What changed in this filing

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Item 9A. Controls and Procedures

2023-03-03 compared with 2022-03-04 · 1097 added, 1187 removed, 2467 unchanged (48% of the section changed)

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Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of December 31, 2022.

There have been no significant changes in our internal control over financial reporting during the quarter ended December 31, 2021, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no significant changes in our internal control over financial reporting during the year ended December 31, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f).

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Exhibits and Financial Statement Schedules

(a) (1)     Financial Statements.

(a) (1) 

 Financial Statements.

The following financial statements and reports of the independent registered public accounting firm of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:

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Consolidated Statements of Income for each of the three years in the period ended December 31, 2022

Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2021

Consolidated Statements of Comprehensive Income (Loss) for each of the three years in the period ended December 31, 2022

Consolidated Statements of Changes in Shareholders’

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Not applicable

(b)     Exhibits:

The Exhibit Index immediately preceding the Signatures Page hereto is incorporated by reference under this item.

Financial Statements Not Included In Annual Report

Not applicable

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

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

CONSOLIDATED FINANCIAL STATEMENTS

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CONSOLIDATED STATEMENTS OF INCOME

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

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FORWARD-LOOKING STATEMENTS

The following discussion and other portions of this Annual Report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and about our company.

The following discussion and other portions of this Annual Report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates, and projections about the financial services industry, the economy, and our company.

Words such as “anticipates,”

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“projects,”

“indicates,”

“strategy,”

“future,”

“likely,”

“may,”

“should,”

“will,”

and variations of such words and similar expressions are intended to identify such forward-looking statements.

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demand for products and services;

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

climate impacts;

labor markets;

the degree of competition by traditional and non-traditional financial services 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;

potential cyber-attacks, information security breaches, and other criminal activities;

litigation liabilities;

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

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

direct and indirect climate change matters;

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

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

changes in the method of determining Libor and the phase-out of Libor;

changes in the national and local economies, including the ongoing disruption to supply chain and financial markets caused by the Coronavirus Pandemic and unstable political and economic environments;

and risk factors described in our annual report on Form 10-K for the year ended December 31, 2022.

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

Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

CRITICAL ACCOUNTING ESTIMATES

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) is based on Mercantile Bank Corporation’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and actual results could differ from those estimates.

We have reviewed the analyses with the Audit Committee of our Board of Directors.

Allowance For Loan Losses :

The allowance for loan losses (“allowance”) is maintained at a level we believe is adequate to absorb probable incurred losses identified and inherent in the loan portfolio.

Our critical accounting estimates are highly dependent upon subjective or complex judgments and assumptions, and changes in such may have a significant impact on the financial statements, just as actual results may differ.

We have reviewed the application of our critical accounting estimates with the Audit Committee of our Board of Directors.

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.

Loan losses are charged against the allowance when we believe the uncollectability of a loan is likely.

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.

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In either instance, unanticipated changes could have a significant impact on the allowance and operating results.

Loans made under the Paycheck Protection Program are fully guaranteed by the Small Business Administration;

therefore, such loans do not have an associated allowance.

We complete a migration analysis quarterly to assist us in determining appropriate reserve allocation factors for non-impaired loans.

Our migration takes into account various time periods;

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

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

Although the migration analysis provides an accurate historical accounting of our net loan losses, it is not able to fully account for environmental factors that will also very likely impact the collectability of our loans as of any quarter-end date.

Therefore, we incorporate the environmental factors as adjustments to the historical data.

Environmental factors include both internal and external items.

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

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

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

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

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

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

Uncollectable loans are charged-off through the allowance.

Recoveries of loans previously charged-off are added to the allowance.

A loan is considered impaired when it is probable that contractual principal and interest payments will not be collected either for the amounts or by the dates as scheduled in the loan agreement.

Impairment is evaluated on an individual loan basis.

If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing interest rate or at the fair value of collateral if repayment is expected solely from the collateral.

The timing of obtaining outside appraisals varies, generally depending on the nature and complexity of the property being evaluated, general breadth of activity within the marketplace and the age of the most recent appraisal.

For collateral dependent impaired loans, in most cases we obtain and use the “as is”

value as indicated in the appraisal report, adjusting for any expected selling costs.

In certain circumstances, we may internally update outside appraisals based on recent information impacting a particular or similar property, or due to identifiable trends (e.g., recent sales of similar properties) within our markets.

The expected future cash flows exclude potential cash flows from certain guarantors.

To the extent these guarantors are able to provide repayments, a recovery would be recorded upon receipt.

Loans are evaluated for impairment when payments are delayed, typically 30 days or more, or when serious deficiencies are identified within the credit relationship.

Our policy for recognizing income on impaired loans is to accrue interest unless a loan is placed on nonaccrual status.

We put loans into nonaccrual status when the full collection of principal and interest is not expected.

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

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 changed how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.

This standard replaced the “incurred loss”

approach with an “expected loss”

Referred to as the current expected credit loss (“CECL”) model, this standard applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures.

The standard also expanded disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance.

In addition, entities 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.

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

Income Tax Accounting :

Current income tax assets and liabilities are established for the amount of taxes payable or refundable for the current year.

In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws for which the outcome may be uncertain.

We periodically review and evaluate the status of our tax positions and make adjustments as necessary.

Deferred income tax assets and liabilities are also established for the future tax consequences of events that have been recognized in our financial statements or tax returns.

A deferred income tax asset or liability is recognized for the estimated future tax effects attributable to temporary differences that can be carried forward (used) in future years.

The valuation of our net deferred income tax asset is considered critical as it requires us to make estimates based on provisions of the enacted tax laws.

The assessment of the realizability of the net deferred income tax asset involves the use of estimates, assumptions, interpretations and judgments concerning accounting pronouncements, federal and state tax codes and the extent of future taxable income.

There can be no assurance that future events, such as court decisions, positions of federal and state taxing authorities, and the extent of future taxable income will not differ from our current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.

Accounting guidance requires us to assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not”

In making such judgments, we consider both positive and negative evidence and analyze changes in near-term market conditions as well as other factors that may impact future operating results.

Significant weight is given to evidence that can be objectively verified.

Securities available for sale consist of bonds and notes which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs and other factors.

Securities classified as available for sale are reported at their fair value.

Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses.

In estimating other-than-temporary losses, we consider:

(1) the length of time and extent that fair value has been less than carrying value;

(2) the financial condition and near term prospects of the issuer;

and (3) our ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.

Fair values for securities available for sale are generally obtained from outside sources and applied to individual securities within the portfolio.

The difference between the amortized cost and the current fair value of securities is recorded as a valuation adjustment and reported in other comprehensive income.

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 the Notes to our Consolidated Financial Statements in this Form 10-K for additional information on our estimation process and methodology related to the allowance.

See also Note 3 –

Loans and Allowance for Credit Losses in the Notes to our Consolidated Financial Statements in this Form 10-K for further information regarding our loan portfolio and allowance.

Mortgage Servicing Rights :

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

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

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

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

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

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

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

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

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

therefore, no further testing was required.

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

No impairments were recorded in 2021 or 2020.

Accounting rules require us to determine the fair value of all the assets and liabilities of an acquired entity, and to record their fair value on the date of acquisition.

We employ a variety of means in determining fair value, including the use of discounted cash flow analysis, market comparisons and projected future revenue streams.

For those items for which we conclude that we have the appropriate expertise to determine fair value, we may choose to use our own calculation of fair value.

In other cases, where the fair value is not readily determined, consultation with outside parties is used to determine fair value.

Once valuations have been determined, the net difference between the price paid for the acquired entity and the fair value of the balance sheet is recorded as goodwill.

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

A more frequent assessment is performed if there are material changes in the market place or within the organizational structure.

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

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

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

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

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CORONAVIRUS PANDEMIC

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

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

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

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

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

The following section summarizes the primary measures that directly impact us and our customers.

Although virtually all related restrictions have been terminated, impacts remain 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”).

Overall, the Coronavirus Pandemic has caused a sustained global economic slowdown of varying durations across different industries, and it is possible that it could still cause a global recession as a result of deteriorating economic and political conditions such as increased unemployment, decreased capital spending, declines in consumer confidence, and economic slowdowns.

This uncertainty is heightened in certain geographic areas due to continued surges in Covid-19 cases, and governments at all levels continue to react to changes in circumstances, including vaccine hesitancy, booster shot efficacy, supply chain disruptions and inflationary pressures.

For example, although many health and safety restrictions have been lifted and vaccine distribution has increased, certain adverse consequences of the Coronavirus Pandemic continue to impact the macroeconomic environment and may persist for some time, including labor shortages and disruptions of global supply chains, particularly in China and other parts of Asia.

In addition, this uncertainty is further heightened by the possibility that new and highly infectious variants and subvariants of Covid-19 might arise which are more severe, more transmissible, and capable of evading vaccinations, booster shots and prior immunity.

The Coronavirus Pandemic has had a significant impact on our financial condition and operating results since its onset in March, 2020.

Federal government stimulus programs resulted in a massive increase to the money supply, providing significant inflationary pressures that the Federal Reserve’s Federal Open Market Committee (“FOMC”) has been attempting to manage through substantial increases in the federal funds rate since March, 2022.

In addition, we experienced significant growth in liquidity as federal government stimulus monies were deposited by program recipients, providing for sizable impacts to our operating performance as well as our capital and liquidity positions during 2022 and 2021.

The following section summarizes the primary Covid-19 related measures that directly impacted us and our customers.

Paycheck Protection Program

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

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

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

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

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

PPP loans were 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.

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

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

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

As of December 31, 2022, we recorded forgiveness transactions on all but five loans aggregating $0.5 million.

Net loan origination fees of less than $0.1 million were recorded during 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.

This program ended on May 31, 2021.

Under the Second Draw, we originated approximately 1,200 loans aggregating $209 million.

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

As of December 31, 2022, we recorded forgiveness transactions on all but six loans aggregating $0.4 million.

Net loan origination fees of $1.0 million were recorded during 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.

The Internal Revenue Service 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 received payments of $1,200 in April 2020, $600 in January 2021, and $1,400 in March 2021.

Troubled Debt Restructuring Relief

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Banking agencies must defer to the financial institution’s election.

We elected to suspend GAAP principles and regulatory determinations as permitted.

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

We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021.

Current Expected Credit Loss Methodology Delay

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

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.

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

For commercial borrowers, we offered 90-day (three payments) interest only amendments as well as 90-day (three payments) principal and interest payment deferments.

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

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

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

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

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

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

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

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

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

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

We adopted the CECL methodology effective January 1, 2022.

We continue to monitor the situation, including cases of sickness within our workforce, and will take action to adjust office attendance policies as circumstances warrant in order to protect the health and safety of employees, contractors, and others who visit our offices.

However, if the Coronavirus Pandemic worsens and shutdown orders are issued in the future, our ability to operate could be adversely impacted, depending on the language of such orders.

The extent to which the Coronavirus Pandemic continues to impact us will depend on future developments, which are highly uncertain and cannot be predicted.

CLIMATE CHANGE

Increased public and investor concern about climate change will likely continue to (1) generate more regional and/or national requirements to reduce greenhouse gas emissions;

(2) increase energy efficiency and reduce carbon pollution;

and (3) cause a shift to cleaner and more sustainable sources of energy which may be more expensive than using fossil fuels as an energy source.

The potential impact of climate changes on our operations and the needs of our customers remains uncertain.

Scientists have proposed that the impacts of climate change could include changes in rainfall patterns, water shortages, changes to the water levels of lakes and other bodies of water, changing storm patterns and intensities, and changing temperature levels.

These changes could be severe and vary by geographic location.

Climate change may also affect the occurrence of certain natural events, the incidence and severity of which are inherently unpredictable.

We could also face indirect financial risks passed through the supply chain that could result in higher prices for resources, such as energy.

Additionally, climate change may adversely impact the demand, prices, and availability of property and casualty insurance that insures our loan collateral.

Due to significant economic variability associated with potential future changing climate conditions, we are unable to predict the impact climate change will have on us.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE MATTERS

There has been an increased focus from regulators and stakeholders on environmental, social, and governance (“ESG”) matters, including greenhouse gas emissions, sustainability, and climate-related risks;

diversity, equity and inclusion;

responsible sourcing and supply chain;

human rights and social responsibility;

and corporate governance and oversight.

Given our commitment to ESG matters, we actively manage these issues and have established and publicly announced certain goals, commitments, and targets which we may refine or even expand further in the future.

These goals, commitments, and targets reflect our current plans and aspirations and are not guarantees that we will be able to achieve them.

Evolving stakeholder expectations and our efforts and ability to manage these issues, provide updates on them, and accomplish our goals, commitments, and targets present numerous operational, regulatory, reputational, financial, legal, and other risks, any of which may be outside of our control or could have a material adverse impact on our business, including on our reputation and stock price.

Further, there is uncertainty around the accounting standards and climate-related disclosures associated with emerging laws and reporting requirements and the related costs to comply with the emerging regulations.

Our failure or perceived failure to achieve our ESG goals, maintain ESG practices, or comply with emerging ESG regulations that meet evolving regulatory or stakeholder expectations could harm our reputation, adversely impact our ability to attract and retain customers and talent, and expose us to increased scrutiny from the investment community and regulatory authorities.

Our reputation also may be harmed by the perception that our stakeholders have about our action or inaction on ESG-related issues.

Our ESG Committee supports our ongoing commitment to environmental, health and safety, corporate social responsibility, corporate governance, sustainability, and other public policy matters relevant to our organization.

The ESG Committee is a cross-functional management committee, led by the Chief Risk Officer, that assists us in:

(1) setting general strategies relating to ESG matters;

(2) developing, implementing, and monitoring initiatives and polices based on those strategies;

(3) recommending communications with employees, investors, and shareholders with respect to ESG matters;

and (4) monitoring and assessing developments relating to, and improving our understanding of, ESG matters.

The committee met four times during 2022.

Highlights for 2022 included the enhancement of our online financial wellness tools, the rollout of the MercStart Fresh deposit program, the development of a diverse vendor database for employee use, and the creation of a Vendor and Supplier Code of Conduct.

The Vendor and Supplier Code of Conduct, along with our Environmental Policy, Diversity, Equity and Inclusion Policy, Human Rights Policy, and Supplier Diversity Program Policy, are reviewed and approved by our Board of Directors at least annually.

These polices are available on our website, along with an application for diverse suppliers.

Also during 2022, we moved Board of Director oversight of ESG matters from the Audit Committee to the Governance Committee.

FINANCIAL OVERVIEW

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

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

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

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

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

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

We recorded net income of $61.1 million, or $3.85 per basic and diluted share, for 2022, compared with net income of $59.0 million, or $3.69 per basic and diluted share, for 2021.

Higher net interest income, stemming from an improved net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and ongoing increases in treasury management fee income, more than offset a significant decline in residential mortgage banking revenue as industry-wide originations come off of the record levels of 2020 and 2021 which were driven by low residential mortgage rates and resulting refinancing activity.

Our earnings performance in 2021 also benefited from negative provisions to the allowance.

Commercial loans increased $181 million during 2022, reflecting the combined growth of commercial loans and activity under the PPP.

Core commercial loans (commercial loans excluding PPP loans) increased $221 million, or almost 8%, during 2022, while PPP loans declined $39.2 million.

Core commercial and industrial loans increased $86.9 million, owner-occupied commercial real estate (“CRE”) loans grew $73.4 million, multi-family and residential rental property loans increased $35.4 million, vacant land, land development, and residential construction loans increased $18.6 million, and nonowner-occupied CRE loans grew $6.3 million.

As a percentage of total core commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 58.2% at December 31, 2022, compared to 57.1% at year-end 2021.

The new commercial loan pipeline remains strong, and at December 31, 2022, we had $197 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.

Residential mortgage loans, excluding home equity lines of credit, increased $275 million during 2022, representing a growth rate of approximately 62%.

With the increase in residential mortgage loan interest rates during 2022, we witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in the prior two years.

Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet.

During 2022, approximately 35% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to about 68% during 2021.

The shift in product mix impacts the timing of revenue recognition;

it takes an estimated 24 months for the amount of net interest income earned on a residential mortgage loan that is retained on our balance sheet to approximate the amount of immediately recorded gain on sale of a residential mortgage loan that has been sold to a third-party investor.

The overall quality of our loan portfolio remains strong, with nonperforming loans equaling 0.20% of total loans as of December 31, 2022.

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

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

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

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

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

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

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

Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties throughout 2022.

Gross loan charge-offs totaled $0.3 million during 2022, while recoveries of prior period loan charge-offs totaled $1.0 million, providing for net loan recoveries of $0.7 million, or 0.02% of average total loans, for the year.

We recorded a credit loss provision expense of $6.6 million during 2022, compared to a negative provision expense of $4.3 million during 2021.

The provision expense recorded during 2022 was necessitated by the net increase in required reserve levels stemming from changes to several environmental factors that largely reflected enhanced inherent risk within the commercial loan and residential mortgage loan portfolios, loan growth, and increased specific reserves for certain distressed loan relationships.

A higher reserve for residential mortgage loans reflecting slower principal prepayment rates, and the resulting extended average life of the portfolio also impacted provision expense in 2022.

The negative provision expense recorded during 2021 primarily reflected reduced allowance allocations attributed to improvement in both current and forecasted economic conditions and net loan recoveries, which more than offset required allowance allocations necessitated by strong loan growth.

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

During 2022, the average balance of these funds equaled $445 million, or 9.3% of average earning assets, compared to $671 million, or 14.9% of average earning assets, during 2021.

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

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

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

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

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

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

The elevated levels during 2022 and 2021 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus programs and reduced business and consumer investing and spending.

The excess level of interest-earning deposits had a negative impact on our net interest margin.

The level of interest-earning deposits was on a declining trend throughout 2022, as excess monies were used to fund loan growth as well as brokered deposit and Federal Home Loan Bank of Indianapolis (“FHLBI”) advance maturities.

We also experienced a net decline in local deposit balances throughout 2022.

Our deposit balance at the Federal Reserve Bank of Chicago equaled $29.4 million as of December 31, 2022.

Total deposits decreased $370 million during 2022, and totaled $3.71 billion at December 31, 2022.

Local deposits declined $346 million, and out-of-area deposits decreased $23.9 million.

A large portion of the decline in local deposits was comprised of a single customer’s anticipated withdrawal of funds that had been deposited in late 2021 from the sale of a business;

excluding the withdrawal of these monies, local deposits were down approximately $150 million in 2022.

Sizable withdrawals by other customers to fund bonus and tax payments, especially during the latter part of the fourth quarter, and public unit withdrawals primarily reflecting transfers into high-yielding accounts at other banks and nonbanks, also contributed to the decrease in local deposits.

Net interest income increased $34.2 million during 2022 compared to 2021.

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

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

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

Interest income was up $38.3 million, while interest expense increased $4.1 million.

Interest income on loans increased significantly during 2022 due to a rapidly increasing interest rate environment and loan growth.

Our yield on loans was 3.87% during the first quarter of 2022, growing to 5.49% during the fourth quarter of 2022, and equaling 4.50% for all of 2022.

Our yield on loans during 2021 was 4.06%, which had been significantly positively impacted by PPP net fee income accretion.

We also recorded growth in interest income on securities, reflecting portfolio growth as we deployed a portion of our excess liquid funds position and the higher interest rate environment.

The higher interest rate environment also provided for increased interest income on our interest-earning deposits.

Interest expense on deposits increased a relatively low $0.9 million in 2022, in large part reflecting generally steady deposit rates in a rapidly increasing interest rate environment during most of 2022.

Interest expense on other borrowed money increased $4.2 million during 2022, reflecting interest costs associated with the $90.0 million in subordinated notes issued between December 2021 and January 2022, and higher interest rates on our floating rate subordinated debentures.

Noninterest income was $32.1 million during 2022, compared to $56.2 million during 2021.

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

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

The decline mainly resulted from a $21.3 million reduction in mortgage banking income, reflecting the aforementioned increase in residential mortgage loan interest rates and corresponding substantial reduction in refinancing activity.

We also recorded a $3.4 million decline in interest rate swap income, as the higher interest rate environment resulted in less transactions.

We continued to record meaningful increased fee income in our treasury management products and services, with service charges on deposit and sweep accounts, credit and debit card fees, and payroll services growing $0.9 million, $0.7 million and $0.4 million, respectively.

Noninterest expense was $108 million during 2022, compared to $111 million during 2021.

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

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

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

Excluding contributions to The Mercantile Bank Foundation, noninterest expense totaled $106 million and $107 million in 2022 and 2021, respectively.

Aggregate salary and benefit costs declined $1.3 million in 2022, in large part reflecting lower residential mortgage lender commissions, reduced stock-based compensation costs, and higher residential mortgage loan deferred costs, which more than offset higher salary costs stemming from annual merit increases, market adjustments, and higher bonus accruals.

FINANCIAL CONDITION

Our total assets increased $820 million during 2021, and totaled $5.26 billion as of December 31, 2021.

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

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

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

Our total assets decreased $385 million during 2022, and totaled $4.87 billion as of December 31, 2022.

Total loans increased $463 million and securities available for sale were up $10.2 million, while interest-earning deposits declined $881 million.

Total deposits decreased $370 million and FHLBI advances were down $65.8 million, while net proceeds from the issuance of subordinated notes totaled $14.6 million.

In large part, the excess funds maintained with the Federal Reserve Bank of Chicago at year-end 2021 were used to fund loan growth, deposit withdrawals, and FHLBI advance maturities during 2022.

Earning Assets

Average earning assets equaled 94.3% of average total assets during 2022, compared to 93.9% during 2021.

The loan portfolio continued to comprise a majority of earning assets, followed by interest-earning deposits and securities.

Average total loans equaled 73.7% of average earning assets during 2021, compared to 81.9% in 2020, while average interest-earning deposits and average securities comprised 14.9% and 11.4% of average earning assets during 2021 and 9.2% and 8.9% during 2020, respectively.

The loan portfolio continued to comprise a majority of earning assets, followed by securities and interest-earning deposits.

Average total loans equaled 77.8% of average earning assets during 2022, compared to 73.7% in 2021, while average securities and interest-earning deposits comprised 12.9% and 9.3% of average earning assets during 2022 and 11.4% and 14.9% of average earning assets during 2021, respectively.

Our loan portfolio has historically been primarily comprised of commercial loans.

Commercial loans increased $156 million during 2021, and at December 31, 2021 totaled $2.95 billion, or 85.4% of our loan portfolio.

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

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

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

Commercial loans increased $181 million during 2022, reflecting the combined net growth of core commercial loans and net activity under the PPP.

Core commercial loans increased $221 million, or almost 8%, during 2022, while PPP loans declined $39.2 million.

Core commercial and industrial loans increased $86.9 million, owner-occupied CRE loans grew $73.4 million, multi-family and residential rental property loans increased $35.4 million, vacant land, land development, and residential construction loans increased $18.6 million, and nonowner-occupied CRE loans grew $6.3 million.

As a percentage of total core commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 58.2% at December 31, 2022, compared to 57.1% at year-end 2021.

We believe our commercial loan portfolio remains well diversified.

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

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

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

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

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

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

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

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

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

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

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

Usage of existing commercial lines of credit was relatively stable during 2022 at approximately 42%, compared to about 36% during the latter half of 2020 and all of 2021, and our historical average of about 47% prior to the Coronavirus Pandemic.

Residential mortgage loans totaled $755 million, or 19.3% of total loans, at December 31, 2022, compared to $443 million, or 12.8% of total loans, as of December 31, 2021.

Residential mortgage loans, excluding home equity lines of credit, increased $275 million during 2022, representing a growth rate of approximately 62%.

We originated $614 million in residential mortgage loans during 2022, compared to $952 million in 2021, a reduction of about 36%.

The decline primarily reflected an increase in residential mortgage loan interest rates throughout 2022, resulting in a substantial reduction of refinancing activity.

Production associated with refinancing activity totaled $134 million in 2022, compared to $458 million in 2021.

With the increase in residential mortgage loan rates, we also witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in 2021.

Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet.

During 2022, approximately 35% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to about 68% during 2021.

The shift in product mix impacts the timing of revenue recognition;

Other consumer-related loans increased $4.9 million during 2022, and at December 31, 2022 totaled $29.8 million, or 0.7% of total loans.

As of December 31, 2021, the other consumer-related loan portfolio comprised 0.7% of total loans.

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

We expect this loan portfolio segment to remain relatively steady in dollar amount but decline as a percent of total loans in future periods as commercial loans and residential mortgage loan portfolios grow.

The following table summarizes our loan portfolio:

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1,137,419,000

1,145,423,000

Land Development & Construction

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1,033,734,000

1,027,415,000

Multi-Family & Residential Rental

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1-4 Family Mortgages

Home Equity & Other Consumer Loans

Other Consumer Loans (**)

3,916,619,000

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2,753,085,000

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

(*) For December 31, 2022, December 31, 2021, and December 31, 2020, includes $0.9 million, $40.1 million, and $365 million in loans originated under the Paycheck Protection Program, respectively.

(**) 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 consumer loans.

Home equity lines of credit totaled $37.4 million, $29.5 million, $32.6 million, $37.7 million, and $41.6 million as of December 31, 2022, December 31, 2021, December 31, 2020, December 31, 2019, and December 31, 2018, respectively.

The following table presents total loans outstanding as of December 31, 2022, according to scheduled repayments of principal on fixed rate loans and repricing frequency on variable rate loans.

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

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

Fifteen Years

Construction and land development

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1,319,400,000

2,467,497,000

Floating rate loans

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2,164,127,000

1,070,873,000

3,916,619,000

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

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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.

In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these items could occur quickly because of changing economic conditions or other factors.

Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on the internal loan watch list.

Senior management and the Board of Directors review this list regularly.

Market value estimates of collateral on impaired loans, as well as on foreclosed and repossessed assets, are reviewed periodically;

however, we have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions.

Market value estimates of collateral on nonperforming loans, as well as on foreclosed and repossessed assets, are reviewed periodically.

We have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions.

Our credit policies establish criteria for obtaining appraisals and determining internal value estimates.

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In addition, we may discount certain appraised and internal value estimates to address distressed market conditions.

Nonaccrual loans totaled $7.7 million, or 0.2% of total loans, as of December 31, 2022, compared to $2.3 million, or 0.1% of total loans, as of December 31, 2021.

Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $7.7 million (0.2% of total assets) as of December 31, 2022, compared to $2.5 million (0.1% of total assets) as of December 31, 2021.

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

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

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

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

The following tables provide a breakdown of nonperforming assets by property type:

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Valuation write-downs

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

During 2022, loan charge-offs totaled $0.3 million, while recoveries of prior period loan charge-offs equaled $1.0 million, providing for net loan recoveries of $0.7 million, or 0.02% of average total loans.

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

We continue our collection efforts on charged-off loans, and we 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 following table summarizes changes in the allowance for the past five years.

For the years 2019, 2018, and 2017, presented loan and allowance data are reflective of only originated loans and the allowance for originated loans.

We terminated the application of purchase accounting associated with our merger with Firstbank effective January 1, 2020.

Loans outstanding at year-end

3,453,459,000

3,193,470,000

2,609,747,000

2,451,324,000

2,167,404,000

Daily average balance of loans outstanding during the year

3,324,612,000

3,190,742,000

2,575,819,000

2,291,901,000

2,052,534,000

Balance of allowance for loans at beginning of year (*)

Loans charged-off:

Commercial, financial and agricultural

Construction and land development

Residential real estate

Instalment loans to individuals

Total charge-offs

Recoveries of previously charged-off loans:

Commercial, financial and agricultural

Construction and land development

Residential real estate

Instalment loans to individuals

Total recoveries

Net loan (charge-offs) recoveries

Provision for loan losses

Balance of allowance for loans at end of year

Ratio of net loan (charge-offs) recoveries to average loans outstanding during the year

Ratio of allowance to loans outstanding at year-end

(*) For the December 31, 2020 column, the balance of allowance for loans at beginning of year includes the December 31, 2019 balance of the allowance for acquired loans.

The following table illustrates the breakdown of the allowance for loans balance by loan type (dollars in thousands) and of the total loan portfolio (in percentages).

The following table illustrates the breakdown of the allowance for credit losses by loan type (dollars in thousands) and of the total loan portfolio (in percentages).

For the years 2019 and 2018, presented loan and allowance data are reflective of only originated loans and the allowance for originated loans.

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Ratio of allowance to nonperforming loans

The increasing trend of the ratio of our allowance to nonperforming loans over the past several years generally reflects the combined impact of an increased allowance balance and reduction in nonperforming loans.

In each accounting period, we adjust the allowance to the amount we believe is necessary to maintain the allowance at an adequate level.

Through the loan review and credit departments, we establish specific portions of the allowance based on specifically identifiable problem loans.

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

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

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

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

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

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

For non-impaired commercial loans, reserve allocation factors are based on the loan ratings as determined by our standardized grade paradigms and by loan purpose.

Our commercial loan portfolio is segregated into five classes:

1) commercial and industrial loans;

2) vacant land, land development and residential construction loans;

3) owner occupied real estate loans;

4) non-owner occupied real estate loans;

and 5) multi-family and residential rental property loans.

The reserve allocation factors are primarily based on the historical trends of net loan charge-offs through a migration analysis whereby net loan losses are tracked via assigned grades over various time periods, with adjustments made for environmental factors reflecting the current status of, or recent changes in, items such as:

lending policies and procedures;

economic conditions;

nature and volume of the loan portfolio;

experience, ability and depth of management and lending staff;

volume and severity of past due, nonaccrual and adversely classified loans;

effectiveness of the loan review program;

value of underlying collateral;

lending concentrations;

and other external factors, including competition and regulatory environment.

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

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

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

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

Non-impaired retail loan reserve allocations are determined in a similar fashion as those for non-impaired commercial loans, except that retail loans are segmented by type of credit and not a grading system.

We regularly review the Allowance Analysis and make adjustments periodically based upon identifiable trends and experience.

A migration analysis is completed quarterly to assist us in determining appropriate reserve allocation factors for non-impaired loans.

Our migration takes into account various time periods;

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

We continue to actively monitor our loan portfolio and assess reserve allocation factors in light of the Coronavirus Pandemic and its impact on the U.S.

economic environment and our borrowers in particular.

Therefore, we incorporate the environmental factors as adjustments to the historical data.

Environmental factors include both internal and external items.

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

We 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 real estate loan and consumer loan is the timeliness of scheduled payments.

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.

The allowance for loans equaled $35.4 million as of December 31, 2021, or 1.0% of total loans outstanding.

The allowance for loans equaled 1.2% of total loans at year-end 2020.

As of December 31, 2021, the allowance for loans was comprised of $34.9 million in general reserves relating to non-impaired loans and $0.5 million in specific allocations on other loans, primarily accruing loans designated as troubled debt restructurings.

Although we believe the allowance is adequate to absorb losses as they arise, there can be no assurance that we will not sustain losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.

See Note 1 - Significant Accounting Policies in this Form 10-K 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 Form 10-K for further information regarding our loan portfolio and allowance.

The allowance equaled $42.2 million, or 1.08% of total loans, and over 500% of nonperforming loans, as of December 31, 2022.

As of December 31, 2022, the allowance was comprised of $39.6 million in general reserves relating to performing loans and $2.6 million in specific reserves on other loans, primarily nonperforming loans.

Troubled debt restructurings totaled $11.6 million at December 31, 2022, consisting of $6.1 million that are on nonaccrual status and $5.5 million that are on accrual status.

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

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

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

The latter are not included in our nonperforming loan totals.

Loans with an aggregate carrying value of $0.4 million as of December 31, 2022 had been subject to previous partial charge-offs aggregating $0.3 million over the past several years.

As of December 31, 2022, there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.

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

Nonperforming

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 $10.2 million during 2022, totaling $603 million as of December 31, 2022.

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

Purchases of U.S.

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

Government agency bonds that totaled $61.9 million.

Purchases of U.S.

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

Government agency guaranteed mortgage-backed securities.

Government agency bonds totaled $54.5 million during 2022, while purchases of U.S.

Government agency guaranteed mortgage-backed securities totaled $2.1 million.

There were no U.S.

Government agency bond maturities or calls during 2022, while principal paydowns on U.S.

Government agency guaranteed mortgage-backed securities totaled $5.8 million.

Purchases of municipal bonds totaled $50.4 million during 2022;

proceeds from matured and called municipal bonds totaled $12.1 million.

No bonds were sold during 2021.

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

At December 31, 2022, the portfolio was primarily comprised of U.S.

Government agency bonds (65%), municipal bonds (30%), and U.S.

Government agency guaranteed mortgage-backed securities (5%).

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

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 December 31, 2022 totaled $603 million, including a net unrealized loss of $82.7 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.

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 upcoming purchases to generally consist of municipal bonds, with the securities portfolio maintained at about 12% of total assets.

The following table reflects the composition of the securities portfolio:

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Other investments

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

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

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

Market values on our U.S.

Government agency bonds, mortgage-backed securities issued or guaranteed by U.S.

Government agencies and municipal bonds are determined on a monthly basis with the assistance of a third party vendor.

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.

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We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.

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

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

FHLBI stock totaled $17.7 million as of December 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.

The following table shows by class of maturities as of December 31, 2022 the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities: 

Obligations of U.S.

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Other investments

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

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

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

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

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

During 2022, the average balance of these funds equaled $445 million, or 9.3% of average earning assets, compared to $671 million, or 14.9% of average earning assets, during 2021.

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

The excess level of interest-earning deposits had a negative impact on our net interest margin.

The level of interest-earning deposits was on a declining trend throughout 2022, as excess monies were used to fund loan growth as well as brokered deposit and FHLBI advance maturities.

We also experienced a net decline in local deposit balances throughout 2022.

Our deposit balance at the Federal Reserve Bank of Chicago equaled $29.4 million as of December 31, 2022.

Non-Earning Assets

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

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

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

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

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

Cash and due from bank balances averaged 1.5% of total assets during 2022, similar to the average level during 2021, and no significant changes are expected in future periods.

Net premises and equipment equaled $51.5 million at December 31, 2022, representing a decrease of $5.8 million during 2022.

The decline primarily reflected the sale of a branch facility located in Lansing, Michigan as part of a branch relocation project whereby we are moving our operations to a leased facility that better aligns with our operations in the greater Lansing area and provides for lower operating costs, along with depreciation expense.

We had no foreclosed or repossessed assets as of December 31, 2022, unchanged from December 31, 2021.

Other assets equaled $95.0 million at December 31, 2022, reflecting an increase of $40.7 million during 2022.

The increase is primarily associated with $21.1 million of growth in the fair value of interest rates swaps and a $16.6 million increase in a deferred tax benefit related to unrealized losses on available for sale securities.

Source of Funds

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

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

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

Total deposits decreased $370 million during 2022, totaling $3.71 billion as of December 31, 2022.

Local deposits declined $346 million and out-of-area deposits decreased $23.9 million.

We had no out-of-area deposits as of December 31, 2022, compared to $23.9 million, or 0.6% of total deposits, as of December 31, 2021.

FHLBI advances decreased $65.7 million during 2022, totaling $308 million as of December 31, 2022.

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

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

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

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

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

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

Noninterest-bearing checking accounts declined $73.2 million during 2022, in large part during the fourth quarter due primarily from commercial customers withdrawing funds for the payment of taxes and bonuses.

Interest-bearing checking accounts increased $36.2 million, while savings deposits declined $12.7 million.

Money market deposit accounts decreased $263 million during 2022, primarily reflecting a single customer’s anticipated withdrawal of funds that had been deposited in late 2021 from the sale of a business.

Local time deposits decreased $33.3 million during 2022.

The $23.9 million reduction in out-of-area time deposits during 2022 reflects maturities that were not replaced as the funds were no longer needed.

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

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

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

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

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

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

Total local deposits had increased an aggregate $1.50 billion during 2020 and 2021.

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

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

Deposit growth associated with new commercial lending relationships was also notable.

Savings deposits were up $125 million, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending.

Securities sold under agreements to repurchase (“sweep accounts”) decreased $3.1 million during 2022, totaling $194 million as of December 31, 2022.

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

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

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

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

FHLBI advances declined $65.7 million during 2022, totaling $308 million as of December 31, 2022.

Advance maturities aggregating $94.0 million were not replaced as the funds were no longer needed, while advances totaling $28.3 million were obtained to match-fund fixed rate longer term commercial lending relationships.

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

FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement.

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

Our borrowing line of credit at year-end 2022 totaled $1.03 billion, with remaining availability based on collateral of $713 million.

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

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Shareholders’

equity increased $15.0 million during 2021, totaling $457 million as of December 31, 2021.

equity declined $15.2 million during 2022, totaling $441 million as of December 31, 2022.

Positively impacting shareholders’

equity was net income of $61.1 million, while negatively affecting shareholders’

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

equity were cash dividends on our common stock totaling $19.6 million.

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

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Negatively impacting shareholders’

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

equity during 2022 was a $61.6 million increase in the after-tax net unrealized loss on available for sale securities.

RESULTS OF OPERATIONS

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We recorded net income of $61.1 million, or $3.85 per basic and diluted share, for 2022, compared to net income of $59.0 million, or $3.69 per basic and diluted share, for 2021.

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

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

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

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

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

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

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

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

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

Return on average assets

Return on average shareholders’

Average shareholders’

equity to average assets

Diluted earnings per share increased $0.16, or 4.3%, during 2022 compared to 2021.

The higher level of net income during 2022 compared to 2021 reflected improved net interest income and lower noninterest expense, which more than offset decreased noninterest income and an increased provision for credit losses.

The increase in net interest income resulted from a higher net interest margin and earning asset growth.

Overhead costs declined in 2022 primarily due to reduced contributions to The Mercantile Bank Foundation and compensation-related costs.

The reduction in noninterest income during 2022 mainly reflected decreased mortgage banking income and interest rate swap income, which outweighed increases in treasury management fee income.

A higher reserve for residential mortgage loans reflecting slower principal prepayment rates and the associated extended average life of the portfolio also impacted provision expense during 2022.

A negative loan loss provision expense was recorded in 2021, primarily reflecting reduced allocations attributable to improvement in both current and forecasted economic conditions and a net loan recovery.

Net Interest Income

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

Interest income (adjusted for tax-exempt income) and interest expense totaled $144 million and $19.4 million during 2021, respectively, providing for net interest income of $124 million.

Interest income (adjusted for tax-exempt income) and interest expense totaled $182 million and $23.6 million, respectively, during 2022, providing for net interest income of $158 million.

During 2021, interest income and interest expense equaled $144 million and $19.4 million, respectively, providing for net interest income of $124 million.

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

In comparing 2022 with 2021, interest income increased 26.7%, interest expense was up 21.4%, and net interest income increased 27.5%.

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

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

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

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

The $34.2 million increase in net interest income in 2022 compared to 2021 resulted from an improved net interest margin and a higher level of average earning assets.

During 2022, the net interest margin equaled 3.33%, up from 2.76% during 2021 due to a higher yield on average earning assets, which more than offset an increase in the cost of funds.

The increased yield on average earning assets mainly resulted from a higher yield on loans and a change in earning asset mix, reflecting a decrease in low-yielding interest-earning deposits.

The increased yield on loans primarily resulted from higher interest rates on variable-rate commercial loans stemming from the FOMC significantly raising the targeted federal funds rate in an effort to curb elevated inflation levels.

The FOMC increased the targeted federal funds rate by 425 basis points during the period of March 2022 through December 2022.

As of December 31, 2022, approximately 65% of the commercial loan portfolio consisted of variable-rate loans.

Higher yields on other interest-earning assets and securities, reflecting the increased interest rate environment, also contributed to the improved yield on earning assets.

During 2022, earning assets averaged $4.77 billion, representing an increase of $256 million, or 5.7%, from the $4.51 billion average during 2021.

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

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

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

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

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

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

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

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

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

Average loans increased $382 million, average interest-earning deposits were down $226 million, and average securities were up $99.9 million.

The cost of funds increased from 0.43% in 2021 to 0.50% in 2022 mainly due to higher costs of non-time deposits and trust preferred securities, reflecting the increased interest rate environment, and the issuance of subordinated notes totaling $90 million in December of 2021 and January of 2022.

Subordinated note issuance proceeds of $85.0 million were injected into Mercantile Bank as an increase to equity capital to support expected loan growth.

A significant volume of excess on-balance sheet liquidity, which initially surfaced in the second quarter of 2020 in large part due to government stimulus programs related to the Covid-19 environment, negatively impacted the yield on average earning assets by 24 basis points and 46 basis points during 2022 and 2021, respectively, and the net interest margin by 19 basis points and 39 basis points during the respective periods.

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

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

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Securities interest income was increased by $0.2 million in 2022, 2021, and 2020 for this non-GAAP, but industry standard, adjustment.

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

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

(Dollars in thousands)

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Total earning assets

Allowance for loan losses

Allowance for credit losses

Cash and due from banks

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

Interest income decreased $4.8 million during 2021 from that earned in 2020, totaling $144 million in 2021 compared to $149 million in the previous year.

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

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

Interest income increased $38.3 million during 2022 from that earned in 2021, totaling $182 million in 2022 compared to $144 million in 2021.

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

During 2022 and 2021, earning assets had an average yield (tax equivalent-adjusted basis) of 3.82% and 3.19%, respectively.

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

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

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

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

Accelerated discount accretion on called U.S.

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

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

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

Interest income generated from the loan portfolio decreased $2.4 million in 2021 compared to the level earned in 2020;

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

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

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

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

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

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

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

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

The higher yield on average earning assets mainly resulted from an increased yield on loans and a change in earning asset mix.

The increased yield on loans primarily reflected higher interest rates on variable-rate commercial loans stemming from the previously mentioned FOMC rate hikes.

On average, lower-yielding interest-earning deposits represented 9.3% of earning assets during 2022, down from 14.9% during 2021, while higher-yielding loans represented 77.8% of earning assets during 2022, up from 73.7% during 2021.

Interest-earning deposits decreased $881 million during 2022 as excess overnight funds were used to fund loan growth, brokered deposit and FHLBI advance maturities, and securities purchases.

In addition, a customer’s withdrawal of a majority of funds that were deposited in late 2021 following the sale of a business, as well as other fund withdrawals by customers to make customary tax and bonus payments, contributed to the lower level of interest-earning deposits.

Improved yields on other interest-earning assets and securities, reflecting the increased interest rate environment, also contributed to the higher yield on average earning assets.

Interest income generated from the loan portfolio increased $31.8 million in 2022 compared to the level earned in 2021.

Growth in the loan portfolio during 2022 resulted in a $16.4 million increase in interest income, while an upturn in loan yield from 4.06% in 2021 to 4.50% in 2022 resulted in a $15.4 million increase in interest income.

The improved yield on loans mainly resulted from a higher yield on commercial loans, which increased from 4.09% during 2021 to 4.72% during 2022 primarily due to the aforementioned FOMC rate increases.

The increase in loan yield during 2022 was achieved despite a significant reduction in PPP net loan fee accretion, which totaled $1.0 million and $10.8 million in 2022 and 2021, respectively.

Interest income generated from the securities portfolio increased $2.8 million in 2022 compared to the level earned in 2021.

Growth in the average balance of the securities portfolio during 2022 resulted in an increase in interest income of $1.5 million, while an increase in the yield on securities from 1.51% during 2021 to 1.72% during 2022 resulted in a $1.3 million increase in interest income.

Interest income on interest-earning deposits increased $3.7 million in 2022 from the level earned in 2021;

a higher yield on these balances resulted in an increase in interest income of $4.1 million, while a reduction in the average balance of these balances resulted in a decrease in interest income of $0.4 million.

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

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

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

Interest expense increased $4.2 million during 2022 from that expensed in 2021, totaling $23.6 million in 2022 compared to $19.4 million in 2021.

Growth in the average balance of interest-bearing liabilities during 2022 resulted in an increase in interest expense of $2.4 million, while an increase in the cost of these liabilities resulted in a $1.8 million increase in interest expense.

During 2022, interest-bearing liabilities averaged $2.89 billion, representing an increase of $178 million, or 6.6%, from the $2.71 billion average during 2021;

average interest-bearing deposits and borrowings were up $90.0 million and $88.0 million, respectively.

During 2022 and 2021, interest-bearing liabilities had a weighted average rate of 0.82% and 0.72%, respectively.

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

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

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

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

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

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

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

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

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

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

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

A lower average rate paid on interest-bearing non-time deposits during 2021 resulted in a $1.2 million decrease in interest expense, while a $400 million increase in the average balance of these deposits equated to a $1.0 million increase in interest expense.

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

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

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

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

Provision for Loan Losses

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

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

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

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

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

The higher average cost of interest-bearing liabilities mainly resulted from increased costs of non-time deposit accounts and borrowings, which more than offset a decreased cost of time deposits.

The cost of interest-bearing non-time deposit accounts increased from 0.20% during 2021 to 0.34% during 2022, primarily reflecting higher interest rates paid on money market accounts;

the higher interest rates mainly reflected the increased interest rate environment.

The cost of borrowed funds increased from 1.71% during 2021 to 1.96% during 2022, primarily reflecting a higher cost of subordinated debentures and the issuance of subordinated notes.

The cost of subordinated debentures was 5.89% during 2022, up from 3.80% during 2021, reflecting the increased interest rate environment.

Subordinated notes totaling $90 million were issued in December of 2021 and January of 2022, with $85.0 million of the proceeds being injected into Mercantile Bank as an increase to equity capital to support expected loan growth.

The cost of time deposits declined from 1.24% during 2021 to 1.02% during 2022 primarily due to lower rates paid on local time deposits.

A higher average rate paid on interest-bearing non-time deposits during 2022 resulted in a $2.5 million increase in interest expense, while $178 million of growth in the average balance of these deposits equated to a $0.4 million increase in interest expense.

An $87.6 million decrease in the average balance of time deposits equated to a $1.0 million reduction in interest expense during 2022, while a lower average rate paid on time deposits also resulted in a $1.0 million decrease in interest expense.

Interest expense related to short-term borrowings, which are comprised entirely of sweep accounts, increased slightly during 2022 due to a higher rate paid on, along with growth in the average balance of, these funds.

A $38.4 million decline in the average balance of FHLBI advances during 2022 resulted in a $0.8 million reduction in interest expense, while a lower average rate paid on these borrowings resulted in a $0.3 million reduction in interest expense.

An $84.8 million increase in the average balance of other borrowings, mainly reflecting the previously mentioned issuance of subordinated notes, during 2022 equated to a $3.7 million increase in interest expense, while an increased average rate paid on these borrowings resulted in a $0.5 million increase in interest expense.

Provision for Credit Losses

A provision for credit losses of $6.6 million was recorded during 2022, compared to a negative provision expense of $4.3 million during 2021.

The provision expense recorded during 2022 primarily reflected the net increase in required reserve levels resulting from changes to several environmental factors that were implemented mainly in response to heightened inherent risk within the commercial loan and residential mortgage loan portfolios, loan growth, and increased specific reserves for certain distressed loan relationships.

A higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio also impacted provision expense during 2022.

The negative provision expense recorded during 2021 primarily reflected diminished allocations attributable to improvement in both current and forecasted economic conditions and a net loan recovery, which more than offset required reserve allocations necessitated by loan growth.

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

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

The allowance for credit losses, as a percentage of total loans, was 1.1% and 1.0% as of December 31, 2022 and December 31, 2021, respectively.

Noninterest Income

Noninterest income during 2022 was $32.1 million, compared to $56.2 million during 2021.

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

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

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

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

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

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

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

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

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

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

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

Noninterest income during 2022 included a $0.5 million bank owned life insurance death benefit claim, while noninterest income during 2021 included a $1.1 million gain on the sale of a branch facility, a $0.6 million recovery of loan collection costs, and $0.5 million in gains on the sales of former branch facilities.

Excluding these transactions, noninterest income decreased $22.6 million in 2022 compared to 2021.

The lower level of noninterest income during 2022 primarily stemmed from decreased mortgage banking income, which more than offset growth in several key fee income sources, including service charges on accounts, credit and debit card income, and payroll servicing fees.

Reduced interest rate swap income, reflecting lower transaction volume, contributed to the decreased level of noninterest income during 2022.

Higher interest rates, lower refinancing activity, a reduced sold percentage, and a decreased gain on sale rate negatively impacted mortgage banking income during 2022.

Sustained strength in purchase mortgage originations during 2022 partially mitigated the impact of these factors.

The residential mortgage loan sold percentage declined from approximately 68% during 2021 to approximately 35% during 2022.

The decreased sold percentage in large part reflects customers’

preferences for adjustable-rate loans in the current interest rate environment and construction loans representing an increased percentage of overall loan production.

In aggregate, service charges on accounts, credit and debit card income, and payroll servicing fees were up approximately 13% during 2022 compared to 2021.

Noninterest Expense

Noninterest expense totaled $108 million during 2022, compared to $111 million during 2021.

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

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

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

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

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

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

Overhead costs during 2022 included $1.5 million in charitable contributions to The Mercantile Bank Foundation (the “Foundation”) and a $0.3 million net loss on the sale of a former branch facility, while overhead costs during the prior year included $4.0 million in expenses and contributions associated with the formation and initial funding of the Foundation and $0.6 million in net losses on sales and write-downs of former branch facilities.

Excluding these transactions, noninterest expense decreased nominally during 2022 compared to 2021.

Compensation-related costs, in large part reflecting higher residential mortgage loan deferred salary costs, reduced residential mortgage lender commissions and associated incentives, and lower stock-based compensation costs, declined in 2022 compared to 2021.

The increased residential mortgage loan deferred salary costs reflected the outcome of an updated loan origination cost study and resulting higher allocated cost per loan, while the decreased residential mortgage lender commissions and associated incentives resulted from reduced loan production, in large part reflecting lower refinancing activity.

Regular salary costs, primarily reflecting annual merit pay increases and market adjustments, and a bonus accrual were up in 2022.

Data processing costs, mainly depicting higher transaction volume and software support costs, and other employee costs, consisting mainly of meals, training, travel, and mileage, also increased in 2022.

The higher level of other employee costs primarily reflected the easing of Covid-19 pandemic-related restrictions.

Federal Income Tax Expense

During 2022, we recorded income before federal income tax of $75.8 million and a federal income tax expense of $14.7 million, compared to income before federal income tax of $73.7 million and a federal income tax expense of $14.7 million during 2021.

The increase in federal income tax expense in 2021 compared to 2020 resulted from the higher level of income before federal income tax.

The less than $0.1 million increase in federal income tax expense in 2022 compared to 2021 resulted from the slightly higher level of income before federal income tax.

Our effective tax rate was 19.4% during 2022, compared to 19.9% during 2021.

The aforementioned bank owned life insurance death benefit claim, substantially all of which was nontaxable, positively impacted the effective tax rate in 2022.

Future changes in tax laws could have a material effect on our business, cash flows, financial condition, results of operations, tax liability, and effective tax rate.

On August 16, 2022, the Inflation Reduction Act of 2022 (the “IR Act”) was signed into federal law.

The IR Act provides for a new U.S.

federal 1% excise tax on certain repurchases of stock by publicly traded U.S.

domestic corporations and certain U.S.

domestic subsidiaries of publicly traded foreign corporations occurring on or after January 1, 2023.

The excise tax is imposed on the repurchasing corporation itself, not its shareholders from which shares are repurchased.

The amount of the excise tax is generally 1% of the fair market value of the shares repurchased at the time of the repurchase.

However, for purposes of calculating the excise tax, repurchasing corporations are permitted to net the fair market value of certain new stock issuances against the fair market value of stock repurchases during the same taxable year.

In addition, certain exceptions apply to the excise tax, such as repurchases under $1 million.

Any redemption or other repurchase that occurs after December 31, 2022, in connection with a business combination, extension vote, or otherwise, may be subject to the excise tax.

Whether and to what extent we would be subject to the excise tax in connection with a business combination, extension vote, or otherwise would depend on a number of factors, including:

(i) the fair market value of the redemptions and repurchases in connection with the business combination, extension, or otherwise;

(ii) the structure of a business combination;

(iii) the nature and amount of any equity issuances in connection with a business combination (or otherwise issued not in connection with a business combination but issued within the same taxable year of a business combination);

and (iv) the content of regulations and other guidance from the U.S.

Department of the Treasury.

The IR Act also included a new 15% Corporate Alternative Minimum Tax (“CAMT”) that acts as a new book minimum tax of at least 15% of consolidated GAAP pre-tax income for corporations with average book income in excess of $1 billion.

Any increase in our effective tax rate will depend on a number of factors, including any offsets for general business credits or changes in book income following business combinations.

The CAMT is effective for tax years beginning on or after January 1, 2023.

Lastly, the IR Act also creates a number of potentially beneficial tax credits to incentivize investments in certain technologies and industries.

We are in the process of evaluating the potential impacts of the IR Act.

While we do not believe the IR Act will have a material negative impact on our business or our financial performance, the effects of the measures are unknown at this time.

Our analysis is ongoing and incomplete, and it is possible that the IR Act could ultimately have a material adverse effect on our tax liability.

We continue to monitor the IR Act and related regulatory developments to evaluate their potential impact on our business, tax rate, and financial results.

CAPITAL RESOURCES

Shareholders’

equity increased $15.0 million during 2021, totaling $457 million as of December 31, 2021.

equity declined $15.2 million during 2022, totaling $441 million as of December 31, 2022.

Positively impacting shareholders’

equity was net income of $61.1 million, while negatively affecting shareholders’

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

equity were cash dividends on our common stock totaling $19.6 million.

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

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Negatively impacting shareholders’

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

equity during 2022 was a $61.6 million increase in the after-tax net unrealized loss on available for sale securities.

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

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As of December 31, 2022, our bank’s total risk-based capital ratio was 13.7%, compared to 13.6% at December 31, 2021.

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

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

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

Our bank’s total regulatory capital increased $66.9 million during 2022, primarily reflecting the net impact of net income totaling $70.2 million, a $15.0 million equity capital injection from us in association with the $15.0 million issuance of subordinated notes in January 2022, and cash dividends paid to us aggregating $26.0 million.

Our bank’s total risk-based capital ratio was also impacted by a $482 million increase in total risk-weighted assets, in large part reflecting growth in commercial loans and residential mortgage loans.

As of December 31, 2022, our bank’s total regulatory capital equaled $619 million, or approximately $166 million in excess of the amount necessary to attain the 10.0% minimum total risk-based capital ratio, which is among the requirements to be categorized as “well capitalized.”

We maintain a stock repurchase program, which is discussed in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”

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These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate our company.

Liquidity is essential to our business.

An inability to maintain sufficient funds through deposits, borrowings, the sale of assets, and other sources could have a material adverse effect on our liquidity.

Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general.

Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold, and interest-earning deposit balances.

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Wholesale funds, comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $308 million, or 7.3% of combined deposits and borrowed funds as of December 31, 2022, compared to $398 million, or 8.5% of combined deposits and borrowed funds, as of December 31, 2021.

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

We had no out-of-area deposits as of December 31, 2022, compared to $23.9 million as of December 31, 2021.

Sweep accounts decreased $3.1 million during 2022, totaling $194 million as of December 31, 2022.

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Weighted average interest rate for twelve months ended December 31, 2022

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

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

FHLBI advances declined $65.7 million during 2022, totaling $308 million as of December 31, 2022.

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

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

We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit.

These lines of credit were not accessed during 2021.

Based on collateral, our aggregate borrowing capacity at year-end 2022 totaled $1.03 billion, with availability of $713 million.

We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit, with an average balance of less than $0.1 million during 2022.

In contrast, our interest-earning deposit account at the Federal Reserve Bank of Chicago averaged $439 million during 2022.

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

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

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

Based on pledged municipal bonds, we could have borrowed up to $27.2 million at December 31, 2022.

We have not utilized this line of credit in over ten years, and we do not plan to access this line of credit in future periods.

The following table reflects, as of December 31, 2022, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

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Of the total unfunded loan commitments, $1.56 billion were commitments available as lines of credit to be drawn at any time as customers’

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

cash needs vary, and $330 million were for loan commitments generally expected to be accepted and become funded within the next 12 to 18 months.

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

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1,098,951,000

1,019,496,000

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

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MARKET RISK ANALYSIS

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk.

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and inflation risk.

All of our transactions are denominated in U.S.

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Interest rate risk is the exposure of our financial condition to adverse movements in interest rates.

Inflation risk is the risk that the values of assets or income from investments will be worth less in the future as inflation decreases the value of money.

Recently, there has been a pronounced rise in inflation.

As a result, the FOMC has significantly increased interest rates and has indicated its intention to continue doing so in an effort to combat inflation.

As inflation increases, the value of our investment securities, particularly those with fixed rates and longer maturities, declines.

In addition, inflation increases salary and benefit costs, as well as the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our noninterest expenses.

Furthermore, our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.

We derive our income primarily from the excess of interest collected on interest-earning assets over the interest paid on interest-bearing liabilities.

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Interest-earning deposits

Allowance for loan losses

Mortgage loans held for sale

Allowance for credit losses

2,101,059,000

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Money market accounts

1,040,176,000

Time deposits under $100,000

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1,007,812,000

1,070,213,000

Cumulative GAP

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and changes in market conditions impacting loan and deposit volume and pricing.

These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment;

These assumptions are inherently uncertain and subject to fluctuation and revision in a dynamic environment;

therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income.

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Interest rates down 300 basis points

Interest rates up 100 basis points

Interest rates down 200 basis points

Interest rates down 100 basis points

Interest rates up 100 basis points

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Interest rates up 300 basis points

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

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

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

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Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in shareholders’

We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), changes in shareholders’

equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”).

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Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 3, 2023 expressed an unqualified opinion thereon.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2022 due to the adoption of ASC Topic 326, Financial Instruments –

Credit Losses. 

Our opinion is not modified with respect to this matter.

Basis for Opinion

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

Allowance for Loan Losses –

Allowance for Credit Losses –

General Reserve

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

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

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

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

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

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

Auditing these assumptions involves especially challenging and subjective auditor judgment.

As described in Notes 1 and 3 to the Company’s consolidated financial statements, the Company has a gross loan balance of $3,916,619,000 and related allowance for credit losses balance of $42,246,000 at December 31, 2022.

The allowance for credit losses consists of quantitative and qualitative components.

The Company considers historical loss experience, current economic and business conditions, as well as reasonable and supportable forecasts to develop the quantitative component.

This quantitative component is then adjusted for qualitative environmental factors that involve significant assumptions that require a high degree of management’s judgment.

We identified management’s selection of reasonable and supportable forecasts that represents market conditions in which the Company operates, as well as significant assumptions used in the determination of certain qualitative environmental factors of the allowance for credit losses as a critical audit matter.

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

Auditing these complex judgments and assumptions involved especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill and knowledge needed.

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

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

Testing the design and operating effectiveness of internal controls over management’s review of the reasonable and supportable forecasts.

As well as their review of certain qualitative environmental factors.

Utilizing personnel with specialized skill and knowledge to assist with evaluating the reliability of the reasonable and supportable forecasts used by management by comparing to other external forecast sources, including considerations of contradictory evidence, and evaluating the reasonableness of management’s conclusions that the forecasts used represent geographic areas for which the Company services.

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

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In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, changes in shareholders’

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), changes in shareholders’

equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and our report dated March 3, 2023 expressed an unqualified opinion thereon.

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3,453,459,000  

Allowance for loan losses

Allowance for credit losses

( 42,246,000 )

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88,628,000  

73,646,000  

Accrued interest and other liabilities

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( 65,341,000 )

5,486,000  

( 3,729,000 )

Total shareholders’

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Net interest income

Provision (benefit) for loan losses

Net interest income after provision for loan losses

Provision (benefit) for credit losses

Net interest income after provision for credit losses

Noninterest income

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MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Years ended December 31, 2022, 2021 and 2020

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Other comprehensive income (loss), net of tax effect

Comprehensive income

Comprehensive income (loss)

See accompanying notes to consolidated financial statements.

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Years ended December 31, 2022, 2021 and 2020

Accumulated  

Comprehensive

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Balances, January 1, 2020

$ 308,005  

$ 75,483  

$ 375,249  

Employee stock purchase plan ( 2,264 shares)

Dividend reinvestment plan ( 35,479 shares)

Stock option exercises ( 8,200 shares)

Stock option exercises, net ( 753 shares)

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

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Net income for 2020

49,456  

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

11,934  

Balances, December 31, 2020

$ 305,035  

$ 107,831  

$ 3,695  

$ 416,561  

See accompanying notes to consolidated financial statements.

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Years ended December 31, 2022, 2021 and 2020

Accumulated  

Comprehensive

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$ 456,559  

$ 441,554  

See accompanying notes to consolidated financial statements.

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Years ended December 31, 2022, 2021 and 2020

Accumulated  

Comprehensive

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$ 456,559  

$ 441,554  

Adoption of ASU 2016-13

Employee stock purchase plan ( 1,388 shares)

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Stock-based compensation expense

Share repurchase program ( 683,191 shares)

Cash dividends ($ 1.26 per common share)

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Cash flows from operating activities

$ 59,021,000  

$ 44,138,000  

$ 49,456,000  

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

Depreciation and amortization

13,678,000  

9,425,000  

9,553,000  

Accretion of acquired loans

Provision for loan losses

( 4,300,000 )

14,050,000  

1,750,000  

Provision for credit losses

Deferred income tax expense (benefit)

2,020,000  

( 4,141,000 )

26,000  

Stock-based compensation expense

3,784,000  

2,325,000  

2,931,000  

Stock grants to directors for retainer fee

344,000  

394,000  

375,000  

Proceeds from sales of mortgage loans held for sale

686,418,000  

677,634,000  

261,021,000  

Origination of mortgage loans held for sale

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Net gain on sales of mortgage loans held for sale

( 30,402,000 )

( 29,541,000 )

( 8,108,000 )

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

Net gain from sale and write-downs on former bank premises

Net loss from sales and disposals of premises and equipment

246,000  

1,514,000  

294,000  

Net (gain) loss from sale and write-downs on former bank premises

Net (gain) loss from sales and disposals of premises and equipment

Earnings on bank owned life insurance

( 1,164,000 )

( 1,214,000 )

( 3,886,000 )

Gain on sale of branch

( 1,058,000 )

Net (gain) loss on instruments designated at fair value and related derivatives

Net change in:

Accrued interest receivable

1,528,000  

( 16,279,000 )

( 10,892,000 )

( 7,636,000 )

Accrued interest and other liabilities

335,000  

1,895,000  

( 2,818,000 )

Net cash from operating activities

64,573,000  

37,877,000  

44,767,000  

Cash flows from investing activities

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

80,432,000  

321,164,000  

79,478,000  

Purchases of Federal Home Loan Bank stock

( 1,980,000 )

Loan originations and payments, net

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( 341,461,000

Proceeds from Federal Home Loan Bank stock redemption

Purchases of bank owned life insurance

( 2,000,000 )

( 4,500,000 )

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

7,708,000  

Proceeds from bank owned life insurance death benefits claim

Net cash transferred in branch sale

( 2,679,000 )

Net purchases of premises and equipment and lease activity

( 5,602,000 )

( 8,989,000 )

( 13,484,000 )

Purchases of premises and equipment and lease activity

Proceeds from sales of former bank premises

753,000  

162,000  

854,000  

Proceeds from sales of foreclosed assets

196,000  

700,000  

790,000  

Net cash for investing activities

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Cash flows from financing activities

Net (decrease) increase in time deposits

Net decrease in time deposits

( 120,512,000

Net (decrease) increase in all other deposits

( 313,193,000

170,921,000  

Net increase in all other deposits

806,796,000  

820,463,000  

55,755,000  

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

79,098,000  

15,690,000  

Proceeds from Federal Home Loan Bank advances

60,000,000  

44,000,000  

Maturities of Federal Home Loan Bank advances

( 20,000,000 )

( 40,000,000 )

Net proceeds from subordinated notes issuance

73,635,000  

Proceeds from stock option exercises, net of cashless exercises

50,000  

128,000  

Employee stock purchase plan

48,000  

49,000  

50,000  

Dividend reinvestment plan

877,000  

814,000  

729,000  

Repurchases of common stock

( 21,380,000 )

( 6,591,000 )

( 7,183,000 )

Payment of cash dividends to common shareholders

( 18,524,000 )

( 17,930,000 )

Net cash (for) from financing activities

( 443,251,000

Net cash from financing activities

780,088,000  

753,204,000  

206,448,000  

See accompanying notes to consolidated financial statements.

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Net change in cash and cash equivalents

( 878,388,000

Cash and cash equivalents at beginning of period

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Transfers from bank premises to other real estate owned

Transfers from premises and equipment to other assets

See accompanying notes to consolidated financial statements.

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These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

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

Recent Events:

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

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

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

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

MERCANTILE BANK CORPORATION

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The following section summarizes the primary measures that directly impact us and our customers.

Coronavirus Pandemic:

Although virtually all related restrictions have been terminated, impacts remain 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”).

Overall, The Coronavirus Pandemic has caused a sustained global economic slowdown of varying durations across different industries, and it is possible that it could still cause a global recession as a result of deteriorating economic and political conditions such as increased unemployment, decreased capital spending, declines in consumer confidence, and economic slowdowns.

This uncertainty is heightened in certain geographic areas due to continued surges in Covid- 19 cases, and governments at all levels continue to react to changes in circumstances, including vaccine hesitancy, booster shot efficacy, supply chain disruptions and inflationary pressures.

In addition, this uncertainty is further heightened by the possibility that new and highly infectious variants and subvariants of Covid- 19 might arise which are more severe, more transmissible, and capable of evading vaccinations, booster shots and prior immunity.

The Coronavirus Pandemic has had a significant impact on our financial condition and operating results since its onset in March, 2020.

The following section summarizes the primary Covid- 19 related measures that directly impacted us and our customers.

Paycheck Protection Program

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

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

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

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

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

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

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

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

As of December 31, 2022, we recorded forgiveness transactions on all but five loans aggregating $ 0.5 million.

Net loan origination fees of less than $ 0.1 million were recorded during 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.

This program ended on May 31, 2021.

Under the Second Draw, we originated approximately 1,200 loans aggregating $ 209 million.

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

As of December 31, 2022, we recorded forgiveness transactions on all but six loans aggregating $ 0.4 million.

Net loan origination fees of $ 1.0 million were recorded during 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

The Internal Revenue Service 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 received payments of $1,200 in April 2020, $600 in January 2021, and $1,400 in March 2021.

Troubled Debt Restructuring Relief

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Banking agencies must defer to the financial institution’s election.

We elected to suspend GAAP principles and regulatory determinations as permitted.

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

We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021.

Current Expected Credit Loss Methodology Delay

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.

However, if the Coronavirus Pandemic worsens and shutdown orders are issued in the future, our ability to operate could be adversely impacted, depending on the language of such orders.

The extent to which the Coronavirus Pandemic continues to impact us will depend on future developments, which are highly uncertain and cannot be predicted.

Cash and Cash Equivalents and Cash Flow Reporting :

Cash and cash equivalents include cash on hand, demand deposits with other financial institutions, short-term investments and federal funds sold.

Cash flows are reported net for customer loan and deposit transactions, interest-earning deposits invested with other financial institutions and short-term borrowings with maturities of 90 days or less.

Debt 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 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, 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 debt 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 issuer of 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 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 is recognized in other comprehensive income.

MERCANTILE BANK CORPORATION

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

For commercial borrowers, we offered 90 -day ( three payments) interest only amendments as well as 90 -day ( three payments) principal and interest payment deferments.

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

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

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

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

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

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

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

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

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

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

Cash and Cash Equivalents and Cash Flow Reporting :

Cash and cash equivalents include cash on hand, demand deposits with other financial institutions, short-term investments (including securities with daily put provisions) and federal funds sold.

Cash flows are reported net for customer loan and deposit transactions, interest-earning time deposits with other financial institutions and short-term borrowings with maturities of 90 days or less.

Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity.

Debt securities are classified as available for sale when they might be sold prior to maturity.

Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

It is not practical to determine the fair value of FHLBI stock due to transferability restrictions;

therefore, its fair value is estimated at carrying value.

Changes in the allowance under CECL are recorded as provisions for (or reversal of) credit loss expense.

Losses are charged against the allowance when the collectability of an available for sale debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

At December 31, 2022, there was no allowance related to the available for sale debt securities portfolio.

Interest income includes amortization of purchase premiums and accretion of discounts.

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Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Declines in the fair value of debt securities below their amortized cost that are other-than-temporary impairment (“OTTI”) are reflected in earnings or other comprehensive income, as appropriate.

For those debt securities whose fair value is less than their amortized cost, we consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and whether we expect to recover the entire amortized cost of the security based on our assessment of the issuer’s financial condition.

In analyzing an issuer’s financial condition, we consider whether the securities are issued by the federal government or its agencies, and whether downgrades by bond rating agencies have occurred.

If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.

For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows:

1 ) OTTI related to credit loss, which must be recognized in the income statement, and 2 ) OTTI related to other factors, such as liquidity conditions in the market or changes in market interest rates, which is recognized in other comprehensive income.

The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses.

It is not practical to determine the fair value of FHLBI stock due to transferability restrictions;

therefore, its fair value is estimated at carrying value.

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.

Interest income is accrued on the unpaid principal balance.

Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

Net unamortized deferred loan fees amounted to $ 2.5 million and $ 4.4 million, respectively, at December 31, 2021 and 2020.

Net unamortized deferred loan fees/(costs) amounted to ($ 1.0 ) million and $ 2.5 million, respectively, at December 31, 2022 and 2021.

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.

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$ 16,117,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Mortgage Loan Derivatives :

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The net gain or loss on derivatives is included in mortgage banking activities in the Consolidated Statements of Income.

The balance of mortgage loan derivatives aggregated $ 0.3 million and $ 0.5 million at December 31, 2021 and 2020, respectively.

The balance of mortgage loan derivatives aggregated less than $ 0.1 million and $ 0.3 million at December 31, 2022 and 2021, respectively.

Mortgage Banking Activities :

3 unchanged sentences

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

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Servicing fee income is recorded for fees earned for servicing mortgage loans.

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Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans.

Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described below under “Allowance for Loan Losses.”

Certain loans modified as troubled debt restructurings may have been previously measured for impairment and included in the allowance under a general allowance methodology (i.e., pooling).

In these circumstances, the allowance may be impacted to the extent there is a difference in the results obtained by the initial measurement methodology and the methodology applied to reflect a troubled debt restructuring.

Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

The federal banking agencies issued an “

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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.

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.

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) significantly changed how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.

The standard replaced the current “incurred loss”

approach with an “expected loss”

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 expanded the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance.

In addition, entities 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.

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses :

The allowance for loan losses (“allowance”) is a valuation allowance for probable incurred credit losses.

Loan losses are charged against the allowance when we believe the uncollectability of a loan is confirmed.

Subsequent recoveries, if any, are credited to the allowance.

We estimate the allowance balance required using past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors.

We estimate credit losses based on individual loans determined to be impaired and on all other loans grouped on similar risk characteristics.

Our historical loss component is based on historical loss experience by credit risk grade for commercial loans and payment status for mortgage and consumer loans.

Loans are pooled based on similar risk characteristics supported by observable data.

The historical loss experience component of the allowance represents the results of migration analysis of historical net charge-offs for portfolios of loans, including groups of commercial loans within each credit risk grade.

For measuring loss exposure in a pool of loans, the historical net charge-off or migration experience is utilized to estimate expected future losses to be realized from the pool of loans.

These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative environmental factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, competition, increasing interest rates, external factors, Coronavirus Pandemic environment, and other considerations.

Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off.

A loan is considered impaired when, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement.

Factors considered in determining impairment include payment status and collateral value.

Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.

We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of delay, the reasons for delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, generally based on delinquency status.

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

Loans made under PPP are fully guaranteed by the Small Business Administration;

therefore, such loans do not have an associated allowance.

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.

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 December 31, 2022 were as follows:

Commercial Loans

Commercial and Industrial :

Risks to this loan category include industry concentration and the practical limitations associated with monitoring the condition of the collateral which often consists of inventory, accounts receivable, and other non-real estate assets.

Equipment and inventory obsolescence can also pose a risk.

Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.

Owner Occupied Commercial Real Estate :

Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral.

Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.

Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category.

MERCANTILE BANK CORPORATION

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Non-Owner Occupied Commercial Real Estate :

Loans in this category are susceptible to declines in occupancy rates, business failure, and general economic conditions.

Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category.

Multi-Family and Residential Rental :

Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral.

Loans in this category are susceptible to weakening general economic conditions and increases in unemployment rates, as well as market demand and supply of similar property and the resulting impact on occupancy rates, market rents, cash flow, and income-based real estate values.

Also, the lack of a suitable alternative use for the properties is a risk for loans in this category.

Vacant Land, Land Development and Residential Construction :

Risks common to commercial construction loans are cost overruns, changes in market demand for property, inadequate long-term financing arrangements, and declines in real estate values.

Residential construction loans are susceptible to those same risks as well as those associated with residential mortgage loans.

Changes in market demand for property could lead to longer marketing times resulting in higher carrying costs, declining values, and higher interest rates.

1 - 4 Family Mortgages :

Residential mortgage loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.

Other Consumer Loans :

Risks common to these loans include regulatory risks, unemployment, and changes in local economic conditions as well as the inability to monitor collateral consisting of personal property.

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.

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.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 December 31, 2022, we used a one -year reasonable and supportable economic forecast period, with a six -month straight-line reversion period for all loan segments.

We are not required to develop and use our own economic forecast model, and elected to utilize economic forecasts from third -party providers that analyze and develop forecasts of the economy for the entire United States at least quarterly.

The economic forecasts used for our December 31, 2022 allowance calculation reflected a $ 0.9 million allowance balance reduction compared to the forecasts used for our January 1, 2022 allowance calculation.

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 the historical loss rates as determined by our migration calculations 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 migration-based historical loss information was determined.

These qualitative adjustments may increase or decrease our estimate of expected future credit losses.

Traditional qualitative factors include:

Changes in lending policies and procedures

Changes in the nature and volume of the loan portfolio and in the terms of loans

Changes in the experience, ability and depth of lending management and other relevant staff

Changes in the volume and severity of past due loans, nonaccrual loans and adversely classified loans

Changes in the quality of the loan review program

Changes in the value of underlying collateral dependent loans

Existence and effect of any concentrations of credit and any changes in such

Effect of other factors such as competition and legal and regulatory requirements

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.

Effective January 1, 2022, we established a historical loss information factor to address the relatively 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.

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 other noninterest expense 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.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Transfers of Financial Assets :

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If fair value subsequently declines, a valuation allowance is recorded through noninterest expense, as are collection and operating costs after acquisition.

Foreclosed assets, included in other assets in the Consolidated Balance Sheets, totaled $ 0 and $ 0.7 million as of December 31, 2021 and 2020, respectively.

Foreclosed assets, included in other assets in the Consolidated Balance Sheets, totaled $ 0 as of December 31, 2022 and 2021.

Bank Owned Life Insurance:

1 unchanged sentence

Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized.

Increases in the net cash surrender value of the policies, as well as insurance proceeds received, are recorded as noninterest income on the Consolidated Statements of Income and are not subject to income taxes.

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

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

therefore, no further testing was required.

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

No impairments were recorded in 2021 or 2020.

GAAP requires us to determine the fair value of all 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 we concluded to have the appropriate expertise to determine the fair value, we may choose to use our own calculation of fair value.

In other cases, where the fair value is not readily determined, consultation with outside parties is used to determine fair value.

Once valuations have been determined, the net difference between the price paid for the acquired company and the fair value of the balance sheet is recorded as goodwill.

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

A more frequent assessment is performed if there are material changes in the market place or within the organizational structure.

We conducted an annual test during 2022 using step zero, with no impairment identified.

The core deposit intangible that arose from the merger with Firstbank was initially measured at fair value and is being amortized into noninterest expense over a ten -year period using the sum-of-the-years-digits methodology.

5 unchanged sentences

December 31, 2022

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

NOTE 1 –

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Financial Instruments and Loan Commitments :

12 unchanged sentences

Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation.

No revenue has been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

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.

27 unchanged sentences

December 31, 2022

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

NOTE 1 –

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Credit and Debit Card Fees:

7 unchanged sentences

Customer Service Fees:

We earn fees by providing a variety of other services to our customers, such as wire transfers, check ordering, sale of cashier checks and money orders, and rental of safe deposit boxes.

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.

Customer service fees are recorded as other noninterest income on our Consolidated Statements of Income.

Advertising Costs :

30 unchanged sentences

If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.

If designated as a hedge, we formally document the relationship between the derivative instrument and the hedged item, as well as the risk-management objective and the strategy for undertaking the hedge transaction.

This documentation includes linking cash flow hedges to specific assets on the balance sheet.

If designated as a hedge, we also formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivative instrument that is used is highly effective in offsetting changes in cash flows of the hedged items.

Ineffective hedge gains and losses are recognized immediately in current earnings as noninterest income or expense.

We discontinue hedge accounting when we determine the derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or terminates, or treatment of the derivatives as a hedge is no longer appropriate or intended.

We had no derivative instruments designated as hedges as of December 31, 2022 and 2021.

2 unchanged sentences

We do not believe there are any such matters outstanding that would have a material effect on the financial statements

Reclassifications:

Certain items in the prior years’

financial statements have been reclassified to conform to the current year presentation.

Accounting Standards Updates :

In June 2016, the FASB issued ASU No.

2016 - 13, Measurement of Credit Losses on Financial Instruments .

This ASU (as subsequently amended by ASU 2018 - 19 ) significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.

The standard will replace the current “incurred loss”

approach with an “expected loss”

The new model, referred to as the CECL model, will apply to:

(i) financial assets subject to credit losses and measured at amortized cost, and (ii) certain off-balance sheet credit exposures.

This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees.

The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans, and expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses.

In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination.

This ASU is effective for interim and annual reporting periods beginning after December 15, 2019.

The Consolidated Appropriations Act, 2021 provided for a further extension of the required CECL adoption date to January 1, 2022.

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

We adopted CECL effective January 1, 2022, which we expect to result in an allowance reduction of $ 0.2 million to $ 2.0 million, of which the assumption related to the Covid- 19 environmental factor presents the most variability within this range.

The resulting impact will be an increase to the retained earnings account on our Consolidated Balance Sheet equal to the after-tax impact of the allowance balance reduction, with the tax impact portion being recorded as a deferred tax asset in other assets on our Consolidated Balance Sheet.

Newly Issued Not Yet Effective Standards :

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.

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 2 –

The amortized cost and fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

The amortized cost and fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows at year-end 2022 and 2021:

Amortized  

Unrealized  

Government agency debt obligations

$ 453,836,000  

$ 266,000  

$ ( 65,092,000 )

3 unchanged sentences

19,000  

( 6,068,000 )

31,953,000  

2 unchanged sentences

450,000  

( 9,058,000 )

154,433,000  

2 unchanged sentences

102,000  

( 3,063,000 )

27,306,000  

33 unchanged sentences

12 Months or More

Unrealized  

Description of Securities

17 unchanged sentences

4,542,000  

130,122,000  

9,058,000  

Municipal revenue bonds

4 unchanged sentences

23,141,000  

3,063,000  

Other investments

10 unchanged sentences

$ 3,495,000  

$ 384,340,000  

$ 8,769,000  

Mortgage-backed securities

23,184,000  

652,000  

24,000  

23,208,000  

652,000  

Municipal general obligation bonds

40,748,000  

392,000  

40,748,000  

392,000  

Municipal revenue bonds

1 unchanged sentence

137,000  

414,000  

13,257,000  

145,000  

Other investments

3 unchanged sentences

$ 3,503,000  

$ 461,553,000  

$ 9,958,000  

MERCANTILE BANK CORPORATION

3 unchanged sentences

SECURITIES (Continued)

We evaluate securities for other-than-temporary impairment at least on a quarterly basis.

Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

We evaluate securities in an unrealized loss position at least quarterly.

Consideration is given to the financial condition of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security.

In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.

At December 31, 2021, 333 debt securities with fair values totaling $ 462 million had unrealized losses aggregating $ 10.0 million.

After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that unrealized losses were due to changing interest rate environments.

At December 31, 2022, 732 debt securities with estimated fair values totaling $ 573 million had unrealized losses aggregating $ 83.3 million.

At December 31, 2021, 333 debt securities with estimated fair values totaling $ 462 million had unrealized losses aggregating $ 10.0 million.

At December 31, 2022, unrealized losses aggregating $ 71.2 million were attributable to bonds issued or guaranteed by agencies of the U.S.

federal government, while unrealized losses totaling $ 12.1 million were associated with bonds issued by state-based municipalities.

After considering the issuers of the bonds, and taking into account the fact that no municipal issuer had been subject to a credit rating downgrade by bond credit rating agencies, 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.

5 unchanged sentences

Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

Weighted  

Amortized  

Average Yield

Due in one year or less

1.92 %  

$ 11,406,000  

$ 11,458,000  

Due from one to five years

185,889,000  

184,788,000  

Due from five to ten years

288,599,000  

285,609,000  

Due after ten years

69,163,000  

68,585,000  

Mortgage-backed securities

41,906,000  

41,803,000  

Other investments

500,000  

1.45 %  

$ 597,463,000  

$ 592,743,000  

No securities were sold during the last three years.

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $ 193 million and $ 155 million at December 31, 2022 and December 31, 2021, respectively, with estimated market values of $ 182 million and $ 158 million at the respective dates.

Securities issued by all other states and their political subdivisions had a combined amortized cost of $ 1.7 million and $ 4.1 million at December 31, 2021 and December 31, 2020, respectively, with estimated market values of $ 1.7 million and $ 4.2 million, respectively.

We had no securities issued by all other states and their political subdivisions as of December 31, 2022.

Securities issued by all other states and their political subdivisions had a combined amortized cost of $ 1.7 million with estimated market values of $ 1.7 million as of December 31, 2021.

Total securities of any other specific issuer, other than the U.S.

7 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES

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.

27 unchanged sentences

2,950,424,000  

Home equity and other

1-4 family mortgages

755,036,000  

442,547,000  

1-4 family mortgages

Other consumer loans (2)

29,753,000  

5 unchanged sentences

For December 31, 2022, and December 31, 2021, includes $ 0.9 million and $ 40.1 million in loans originated under the Paycheck Protection Program, respectively.

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 $ 37.4 million and $ 29.5 million as of December 31, 2022, and 2021, respectively.

Concentrations within the loan portfolio were as follows at year-end:

Percentage  

Commercial real estate loans to lessors of non-residential buildings

5 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Year-end nonperforming loans were as follows:

17 unchanged sentences

non-owner occupied

22,000  

Real estate –

3 unchanged sentences

663,000  

Home equity and other

119,000  

242,000  

1-4 family mortgages

1 unchanged sentence

1,686,000  

Other consumer loans

119,000  

1,456,000  

1,805,000  

Total nonperforming loans

5 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

An age analysis of past due loans is as follows as of December 31, 2022:

Recorded  

Greater  

Balance >  

Than 89  

Days and  

Commercial and industrial

4 unchanged sentences

$ 1,185,083,000  

$ 155,000  

Vacant land, land development, and residential construction

1 unchanged sentence

61,873,000  

43,226,000  

43,239,000  

Real estate –

2 unchanged sentences

248,000  

638,944,000  

639,192,000  

Real estate –

12 unchanged sentences

3,131,830,000  

155,000  

Home equity and other

132,000  

1-4 family mortgages

1,334,000  

2 unchanged sentences

1,538,000  

1- 4 family mortgages

753,498,000  

755,036,000  

Other consumer loans

15,000  

15 unchanged sentences

$ 3,916,619,000  

$ 155,000  

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

An age analysis of past due loans is as follows as of December 31, 2021:

Recorded  

Greater  

Balance >  

Than 89  

Days and  

Commercial and industrial

4 unchanged sentences

$ 1,137,419,000  

Vacant land, land development, and residential construction

$ 155,000  

Vacant land, land development, and residential construction

13,000  

Real estate –

owner occupied

13,000  

1 unchanged sentence

43,239,000  

Real estate –

owner occupied

565,758,000  

4 unchanged sentences

1,027,415,000  

917,413,000  

917,436,000  

Real estate –

15 unchanged sentences

60,488,000  

61,620,000  

1- 4 family mortgages

18 unchanged sentences

$ 3,453,459,000  

$ 155,000  

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans with no related allowance recorded were as follows as of December 31, 2021:

Year-To-Date Average

Recorded Principal Balance

With no related allowance recorded:

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.

Senior management and the Board of Directors review this list regularly.

Fair value estimates of collateral on distressed lending relationships, 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.

Collateral dependent loans, representing the entire amount of loans on nonaccrual, totaled $ 7.7 million as of December 31, 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 3 –

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Nonaccrual loans as of December 31, 2022 were as follows:

With no allowance recorded:

Commercial and industrial

$ 249,000  

$ 2,818,000  

$ 3,632,000  

Vacant land, land development and residential construction

1 unchanged sentence

owner occupied

9,674,000  

12,634,000  

Real estate –

non-owner occupied

131,000  

Real estate –

multi-family and residential rental

91,000  

37,000  

Total commercial

249,000  

12,583,000  

16,434,000  

Home equity and other

1,173,000  

1,107,000  

1,096,000  

1-4 family mortgages

1,064,000  

2,025,000  

2,327,000  

4,339,000  

3,132,000  

3,423,000  

Total with no related allowance recorded

$ 16,997,000  

Other consumer loans

1,064,000  

Total with no allowance recorded

$ 1,313,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2021:

Year-To-Date Average Recorded Principal Balance

With an allowance recorded:

2 unchanged sentences

$ 2,051,000  

$ 266,000  

$ 1,732,000  

Vacant land, land development and residential construction

3 unchanged sentences

32,000  

84,000  

803,000  

Real estate –

non-owner occupied

146,000  

154,000  

Real estate –

3 unchanged sentences

2,083,000  

354,000  

2,689,000  

Home equity and other

160,000  

140,000  

123,000  

214,000  

1-4 family mortgages

1 unchanged sentence

200,000  

69,000  

537,000  

572,000  

552,000  

Other consumer loans

392,000  

3 unchanged sentences

$ 2,283,000  

$ 546,000  

$ 3,440,000  

Total impaired loans:

$ 15,757,000  

$ 15,682,000  

$ 354,000  

$ 19,123,000  

4,911,000  

3,684,000  

Total nonaccrual loans:

$ 6,272,000  

$ 2,083,000  

Total impaired loans

1,456,000  

200,000  

Total nonaccrual loans

$ 7,728,000  

4 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Impaired loans with no related allowance recorded were as follows as of December 31, 2021: 

7 unchanged sentences

Vacant land, land development and residential construction

187,000  

Real estate –

6 unchanged sentences

131,000  

341,000  

227,000  

Real estate –

multi-family and residential rental

91,000  

37,000  

Total commercial

21 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2021:

7 unchanged sentences

Vacant land, land development and residential construction

77,000  

Real estate –

49 unchanged sentences

$ 23,297,000  

Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated fair value.

Interest income recognized on accruing troubled debt restructurings totaled $ 1.5 million in 2021, and $ 1.3 million in 2020 and 2019.

Interest income recognized on nonaccrual loans totaled less than $ 0.1 million in 2021, 2020 and 2019, reflecting the collection of interest at the time of principal pay-off.

Lost interest income on nonaccrual loans totaled $ 0.1 million in 2021, $ 0.2 million in 2020, and $ 0.1 million in 2019.

Impaired commercial loans for which no allocation of the allowance has been made in large part consist of performing troubled debt restructurings where the estimated collateral fair value exceeds the recorded principal balance, while impaired retail loans with no allowance allocation generally reflect situations whereby the recorded principal balances have been charged-down to estimated collateral fair value.

Interest income recognized on accruing troubled debt restructurings totaled $ 1.5 million in 2021.

Interest income recognized on nonaccrual loans totaled less than $ 0.1 million in 2021, reflecting the collection of interest at the time of principal pay-off.

Lost interest income on nonaccrual loans totaled $ 0.1 million in 2021.

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Credit Quality Indicators.

7 unchanged sentences

credit risk profiled by internal credit risk grades:

Land Development,

and Residential

30 unchanged sentences

credit risk profiled by collateral type:

Consumer Loans

$ 753,580,000  

4 unchanged sentences

$ 29,753,000  

$ 442,547,000  

Included in Commercial and Industrial Loans Grades 1 – 

4 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Loans by credit quality indicators were as follows as of December 31, 2021:

47 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

All commercial loans are graded using the following criteria:

19 unchanged sentences

The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments;

loans 90 days or more past due are considered nonperforming.

We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’

4 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2021 are as follows (dollars in thousands):

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The following table reflects loan balances as of December 31, 2022 based on year of origination (dollars in thousands):

Commercial and Industrial:

Commercial vacant land, land development and residential construction

Commercial real estate –

Grades 1 –

$ 115,494  

$ 141,481  

$ 43,961  

$ 9,194  

$ 3,230  

$ 9,851  

$ 323,211  

$ 396,372  

$ 719,583  

Grades 5 –

151,783  

47,030  

31,697  

240,042  

210,363  

450,405  

Grades 8 –

10,985  

15,095  

$ 271,061  

$ 188,760  

$ 75,658  

$ 18,064  

$ 3,847  

$ 9,973  

$ 567,363  

$ 617,720  

$ 1,185,083  

Vacant Land, Land Development and Residential Construction:

Grades 1 –

$ 31,756  

$ 6,196  

$ 3,428  

$ 41,711  

Grades 5 –

10,270  

20,057  

Grades 8 –

$ 42,026  

$ 14,956  

$ 3,779  

$ 1,048  

$ 61,873  

Real Estate –

Owner Occupied:

Commercial real estate –

Grades 1 –

$ 194,072  

$ 113,528  

$ 53,630  

$ 19,670  

$ 19,279  

$ 6,162  

$ 406,341  

Grades 5 –

115,720  

56,173  

33,913  

10,245  

12,550  

229,766  

Grades 8 –

$ 312,711  

$ 169,701  

$ 87,587  

$ 29,915  

$ 31,951  

$ 7,327  

$ 639,192  

Real Estate –

Non-Owner Occupied:

Commercial real estate –

Grades 1 –

$ 129,153  

$ 163,035  

$ 89,125  

$ 44,196  

$ 10,079  

$ 12,018  

$ 447,606  

Grades 5 –

183,388  

164,334  

139,951  

35,200  

13,456  

37,399  

573,728  

Grades 8 –

12,400  

$ 319,253  

$ 333,057  

$ 229,076  

$ 79,396  

$ 23,535  

$ 49,417  

$ 1,033,734  

Real Estate –

Multi-Family and Residential Rental:

Home equity and other

Grades 1 –

$ 31,470  

$ 38,176  

$ 36,348  

$ 5,306  

$ 3,082  

$ 4,003  

$ 118,385  

Grades 5 –

48,847  

25,786  

12,879  

93,514  

Grades 8 –

$ 80,317  

$ 63,962  

$ 49,227  

$ 8,468  

$ 5,639  

$ 4,335  

$ 211,948  

Total Commercial

$ 1,025,368  

$ 770,436  

$ 445,327  

$ 135,893  

$ 64,986  

$ 72,100  

$ 2,514,110  

$ 617,720  

$ 3,131,830  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 3 –

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

1-4 Family Mortgages:

Allowance for loan losses:

Beginning balance

$ 313,611  

4 unchanged sentences

$ 41,622  

Provision for loan losses

$ 716,510  

1 unchanged sentence

$ 753,580  

Nonperforming

$ 313,753  

7 unchanged sentences

$ 755,036  

Ending balance

Other Consumer Loans:

$ 4,349  

4 unchanged sentences

$ 19,595  

Ending balance:

individually evaluated for impairment

Ending balance:

collectively evaluated for impairment

$ 29,753  

Nonperforming

$ 4,349  

3 unchanged sentences

$ 10,158  

Total loans (*):

Ending balance

$ 19,595  

6 unchanged sentences

$ 43,081  

Ending balance:

individually evaluated for impairment

$ 728,124  

3 unchanged sentences

$ 1,016,338  

Ending balance:

collectively evaluated for impairment

$ 538,303  

5 unchanged sentences

$ 3,916,619  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 3 –

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The allowance for credit losses for the year-ended December 31, 2022 is as follows (dollars in thousands):

and industrial

Commercial vacant

development and

Commercial real

estate –

Commercial real

estate –

Commercial real

estate –

multi-family and

residential rental

Allowance for credit losses:

Beginning balance

$ 10,782  

(*) Excludes $40.1 million in loans originated under the Paycheck Protection Program.

$ 6,045  

$ 13,301  

$ 1,695  

$ 2,449  

$ 35,363  

Adoption of ASU 2016-13

( 1,571 )  

( 43 )  

( 560 )  

( 2,534 )  

( 621 )  

( 411 )  

( 55 )  

Provision for credit losses

( 603 )  

( 111 )  

( 171 )  

( 29 )  

( 38 )  

( 33 )  

( 21 )  

Ending balance

$ 10,203  

$ 5,914  

$ 10,164  

$ 1,269  

$ 14,027  

$ 42,246  

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2021 are as follows (dollars in thousands):

Commercial and industrial

Commercial vacant land, land development and residential construction

Commercial real estate –

Commercial vacant

development and

Commercial real

estate –

Commercial real

estate –

owner occupied

Commercial real estate –

non-owner occupied

Commercial real estate –

multi-family and residential rental

Home equity and other

4 family mortgages

real estate –

and residential

Allowance for loan losses:

4 unchanged sentences

$ 1,819  

$ 3,240  

$ 37,967  

Provision for loan losses

7 unchanged sentences

( 882 )  

( 15 )  

( 12 )  

( 43 )  

( 92 )  

Ending balance

47 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2020 are as follows (dollars in thousands):

Commercial and industrial

Commercial vacant land, land development and residential construction

Commercial real estate –

Commercial vacant

development and

Commercial real

estate –

Commercial real

estate –

owner occupied

Commercial real estate –

non-owner occupied

Commercial real estate –

multi-family and residential rental

Home equity and other

4 family mortgages

real estate –

and residential

Allowance for loan losses:

11 unchanged sentences

( 18 )  

( 96 )  

( 129 )  

Ending balance

4 unchanged sentences

$ 3,240  

$ 37,967  

Ending balance:

individually evaluated for impairment

$ 1,623  

Ending balance:

5 unchanged sentences

$ 3,068  

$ 37,416  

Total loans (*):

Ending balance

24 unchanged sentences

$ 2,801,253  

(*) Excludes $ 365 million in loans originated under the Paycheck Protection Program.

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Loans modified as troubled debt restructurings generally reflect payment extensions and below market interest rates.

Loans modified as troubled debt restructurings during the year-ended December 31, 2022 were as follows:

5 unchanged sentences

owner occupied

692,000  

Real estate –

2 unchanged sentences

multi-family and residential rental

93,000  

Total commercial

2 unchanged sentences

Home equity and other

485,000  

482,000  

1-4 family mortgages

16 unchanged sentences

non-owner occupied

319,000  

318,000  

Real estate –

multi-family and residential rental

93,000  

Total commercial

15 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

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 during the year-ended December 31, 2022 ( amounts as of period end):

Commercial and industrial

$ 5,665,000  

Vacant land, land development and residential construction

6 unchanged sentences

Total commercial

5,665,000  

Home equity and other

1-4 family mortgages

$ 5,665,000  

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2021 ( amounts as of period end):

14 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2022 is as follows:

Land Development,

and Residential

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

3 unchanged sentences

$ 146,000  

( 4,278,000 )

$ 91,000  

( 9,683,000 )

2 unchanged sentences

4,566,000  

686,000  

92,000  

Ending Balance

2 unchanged sentences

$ 130,000  

$ 91,000  

Retail Loan Portfolio:

4 unchanged sentences

Net Additions/Deletions (1)

482,000  

( 1,187,000 )

2,426,000  

2 unchanged sentences

$ 2,736,000  

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.

MERCANTILE BANK CORPORATION

2 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2021 is as follows:

Land Development,

and Residential

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

3 unchanged sentences

$ 480,000  

$ 178,000  

$ 7,000  

( 4,278,000 )

9 unchanged sentences

$ 146,000  

$ 91,000  

Retail Loan Portfolio:

13 unchanged sentences

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2020 is as follows:

Land Development,

and Residential

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

4 unchanged sentences

$ 178,000  

$ 7,000  

( 11,260,000 )

9 unchanged sentences

$ 480,000  

$ 178,000  

$ 7,000  

Retail Loan Portfolio:

9 unchanged sentences

$ 806,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 3 –

LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The allowance related to loans categorized as troubled debt restructurings was as follows:

Commercial and industrial

$ 266,000  

$ 53,000  

Vacant land, land development, and residential construction

Real estate –

owner occupied

84,000  

59,000  

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

355,000  

120,000  

Home equity and other

95,000  

202,000  

1-4 family mortgages

69,000  

145,000  

164,000  

347,000  

Total related allowance

$ 519,000  

$ 467,000  

In general, our policy dictates that a renewal or modification of an 8 - or 9 -rated commercial loan meets the criteria of a troubled debt restructuring, although we review and consider all renewed and modified loans as part of our troubled debt restructuring assessment procedures.

Loan relationships rated 8 contain significant financial weaknesses, resulting in a distinct possibility of loss, while relationships rated 9 reflect vital financial weaknesses, resulting in a highly questionable ability on our part to collect principal.

We believe borrowers warranting such ratings would have difficulty obtaining financing from other market participants.

Thus, due to the lack of comparable market rates for loans with similar risk characteristics, we believe 8 - or 9 -rated loans renewed or modified were done so at below market rates.

Loans that are identified as troubled debt restructurings are considered impaired and are individually evaluated for impairment when assessing these credits in our allowance for loan losses calculation.

NOTE 4 - PREMISES AND EQUIPMENT, NET

20 unchanged sentences

December 31, 2022

NOTE 4 –

PREMISES AND EQUIPMENT, NET (Continued)

NOTE 4 - PREMISES AND EQUIPMENT, NET (Continued)

We enter into facility leases in the normal course of business.

As of December 31, 2021, we were under lease contracts for ten of our branch facilities.

The leases have maturity dates ranging from June, 2022 through December, 2026, with a weighted average life of the lease term of 2.8 years as of December 31, 2021.

As of December 31, 2022, we were under lease contracts for eleven of our branch facilities.

The leases have maturity dates ranging from June, 2023 through December, 2029, with a weighted average life of 2.5 years as of December 31, 2022.

All of our leases have multiple three - to five -year extensions;

6 unchanged sentences

The weighted average discount rate for leases was 5.47 % as of December 31, 2022.

The right-of-use assets, included in premises and equipment, net on our Consolidated Balance Sheets, and the lease liabilities, included in other liabilities on our Consolidated Balance Sheets, totaled $ 2.9 million and $ 2.8 million as of December 31, 2021, respectively, and totaled $ 1.1 million and $ 0.9 million as of December 31, 2020, respectively.

The right-of-use assets, included in premises and equipment, net on our Consolidated Balance Sheets, and the lease liabilities, included in other liabilities on our Consolidated Balance Sheets, totaled $ 3.5 million as of December 31, 2022, and totaled $ 2.9 million and $ 2.8 million as of December 31, 2021, respectively.

As permitted by applicable accounting standards, we have elected not to recognize short-term leases with original terms of twelve months or less on our Consolidated Balance Sheet.

Total operating lease expense associated with the leases aggregated $ 0.6 million in each of 2021 and 2020, and $ 0.5 million in 2019.

Future lease payments at December 31, 2021 totaled $ 3.6 million, comprised of $ 0.8 million in one year, $ 1.4 million in one to three years, $ 0.3 million in three to five years and $ 1.1 million in over five years.

Future lease payments at December 31, 2020 totaled $ 3.4 million, comprised of $ 0.6 million in one year, $ 1.2 million in one to three years, $ 0.5 million in three to five years and $ 1.1 million in over five years.

Total operating lease expense associated with the leases aggregated $ 1.3 million, $ 1.2 million and $ 1.4 million in 2022, 2021 and 2020, respectively

Future lease payments were as follows as of December 31, 2022:

$ 1,091,000  

883,000  

443,000  

339,000  

288,000  

1,589,000  

Total undiscounted lease payments

4,633,000  

Less effect of discounting

( 1,118,000 )

Present value of future lease payments (lease liability)

3,515,000  

NOTE 5 –

MORTGAGE LOAN SERVICING

Mortgage loans serviced for others are not reported as assets in the Consolidated Balance Sheets.

Mortgage loans serviced for others are not reported as assets on the Consolidated Balance Sheets.

The year-end aggregate unpaid principal balances of mortgage loans serviced for others were as follows:

14 unchanged sentences

NOTE 5 –

MORTGAGE LOAN SERVICING 

Activity for capitalized mortgage loan servicing rights during 2021 and 2020 was as follows:

MORTGAGE LOAN SERVICING (Continued)

Activity for capitalized mortgage loan servicing rights, which are reported as other assets on the Consolidated Balance Sheets, during 2022 and 2021 was as follows:

Balance at beginning of year

9 unchanged sentences

$ 12,248,000  

Mortgage servicing rights result from our mortgage loan origination activities.

Late and ancillary fees, included as part of mortgage banking income and reported as noninterest income in the Consolidated Statements of Income, aggregated less than $ 0.1 million during 2022 and 2021.

Accounting for mortgage servicing rights is based on the class of mortgage servicing rights.

We have identified four classes of mortgage servicing rights based on the initial term of the underlying mortgage loans:

10 years, 15 years, 20 years and 30 years.

We distinguish between these classes based on the differing sensitivities to the change in value from changes in mortgage interest rates.

Mortgage servicing rights are initially recorded at fair value, and then are accounted for using the amortization method.

Netted against mortgage banking income, mortgage servicing rights amortization expense is reported as noninterest income in the Consolidated Statements of Income.

Mortgage servicing rights amortization is determined by amortizing the mortgage servicing rights balance in proportion to, and over the period of the estimated future net servicing income, of the underlying mortgage loans.

Interest rate risk, prepayment risk and default risk are inherent in mortgage servicing rights valuation.

Interest rate changes largely drive prepayment rates.

Refinance activity generally increases as interest rates decline.

A significant decrease in interest rates beyond expectation could cause a decline in the value of mortgage servicing rights.

On the contrary, borrowers are less likely to refinance or prepay their mortgage loans if interest rates increase, which would extend the duration of the underlying mortgage loans and the associated mortgage servicing rights would likely rise.

Because of these risks, discount rates and prepayment speeds are used to estimate the fair value of mortgage servicing rights.

We determined that no valuation allowance was necessary as of December 31, 2022 or December 31, 2021.

11 unchanged sentences

2,905,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 6 –

4 unchanged sentences

The scheduled amortization expense on core deposit intangible assets in future periods is:

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

$ 450,000  

133,000  

NOTE 7 –

23 unchanged sentences

23,913,000  

46,934,000  

Total deposits

21 unchanged sentences

$ 431,897,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 7 –

DEPOSITS (Continued)

The following table depicts the maturity distribution for time deposits with balances of $100,000 or more at year-end:

15 unchanged sentences

Total time deposits of more than $250,000 totaled $ 187 million and $ 207 million at year-end 2022 and 2021, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

Deposit overdrafts, which are reported as loans on the Consolidated Balance Sheets, totaled $ 0.9 million and $ 0.1 million as of December 31, 2022 and December 31, 2021, respectively.

NOTE 8 –

7 unchanged sentences

Securities sold under agreements to repurchase (“repurchase agreements”) generally have original maturities of less than one year.

Repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as liabilities.

Securities involved with the repurchase agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank.

Repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as liabilities on our Consolidated Balance Sheets.

Repurchase agreements are secured by securities with an aggregate fair value equal to the aggregate outstanding balance of the repurchase agreements.

The securities, which are included in securities available for sale on our Consolidated Balance Sheets, are held in safekeeping by a correspondent bank.

Repurchase agreements are offered principally to certain large deposit customers.

Repurchase agreements are secured by securities with an aggregate fair value equal to the aggregate outstanding balance.

NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $ 374 million at December 31, 2021, and were expected to mature at varying dates from January 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 2.00 %.

Federal Home Loan Bank of Indianapolis (“FHLBI”) advances totaled $ 394 million at December 31, 2020, and were expected to mature at varying dates from November 2021 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 2.06 %.

Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date.

The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement.

Our borrowing line of credit as of December 31, 2021 totaled $ 889 million, with remaining availability based on collateral of $ 509 million.

Scheduled maturities as of December 31, 2021:

NOTE 9 - FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $ 280 million at December 31, 2022, and were expected to mature at varying dates from January 2023 through June 2027, with fixed rates of interest from 0.55 % to 3.13 % and averaging 1.84 %.

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 %.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 9 - FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES (Continued)

Maturities of FHLBI bullet advances as of December 31, 2022 were as follows:

$ 80,000,000  

3 unchanged sentences

40,000,000  

FHLBI amortizing advances totaled $ 28.3 million as of December 31, 2022, with an average fixed rate of 2.52 % and maturities in 2042.

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.

Scheduled principal payments on FHLBI amortizing advances as of December 31, 2022 were as follows:

$ 353,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

826,000  

862,000  

899,000  

938,000  

24,385,000  

Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date.

Our borrowing line of credit as of December 31, 2022 totaled $ 1.03 billion, with remaining availability based on collateral of $ 713 million.

NOTE 10 - FEDERAL INCOME TAXES

5 unchanged sentences

Deferred expense

2,020,000  

( 1,353,000 )

2,020,000  

( 4,141,000 )

Change in valuation allowance

2 unchanged sentences

$ 10,710,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 10 - FEDERAL INCOME TAXES (Continued)

A reconciliation of the differences between the federal income tax expense recorded and the amount computed by applying the federal statutory rate to income before income taxes is as follows:

13 unchanged sentences

The statutory tax rate was 21 % for 2022, 2021 and 2020.

Significant components of deferred tax assets and liabilities as of December 31, 2021 and 2020 are as follows:

Significant components of deferred tax assets and liabilities, included in other assets on our Consolidated Balance Sheets, as of December 31, 2022 and 2021 are as follows: 

Deferred income tax assets

Allowance for loan losses

Allowance for credit losses

$ 8,872,000  

9 unchanged sentences

159,000  

Deferred loan fees

Unrealized loss on securities

17,369,000  

991,000  

Unrealized loss on securities

Lease liability

810,000  

Fair value write-downs on foreclosed properties

749,000  

Deferred loan fees and costs

520,000  

494,000  

595,000  

Deferred tax asset

13 unchanged sentences

2,572,000  

Unrealized gain on securities

Deferred loan fees and costs

211,000  

Right of use lease asset

810,000  

749,000  

Business combination adjustments

9 unchanged sentences

$ 4,253,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 10 - FEDERAL INCOME TAXES (Continued)

A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized.

4 unchanged sentences

federal income tax returns are no longer subject to examination for all years before 2019.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 11 –

1 unchanged sentence

Stock-based compensation plans are used to provide directors and employees with an increased incentive to contribute to our long-term performance and growth, to align the interests of directors and employees with the interests of our shareholders through the opportunity for increased stock ownership and to attract and retain directors and employees.

During 2014 and 2015, stock option and restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2006.

During the years 2016 through 2019, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2016.

During 2020 and 2021, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2020.

During 2015, stock option grants were provided to certain employees from the Stock Incentive Plan of 2006.

Stock option grants were provided to certain employees during 2016 from the Stock Incentive Plan of 2016.

Stock grants to directors as retainer payments during the years 2016 through 2019 were from the Stock Incentive Plan of 2016, while stock grants to directors as retainer payments during 2020 and 2021 were from the Stock Incentive Plan of 2020.

During the years 2016 through 2019, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2016.

During the years 2020 through 2022, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2020.

Stock grants to directors as retainer payments during the years 2016 through 2019 were from the Stock Incentive Plan of 2016, while stock grants to directors as retainer payments during the years 2020 through 2022 were from the Stock Incentive Plan of 2020.

The Stock Incentive Plan of 2006 expired on January 18, 2016, and was effectively replaced with the Stock Incentive Plan of 2016 that was approved by shareholders in May, 2016.

5 unchanged sentences

The restricted stock awards granted during the years 2016 through 2022 fully vest after three years and, in the case of performance-based restricted stock issued to executive officers in 2018 through 2022, are subject to the attainment of pre-determined performance goals.

The stock options granted during 2014, 2015 and 2016, which were at 110 % of the market price on the date of grant, fully vest after two years and expire after seven years.

The stock options granted during 2014, which were at 110 % of the market price on the date of grant, fully vest after two years and expire after seven years.

At year-end 2022, there were approximately 66,000 shares authorized for future incentive awards.

In conjunction with the Firstbank merger, we issued Mercantile stock options in replacement of all outstanding Firstbank stock option grants that had been previously issued to Firstbank employees under the Firstbank Corporation Stock Option and Restricted Stock Plan of 1997 and the Firstbank Corporation 2006 Stock Compensation Plan.

In general, stock option grants for 50 shares or less fully vested after one year from date of grant, while stock option grants for more than 50 shares vested over a five -year period at 20 % of the grant per annum starting one year from date of grant.

The stock option grants expire ten years from date of grant.

There were approximately 282,200 Mercantile stock options issued as a result of the merger, with about 258,400 of the stock option grants fully vested and exercisable on the date of merger.

The remaining 23,800 stock option grants vested during 2015.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

A summary of restricted stock activity from grants issued during the past three years is as follows:

16 unchanged sentences

$ 29.42  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

Of the restricted stock shares granted in 2022, 2021 and 2020, a total of 26,112 shares, 22,703 shares and 31,295 shares, respectively, are performance-based awards made to our Named Executive Officers at the target level and are subject to the attainment of pre-determined performance goals.

Of the shares granted in 2022, a total of 11,350 , 2,778 and 690 shares reflect increases in performance-based grants to our Named Executive Officers that were awarded in 2021, 2020 and 2019, respectively.

Of the granted shares during 2021, a total of 11,454 , 23,053 and 22,836 shares reflect increases in performance-based grants to our Named Executive Officers that were awarded in 2020, 2019 and 2018, respectively.

7 unchanged sentences

$ 30.25  

$ 23.92  

Forfeited or expired

3 unchanged sentences

$ 32.83  

$ 30.25  

Options exercisable at year-end

2 unchanged sentences

$ 32.83  

$ 30.25  

The fair value of each stock option award is estimated on the date of grant using a closed option valuation (Black-Scholes) model that uses the assumptions noted in the table below.

5 unchanged sentences

No stock option grants were made during the past three years.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

Options at year-end 2022 were as follows:

5 unchanged sentences

$ 36.22  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

Information related to options outstanding at year-end 2022, 2021 and 2020 is as follows:

15 unchanged sentences

Weighted average per share fair value of stock options granted

The aggregate intrinsic value of in-the-money stock options issued under Mercantile plans outstanding and exercisable at December 31, 2021 was less than $ 0.1 million.

No stock option awards outstanding and exercisable at December 31, 2022 were in-the-money.

Shares issued as a result of the exercise of stock option grants have been authorized and were previously unissued shares.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 11 –

STOCK-BASED COMPENSATION (Continued)

On May 23, 2019, we granted about 12,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2019 through May 31, 2020.

The associated $ 0.4 million cost was expensed on a straight-line basis over the respective twelve month period.

On October 25, 2018, we granted about 1,000 shares of common stock to newly appointed Bank Board members for retainer payments for the period of October 1, 2018 through May 31, 2019.

The associated less than $ 0.1 million cost was expensed over the respective eight -month period.

The associated $ 0.4 million cost was expensed on a straight-line basis over the respective twelve month period.

On June 1, 2020, we granted about 16,000 shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of June 1, 2020 through May 31, 2021.

1 unchanged sentence

On August 27, 2020, we granted about 1,700 shares of common stock to newly appointed Corporate and Bank Board members for retainer payments for the period of September 1, 2020 through May 31, 2021.

The associated less than $ 0.1 million cost was expensed over the respective nine -month period.

The associated cost of less than $ 0.1 million was expensed over the respective nine -month period.

On May 27, 2021, we granted about 10,500 shares of common stock to our Corporate and Bank Boards of Directors for retainer payments for the period of June 1, 2021 through May 31, 2022.

The associated $ 0.3 million cost was expensed on a straight-line basis over the respective twelve -month period.

On May 26, 2022, we granted about 10,300 shares of our common stock to our Corporate and Bank Board of Directors for retainer payments for the period of June 1, 2022 through May 31, 2023.

The associated $ 0.3 million cost is being expensed on a straight-line basis over the respective twelve -month period.

On June 9, 2022, we granted about 600 shares of common stock to a newly appointed Bank Board member for retainer payments for the period of June 1, 2022 through May 31, 2023.

The associated cost of less than $ 0.1 million is being expensed on a straight-line basis over the respective twelve -month period.

On November 25, 2022, we granted about 300 shares of common stock to a newly appointed Bank Board member for retainer payments for the period of November 1, 2022 through May 31, 2023.

The associated cost of less than $ 0.1 million is being expensed on a straight-line basis over the respective seven -month period.

Stock-based compensation, reported as noninterest expense in the Consolidated Statements of Income, totaled $ 3.4 million, $ 3.8 million and $ 2.3 million in 2022, 2021 and 2020, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2022

NOTE 12 –

3 unchanged sentences

Beginning balance

$ 108,042,000  

$ 104,043,000  

2,542,000  

13,823,000  

( 22,912,000 )

( 9,824,000 )

Ending balance

$ 87,672,000  

$ 108,042,000  

We had no PPP loans outstanding to related companies of our directors as of December 31, 2021.

PPP loans to related companies of our directors totaled $ 0.3 million as of December 31, 2020.

Related party deposits and repurchase agreements totaled $ 21.5 million and $ 18.4 million at year-end 2022 and 2021, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 13 –

7 unchanged sentences

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet.

Our maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.

We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on management’s credit assessment of the borrower.

If required, estimated loss exposure resulting from these instruments is expensed and recorded as a liability.

There was no liability balance for these instruments as of December 31, 2021 and 2020.

At year-end 2021 and 2020, the rates on existing off-balance sheet instruments were substantially equivalent to current market rates, considering the underlying credit standing of the counterparties.

Our maximum exposure to credit losses for loan commitments and standby letters of credit outstanding at year-end was as follows:

Commercial unused lines of credit

$ 1,098,951,000  

$ 1,019,496,000  

Unused lines of credit secured by 1 –

4 family residential properties

64,313,000  

59,396,000  

Credit card unused lines of credit

92,146,000  

72,495,000  

Other consumer unused lines of credit

64,876,000  

30,707,000  

Commitments to make loans

212,476,000  

227,558,000  

Standby letters of credit

33,109,000  

20,543,000  

Total commitments

$ 1,565,871,000  

$ 1,430,195,000  

Commitments to make loans generally reflect our binding obligations to existing and prospective customers to extend credit, including line of credit facilities secured by accounts receivable and inventory, and term debt secured by either real estate or equipment.

In most instances, line of credit facilities are for a one -year term and have been at a floating rate tied to the Wall Street Journal Prime Rate or the 30 -Day Libor Rate.

For term debt secured by real estate, customers have been generally offered a floating rate tied to the Wall Street Journal Prime Rate or the 30 -Day Libor Rate, and a fixed rate currently ranging from 3.00 % to 5.00 %.

These credit facilities generally balloon within five years, with payments based on amortizations ranging from 10 to 20 years.

For term debt secured by non-real estate collateral, customers have been generally offered a floating rate tied to the Wall Street Journal Prime Rate or the 30 -Day Libor Rate, and a fixed rate currently ranging from 3.50 % to 5.00 %.

These credit facilities generally mature and fully amortize within three to seven years.

Effective January 1, 2022, we replaced the 30 -Day Libor Rate with the CBM Term SOFR Rate for all new floating rate commercial loan commitments.

It is expected that currently outstanding commercial loans tied to the 30 -Day Libor Rate will convert to an equivalent fallback SOFR Rate on or about June 30, 2023.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 13 –

COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)

The following instruments are considered financial guarantees under current accounting guidance.

These instruments are carried at fair value as an other liability on our Consolidated Balance Sheets.

Standby letters of credit

$ 33,109,000  

$ 212,000  

$ 20,543,000  

$ 138,000  

NOTE 14 –

BENEFIT PLANS

We have a 401 (k) benefit plan that covers substantially all of our employees.

The percent of our matching contributions to the 401 (k) benefit plan is determined annually by the Board of Directors.

The matching contribution had been 4.25 % since January 1, 2014;

effective April 1, 2018, the matching contribution was increased to 5.00 %.

Matching contributions, if made, are immediately vested.

Our 2021, 2020 and 2019 matching 401 (k) contributions charged to expense were $ 2.1 million, $ 1.9 million and $ 1.7 million, respectively.

We have a deferred compensation plan in which all persons serving on the Board of Directors may defer all or portions of their annual retainer and meeting fees, with distributions to be paid upon termination of service as a director or specific dates selected by the director.

We also have a non-qualified deferred compensation program in which selected officers may defer all or portions of salary and bonus payments.

The deferred amounts, totaling $ 1.2 million and $ 2.4 million as of December 31, 2021 and 2020, respectively, are categorized as other liabilities in the Consolidated Balance Sheets, and are paid interest at a rate equal to the Wall Street Journal Prime Rate.

Interest expense was less than $ 0.1 million during 2021, and $ 0.1 million during 2020 and 2019.

The Mercantile Bank Corporation Employee Stock Purchase Plan of 2014 is a non-compensatory plan intended to encourage full- and part-time employees of Mercantile and its subsidiaries to promote our best interests and to align employees’

interests with the interests of our shareholders by permitting employees to purchase shares of our common stock through regular payroll deductions.

Shares are purchased on the last business day of each calendar quarter at a price equal to the consolidated closing bid price of our common stock reported on The Nasdaq Stock Market.

A total of 250,000 shares of common stock may be issued under the existing plan;

however, the number of shares may be adjusted to reflect any stock dividends and other changes in our capitalization.

The number of shares issued totaled 1,481 and 2,264 in 2021 and 2020, respectively.

As of December 31, 2021, there were approximately 237,000 shares available under our current plan.

NOTE 15 –

DERIVATIVES AND HEDGING ACTIVITIES

We are exposed to certain risks arising from both business operations and economic conditions.

We principally manage the exposure to a wide variety of operational risks through core business activities.

Economic risks, including interest rate, liquidity and credit risk, are primarily administered via the amount, sources and duration of assets and liabilities.

Derivative financial instruments may also be used to assist in managing economic risks.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 15 –

DERIVATIVES AND HEDGING ACTIVITIES (Continued)

Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers.

We execute interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with correspondent banks to offset the impact of the interest rate swaps with the commercial banking customers.

The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions.

As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent banks are recognized directly to earnings.

The fair value of derivative instruments as of December 31, 2021, are reflected in the following table.

Notional Amount

Balance Sheet

Derivative Assets  

Interest rate swaps

$ 279,419,000  

$ 4,609,000  

Derivative Liabilities  

Interest rate swaps

279,419,000  

Other Liabilities

4,857,000  

The effect of interest rate swaps that are not designated as hedging instruments resulted in noninterest expense of $ 0.2 million during the year-ended December 31, 2021.

The fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $ 4.9 million as of December 31, 2021.

Cash collateral totaling $ 3.6 million was provided to the counterparty correspondent banks as of December 31, 2021.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 279 million as of December 31, 2021.

Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instrument that has been hedged.

The fair value of derivative instruments as of December 31, 2020, are reflected in the following table.

Notional Amount

Balance Sheet

Derivative Assets  

Interest rate swaps

$ 33,731,000  

$ 1,003,000  

Derivative Liabilities  

Interest rate swaps

33,731,000  

Other Liabilities

1,027,000  

The effect of interest rate swaps that are not designated as hedging instruments resulted in noninterest expense of less than $ 0.1 million during the year-ended December 31, 2020.

There were no such instruments outstanding during 2019.

Cash collateral totaling $ 1.1 million was provided to the counterparty correspondent bank as of December 31, 2020.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 33.7 million as of December 31, 2020.

Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instrument that has been hedged.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2021

NOTE 16 –

FAIR VALUES OF FINANCIAL INSTRUMENTS

Carrying amount, estimated fair value and level within the fair value hierarchy of financial instruments were as follows at year-end (dollars in thousands):

Financial assets

$ 17,872  

$ 16,953  

Cash equivalents

957,288  

609,053  

Securities available for sale

592,743  

387,347  

Federal Home Loan Bank stock

18,002  

3,418,096  

3,498,345  

3,155,503  

3,294,522  

Loans held for sale

16,117  

16,707  

22,888  

24,029  

Mortgage servicing rights

12,248  

15,445  

10,006  

Accrued interest receivable

10,861  

Interest rate swaps

Financial liabilities

4,083,193  

4,028,249  

3,411,553  

3,397,768  

Securities sold under agreements to repurchase

197,463  

118,365  

Federal Home Loan Bank advances

374,000  

384,927  

394,000  

410,881  

Subordinated debentures

48,244  

48,284  

47,563  

47,574  

Subordinated notes

73,646  

Accrued interest payable

Interest rate swaps

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 9A. Controls and Procedures