorded principal balance. If the fair value of the collateral exceeds the recorded principal balance, no allowance is required.   We had no commercial loans on nonaccrual as of March 31, 2022, while nonaccrual retail loans aggregated $ 1.6 million, a vast majority of which were collateralized by residential property. Nonaccrual loans aggregating $ 1.5 million had no related specific reserve allocations as of March 31, 2022.   Impaired loans as of December 31, 2021, and average impaired loans for the three months ended March 31, 2021, were as follows:                               First Quarter       Unpaid                     Average       Contractual     Recorded             Recorded       Principal     Principal     Related     Principal       Balance     Balance     Allowance     Balance   With no related allowance recorded:                                 Commercial:                                 Commercial and industrial   $ 2,893,000     $ 2,818,000             $ 4,913,000   Vacant land, land development and residential construction     0       0               0   Real estate – owner occupied     9,674,000       9,674,000               14,074,000   Real estate – non-owner occupied     0       0               326,000   Real estate – multi-family and residential rental     91,000       91,000               0   Total commercial     12,658,000       12,583,000               19,313,000                                     Retail:                                 Home equity and other     1,173,000       1,107,000               963,000   1-4 family mortgages     3,166,000       2,205,000               2,550,000   Total retail     4,339,000       3,132,000               3,513,000                                     Total with no related allowance recorded   $ 16,997,000     $ 15,715,000             $ 22,826,000     (Continued)   24 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)                               First Quarter       Unpaid                     Average       Contractual     Recorded             Recorded       Principal     Principal     Related     Principal       Balance     Balance     Allowance     Balance   With an allowance recorded:                                 Commercial:                                 Commercial and industrial   $ 2,192,000     $ 2,192,000     $ 266,000     $ 345,000   Vacant land, land development and residential construction     0       0       0       0   Real estate – owner occupied     761,000       761,000       84,000       632,000   Real estate – non-owner occupied     146,000       146,000       4,000       160,000   Real estate – multi-family and residential rental     0       0       0       0   Total commercial     3,099,000       3,099,000       354,000       1,137,000                                     Retail:                                 Home equity and other     160,000       140,000       123,000       267,000   1-4 family mortgages     412,000       412,000       69,000       665,000   Total retail     572,000       552,000       192,000       932,000                                     Total with an allowance recorded   $ 3,671,000     $ 3,651,000     $ 546,000     $ 2,069,000                                     Total impaired loans:                                 Commercial   $ 15,757,000     $ 15,682,000     $ 354,000     $ 20,450,000   Retail     4,911,000       3,684,000       192,000       4,445,000   Total impaired loans   $ 20,668,000     $ 19,366,000     $ 546,000     $ 24,895,000     Impaired loans for which no allocation of the allowance for credit 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 $ 0.4 million during the first quarter of 2021. No interest income was recognized on nonaccrual loans during the first quarter of 2021. Lost interest income on nonaccrual loans totaled less than $ 0.1 million during the first quarter of 2021.   (Continued)   25 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT 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.   Credit quality indicators were as follows as of March 31, 2022:   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)   $ 719,267,000     $ 34,546,000     $ 358,249,000     $ 497,951,000     $ 132,781,000   Grades 5 – 7     415,709,000       18,031,000       222,095,000       496,757,000       75,034,000   Grades 8 – 9     18,838,000       116,000       2,388,000       12,653,000       147,000   Total commercial   $ 1,153,814,000     $ 52,693,000     $ 582,732,000     $ 1,007,361,000     $ 207,962,000       Retail credit exposure – credit risk profiled by collateral type:       Retail     Retail       1-4 Family     Other Consumer       Mortgages     Loans                     Performing   $ 520,946,000     $ 28,670,000   Nonperforming     1,610,000       2,000   Total retail   $ 522,556,000     $ 28,672,000       ( 1 ) Included in Commercial and Industrial Loans Grades 1 –  4 are $ 12.2 million of loans originated under the Paycheck Protection Program.   (Continued)   26 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   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     Retail       Home Equity     1-4 Family       and Other     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)   27 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT 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 for 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 rate 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 uncollectible, 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)   28 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   The following table reflects loan balances as of March 31, 2022 based on year of origination (dollars in thousands):       2022     2021     2020     2019     2018     Prior     Term Total     Revolving Loans     Grand Total   Commercial:                                                                         Commercial and Industrial:                                                                         Grades 1 – 4   $ 23,869     $ 215,466     $ 59,456     $ 14,728     $ 4,966     $ 11,888     $ 330,373     $ 388,894     $ 719,267   Grades 5 – 7     27,468       148,260       73,905       10,949       2,874       850       264,306       151,403       415,709   Grades 8 – 9     3,673       4,716       87       0       60       56       8,592       10,246       18,838   Total   $ 55,010     $ 368,442     $ 133,448     $ 25,677     $ 7,900     $ 12,794     $ 603,271     $ 550,543     $ 1,153,814                                                                             Vacant Land, Land Development and Residential Construction:                                                                         Grades 1 – 4   $ 7,651     $ 21,988     $ 4,099     $ 0     $ 0     $ 453     $ 34,191     $ 355     $ 34,546   Grades 5 – 7     4,017       12,444       438       116       0       842       17,857       174       18,031   Grades 8 – 9     0       0       0       0       17       99       116       0       116   Total   $ 11,668     $ 34,432     $ 4,537     $ 116     $ 17     $ 1,394     $ 52,164     $ 529     $ 52,693                                                                             Real Estate – Owner Occupied:                                                                         Grades 1 – 4   $ 51,926     $ 186,183     $ 64,960     $ 22,202     $ 18,739     $ 14,239     $ 358,249     $ 0     $ 358,249   Grades 5 – 7     50,222       87,685       46,255       12,241       16,595       9,097       222,095       0       222,095   Grades 8 – 9     0       0       48       2,171       169       0       2,388       0       2,388   Total   $ 102,148     $ 273,868     $ 111,263     $ 36,614     $ 35,503     $ 23,336     $ 582,732     $ 0     $ 582,732                                                                             Real Estate – Non-Owner Occupied:                                                                         Grades 1 – 4   $ 40,445     $ 199,956     $ 146,664     $ 71,923     $ 21,200     $ 17,763     $ 497,951     $ 0     $ 497,951   Grades 5 – 7     35,131       193,821       162,866       39,685       15,924       49,330       496,757       0       496,757   Grades 8 – 9     0       12,653       0       0       0       0       12,653       0       12,653   Total   $ 75,576     $ 406,430     $ 309,530     $ 111,608     $ 37,124     $ 67,093     $ 1,007,361     $ 0     $ 1,007,361                                                                             Real Estate – Multi-Family and Residential Rental:                                                                         Grades 1 – 4   $ 20,158     $ 59,645     $ 38,770     $ 5,905     $ 3,165     $ 5,138     $ 132,781     $ 0     $ 132,781   Grades 5 – 7     17,570       32,757       15,146       3,992       3,714       1,855       75,034       0       75,034   Grades 8 – 9     0       89       0       0       0       58       147       0       147   Total   $ 37,728     $ 92,491     $ 53,916     $ 9,897     $ 6,879     $ 7,051     $ 207,962     $ 0     $ 207,962   Total Commercial   $ 282,130     $ 1,175,663     $ 612,694     $ 183,912     $ 87,423     $ 111,668     $ 2,453,490     $ 551,072     $ 3,004,562                                                                             Retail:                                                                         1-4 Family Mortgages   $ 67,861     $ 235,895     $ 101,123     $ 16,365     $ 17,173     $ 52,618     $ 491,035     $ 31,521     $ 522,556   Other Consumer Loans     1,261       4,369       1,915       1,892       807       935       11,179       17,493       28,672   Total Retail   $ 69,122     $ 240,264     $ 103,038     $ 18,257     $ 17,980     $ 53,553     $ 502,214     $ 49,014     $ 551,228                                                                             Grand Total   $ 351,252     $ 1,415,927     $ 715,732     $ 202,169     $ 105,403     $ 165,221     $ 2,955,704     $ 600,086     $ 3,555,790     (Continued)   29 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Activity in the allowance for credit losses during the three months ended March 31, 2022 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     1-4 family mortgages     Other consumer loans     Unallocated     Total   Allowance for credit losses:                                                                         Beginning balance   $ 10,782     $ 420     $ 6,045     $ 13,301     $ 1,695     $ 2,449     $ 626     $ 45     $ 35,363   Adoption of ASU 2016-13     ( 1,571 )     ( 43 )     ( 560 )     ( 2,534 )     ( 621 )     5,395       ( 411 )     ( 55 )     ( 400 ) Provision for credit losses     ( 742 )     106       286       ( 445 )     194       593       ( 33 )     141       100   Charge-offs     ( 170 )     ( 29 )     0       0       0       ( 2 )     ( 4 )     0       ( 205 ) Recoveries     114       1       32       0       8       127       13       0       295   Ending balance   $ 8,413     $ 455     $ 5,803     $ 10,322     $ 1,276     $ 8,562     $ 191     $ 131     $ 35,153     (Continued)   30 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Activity in the allowance for loan losses for loans during the three months ended March 31, 2021 and the recorded investments in loans as of 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     583       40       ( 181 )     140       6       ( 82 )     ( 337 )     131       300   Charge-offs     0       ( 15 )     0       0       0       ( 4 )     ( 33 )     0       ( 52 ) Recoveries     104       16       239       0       0       38       83       0       480   Ending balance   $ 10,111     $ 720     $ 8,304     $ 13,751     $ 1,825     $ 841     $ 2,953     $ 190     $ 38,695                                                                             Ending balance: individually evaluated for impairment   $ 62     $ 0     $ 47     $ 7     $ 0     $ 230     $ 141     $ 0     $ 487                                                                             Ending balance: collectively evaluated for impairment   $ 10,049     $ 720     $ 8,257     $ 13,744     $ 1,825     $ 611     $ 2,812     $ 190     $ 38,208                                                                             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)   31 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Loans modified as troubled debt restructurings during the three months ended March 31, 2022 were as follows:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     0     $ 0     $ 0   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     0       0       0   Real estate – non-owner occupied     0       0       0   Real estate – multi-family and residential rental     0       0       0   Total commercial     0       0       0                             Retail:                         1-4 family mortgages     2       128,000       128,000   Other consumer loans     0       0       0   Total retail     2       128,000       128,000                             Total loans     2     $ 128,000     $ 128,000     Loans modified as troubled debt restructurings during the three months ended March 31, 2021 were as follows:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     1     $ 23,000     $ 22,000   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     0       0       0   Real estate – non-owner occupied     0       0       0   Real estate – multi-family and residential rental     0       0       0   Total commercial     1       23,000       22,000                             Retail:                         Home equity and other     1       71,000       71,000   1-4 family mortgages     1       36,000       36,000   Total retail     2       107,000       107,000                             Total loans     3     $ 130,000     $ 129,000     (Continued)   32 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2022 ( amounts as of period end):               Recorded       Number of     Principal       Contracts     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:                 1-4 family mortgages     0       0   Other consumer loans     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 within the three months ended March 31, 2021 ( amounts as of period end):               Recorded       Number of     Principal       Contracts     Balance   Commercial:                 Commercial and industrial     2     $ 593,000   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     2       593,000                     Retail:                 Home equity and other     0       0   1-4 family mortgages     1       6,000   Total retail     1       6,000                     Total     3     $ 599,000     (Continued)   33 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2022 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   $ 4,973,000     $ 0     $ 10,435,000     $ 146,000     $ 91,000   Charge-Offs     0       0       0       0       0   Payments     ( 212,000 )     0       ( 9,677,000 )     ( 3,000 )     ( 1,000 ) Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     ( 1,932,000 )     0       ( 669,000 )     0       0   Ending Balance   $ 2,829,000     $ 0     $ 89,000     $ 143,000     $ 90,000           Retail     Retail       1-4 Family     Other Consumer       Mortgages     Loans   Retail Loan Portfolio:                 Beginning Balance   $ 627,000     $ 1,202,000   Charge-Offs     0       0   Payments     ( 78,000 )     ( 2,000 ) Transfers to ORE     0       0   Net Additions/Deletions (1)     1,797,000       ( 1,187,000 ) Ending Balance   $ 2,346,000     $ 13,000       ( 1 ) Includes $ 1.2 million in the transfer of home equity lines of credit from other consumer loans to 1 - 4 family mortgages in association with the adoption of the CECL methodology effective January 1, 2022.   (Continued)   34 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2021 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   $ 6,414,000     $ 0     $ 14,797,000     $ 480,000     $ 0   Charge-Offs     0       0       0       0       0   Payments     ( 2,676,000 )     0       ( 910,000 )     ( 9,000 )     0   Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     22,000       0       0       0       0   Ending Balance   $ 3,760,000     $ 0     $ 13,887,000     $ 471,000     $ 0           Retail     Retail       Home Equity     1-4 Family       and Other     Mortgages   Retail Loan Portfolio:                 Beginning Balance   $ 1,146,000     $ 806,000   Charge-Offs     0       0   Payments     ( 118,000 )     ( 22,000 ) Transfers to ORE     0       0   Net Additions/Deletions     71,000       36,000   Ending Balance   $ 1,099,000     $ 820,000     (Continued)   35 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)             4.      PREMISES AND EQUIPMENT, NET   Premises and equipment are comprised of the following:       March 31,     December 31,       2022     2021                     Land and improvements   $ 15,111,000     $ 15,111,000   Buildings     56,202,000       56,168,000   Furniture and equipment     23,244,000       22,974,000         94,557,000       94,253,000   Less: accumulated depreciation     38,479,000       36,955,000                     Premises and equipment, net   $ 56,078,000     $ 57,298,000     Depreciation expense totaled $ 1.6 million and $ 1.4 million during the first quarters of 2022 and 2021, respectively.   (Continued)   36 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     4. PREMISES AND EQUIPMENT, NET (Continued)   We enter into facility leases in the normal course of business. As of March 31, 2022 and December 31, 2021, we were under lease contracts for ten of our banking facilities. The leases had maturity dates ranging from June, 2022 through December, 2026, with a weighted average life of 2.6 years and 2.8 years as of March 31, 2022 and December 31, 2021, respectively. All of our leases have multiple three - to five - year extensions; however, those 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 commitment 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 4.70 % as of March 31, 2022 and 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, each totaled $ 2.6 million as of March 31, 2022, and $ 2.9 million as of December 31, 2021. 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 $ 0.2 million during the first quarters of 2022 and 2021.   Future lease payments at March 31, 2022 totaled $ 3.4 million, comprised of $ 0.8 million in one year, $ 1.2 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, 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.   (Continued)   37 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       5. DEPOSITS   Our total deposits at March 31, 2022 totaled $ 3.98 billion, a decrease of $ 107 million, or 2.6 %, from December  31, 2021. The components of our outstanding balances at March 31, 2022 and December 31, 2021, and percentage change in deposits from the end of 2021 to the end of the first quarter of 2022, are as follows:                                       Percent       March 31, 2022     December 31, 2021     Increase       Balance     %     Balance     %     (Decrease)                                             Noninterest-bearing checking   $ 1,686,203,000       42.4 %   $ 1,677,952,000       41.1 %     0.5 % Interest-bearing checking     544,221,000       13.7       538,838,000       13.2       1.0   Money market     943,246,000       23.7       1,040,176,000       25.5       ( 9.3 ) Savings     406,545,000       10.2       394,330,000       9.7       3.1   Time, under $100,000     127,755,000       3.2       132,776,000       3.2       ( 3.8 ) Time, $100,000 and over     252,088,000       6.4       275,208,000       6.7       ( 8.4 ) Total local deposits     3,960,058,000       99.6       4,059,280,000       99.4       ( 2.4 )                                           Out-of-area time, $100,000 and over     16,193,000       0.4       23,913,000       0.6       ( 32.3 )                                           Total deposits   $ 3,976,251,000       100.0 %   $ 4,083,193,000       100.0 %     ( 2.6 %)   Time deposits of more than $250,000 totaled $ 181 million and $ 207 million at March 31, 2022 and December 31, 2021, respectively.       6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE   Securities sold under agreements to repurchase (“repurchase agreements”) are offered principally to certain large deposit customers. Information relating to our repurchase agreements follows:       Three Months Ended     Twelve Months Ended       March 31, 2022     December 31, 2021                     Outstanding balance at end of period   $ 204,271,000     $ 197,463,000   Average interest rate at end of period     0.10 %     0.11 %                   Average daily balance during the period   $ 198,949,000     $ 158,855,000   Average interest rate during the period     0.10 %     0.11 %                   Maximum daily balance during the period   $ 224,345,000     $ 209,093,000     Repurchase agreements generally have original maturities of less than one year. Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities. Securities involved with the agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank. Repurchase agreements are secured by securities with an aggregate market value equal to the aggregate outstanding balance.   (Continued)   38 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       7. FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES   Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $ 354 million at March 31, 2022, and were expected to mature at varying dates from April 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 1.98 %. FHLBI bullet 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 %.   Maturities of FHLBI bullet advances as of March 31, 2022 were as follows:   2022   $ 74,000,000   2023     80,000,000   2024     80,000,000   2025     50,000,000   2026     30,000,000   Thereafter     40,000,000     FHLBI amortizing advances totaled $ 28.3 million as of March 31, 2022, with an average rate of 2.52 %. We had no FHLBI amortizing advances outstanding as of December 31, 2021. FHLBI amortizing advances are obtained periodically to assist in managing interest rate risk associated with certain longer-term fixed rate commercial loans, with annual principal payments that closely align with the scheduled amortization of the underlying commercial loans.   Schedule principal payments of FHLBI amortizing advances as of March 31, 2022 were as follows:   2022   $ 0   2023     353,000   2024     826,000   2025     862,000   2026     899,000   Thereafter     25,323,000     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 March 31, 2022 totaled $ 932 million, with remaining availability based on collateral equaling $ 544 million.       8. COMMITMENTS AND OFF-BALANCE SHEET RISK   Our bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by 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.   (Continued)   39 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     8. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)   These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on our credit assessment of the borrower.   We are required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.   We have determined that our commercial-related lending commitments are unconditionally cancellable. Additionally, the vast majority of unfunded commercial loan commitments consist of revolving lines of credit wherein the aggregate amounts outstanding and available remain relatively stable, and any seasonality of line usage is nominal. Line of credit draws, irrespective of the maximum credit or individual note amount, are governed by borrowing or advance formulas, while draws off of commercial and residential construction loans are governed by the receipt and satisfactory review of contractor and subcontractor sworn statements, lien waivers and title insurance company endorsements. Letters of credit are rarely drawn. For retail lines of credit, including home equity lines of credit, overdraft protection lines of credit and personal unsecured lines of credit, and credit cards, average outstanding balances as a percent of total available credit have remained relatively steady over the past several years. We determined allowance requirements for these credit types by calculating the difference between the average percent outstanding of funded commitments over the past several years to actual percent outstanding as of March 31, 2022 and applying the respective expected loss allocation factors to the difference as this difference represents the average of unfunded commitments we expect to eventually be drawn upon. The calculated allowance for the retail lines of credit and credit cards as of March 31, 2022 was less than $ 0.1 million.   A summary of the contractual amounts of our financial instruments with off-balance sheet risk at March 31, 2022 and December 31, 2021 is as follows:        March 31,     December 31,       2022     2021                     Commercial unused lines of credit   $ 1,115,888,000     $ 1,098,951,000   Unused lines of credit secured by 1–4 family residential properties     65,112,000       64,313,000   Credit card unused lines of credit     95,813,000       92,146,000   Other consumer unused lines of credit     72,544,000       64,876,000   Commitments to make loans     158,102,000       212,476,000   Standby letters of credit     32,954,000       33,109,000       $ 1,540,413,000     $ 1,565,871,000       9. 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)   40 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     9. 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 values of derivative instruments as of March 31, 2022 are reflected in the following table.       Notional Amount   Balance Sheet Location   Fair Value   Derivative Assets                   Interest rate swaps   $ 338,231,000   Other Assets   $ 10,053,000   Derivative Liabilities                   Interest rate swaps     338,231,000   Other Liabilities     10,246,000     The effect of interest rate swaps that are not designated as hedging instruments resulted in noninterest income of less than $ 0.1 million during the first quarter of 2022.   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 $ 10.2 million as of March 31, 2022. Cash collateral totaling $ 10.3 million was provided by the counterparty correspondent banks as of March 31, 2022.   Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 338 million as of March 31, 2022. 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 values 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.   (Continued)   41 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       10. FAIR VALUES OF FINANCIAL INSTRUMENTS   The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of March 31, 2022 and December 31, 2021 ( dollars in thousands):       Level in   March 31, 2022     December 31, 2021       Fair Value   Carrying     Fair     Carrying     Fair       Hierarchy   Values     Values     Values     Values   Financial assets:                                     Cash   Level 1   $ 18,898     $ 18,898     $ 17,872     $ 17,872   Cash equivalents   Level 1     751,306       751,306       957,288       957,288   Securities available for sale   (1)     605,661       605,661       592,743       592,743   FHLBI stock   (2)     17,721       17,721       18,002       18,002   Loans, net   Level 3     3,520,637       3,542,217       3,418,096       3,498,345   Mortgage loans held for sale   Level 2     14,746       15,208       16,117       16,707   Mortgage servicing rights   Level 2     12,484       16,533       12,248       15,445   Accrued interest receivable   Level 2     10,655       10,655       9,311       9,311   Interest rate swaps   Level 2     10,053       10,053       4,609       4,609                                         Financial liabilities:                                     Deposits   Level 2     3,976,251       3,795,104       4,083,193       4,028,249   Repurchase agreements   Level 2     204,271       204,271       197,463       197,463   FHLBI advances   Level 2     382,263       372,887       374,000       384,927   Subordinated debentures   Level 2     48,415       49,990       48,244       48,284   Subordinated notes   Level 2     88,428       88,429       73,646       73,646   Accrued interest payable   Level 2     2,150       2,150       1,393       1,393   Interest rate swaps   Level 2     10,246       10,246       4,857       4,857       ( 1 ) See Note 11 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities.     ( 2 ) It is not practical to determine the fair value of FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount.   Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. Fair value for loans is based on an exit price model as required by ASU 2016 - 01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposit accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. 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. The fair values of subordinated debentures, subordinated notes, and FHLBI advances are based on current rates for similar financing. The fair value of off-balance sheet items is estimated to be nominal.   (Continued)   42 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       11. FAIR VALUES   Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.   We are required to use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources, or unobservable, meaning those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:   Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.   Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.   Level 3: Significant unobservable inputs that reflect our own conclusions about the assumptions that market participants would use in pricing an asset or liability.   The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities that are recorded at fair value on a recurring or nonrecurring basis:   Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal general obligation and revenue bonds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment. There was no such impairment as of March 31, 2022 or December 31, 2021. We have no Level 1 securities available for sale.   (Continued)   43 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11. FAIR VALUES (Continued)   Derivatives . We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves.   Mortgage loans held for sale . Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors, and are measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics. As of March 31, 2022 and December 31, 2021, we determined the fair value of our mortgage loans held for sale to be $ 15.2 million and $ 16.7 million, respectively.   Loans . We do not record loans at fair value on a recurring basis. However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge-off. The fair values of impaired loans are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.   Foreclosed Assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed and repossessed assets, establishing a new cost basis. We subsequently adjust estimated fair value of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.   Assets and Liabilities Measured at Fair Value on a Recurring Basis   The balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2022 are as follows:               Quoted                               Prices in                               Active     Significant                       Markets for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)   Available for sale securities                                 U.S. Government agency debt obligations   $ 410,578,000     $ 0     $ 410,578,000     $ 0   Mortgage-backed securities     37,746,000       0       37,746,000       0   Municipal general obligation bonds     134,671,000       0       133,994,000       677,000   Municipal revenue bonds     22,166,000       0       22,166,000       0   Other investments     500,000       0       500,000       0   Interest rate swaps     10,053,000       0       10,053,000       0   Total   $ 615,714,000     $ 0     $ 615,037,000     $ 677,000     There were no transfers in or out of Level 1, Level 2 or Level 3 available for sale securities during the first three months of 2022.   (Continued)   44 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11. FAIR VALUES (Continued)   The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2021 are as follows:               Quoted                               Prices in                               Active     Significant                       Markets for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)   Available for sale securities                                 U.S. Government agency debt obligations   $ 390,371,000     $ 0     $ 390,371,000     $ 0   Mortgage-backed securities     41,803,000       0       41,803,000       0   Municipal general obligation bonds     137,594,000       0       136,917,000       677,000   Municipal revenue bonds     22,475,000       0       22,475,000       0   Other investments     500,000       0       500,000       0   Interest rate swaps     4,609,000       0       4,609,000       0   Total   $ 597,352,000     $ 0     $ 596,675,000     $ 677,000     There were no transfers in or out of Level 1, Level 2 or Level 3 available for sale securities during 2021.   Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis   The balances of assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2022 are as follows:               Quoted                               Prices in                               Active     Significant                       Markets for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)                                     Loans   $ 1,338,000     $ 0     $ 0     $ 1,338,000   Foreclosed assets     0       0       0       0   Total   $ 1,338,000     $ 0     $ 0     $ 1,338,000     (Continued)   45 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11. FAIR VALUES (Continued)   The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2021 are as follows:               Quoted                               Prices in                               Active     Significant                       Markets for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)                                     Impaired loans   $ 3,807,000     $ 0     $ 0     $ 3,807,000   Foreclosed assets     0       0       0       0   Total   $ 3,807,000     $ 0     $ 0     $ 3,807,000     The carrying values are based on the estimated value of the property or other assets. Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. For real estate dependent loans and foreclosed assets, we generally assign a 15 % to 25 % discount factor for commercial-related properties, and a 25 % to 50 % discount factor for residential-related properties. In a vast majority of cases, we assign a 10 % discount factor for estimated selling costs.       12. REGULATORY MATTERS   We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements.   The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if, after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator. At March 31, 2022 and December 31, 2021, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since March 31, 2022 that we believe have changed our bank’s categorization.   (Continued)   46 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     12. REGULATORY MATTERS (Continued)   Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:                                       Minimum Required                                       to be Well                       Minimum Required     Capitalized Under                       for Capital     Prompt Corrective       Actual     Adequacy Purposes     Action Regulations       Amount     Ratio     Amount     Ratio     Amount     Ratio   March 31, 2022                                                 Total capital (to risk weighted assets)                                                 Consolidated   $ 587,976       14.1 %   $ 333,754       8.0 %   $ NA     NA   Bank     574,013       13.8       333,587       8.0       416,984       10.0 % Tier 1 capital (to risk weighted assets)                                                 Consolidated     464,396       11.1       250,315       6.0       NA     NA   Bank     538,860       12.9       250,191       6.0       333,587       8.0   Common equity tier 1 (to risk weighted assets)                                                 Consolidated     418,055       10.0       187,737       4.5       NA     NA   Bank     538,860       12.9       187,643       4.5       271,040       6.5   Tier 1 capital (to average assets)                                                 Consolidated     464,396       9.0       205,492       4.0       NA     NA   Bank     538,860       10.5       205,409       4.0       256,761       5.0                                                     December 31, 2021                                                 Total capital (to risk weighted assets)                                                 Consolidated   $ 565,143       14.0 %   $ 324,101       8.0 %   $ NA     NA   Bank     551,760       13.6       323,928       8.0       404,910       10.0 % Tier 1 capital (to risk weighted assets)                                                 Consolidated     456,133       11.3       243,076       6.0       NA     NA   Bank     516,397       12.8       242,946       6.0       323,928       8.0   Common equity tier 1 (to risk weighted assets)                                                 Consolidated     409,963       10.1       182,307       4.5       NA     NA   Bank     516,397       12.8       182,210       4.5       263,192       6.5   Tier 1 capital (to average assets)                                                 Consolidated     456,133       9.2       198,574       4.0       NA     NA   Bank     516,397       10.4       198,510       4.0       248,137       5.0     (Continued)   47 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     12. REGULATORY MATTERS (Continued)   Our consolidated capital levels as of March 31, 2022 and December 31, 2021 include $ 46.3 million and $ 46.2 million, respectively, of trust preferred securities. Under applicable Federal Reserve guidelines, the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate amount of restricted core elements that may be included in our Tier 1 capital must not exceed 25 % of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Our ability to include the trust preferred securities in Tier 1 capital in accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated assets as of December 31, 2009 were less than $ 15.0 billion. As of March 31, 2022 and December 31, 2021, all $ 46.3 million and $ 46.2 million, respectively, of the trust preferred securities were included in our consolidated Tier 1 capital.   Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5 % of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0 %, the Tier 1 capital ratio to 8.5 % and the total capital ratio to 10.5 % on a fully phased-in basis on January 1, 2019. We believe that, as of March 31, 2022, our bank met all capital adequacy requirements under the BASEL III capital rules.   Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On January 13, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.31 per share that was paid on March 16, 2022 to shareholders of record as of March 4, 2022. On April 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.31 per share that will be paid on June 15, 2022 to shareholders of record as of June 3, 2022.   As of March 31, 2022, we had the ability to repurchase up to $ 6.8 million in common stock shares from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations as part of a $ 20.0 million common stock repurchase program announced in May 2021. No shares were repurchased during the first three months of 2022. Historically, stock repurchases have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.     48 Table of Contents   MERCANTILE BANK CORPORATION     Item 2.       Management ’ s Discussion and Analysis of Financial Condition and Results of Operations   Forward-Looking Statements This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “is likely,” “plans,” “projects,” “indicates,” “strategy,” “future,” “likely,” “may,” “should,” “will,” 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 tax laws; 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; unstable political and economic environment; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2021. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.   Introduction The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank of Michigan (“our bank”) and our bank’s subsidiary Mercantile Insurance Center, Inc., at March 31, 2022 and December 31, 2021 and the results of operations for the three months ended March 31, 2022 and March 31, 2021. This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.   Critical Accounting Policies   Accounting principles generally accepted in the United States of America (“GAAP”) are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting policies, see Note 1 of the Notes to our Consolidated Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2021 (Commission file number 000-26719). Our critical accounting policies are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such estimates may have a significant impact on the financial statements, and actual results may differ from those estimates. We have reviewed the application of these policies with the Audit Committee of our Board of Directors.     49 Table of Contents   MERCANTILE BANK CORPORATION     Allowance for Credit Losses ( “ Allowance ” ) : The allowance is maintained at a level we believe is adequate to absorb estimated credit 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. Credit losses are charged against the allowance when we believe the uncollectibility 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. The allowance is increased through a provision charged to operating expense. Uncollectible loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.   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 current expected credit loss (“CECL”) model, applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. 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 was 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 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.   We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.   See Note 1- Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.     50 Table of Contents   MERCANTILE BANK CORPORATION     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 tax 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 that we 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 which may impact future operating results. Significant weight is given to evidence that can be objectively verified.   Debt Securities Available for Sale : Debt securities available for sale consist of bonds which might be sold prior to maturity due to a number of factors, including changes in interest rates, prepayment risks, yield and availability of alternative investments or liquidity needs. Debt securities classified as available for sale are reported at their fair value. For available for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance. For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors. In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.   Changes in the allowance for credit losses under CECL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when we believe the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At March 31, 2022, there was no allowance for credit losses related to the available for sale debt securities portfolio   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 prepayment speeds, the remaining life of the mortgage 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.     51 Table of Contents   MERCANTILE BANK CORPORATION     Goodwill : GAAP requires us to determine the fair value of all of the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value. In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as 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 if conditions in the market place or changes in the company’s organizational structure occur.   Coronavirus Pandemic There remains a significant amount of stress and uncertainty across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances, including supply chain disruptions and inflationary pressures.   The Coronavirus Pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a material negative impact on our financial condition and results of operations. We continue to occupy an asset-sensitive position, whereby interest rate environments characterized by numerous and/or high magnitude interest rate reductions have a negative impact on our net interest income and net income. 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 reduce net income.   The following section summarizes the primary measures that directly impact us and our customers.     ● Paycheck Protection Program The Paycheck Protection Program (“PPP”) reflects a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors. The PPP provides 100% guaranteed loans to cover specific operating costs. 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 paid by 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 $553 million. As of March 31, 2022, we recorded forgiveness transactions on all but six loans aggregating $0.9 million. Net loan origination fees of less than $0.1 million were recorded during the first quarter of 2022.   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 March 31, 2022, we recorded forgiveness transactions on all but 38 loans aggregating $11.3 million. Net loan origination fees of $0.8 million were recorded during the first quarter of 2022.     52 Table of Contents   MERCANTILE BANK CORPORATION       ● 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. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022. We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021.     ● Current Expected Credit Loss Methodology Delay   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 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. We adopted the CECL methodology effective January 1, 2022.     First Quarter 2022 Financial Overview We reported net income of $11.5 million, or $0.73 per diluted share, for the first quarter of 2022, compared with net income of $14.2 million, or $0.87 per diluted share, during the first quarter of 2021. Ongoing strong core commercial loan growth, continued strength in asset quality metrics and increases in several key fee income revenue streams in large part mitigated a significant decline in mortgage banking revenue as originations come off of 2020 and 2021 record levels driven by low mortgage loan rates and resulting brisk refinancing activity.   Commercial loans increased $54.1 million during the first three months of 2022, reflecting net growth of core commercial loans and payment activities under the PPP. Core commercial loans increased $82.0 million, or over 11% on an annualized basis, while PPP payment activities aggregated $27.9 million, during the first three months of 2022. Core commercial and industrial loans increased $44.3 million, multi-family and residential rental property loans grew $31.4 million, owner occupied commercial real estate (“CRE”) loans were up $17.0 million, and vacant land, land development and residential construction loans increased $9.5 million, while non-owner occupied CRE loans were down $20.1 million. As a percent of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 57.6% as of March 31, 2022, compared to 57.1% at December 31, 2021. The new commercial loan pipeline remains strong, and as of March 31, 2022, we had $184 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 only 0.05% of total loans as of March 31, 2022. Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties as of March 31, 2022. Gross loan charge-offs totaled $0.2 million during the first quarter of 2022, while recoveries of prior period loan charge-offs totaled $0.3 million, providing for net loan recoveries of $0.1 million, or 0.01% of average total loans on an annualized basis.   We recorded a provision expense of $0.1 million during the first quarter of 2022, compared to $0.3 million during the prior-year first quarter. The provision expense recorded during both periods mainly reflected allocations necessitated by net loan growth; the recording of net loan recoveries and continued strong loan quality metrics during the periods in large part mitigated additional reserves associated with loan growth. Our adoption of Accounting Standards Update No. 2016-13, Measurement of Credit Losses on Financial Instruments , on January 1, 2022, resulted in a $0.4 million one-time reduction to the allowance for credit losses.     53 Table of Contents   MERCANTILE BANK CORPORATION     Interest-earning balances, primarily consisting of excess funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During the first three months of 2022, the average balance of these funds equaled $784 million, or 16.1% of average earning assets, compared to $592 million, or 13.7% of average earning assets, during the first quarter of 2021, and $671 million, or 14.9% of average earning assets, during 2021; these levels are substantially higher than our typical average balance of $75 million, or approximately 2% of average earning assets. The elevated levels during 2021 and through the first quarter of 2022 primarily reflect increased local deposits from federal government stimulus programs and reduced business and consumer investing and spending, and have resulted in a significant negative impact on our net interest margin.   Total deposits decreased $107 million during the first three months of 2022, totaling $3.98 billion at March 31, 2022. Local deposits decreased $99.2 million, while out-of-area deposits declined $7.7 million. The reduced level of local deposits primarily reflected a single customer’s withdrawal of a majority of funds that were deposited in late 2021; excluding this withdrawal, local deposits were up approximately $50 million during the first three months of 2022.   Net interest income totaled $30.9 million during the first quarter of 2022, compared to $29.5 million during the same time period in 2021. Interest income increased $1.1 million, as growth in average loans and securities more than offset a lower level of PPP loan net fee income accretion. Interest expense declined $0.3 million, primarily comprised of a $0.9 million reduction in deposit interest expense reflecting lower deposit rates that more than offset increased interest-bearing deposit balances, and a $0.8 million increase in the cost of other borrowed money stemming from the issuance of $75.0 million in subordinated notes in December 2021 and a $15.0 million follow-on issuance in mid-January 2022.   Noninterest income totaled $9.3 million during the first quarter of 2022, compared to $13.5 million during the first quarter of 2021. The lower level of noninterest income almost exclusively reflected decreased mortgage banking income, which more than offset growth in several key fee income sources, including interest rate swap income, service charges on accounts, credit and debit card income, and payroll processing fees. Sustained strength in purchase mortgage loan originations partially mitigated the negative impacts of reduced refinance activity, rising mortgage loan interest rates, a lower mortgage loan sold percentage and a decreased gain on sale rate during the first quarter of 2022.   Noninterest expense totaled $25.7 million during the first quarter of 2022, compared to $25.1 million during the same time period in 2021. Overhead costs during the first three months of 2021 included write-downs of former branch facilities totaling $0.5 million. The higher level of expense primarily resulted from increased compensation costs, mainly depicting annual merit pay increases, market adjustments and promotions over the past twelve months.   Financial Condition Our total assets decreased $81.9 million during the first three months of 2022, and totaled $5.18 billion as of March 31, 2022. Total loans increased $102 million and securities available for sale grew $12.9 million, while interest-earning deposits declined $217 million. Total deposits decreased $107 million during the first three months of 2022.   Commercial loans increased $54.1 million during the first three months of 2022, reflecting net growth of core commercial loans and payment activities under the PPP. Core commercial loans increased $82.0 million, or over 11% on an annualized basis, while PPP payment activities aggregated $27.9 million, during the first three months of 2022. Core commercial and industrial loans increased $44.3 million, multi-family and residential rental property loans grew $31.4 million, owner occupied CRE loans were up $17.0 million, and vacant land, land development and residential construction loans increased $9.5 million, while non-owner occupied CRE loans were down $20.1 million. As a percent of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 57.6% as of March 31, 2022, compared to 57.1% at December 31, 2021.     54 Table of Contents   MERCANTILE BANK CORPORATION     As of March 31, 2022, availability on existing construction and development loans totaled $184 million, with most of those 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 approximately $158 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 ongoing additional opportunities they are currently discussing with existing and potentially new borrowers. 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 has been on an increasing trend over the past several quarters, equaling 38% as of March 31, 2022. Historically, the level of commercial lines of credit usage has equaled 40% to 45%; however, the level averaged approximately 32% since the onset of the Coronavirus Pandemic through the end of the third quarter of 2021.   Residential mortgage loans increased $48.1 million during the first quarter of 2022, totaling $523 million, or 14.7% of total loans, as of March 31, 2022. Activity within the residential mortgage loan function has declined over the past several months, in large part reflecting increased mortgage loan rates and the resulting decline in mortgage loan refinance activity that was only partially mitigated by increased purchase mortgage loan activity. Residential mortgage loan originations totaled $168 million during the first three months of 2022, an almost 32% decline from the $245 million originated during the same time period in 2021. Refinance mortgage loans originated comprised about 40% of the total mortgage loans originated during the first quarter of 2022, compared to over 66% during the first quarter of 2021. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $75.7 million during the first quarter of 2022, or about 45% of the total residential mortgage loans originated during the first three months of 2022, compared to approximately 80% during the same time period in 2021. Residential mortgage loans originated not sold are generally comprised of adjustable rate residential mortgage loans.   Other consumer-related loans remained relatively unchanged during the first quarter of 2022, and at March 31, 2022 totaled $28.7 million, or 0.8% of total loans. Other consumer-related loans comprised 0.9% of total loans as of December 31, 2021. We expect this loan portfolio segment to decline in future periods as scheduled principal payments exceed origination volumes.   The following table summarizes our loan portfolio over the past twelve months:       3/31/22     12/31/21     9/30/21     6/30/21     3/31/21   Commercial:                                         Commercial & Industrial (1)   $ 1,153,814,000     $ 1,137,419,000     $ 1,074,394,000     $ 1,103,807,000     $ 1,284,507,000   Land Development & Construction     52,693,000       43,239,000       38,380,000       43,111,000       58,738,000   Owner Occupied Commercial RE     582,732,000       565,758,000       551,762,000       550,504,000       544,342,000   Non-Owner Occupied Commercial RE     1,007,361,000       1,027,415,000       998,697,000       950,993,000       932,334,000   Multi-Family & Residential Rental     207,962,000       176,593,000       179,126,000       161,894,000       147,294,000   Total Commercial     3,004,562,000       2,950,424,000       2,842,359,000       2,810,309,000       2,967,215,000                                             Retail (2):                                         1-4 Family Mortgages     522,556,000       442,547,000       411,618,000       380,292,000       337,844,000   Other Consumer Loans     28,672,000       60,488,000       59,732,000       58,240,000       59,311,000   Total Retail     551,228,000       503,035,000       471,350,000       438,532,000       397,155,000                                             Total   $ 3,555,790,000     $ 3,453,459,000     $ 3,313,709,000     $ 3,248,841,000     $ 3,364,370,000       (1) Includes $12.2 million, $40.1 million, $116 million, $246 million, and $455 million in loans originated under the Paycheck Protection Program for March 31, 2022, December 31, 2021, September 30, 2021, June 30, 2021, and March 31, 2021, respectively.   (2) For March 31, 2022, home equity lines of credit balances are included in 1-4 family mortgage loans. For prior periods, home equity lines of credit balances are included in other consumer loans.     55 Table of Contents   MERCANTILE BANK CORPORATION     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 an internal 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. We also 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 $1.6 million (0.03% of total assets) as of March 31, 2022, compared to $2.5 million (0.05% of total assets) as of December 31, 2021.   The following tables provide a breakdown of nonperforming assets by collateral type:   NONPERFORMING LOANS                                                 3/31/22     12/31/21     9/30/21     6/30/21     3/31/21   Residential Real Estate:                                         Land Development   $ 31,000     $ 32,000     $ 33,000     $ 34,000     $ 34,000   Construction     0       0       0       0       0   Owner Occupied / Rental     1,579,000       1,768,000       2,052,000       2,096,000       2,294,000         1,610,000       1,800,000       2,085,000       2,130,000       2,328,000                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     0       0       0       0       283,000   Non-Owner Occupied     0       0       0       0       0         0       0       0       0       283,000                                             Non-Real Estate:                                         Commercial Assets     0       662,000       673,000       606,000       169,000   Consumer Assets     2,000       6,000       8,000       10,000       13,000         2,000       668,000       681,000       616,000       182,000                                             Total   $ 1,612,000     $ 2,468,000     $ 2,766,000     $ 2,746,000     $ 2,793,000       56 Table of Contents   MERCANTILE BANK CORPORATION     OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS                                                 3/31/22     12/31/21     9/30/21     6/30/21     3/31/21   Residential Real Estate:                                         Land Development   $ 0     $ 0     $ 0     $ 0     $ 0   Construction     0       0       0       0       0   Owner Occupied / Rental     0       0       11,000       41,000       11,000         0       0       11,000       41,000       11,000                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     0       0       100,000       363,000       363,000   Non-Owner Occupied     0       0       0       0       0         0       0       100,000       363,000       363,000                                             Non-Real Estate:                                         Commercial Assets     0       0       0       0       0   Consumer Assets     0       0       0       0       0         0       0       0       0       0                                             Total   $ 0     $ 0     $ 111,000     $ 404,000     $ 374,000       The following tables provide a reconciliation of nonperforming assets:   NONPERFORMING LOANS RECONCILIATION                                                 1st Qtr     4th Qtr     3rd Qtr     2nd Qtr     1st Qtr       2022     2021     2021     2021     2021                                             Beginning balance   $ 2,468,000     $ 2,766,000     $ 2,746,000     $ 2,793,000     $ 3,384,000   Additions, net of transfers to ORE     93,000       218,000       361,000       492,000       116,000   Returns to performing status     (213,000 )     0       (50,000 )     0       (115,000 ) Principal payments     (641,000 )     (377,000 )     (291,000 )     (484,000 )     (559,000 ) Loan charge-offs     (95,000 )     (139,000 )     0       (55,000 )     (33,000 )                                           Total   $ 1,612,000     $ 2,468,000     $ 2,766,000     $ 2,746,000     $ 2,793,000       57 Table of Contents   MERCANTILE BANK CORPORATION     OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION                                                 1st Qtr     4th Qtr     3rd Qtr     2nd Qtr     1st Qtr       2022     2021     2021     2021     2021                                             Beginning balance   $ 0     $ 111,000     $ 404,000     $ 374,000     $ 701,000   Additions     0       0       0       30,000       0   Sale proceeds     0       (111,000 )     (209,000 )     0       (77,000 ) Valuation write-downs     0       0       (84,000 )     0       (250,000 )                                           Total   $ 0     $ 0     $ 111,000     $ 404,000     $ 374,000     During the first quarter of 2022, loan charge-offs totaled $0.2 million, while recoveries of prior period loan charge-offs equaled $0.3 million, providing for net loan recoveries of $0.1 million, or an annualized 0.01% of average total loans. We continue our collection efforts on charged-off loans and expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries. The allowance equaled $35.2 million, or 0.99% of total loans, and 2,181% of nonperforming loans, as of March 31, 2022.   We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, which included a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.   The allowance for loan loss accounting in effect at December 31, 2021 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date (“incurred loss” methodology). Under the CECL methodology, our allowance is based on the total amount of credit losses that are expected over the remaining life of the loan portfolio. Our estimate of credit losses under CECL is determined using a complex model that relies on historical loss information, reasonable and supportable economic forecasts, and various qualitative factors.   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 we have a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential mortgage 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.   See Note 1- Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.   As of March 31, 2022, the allowance was comprised of $34.9 million in general reserves relating to performing loans and $0.3 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings. Specific reserve allocations relating to nonaccrual loans were nominal in amount. Troubled debt restructurings totaled $5.5 million at March 31, 2022, consisting of $0.4 million that are on nonaccrual status and $5.1 million that are on accrual status. The latter are not included in our nonperforming loan totals. Loans with an aggregate carrying value of $0.4 million as of March 31, 2022 had been subject to previous partial charge-offs aggregating $0.4 million over the past several years. As of March 31, 2022, there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.     58 Table of Contents   MERCANTILE BANK CORPORATION     The following table provides a breakdown of our loans categorized as troubled debt restructurings:       3/31/22     12/31/21     9/30/21     6/30/21     3/31/21                                             Performing   $ 5,131,000     $ 16,728,000     $ 20,518,000     $ 20,840,000     $ 19,606,000   Nonperforming     379,000       746,000       782,000       859,000       431,000                                             Total   $ 5,510,000     $ 17,474,000     $ 21,300,000     $ 21,699,000     $ 20,037,000     Although we believe the allowance is adequate to absorb loan losses in our originated loan portfolio as they arise, there can be no assurance that we will not sustain loan losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.   Securities available for sale increased $12.9 million during the first three months of 2022, totaling $606 million as of March 31, 2022. Purchases of U.S. Government agency bonds totaled $43.7 million during the first quarter of 2022. There were no purchases of U.S. Government agency guaranteed mortgage-backed securities during the first three months of 2022; however, we did receive $1.6 million in principal paydowns on U.S. Government agency guaranteed mortgage-backed securities. Purchases of municipal bonds totaled $8.0 million during the first quarter of 2022; proceeds from matured and called municipal bonds totaled $1.1 million. At March 31, 2022, the portfolio was primarily comprised of U.S. Government agency bonds (68%), municipal bonds (26%) and U.S. Government agency guaranteed mortgage-backed securities (6%). All of our securities are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at March 31, 2022 totaled $606 million, including a net unrealized loss of $40.4 million. The net unrealized loss equaled $4.7 million as of December 31, 2021; the increase in the net unrealized loss during the first quarter of 2022 reflects significant increases in market interest rates during that time. 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. We expect purchases during the remainder of 2022 to generally consist of U.S. Government agency bonds and municipal bonds, with the securities portfolio maintained at about 12% of total assets.   Federal Home Loan Bank of Indianapolis (“FHLBI”) stock totaled $17.7 million as of March 31, 2022, compared to $18.0 million as of December 31, 2021. The reduction reflects the FHLBI’s repurchase of excess stock. 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 generally 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.   Interest-earning balances, primarily consisting of excess funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate sensitivity. During the first three months of 2022, the average balance of these funds equaled $784 million, or 16.1% of average earning assets, compared to $592 million, or 13.7% of average earning assets, during the first quarter of 2021, and $671 million, or 14.9% of average earning assets, during 2021; these levels are substantially higher than our typical average balance of $75 million, or approximately 2% of average earning assets. The elevated levels during 2021 and through the first quarter of 2022 primarily reflect increased local deposits from federal government stimulus programs and reduced business and consumer investing and spending, and have resulted in a significant negative impact on our net interest margin.     59 Table of Contents   MERCANTILE BANK CORPORATION     Net premises and equipment equaled $56.1 million at March 31, 2022, representing a decrease of $1.2 million during the first three months of 2022. The decline was primarily attributable to depreciation expense of $1.6 million. We had no foreclosed or repossessed assets as of March 31, 2022 or December 31, 2021.   Total deposits decreased $107 million during the first three months of 2022, totaling $3.98 billion at March 31, 2022. Local deposits decreased $99.2 million, while out-of-area deposits declined $7.7 million. The reduced level of local deposits primarily reflected a single customer’s withdrawal of a majority of funds that were deposited in late 2021; excluding this withdrawal, local deposits were up approximately $50 million during the first three months of 2022. As a percent of total deposits, out-of-area deposits equaled 0.4% as of March 31, 2022, compared to 0.6% as of December 31, 2021.   Noninterest-bearing deposits increased $8.3 million during the first three months of 2022, while interest-bearing checking accounts and savings deposits were up $5.4 million and $12.2 million, respectively. Money market deposit balances were down $96.9 million on an actual basis and up approximately $53 million excluding the previously mentioned large withdrawal from a single customer. Local time deposits declined $28.1 million during the first three months of 2022. The reduction in out-of-area deposits during the first three months of 2022 reflects maturities not replaced as the funds were no longer needed.   Sweep accounts increased $6.8 million during the first three months of 2022, totaling $204 million as of March 31, 2022. The aggregate balance of this funding type is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances maintained by many of the customers. The average balance of sweep accounts equaled $199 million during the first quarter of 2022, with a high balance of $224 million and a low balance of $176 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings.   FHLBI advances increased $8.3 million during the first quarter of 2022, totaling $382 million as of March 31, 2022. Amortizing FHLBI advance aggregating $28.3 million were obtained, while bullet advances aggregating $20.0 million matured. Amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk. FHLBI 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 March 31, 2022 totaled $932 million, with remaining availability based on collateral equaling $544 million.   On January 14, 2022, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $15.0 million in aggregate principal amount of its 3.25% fixed-to-floating rate subordinated notes (“Notes”). The Notes have a stated maturity date 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 January 14, 2022, we injected $15.0 million of the issuance proceeds into our bank as an increase to equity capital. This $15.0 million issuance was a follow-on to the $75.0 million issuance that was completed on December 15, 2021, in which $70.0 million of the issuance proceeds were injected into our bank as an increase to equity capital.   Shareholders’ equity was $436 million at March 31, 2022, compared to $457 million at December 31, 2021. Shareholders’ equity was positively impacted by first quarter net income of $11.5 million, which was partially offset by the $4.8 million payment of a cash dividend. A $28.2 million after-tax decline in the market value of our available for sale securities portfolio, reflecting significant increases in market interest rates, negatively impacted shareholders’ equity during the first three months of 2022.     60 Table of Contents   MERCANTILE BANK CORPORATION     Liquidity Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and 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 deposits. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.   To assist in providing needed funds and managing interest rate risk, we periodically obtain monies from wholesale funding sources. Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $398 million, or 8.7% of combined deposits and borrowed funds, as of March 31, 2022, compared to $398 million, or 8.5% of combined deposits and borrowed funds, as of December 31, 2021.   Sweep accounts increased $6.8 million during the first three months of 2022, totaling $204 million as of March 31, 2022. The aggregate balance of this funding type is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances maintained by many of the customers. The average balance of sweep accounts equaled $199 million during the first quarter of 2022, with a high balance of $224 million and a low balance of $176 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements. Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings. Information regarding our repurchase agreements as of March 31, 2022 and during the first three months of 2022 is as follows:   Outstanding balance at March 31, 2022   $ 204,271,000   Weighted average interest rate at March 31, 2022     0.10 % Maximum daily balance three months ended March 31, 2022   $ 224,345,000   Average daily balance for three months ended March 31, 2022   $ 198,949,000   Weighted average interest rate for three months ended March 31, 2022     0.10 %   FHLBI advances increased $8.3 million during the first quarter of 2022, totaling $382 million as of March 31, 2022. Amortizing FHLBI advance aggregating $28.3 million were obtained, while bullet advances aggregating $20.0 million matured. Amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk. FHLBI 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 March 31, 2022 totaled $932 million, with remaining availability based on collateral equaling $544 million.   We also have the ability to borrow up to an aggregate $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. We did not access these lines of credit during the first three months of 2022. In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged $776 million during the first three months of 2022. We also 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 $31.1 million as of March 31, 2022. We did not utilize this line of credit during the first three months of 2022 or at any time during the previous 13 fiscal years, and do not plan to access this line of credit in future periods.     61 Table of Contents   MERCANTILE BANK CORPORATION     The following table reflects, as of March 31, 2022, 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   $ 3,580,215,000     $ 0     $ 0     $ 0     $ 3,580,215,000   Time deposits     233,776,000       106,437,000       55,823,000       0       396,036,000   Short-term borrowings     204,271,000       0       0       0       204,271,000   Federal Home Loan Bank advances     84,353,000       171,689,000       71,838,000       54,383,000       382,263,000   Subordinated debentures     0       0       0       48,415,000       48,415,000   Subordinated notes     0       0       0       88,428,000       88,428,000   Other borrowed money     0       0       0       1,201,000       1,201,000   Property leases     787,000       1,217,000       232,000       1,145,000       3,381,000     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. As of March 31, 2022, we had a total of $1.51 billion in unfunded loan commitments and $33.0 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.35 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $158 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.   We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, changes in economic or market conditions, a reduction 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.   Capital Resources Shareholders’ equity was $436 million at March 31, 2022, compared to $457 million at December 31, 2021. Shareholders’ equity was positively impacted by first quarter net income of $11.5 million, which was partially offset by the $4.8 million payment of a cash dividend. A $28.2 million after-tax decline in the market value of our available for sale securities portfolio, reflecting significant increases in market interest rates, negatively impacted shareholders’ equity during the first three months of 2022.   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. Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of March 31, 2022, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.     62 Table of Contents   MERCANTILE BANK CORPORATION     As of March 31, 2022, our bank’s total risk-based capital ratio was 13.8%, compared to 13.6% at December 31, 2021. Our bank’s total regulatory capital increased $22.3 million during the first three months of 2022, in large part reflecting net income totaling $13.6 million and a $15.0 million equity injection associated with the Notes issuance, which was partially offset by cash dividends paid to us aggregating $6.5 million. Our bank’s total risk-based capital ratio was also impacted by a $121 million increase in total risk-weighted assets, primarily resulting from net growth in commercial loans and the securities portfolio. As of March 31, 2022, our bank’s total regulatory capital equaled $574 million, or $157 million in excess of the 10.0% minimum that is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of March 31, 2022 and December 31, 2021 are disclosed in Note 12 of the Notes to Consolidated Financial Statements.   Results of Operations We recorded net income of $11.5 million, or $0.73 per basic and diluted share, for the first quarter of 2022, compared to net income of $14.2 million, or $0.87 per basic and diluted share, for the first quarter of 2021. The decline in net income resulted from decreased noninterest income and increased noninterest expense, which more than offset improved net interest income and a lower provision for credit losses. The reduction in noninterest income primarily reflected decreased mortgage banking income, which outweighed increases in all other key fee income categories. Noninterest expense increased in the first three months of 2022 compared to the respective prior-year period mainly due to higher compensation and data processing costs. The higher level of net interest income during the first quarter of 2022 resulted from the positive impact of earning asset growth, which more than offset the negative impact of a lower net interest margin, in large part driven by reduced PPP net loan fee income accretion. The credit loss provision expense recorded during both the first quarter of 2022 and the prior-year first quarter was primarily necessitated by net loan growth; the recording of net loan recoveries and ongoing strong loan quality metrics during both periods in large part offset additional reserve allocations stemming from loan growth.   Interest income during the first quarter of 2022 was $35.9 million, an increase of $1.1 million, or 3.2%, from the $34.8 million earned during the first quarter of 2021. The increase resulted from growth in average earning assets, which more than offset the impact of a lower yield on average earning assets. Average earning assets equaled $4.88 billion during the current-year first quarter, up $553 million, or 12.8%, from the level of $4.33 billion during the respective 2021 period; average securities were up $194 million, average interest-earning deposits increased $193 million, and average loans were up $166 million. The yield on average earning assets was 2.99% during the first quarter of 2022, compared to 3.26% during the first quarter of 2021. The decline primarily resulted from a change in earning asset mix and a decreased yield on loans. On average, lower-yielding interest-earning deposits and securities represented 16.1% and 12.5% of earning assets, respectively, during the first quarter of 2022, up from 13.7% and 9.7%, respectively, during the first quarter of 2021, while higher-yielding loans represented 71.4% and 76.6% of earning assets during the respective periods. 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 has persisted since that time, negatively impacted the yield on average earning assets by approximately 45 basis points during the first quarters of 2022 and 2021. The excess funds, consisting almost entirely of low-yielding deposits with the Federal Reserve Bank of Chicago, are mainly a product of local deposit growth and PPP loan forgiveness activities. The yield on loans was 3.87% during the first three months of 2022, down from 4.03% during the respective prior-year period mainly due to a decreased yield on commercial loans, which declined from 4.07% during the first quarter of 2021 to 3.94% during the first quarter of 2022. The reduced yield on commercial loans primarily reflected a lower level of PPP loan fee accretion, which totaled $0.8 million and $2.8 million in the first quarters of 2022 and 2021, respectively.   Interest expense during the first quarter of 2022 was $5.0 million, a decrease of $0.3 million, or 4.9%, from the $5.3 million expensed during the first quarter of 2021. The decrease is attributable to a lower weighted average cost of interest-bearing liabilities, which equaled 0.66% in the current-year first quarter compared to 0.82% in the prior-year first quarter. The decline mainly reflected lower rates paid on local time deposits and 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. The cost of time deposits declined from 1.49% during the first quarter of 2021 to 0.89% during the current-year first quarter primarily due to lower interest rates paid on local time deposits, reflecting a decreasing interest rate environment. On average, lower-cost non-time deposits represented 63.9% of total interest-bearing liabilities during the first quarter of 2022, up from 57.4% during the first quarter of 2021, while higher-cost time deposits represented 13.1% and 20.5% of total interest-bearing liabilities during the respective periods. Average interest-bearing liabilities were $3.07 billion during the first three months of 2022, up $468 million, or 18.0%, from the $2.60 billion average during the respective 2021 period.     63 Table of Contents   MERCANTILE BANK CORPORATION     Net interest income during the first quarter of 2022 was $30.9 million, an increase of $1.4 million, or 4.6%, from the $29.5 million earned during the prior-year first quarter. The increase resulted from the positive impact of an increase in average earning assets, which more than offset a lower net interest margin, in large part reflecting a reduced level of PPP net loan fee income accretion. The net interest margin decreased from 2.77% in the first quarter of 2021 to 2.57% in the current-year first quarter due to a lower yield on average earning assets, which more than offset a reduction in the cost of funds. The decreased yield on average earning assets mainly reflected a change in earning asset mix and a lower yield on commercial loans, while the reduced cost of funds primarily reflected lower rates paid on local time deposits and a change in funding mix. The previously discussed significant level of excess on-balance sheet liquidity negatively impacted the net interest margin by approximately 40 basis points during the first quarters of 2022 and 2021.   The following table sets forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the first quarters of 2022 and 2021. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. Tax-exempt securities interest income and yield for the first quarters of 2022 and 2021 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%. Securities interest income was increased by $60,000 in the first quarter of both 2022 and 2021 for this non-GAAP, but industry standard, adjustment. These adjustments equated to increases in our net interest margin of less than one basis point for the first three months of 2022 and the respective 2021 period.     64 Table of Contents   MERCANTILE BANK CORPORATION         Quarters ended March 31,       2 0 2 2     2 0 2 1       Average             Average     Average             Average       Balance     Interest     Rate     Balance     Interest     Rate       (dollars in thousands)   ASSETS                                                 Loans   $ 3,484,511     $ 33,251       3.87 %   $ 3,318,281     $ 32,985       4.03 % Investment securities     613,317       2,325       1.52       419,514       1,692       1.61   Other interest-earning assets     784,193       366       0.19       591,617       168       0.11   Total interest - earning assets     4,882,021       35,942       2.99       4,329,412       34,845       3.26                                                     Allowance for credit losses     (35,288 )                     (38,467 )                 Other assets     321,829                       287,942                                                                     Total assets   $ 5,168,562                     $ 4,578,887                                                                                                                       LIABILITIES AND SHAREHOLDERS ’ EQUITY                                                 Interest-bearing deposits   $ 2,364,437     $ 1,825       0.31 %   $ 2,026,896     $ 2,717       0.54 % Short-term borrowings     198,949       50       0.10       132,845       36       0.11   Federal Home Loan Bank advances     372,662       1,864       2.00       394,000       2,027       2.06   Other borrowings     135,867       1,258       3.76       49,801       472       3.79   Total interest-bearing liabilities     3,071,915       4,997       0.66       2,603,542       5,252       0.82                                                     Noninterest-bearing deposits     1,625,453                       1,510,334                   Other liabilities     21,331                       21,463                   Shareholders’ equity     449,863                       443,548                                                                     Total liabilities and shareholders’ equity   $ 5,168,562                     $ 4,578,887                                                                     Net interest income           $ 30,945                     $ 29,593                                                             Net interest rate spread                     2.33 %                     2.44 % Net interest spread on average assets                     2.43 %                     2.62 % Net interest margin on earning assets                     2.57 %                     2.77 %   A credit loss provision expense of $0.1 million and $0.3 million was recorded during the first quarters of 2022 and 2021, respectively. The provision expense recorded during both periods mainly reflected allocations stemming from net loan growth; the recording of net loan recoveries and continued strong loan quality metrics during the periods essentially offset additional reserve allocations associated with loan growth. We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.     65 Table of Contents   MERCANTILE BANK CORPORATION     During the first quarter of 2022, loan charge-offs totaled $0.2 million, while recoveries of prior period loan charge-offs equaled $0.3 million, providing for net loan recoveries of $0.1 million, or an annualized 0.01% of average total loans. During the first quarter of 2021, loan charge-offs totaled $0.1 million, while recoveries of prior period loan charge-offs equaled $0.5 million, providing for net loan recoveries of $0.4 million, or an annualized 0.05% of average total loans. The allowance for loans, as a percentage of total loans, was 1.0% as of March 31, 2022, and December 31, 2021, and 1.2% as of March 31, 2021. Excluding PPP loans, the allowance for loans, as a percentage of total loans, equaled 1.0% as of March 31, 2022, and December 31, 2021, and 1.3% as of March 31, 2021.   Noninterest income during the first quarter of 2022 was $9.3 million, compared to $13.5 million during the prior-year first quarter. The lower level of noninterest income almost exclusively reflected decreased mortgage banking income, which more than offset growth in several key fee income sources, including interest rate swap income, service charges on accounts, credit and debit card income, and payroll processing fees. Sustained strength in purchase mortgage originations partially mitigated the negative impacts of reduced refinance activity, rising mortgage loan interest rates, a lower mortgage loan sold percentage, and a decreased gain on sale rate on mortgage banking income during the first quarter of 2022. Purchase transactions totaled $101 million during the first three months of 2022, compared to $81.5 million during the respective 2021 period, representing an increase of $19.9 million, or approximately 24%. Refinance transactions totaled $66.8 million during the first quarter of 2022, compared to $164 million during the first quarter of 2021, representing a decrease of $96.9 million, or approximately 59%. Residential mortgage loans originated for sale, generally consisting of longer-term fixed rate residential mortgage loans, totaled $75.7 million, or approximately 45% of total mortgage loans originated, during the first three months of 2022. During the first three months of 2021, residential mortgage loans originated for sale totaled $196 million, or approximately 80% of total mortgage loans originated.   Noninterest expense totaled $25.7 million during the first quarter of 2022, compared to $25.1 million during the first quarter of 2021. Overhead costs during the first three months of 2021 included write-downs of former branch facilities totaling $0.5 million. Excluding these transactions, noninterest expense increased $1.2 million, or 4.8%, during the first quarter of 2022 compared to the respective 2021 period. The higher level of expense primarily resulted from increased salary costs, mainly depicting annual merit pay increases, lower residential mortgage loan deferred salary costs stemming from decreased production, and higher stock-based compensation expense. Increased data processing costs, in large part reflecting higher transaction volume and software support costs, also contributed to the increase in overhead costs during the first three months of 2022.   During the first quarter of 2022, we recorded income before federal income tax of $14.3 million and a federal income tax expense of $2.8 million. During the first quarter of 2021, we recorded income before federal income tax of $17.6 million and a federal income tax expense of $3.4 million. The decrease in federal income tax expense during the first quarter of 2022 compared to the prior-year first quarter resulted from the lower level of income before federal income tax. Our effective tax rate was 19.8% and 19.0% during the first quarters of 2022 and 2021, respectively.