What changed in this filing

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Item 1. Financial Statements

2023-05-05 compared with 2022-11-04 · 756 added, 1290 removed, 1906 unchanged (52% of the section changed)

1 unchanged sentence

CONSOLIDATED BALANCE SHEETS

September 30,

Cash and due from banks

51 unchanged sentences

194,340,000  

Federal funds purchased

17,207,000  

Federal Home Loan Bank advances

19 unchanged sentences

40,000,000 shares authorized;

15,866,243 shares issued and outstanding at September 30, 2022 and 15,839,944 shares issued and outstanding at December 31, 2021

16,001,448 shares outstanding at March 31, 2023 and 15,994,884 shares outstanding at December 31, 2022

291,516,000  

3 unchanged sentences

216,313,000  

Accumulated other comprehensive gain/(loss)

Accumulated other comprehensive income (loss)

( 56,267,000 )

9 unchanged sentences

CONSOLIDATED STATEMENTS OF INCOME

Sept 30, 2022

Sept 30, 2021

Sept 30, 2022

Sept 30, 2021

Interest income

2 unchanged sentences

Securities, tax-exempt

Other interest-earning assets

Interest-earning deposits

Total interest income

2 unchanged sentences

Federal Home Loan Bank advances

Subordinated debt and other borrowings

Subordinated debentures and other borrowings

Total interest expense

4 unchanged sentences

Service charges on deposit and sweep accounts

Mortgage banking income

Credit and debit card income

Mortgage banking income

Interest rate swap fees

Payroll services income

Payroll processing

Earnings on bank owned life insurance

Gain on sale of branch

Total noninterest income

3 unchanged sentences

Data processing costs

Charitable foundation contribution

Other expense

4 unchanged sentences

Diluted earnings per share

Cash dividends per share

Average basic shares outstanding

3 unchanged sentences

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Sept 30, 2022

Sept 30, 2021

Sept 30, 2022

Sept 30, 2021

Other comprehensive income (loss):

1 unchanged sentence

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

Other comprehensive income/(loss), net of tax

Other comprehensive income (loss), net of tax effect

Comprehensive income (loss)

1 unchanged sentence

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’

The following table depicts the change in shareholders’

equity for the three months ended September 30, 2022:

($ in thousands except per share amounts)

Comprehensive

Income (Loss)

Shareholders’

Balances, June 30, 2022

$ 288,199  

$ 188,452  

$ 428,983  

Employee stock purchase plan ( 412 shares)

Dividend reinvestment plan ( 6,733 shares)

Stock-based compensation expense

Cash dividends ($ 0.32 per common share)

Net income for the three months ended September 30, 2022

16,030  

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

Balances, September 30, 2022

$ 289,219  

$ 199,505  

$ 416,261  

See accompanying notes to consolidated financial statements.

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’

EQUITY (Continued)

The following table depicts the change in shareholders’

equity for the nine months ended September 30, 2022:

CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’

($ in thousands except per share amounts)

6 unchanged sentences

$ 441,408  

Adoption of ASU 2016-13

Employee stock purchase plan ( 327 shares)

Dividend reinvestment plan ( 6,880 shares)

Stock grants to directors for retainer fees ( 10,837 shares)

Stock option exercises ( 1,355 shares)

Stock-based compensation expense

Cash dividends ($ 0.33 per common share)

Net income for the nine months ended September 30, 2022

39,260  

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

Balances, September 30, 2022

$ 289,219  

$ 199,505  

$ 416,261  

See accompanying notes to consolidated financial statements.

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’

EQUITY (Continued)

The following table depicts the change in shareholders’

equity for the three months ended September 30, 2021:

($ in thousands except per share amounts)

Comprehensive

Income (Loss)

Shareholders’

Balances, June 30, 2021

$ 293,232  

$ 157,150  

$ 1,506  

$ 451,888  

Employee stock purchase plan ( 404 shares)

Dividend reinvestment plan ( 7,904 shares)

Stock option exercises ( 2,000 shares)

Stock-based compensation expense

Share repurchase program ( 288,863 shares)

Cash dividends ($ 0.30 per common share)

Net income for the three months ended September 30, 2021

Net income for the three months ended March 31, 2023

20,974  

1 unchanged sentence

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

Balances, September 30, 2021

Balances, March 31, 2023

$ 291,516  

2 unchanged sentences

See accompanying notes to consolidated financial statements.

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’

MERCANTILE BANK CORPORATION 

CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’

EQUITY (Continued)

The following table depicts the change in shareholders’

equity for the nine months ended September 30, 2021:

($ in thousands except per share amounts)

6 unchanged sentences

$ 456,559  

$ 441,554  

Adoption of ASU 2016-13

Employee stock purchase plan ( 281 shares)

Dividend reinvestment plan ( 5,835 shares)

Stock grants to directors for retainer fees ( 10,489 shares)

Stock option exercises ( 1,355 shares)

Stock-based compensation expense

Share repurchase program ( 635,773 shares)

Cash dividends ($ 0.31 per common share)

Net income for the nine months ended September 30, 2021

Net income for the three months ended March 31, 2022

11,492  

1 unchanged sentence

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

Balances, September 30, 2021

Balances, March 31, 2022

$ 286,831  

4 unchanged sentences

CONSOLIDATED STATEMENTS OF CASH FLOWS

Sept 30, 2022

Sept 30, 2021

March 31, 2023

March 31, 2022

Cash flows from operating activities

$ 39,260,000  

$ 47,382,000  

Adjustments to reconcile net income to net cash from operating activities

Depreciation and amortization

9,855,000  

10,200,000  

Accretion of acquired loans

Provision for credit losses

3,500,000  

Stock-based compensation expense

2,398,000  

1,725,000  

Stock grants to directors for retainer fee

347,000  

344,000  

Proceeds from sales of mortgage loans held for sale

195,374,000  

509,763,000  

Origination of mortgage loans held for sale

( 186,881,000 )

( 510,571,000 )

Net gain from sales of mortgage loans held for sale

( 6,787,000 )

( 23,551,000 )

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

Net loss from sales and valuation write-downs of former bank premises

275,000  

243,000  

Net (gain) loss from sales and write-downs of fixed assets

246,000  

Earnings on bank owned life insurance

( 1,310,000 )

Change in fair value of derivative asset

( 23,836,000 )

( 3,865,000 )

Change in fair value of derivative liability

23,687,000  

4,060,000  

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

( 4,677,000 )

853,000  

( 11,504,000 )

Accrued interest payable and other liabilities

32,060,000  

( 3,150,000 )

Accrued interest and other liabilities

Net cash from operating activities

82,793,000  

19,169,000  

Cash flows from investing activities

1 unchanged sentence

( 102,241,000

( 129,522,000 )

Purchases of securities available for sale

( 91,200,000 )

( 257,967,000 )

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

13,262,000  

77,531,000  

Proceeds from sales of foreclosed assets

47,000  

181,000  

Proceeds from sales of former bank premises

2,994,000  

270,000  

Proceeds from Federal Home Loan Bank stock redemption

281,000  

Proceeds from bank owned life insurance death benefits claim

628,000  

Net cash transferred in branch sale

( 2,679,000 )

Net purchases of premises and equipment and lease activity

( 2,166,000 )

( 4,250,000 )

Net cash for investing activities

( 151,130,000

( 316,436,000 )

See accompanying notes to consolidated financial statements.

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

Sept 30, 2022

Sept 30, 2021

Cash flows from financing activities

Net decrease in time deposits

( 113,842,000

Net (decrease) increase in all other deposits

Net increase (decrease) in time deposits

Net decrease in all other deposits

( 201,908,000

Net increase in securities sold under agreements to repurchase

Maturities of Federal Home Loan Bank advances

Net change in federal funds purchased

Proceeds from Federal Home Loan Bank advances

Net proceeds from subordinated notes issuance

Proceeds from stock option exercises, net of cashless exercises

Payoffs of and paydowns on Federal Home Loan Bank advances

Employee stock purchase plan

Net proceeds from stock option exercises

Dividend reinvestment plan

Repurchases of common stock shares

Proceeds from subordinated notes issuance

Payment of cash dividends to common shareholders

Net cash (for) from financing activities

( 270,943,000

Net cash from (for) financing activities

Net change in cash and cash equivalents

2 unchanged sentences

Cash and cash equivalents at end of period

See accompanying notes to consolidated financial statements.

MERCANTILE BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

March 31, 2023

March 31, 2022

Supplemental disclosures of cash flows information

Cash paid during the period for:

Federal income tax

Noncash financing and investing activities:

Transfers from premises and equipment to other assets

Transfers from loans to foreclosed assets

Transfers from bank premises to other real estate owned

See accompanying notes to consolidated financial statements.

1 unchanged sentence

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation :

The unaudited financial statements for the nine months ended September 30, 2022 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries.

The unaudited financial statements for the three months ended March 31, 2023 include the consolidated results of operations of Mercantile Bank Corporation and its consolidated subsidiaries.

These subsidiaries include Mercantile Bank (“our bank”) and our bank’s subsidiary, Mercantile Insurance Center, Inc.

1 unchanged sentence

In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods.

The results for the period ended September 30, 2022 should not be considered as indicative of results for a full year.

The results for the period ended March 31, 2023 should not be considered as indicative of results for a full year.

For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10 -K for the year ended December 

2 unchanged sentences

The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as a liability.

Coronavirus Pandemic :

Although there has been an easing of Covid- 19 pandemic-related restrictions, there remains a significant amount of stress and uncertainty across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid- 19”

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

This uncertainty is heightened as certain geographic areas continue to experience surges in Covid- 19 cases and governments at all levels continue to react to changes in circumstances, including 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 capable of evading vaccinations, booster shots and prior immunity.

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.

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

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

Paycheck Protection Program

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

The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, self-employed and individual contractors.

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

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

In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date.

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

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

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

The program ended on August 8, 2020.

We originated approximately 2,200 loans aggregating $ 553 million.

As of September 30, 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 the first nine months of 2022.

Earnings Per Share :

Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period.

Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans and are determined using the treasury stock method.

Our unvested restricted shares, which contain non-forfeitable rights to dividends whether paid or accrued (i.e., participating securities), are included in the number of shares outstanding for both basic and diluted earnings per share calculations.

In the event of a net loss, our unvested restricted shares are excluded from the calculation of both basic and diluted earnings per share.

Approximately 360,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2023.

Stock options for 5,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three months ended March 31, 2023.

Approximately 335,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three months ended March 31, 2022.

In addition, stock options for approximately 8,000 shares of common stock were included in determining diluted earnings per share for the three months ended March 31, 2022.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

The program ended on May 31, 2021.

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

As of September 30, 2022, we recorded forgiveness transactions on all but seven loans aggregating $ 2.1 million.

Net loan origination fees of $ 0.9 million were recorded during the first nine months of 2022 under the Second Draw.

Individual Economic Impact Payments

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

From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid- 19 that would otherwise be categorized as troubled debt restructurings.

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

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

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

Current Expected Credit Loss ( “

CECL ”

) Methodology Delay  

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

We elected to postpone CECL adoption as permitted.

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

We adopted the CECL methodology effective January 1, 2022.

Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity.

Debt securities are classified as available for sale when they might be sold prior to maturity.

As of September 30, 2022 and December 31, 2021, all of our debt securities were designated as available for sale.

Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Federal Home Loan Bank stock is carried at cost.

Changes in the allowance are recorded as provisions for (or reversals of) credit loss expense.

Losses are charged against the allowance when the collectibility of an available for sale debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

At March 31, 2023, and 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.

Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated.

Premiums on debt securities are amortized to the initial call date, if applicable, or to the maturity date, on the level-yield method.

Discounts on debt securities are accreted to the maturity date on the level-yield method.

Premiums and discounts on mortgage-backed securities are amortized or accreted based on anticipated prepayments on the level-yield method.

Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance.

For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors.

In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors.

If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security.

If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis.

Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Changes in the allowance for credit losses are recorded as provision for (or reversal of) credit loss expense.

Losses are charged against the allowance when we believe the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

At September 30, 2022, there was no allowance for credit losses related to the available for sale debt securities portfolio.

Accrued interest receivable on available for sale debt securities totaled $ 3.1 million at September 30, 2022 and was excluded from the estimate of credit losses as any accrued interest that is not expected to be collected is reversed against interest income.

Loans 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 credit losses.

FHLBI stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par 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/(costs) amounted to ($ 1.4 ) million and ($ 1.0 ) million at March 31, 2023, and December 31, 2022, respectively.

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.

2 unchanged sentences

In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal and interest is considered doubtful.

Accrued interest is included in other assets in the Consolidated Balance Sheets.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income.

4 unchanged sentences

Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

As of September 30, 2022 and December 31, 2021, we determined that the fair value of our mortgage loans held for sale was $ 14.7 million and $ 16.7 million, respectively.

As of March 31, 2023 and December 31, 2022, we determined that the fair value of our mortgage loans held for sale totaled $ 3.9 million and $ 3.6 million, respectively.

Mortgage loans held for sale are generally sold with servicing rights retained.

Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right.

We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower.

Gains and losses on sales of mortgage loans are based on the difference between the selling price, which includes a gain or loss on the interest rate commitment coverage position, and the carrying value of the related loan sold, which is reduced by the cost allocated to the servicing right.

Market rate risk on interest rate commitments with borrowers prior to loan closing is mitigated through forward commitments referred to as to-be-announced mortgage-backed securities.

These mortgage banking activities are not designated as hedges and are carried at fair value.

The net gain or loss on mortgage banking derivatives, which is generally nominal in dollar amount, is included in the gain on sale of loans and recorded as part of mortgage banking income.

Mortgage loans serviced for others totaled about $ 1.38 billion and $ 1.34 billion as of September 30, 2022 and December 31, 2021, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

3 unchanged sentences

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”

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 expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance.

In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination.

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.

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

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

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

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

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

We recorded a provision expense of $ 0.6 million during the first quarter of 2023, mainly reflecting allocations necessitated by net loan growth;

nominal loan charge-offs and continued strong loan quality metrics in large part mitigated additional reserves associated with loan growth.

We did not adjust any qualitative reserve factors during the first quarter of 2023, and the impact of the updated economic forecast was less than $ 0.1 million.

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.

14 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

Our loan portfolio segments as of September 30, 2022 were as follows:

Our loan portfolio segments as of March 31, 2023 and December 31, 2022 were as follows:

Commercial Loans

4 unchanged sentences

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.

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.

Non-Owner Occupied Commercial Real Estate :

2 unchanged sentences

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.

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 :

3 unchanged sentences

1 - 4 Family Mortgages :

Residential mortgage loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.

Residential mortgage loans are susceptible to weakening general economic conditions, 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.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

This non-discounted cash flow approach projects an estimated future amortized cost basis based on current loan balance, repayment terms, and estimated prepayments.

Our historical loss rate is then applied to the monthly estimated future loan balances at the instrument level.

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, 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.

7 unchanged sentences

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 September 30, 2022, we used a one -year reasonable and supportable economic forecast period, with a six -month straight-line reversion period.

As of March 31, 2023 and 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 September 30, 2022 allowance calculation reflected a $ 1.0 million allowance balance increase compared to the forecasts used for our June 30, 2022 allowance calculation, in large part reflecting lower economic growth and higher unemployment conditions.

The economic forecasts used for our March 31, 2023 allowance calculation reflected a less than $ 0.1 million allowance balance increase compared to the forecasts used for our December 31, 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.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

During each reporting period, we also consider the need to adjust historical loss information to reflect the extent to which we expect current conditions and reasonable and supportable economic forecasts to differ from the conditions that existed for the period over which the historical loss information was determined.

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.

8 unchanged sentences

Effect of other factors such as competition and legal and regulatory requirements

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

The estimation of future credit losses should reflect consideration of all significant factors that affect the collectibility of the loan portfolio at each evaluation date.

While our methodology considers both the historical loss rates as well as the traditional qualitative factors, there may be instances or situations where additional qualitative factors need to be considered.

As of September 30, 2022, we employed two additional qualitative factors:

The Coronavirus Pandemic Factor was established effective June 30, 2020 to address the unique circumstances, challenges and uncertainties associated with the Coronavirus Pandemic.

The Historical Loss Information Factor was established effective January 1, 2022 to address the low level of loan losses during the look-back period.

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.

1 unchanged sentence

We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us.

Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income.

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.

A provision for credit losses of $ 2.9 million was recorded during the third quarter of 2022, compared to a provision expense of $ 1.9 million during the third quarter of 2021.

A provision for credit losses of $ 3.5 million was recorded during the first nine months of 2022, compared to a negative provision of $ 0.9 million during the first nine months of 2021.

The provision expense recorded during the current-year third quarter mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, and a decline in forecasted economic conditions. 

The provision expense recorded during the first nine months of 2022 primarily resulted from these factors, along with a higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio. 

The increases were partially mitigated by the recording of net loan recoveries and ongoing strong loan quality metrics during the periods. 

In addition, reflecting improvement in overall Covid- 19 conditions, including increased vaccination rates, the availability of booster shots, and the lifting of many economic growth-restraining restrictions, we reduced the allocation amounts associated with the Covid- 19 environmental factor during the second quarter of 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

Mortgage Banking Activities :

Mortgage loans serviced for others totaled approximately $ 1.37 billion and $ 1.38 billion as of March 31, 2023 and December 31, 2022, respectively.

Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold.

12 unchanged sentences

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.”

Impairment for these loans is measured on a loan-by-loan basis.

Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies.

Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

The federal banking agencies issued an “

Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus ”

on March 22, 2020, which was subsequently revised on April 7, 2020.

This guidance encourages financial institutions to work prudently with borrowers that are or may be unable to meet their contractual obligations because of the effects of the Coronavirus Pandemic.

Pursuant to the guidance, the federal banking agencies concluded, in consultation with FASB staff, that short-term modifications (e.g.

six months) made on a good faith basis to borrowers who were current prior to any relief are not troubled debt restructurings.

This guidance complements Section 4013 of the CARES Act, which specified that Coronavirus-related modifications made on loans that were current as of December 31, 2019 and that occur between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency declared by President Trump on March 13, 2020 ( the “National Emergency”) or December 31, 2020, as applicable, are not troubled debt restructurings.

As part of the Consolidated Appropriations Act that was enacted in late 2020, this guidance was extended to January 1, 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

The accounting guidance for troubled debt restructurings by creditors in Subtopic 310 - 40, Receivables –

Troubled Debt Restructurings by Creditors was eliminated upon our adoption of ASU No.

2022 - 02 Financial Instruments –

Credit Losses (Topic 326 ):

Troubled Debt Restructurings and Vintage Disclosures effective January 1, 2023.

Derivatives :

1 unchanged sentence

The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting.

Used as part of our asset and liability management to help manage interest rate risk, our derivatives have generally consisted of interest rate swap agreements that qualify for hedge accounting.

We do not use derivatives for speculative purposes.

Used as part of our asset and liability management to help manage interest rate risk, our derivatives have historically generally consisted of interest rate swap agreements that qualified for hedge accounting.

We do not use derivatives for trading purposes.

Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income.

1 unchanged sentence

If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense.

We had no derivative instruments designated as hedges as of September 30, 2022 and December 31, 2021.

We had no derivative instruments designated as hedges as of March 31, 2023, and December 31, 2022.

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 conducted an annual test during 2021, with no impairment recognized, and no circumstances have arisen in 2022 to warrant an additional impairment analysis beyond the annual test in 2022.

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

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

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

The core deposit intangible that arose from the Firstbank Corporation acquisition was initially measured at fair value and is being amortized into noninterest expense over a ten -year period using the sum-of-the-years-digits methodology.

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.

Revenue from Contracts with Customers :

We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “

Revenue from Contracts with Customers ”

We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers”

(“Topic 606”

7 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SIGNIFICANT ACCOUNTING POLICIES (Continued)

The following table depicts our sources of noninterest income that are scoped within Topic 606:

Sept 30, 2022

Sept 30, 2021

Sept 30, 2022

Sept 30, 2021

The following table depicts our sources of noninterest income presented in the Consolidated Statements of Income that are scoped within Topic 606:

Ended March 31,

Service charges on deposit and sweep accounts

1 unchanged sentence

$ 1,416,000  

$ 4,489,000  

$ 3,687,000  

Credit and debit card fees

1 unchanged sentence

1,881,000  

6,101,000  

5,545,000  

Payroll processing

1 unchanged sentence

638,000  

1,635,000  

1,374,000  

Customer service fees

1 unchanged sentence

242,000  

654,000  

650,000  

Service Charges on Deposit and Sweep Accounts:

16 unchanged sentences

Customer service fees are recorded as other noninterest income on our Consolidated Statements of Income.

Newly Issued Not Yet Effective Standards :

Adoption of New Accounting Standards :

2022 - 02 Financial Instruments –

5 unchanged sentences

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.

This ASU was effective for fiscal years beginning after December 15, 2022.

The prospective adoption of this ASU did not have a material impact on our financial results.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 are as follows:

September 30, 2022

The amortized cost and estimated fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:

March 31, 2023

Government agency debt obligations

14 unchanged sentences

30,812,000  

200,000  

( 2,420,000 )

10 unchanged sentences

$ 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  

6 unchanged sentences

$ 602,936,000  

Securities with unrealized losses at September 30, 2022 and December 31, 2021, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

Securities with unrealized losses at March 31, 2023 and December 31, 2022, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

Less than 12 Months

12 Months or More

September 30, 2022

March 31, 2023

Government agency debt obligations

11 unchanged sentences

30,758,000  

5,596,000  

Municipal general obligation bonds

20 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SECURITIES (Continued)

20 unchanged sentences

4,542,000  

130,122,000  

9,058,000  

Municipal revenue bonds

10 unchanged sentences

$ 573,146,000  

$ 83,281,000  

We evaluate securities in an unrealized loss position at least quarterly.

Consideration is given to 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.

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 September 30, 2022, 774 debt securities with estimated fair values totaling $ 574 million had unrealized losses aggregating $ 91.8 million.

At March 31, 2023, 653 debt securities with estimated fair values totaling $ 560 million had unrealized losses aggregating $ 72.5 million.

At December 31, 2022, 732 debt securities with estimated fair values totaling $ 573 million had unrealized losses aggregating $ 83.3 million.

At September 30, 2022, unrealized losses aggregating $ 74.6 million were attributable to bonds issued or guaranteed by agencies of the U.S.

At March 31, 2023, unrealized losses aggregating $ 63.4 million were attributable to bonds issued or guaranteed by agencies of the U.S.

federal government, while unrealized losses totaling $ 9.1 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.

The amortized cost and fair value of debt securities at September 30, 2022, by maturity, are shown in the following table.

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.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SECURITIES (Continued)

The amortized cost and fair value of debt securities at March 31, 2023, by maturity, are shown in the following table.

The contractual maturity is utilized for U.S.

3 unchanged sentences

Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SECURITIES (Continued)

$ 20,361,000  

$ 19,997,000  

$ 3,732,000  

Due in 2024 through 2028

16 unchanged sentences

$ 619,973,000  

$ 582,999,000  

Securities issued by the State of Michigan and all its political subdivisions had combined amortized costs of $ 181 million and $ 155 million at September 30, 2022 and December 31, 2021, respectively, with estimated market values of $ 164 million and $ 158 million, respectively.

Securities issued by all other states and their political subdivisions had combined amortized costs of $ 0.2 million and $ 1.7 million and estimated market values of $ 0.3 million and $ 1.7 million at September 30, 2022 and December 31, 2021, respectively.

No securities were sold during the first three months of 2023 or the full-year 2022.

Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $ 200 million and $ 193 million at March 31, 2023 and December 31, 2022, respectively, with estimated market values of $ 192 million and $ 182 million at the respective dates.

We had no securities issued by all other states and their political subdivisions as of March 31, 2023, and December 31, 2022.

Total securities of any other specific issuer, other than the U.S.

1 unchanged sentence

The carrying value of U.S.

Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $ 199 million and $ 197 million at September 30, 2022 and December 31, 2021, respectively.

Investments in Federal Home Loan Bank stock are restricted and may only be resold or redeemed by the issuer.

LOANS AND ALLOWANCE FOR CREDIT LOSSES

Loans originated for investment are stated at their principal amount outstanding adjusted for partial charge-offs, the allowance, and net deferred loan fees and costs.

Interest income on loans is accrued over the term of the loans primarily using the simple interest method based on the principal balance outstanding.

Interest is not accrued on loans where collectibility is uncertain.

Accrued interest is presented separately in the consolidated balance sheet.

Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.

Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $ 227 million and $ 194 million at March 31, 2023, and December 31, 2022, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Our total loans at September 30, 2022 were $ 3.88 billion compared to $ 3.45 billion at December 31, 2021, an increase of $ 427 million, or 12.4 %.

The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at September 30, 2022 and December 31, 2021, and the percentage change in loans from the end of 2021 to the end of the third quarter of 2022, are as follows:

September 30, 2022

LOANS AND ALLOWANCE FOR CREDIT LOSSES

Our total loans at March 31, 2023 were $ 3.97 billion compared to $ 3.92 billion at December 31, 2022, an increase of $ 48.9 million, or 1.2 %.

The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at March 31, 2023 and December 31, 2022, and the percentage change in loans from the end of 2022 to the end of the first quarter of 2023, are as follows:

March 31, 2023

December 31, 2022

30 unchanged sentences

$ 3,916,619,000  

For September 30, 2022, and December 31, 2021, includes $ 2.6 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 $ 35.6 million and $ 29.5 million as of September 30, 2022 and December 31, 2021, respectively.

Nonperforming loans as of September 30, 2022 and December 31, 2021 were as follows:

September 30,

For March 31, 2023, and December 31, 2022, includes $ 0.4 million and $ 0.9 million in loans originated under the Paycheck Protection Program, respectively.

Nonperforming loans as of March 31, 2023 and December 31, 2022 were as follows:

Loans past due 90 days or more still accruing interest

$ 155,000  

Nonaccrual loans

6 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The recorded principal balance of nonperforming loans was as follows:

September 30,

Commercial and industrial

4 unchanged sentences

owner occupied

229,000  

248,000  

Real estate –

11 unchanged sentences

1,456,000  

1,805,000  

Total nonperforming loans

1 unchanged sentence

$ 7,728,000  

An age analysis of past due loans is as follows as of September 30, 2022:

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

An age analysis of past due loans is as follows as of March 31, 2023:

Commercial and industrial

7 unchanged sentences

66,233,000  

60,938,000  

60,970,000  

Real estate –

2 unchanged sentences

44,000  

229,000  

479,000  

629,708,000  

630,187,000  

Real estate –

6 unchanged sentences

27,000  

219,312,000  

219,339,000  

Total commercial

4 unchanged sentences

3,139,547,000  

3,140,420,000  

1-4 family mortgages

14 unchanged sentences

1,289,000  

823,819,000  

825,108,000  

Total past due loans

7 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

6 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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.

1 unchanged sentence

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

Market value estimates of collateral on distressed lending relationships, as well as on foreclosed and repossessed assets, are reviewed periodically.

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.

5 unchanged sentences

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 $ 1.4 million as of September 30, 2022. 

Residential real estate served as collateral on $ 1.2 million in loans categorized as 1 - 4 family mortgages, with non-real estate business assets serving as collateral on $ 0.2 million in loans categorized as commercial and industrial loans. 

Specific reserve allocations on nonaccrual loans totaled less than $ 0.1 million as of September 30, 2022. 

No interest income was recognized on nonaccrual loans during the third quarter and first nine months of 2022.

Lost interest income on nonaccrual loans totaled less than $ 0.1 million and $ 0.1 million during the third quarter and first nine months of 2022, respectively.

Collateral dependent loans, representing the entire amount of loans on nonaccrual, totaled $ 7.8 million and $ 7.7 million as of March 31, 2023 and December 31, 2022, respectively.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Impaired loans as of December 31, 2021, and average impaired loans for the three and nine months ended September 30, 2021, were as follows:

With no related allowance recorded

Nonaccrual loans as of March 31, 2023 were as follows:

With no allowance recorded:

Commercial and industrial

$ 1,986,000  

$ 2,818,000  

$ 2,759,000  

$ 3,836,000  

Vacant land, land development and residential construction

2 unchanged sentences

229,000  

9,674,000  

12,674,000  

13,374,000  

Real estate –

non-owner occupied

163,000  

Real estate –

multi-family and residential rental

91,000  

46,000  

23,000  

Total commercial

2,215,000  

1-4 family mortgages

1,096,000  

Other consumer loans

1,096,000  

Total with no allowance recorded

$ 3,311,000  

Home equity and other

With an allowance recorded:

Commercial and industrial

$ 3,668,000  

$ 2,060,000  

Vacant land, land development and residential construction

Real estate –

owner occupied

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

3,668,000  

3 unchanged sentences

378,000  

Other consumer loans

803,000  

378,000  

Total with an allowance recorded

$ 4,471,000  

$ 2,438,000  

Total nonaccrual loans:

$ 5,883,000  

$ 2,060,000  

Total with no related allowance recorded

1,899,000  

378,000  

Total nonaccrual loans

$ 7,782,000  

$ 2,438,000  

No interest income was recognized on nonaccrual loans during the first quarter of 2023.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

With an allowance recorded

Nonaccrual loans as of December 31, 2022 were as follows:

With no allowance recorded:

Commercial and industrial

$ 249,000  

$ 2,192,000  

$ 266,000  

$ 2,888,000  

$ 1,617,000  

Vacant land, land development and residential construction

1 unchanged sentence

owner occupied

761,000  

84,000  

994,000  

813,000  

Real estate –

non-owner occupied

146,000  

152,000  

156,000  

Real estate –

2 unchanged sentences

249,000  

1-4 family mortgages

1,064,000  

Other consumer loans

1,064,000  

Total with no allowance recorded

$ 1,313,000  

With an allowance recorded:

Commercial and industrial

$ 5,775,000  

Home equity and other

$ 2,051,000  

Vacant land, land development and residential construction

Real estate –

owner occupied

248,000  

32,000  

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

6,023,000  

3 unchanged sentences

200,000  

69,000  

472,000  

569,000  

572,000  

552,000  

192,000  

Other consumer loans

392,000  

3 unchanged sentences

$ 2,283,000  

$ 546,000  

$ 4,703,000  

$ 3,387,000  

Total impaired loans:

$ 15,757,000  

$ 15,682,000  

$ 354,000  

$ 19,513,000  

$ 19,982,000  

4,911,000  

3,684,000  

192,000  

4,148,000  

Total nonaccrual loans:

$ 6,272,000  

Total impaired loans

$ 2,083,000  

1 unchanged sentence

200,000  

Total nonaccrual loans

$ 7,728,000  

$ 2,283,000  

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 $ 0.4 million and $ 1.2 million during the third quarter and first nine months of 2021, respectively.

No interest income was recognized on nonaccrual loans during the third quarter and first nine months of 2021.

Lost interest income on nonaccrual loans totaled less than $ 0.1 million and $ 0.1 million during the third quarter and first nine months of 2021, respectively.

No interest income was recognized on nonaccrual loans during 2022.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

4 unchanged sentences

All commercial loans are graded at inception and reviewed and, if appropriate, re-graded at various intervals thereafter.

The risk assessment for retail loans is primarily based on the type of collateral.

Credit quality indicators were as follows as of September 30, 2022:

Commercial credit exposure –

credit risk profiled by internal credit risk grades:

Real Estate -

Internal credit risk grade groupings:

Grades 1 –

$ 740,682,000  

$ 42,738,000  

$ 385,604,000  

$ 499,327,000  

$ 138,694,000  

Grades 5 –

455,801,000  

18,123,000  

254,827,000  

490,785,000  

85,502,000  

Grades 8 –

17,147,000  

109,000  

3,146,000  

12,526,000  

52,000  

Total commercial

$ 1,213,630,000  

$ 60,970,000  

$ 643,577,000  

$ 1,002,638,000  

$ 224,248,000  

Retail credit exposure –

credit risk profiled by collateral type:

$ 30,454,000  

$ 704,274,000  

Nonperforming

1,167,000  

$ 30,454,000  

$ 705,441,000  

Included in Commercial and Industrial Loans Grades 1 – 

4 are $ 2.6 million of loans originated under the Paycheck Protection Program.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Credit quality indicators were as follows as of December 31, 2021:

Commercial credit exposure –

credit risk profiled by internal credit risk grades:

Real Estate -

Internal credit risk grade groupings:

Grades 1 –

$ 729,224,000  

$ 28,390,000  

$ 346,082,000  

$ 503,482,000  

$ 119,473,000  

Grades 5 –

398,378,000  

14,730,000  

208,060,000  

511,280,000  

56,968,000  

Grades 8 –

9,817,000  

119,000  

11,616,000  

12,653,000  

152,000  

Total commercial

$ 1,137,419,000  

$ 43,239,000  

$ 565,758,000  

$ 1,027,415,000  

$ 176,593,000  

Retail credit exposure –

credit risk profiled by collateral type:

$ 60,369,000  

$ 440,861,000  

Nonperforming

119,000  

1,686,000  

$ 60,488,000  

$ 442,547,000  

Included in Commercial and Industrial Loans Grades 1 – 

4 are $ 40.1 million of loans originated under the Paycheck Protection Program.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

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

We have a policy of requesting and reviewing periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the existence of collateral and its value.

All commercial loans are graded using the following criteria:

6 unchanged sentences

“Acceptable”  Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements.

These are loans for which repayment risks are satisfactory.

These are for loans for which repayment risks are satisfactory.

“Monitor”  Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses.

2 unchanged sentences

If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

“Substandard”  Loans with this rating are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any.

“Substandard”  Loans with this rate are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any.

A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt.

1 unchanged sentence

“Doubtful”  Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.

“Loss”  Loans with this rating are considered uncollectable, and of such little value that continuance as an active asset is not warranted.

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

We have a policy of requesting and reviewing periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the existence of collateral and its value.

“Loss”  Loans with this rating are considered uncollectible, and of such little value that continuance as an active asset is not warranted.

The primary risk 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’

rights in order to preserve our collateral position.

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.

Retail loans that reach 90 days or more past due are generally placed into nonaccrual status and are categorized as nonperforming.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The following table reflects loan balances as of September 30, 2022 based on year of origination (dollars in thousands):

The following table reflects amortized cost basis of loans and year-to-date loan charge-offs as of March 31, 2023 based on year of origination (dollars in thousands):

Commercial and Industrial:

16 unchanged sentences

194,070  

426,058  

Grades 8 –

10 unchanged sentences

$ 604,374  

$ 1,173,440  

Current year-to-date gross write offs

Vacant Land, Land Development and Residential Construction:

5 unchanged sentences

$ 40,228  

Grades 5 –

1 unchanged sentence

25,530  

25,904  

Grades 8 –

5 unchanged sentences

$ 65,859  

$ 66,233  

Current year-to-date gross write offs

Real Estate –

26 unchanged sentences

$ 34,605  

$ 630,187  

Current year-to-date gross write offs

Real Estate –

29 unchanged sentences

$ 1,051,221  

Current year-to-date gross write offs

Real Estate –

24 unchanged sentences

$ 8,254  

$ 9,059  

$ 219,339  

Current year-to-date gross write offs

Total Commercial

8 unchanged sentences

$ 3,140,420  

Total Comm current YTD gross write offs

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Term Total  

1-4 Family Mortgages:

18 unchanged sentences

$ 795,007  

Current year-to-date gross write offs

Other Consumer Loans:

5 unchanged sentences

$ 30,101  

$ 30,454  

Nonperforming

5 unchanged sentences

$ 30,101  

$ 30,454  

Current year-to-date gross write offs

$ 36,818  

7 unchanged sentences

$ 825,108  

Total Retail Current YTD gross write offs

$ 273,624  

7 unchanged sentences

$ 3,965,528  

Grand Total Current YTD gross write offs

There were no revolving loans converted to term loans during the first three months of 2023.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity in the allowance for credit losses during the three months and nine months ended September 30, 2022 is as follows (dollars in thousands):

The following table reflects amortized cost of basis of loans 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 –

owner occupied

Commercial real estate –

non-owner occupied

Commercial real estate –

multi-family and residential rental

1-4 family mortgages

Other consumer loans

Allowance for credit losses:

Balance at 6-30-22

Grades 1 –

$ 115,494  

4 unchanged sentences

$ 9,851  

Provision for credit losses

$ 323,211  

1 unchanged sentence

$ 719,583  

Ending balance

Grades 5 –

151,783  

4 unchanged sentences

450,405  

Balance at 12-31-21

Grades 8 –

10,985  

4 unchanged sentences

$ 18,064  

Adoption of ASU 2016-13

$ 3,847  

3 unchanged sentences

$ 1,185,083  

Vacant Land, Land Development and Residential Construction:

Grades 1 –

$ 31,756  

$ 6,196  

Provision for credit losses

$ 3,428  

1 unchanged sentence

$ 41,711  

Grades 5 –

10,270  

20,057  

Ending balance

20,057  

Grades 8 –

$ 42,026  

3 unchanged sentences

$ 61,873  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity in the allowance for loan losses during the three months and nine months ended September 30, 2021 and the recorded investments in loans as of December 31, 2021 are as follows (dollars in thousands):

Commercial and industrial

Commercial vacant land, land development and residential construction

Commercial real 

estate –

$ 61,873  

Real Estate –

Owner Occupied:

Commercial real 

estate –

non-owner occupied

Commercial real estate –

multi-family and 

residential rental

Home equity and other

4 family mortgages

Allowance for loan losses:

Balance at 6-30-21

Grades 1 –

$ 194,072  

4 unchanged sentences

$ 6,162  

Provision for loan losses

$ 406,341  

Grades 5 –

115,720  

2 unchanged sentences

10,245  

Ending balance

12,550  

1 unchanged sentence

229,766  

Grades 8 –

$ 312,711  

1 unchanged sentence

$ 87,587  

Balance at 12-31-20

$ 29,915  

3 unchanged sentences

$ 639,192  

Real Estate –

Non-Owner Occupied:

Grades 1 –

$ 129,153  

Provision for loan losses

$ 163,035  

5 unchanged sentences

$ 447,606  

Grades 5 –

183,388  

Ending balance

164,334  

4 unchanged sentences

573,728  

Ending balance:

individually evaluated for impairment

Ending balance:

collectively evaluated for impairment

573,728  

Grades 8 –

12,400  

3 unchanged sentences

$ 229,076  

Total loans (*):

Ending balance

$ 79,396  

3 unchanged sentences

$ 1,033,734  

Real Estate –

Multi-Family and Residential Rental:

Grades 1 –

$ 31,470  

1 unchanged sentence

$ 36,348  

Ending balance:

individually evaluated for impairment

$ 5,306  

3 unchanged sentences

$ 118,385  

Ending balance:

collectively evaluated for impairment

Grades 5 –

48,847  

3 unchanged sentences

93,514  

Grades 8 –

$ 80,317  

1 unchanged sentence

$ 49,227  

(*) Excludes $40.1 million in loans originated under the Paycheck Protection Program.

$ 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

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Loans modified as troubled debt restructurings generally reflect other than insignificant payment delays and below market interest rates.

Loans modified as troubled debt restructurings during the three months ended September 30, 2022 were as follows:

Commercial and industrial

1-4 Family Mortgages:

$ 313,611  

$ 242,950  

Vacant land, land development and residential construction

Real estate –

owner occupied

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

$ 91,936  

$ 12,094  

1-4 family mortgages

$ 14,297  

$ 41,622  

Other consumer loans

$ 716,510  

1 unchanged sentence

$ 753,580  

Nonperforming

$ 313,753  

Loans modified as troubled debt restructurings during the nine months ended September 30, 2022 were as follows:

Commercial and industrial

$ 243,032  

$ 91,936  

Vacant land, land development and residential construction

Real estate –

owner occupied

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

$ 12,094  

$ 14,500  

1-4 family mortgages

$ 42,651  

$ 717,966  

$ 37,070  

$ 755,036  

Other Consumer Loans:

3 unchanged sentences

$ 1,074  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Loans modified as troubled debt restructurings during the three months ended September 30, 2021 were as follows:

Commercial and industrial

$ 10,158  

$ 19,595  

Vacant land, land development and residential construction

Real estate –

owner occupied

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

$ 29,753  

Nonperforming

$ 4,349  

Total commercial

$ 2,870  

$ 1,040  

Home equity and other

1-4 family mortgages

$ 1,074  

$ 10,158  

Loans modified as troubled debt restructurings during the nine months ended September 30, 2021 were as follows:

Commercial and industrial

$ 19,595  

$ 29,753  

Vacant land, land development and residential construction

Real estate –

owner occupied

$ 318,102  

$ 245,902  

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

$ 92,976  

$ 13,168  

Total commercial

$ 14,895  

$ 43,081  

Home equity and other

$ 728,124  

$ 56,665  

1-4 family mortgages

$ 784,789  

4 unchanged sentences

$ 79,881  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

We had no loans modified as troubled debt restructurings within the previous twelve months that became over 30 days past due within the three months or nine months ended September 30, 2022.

We had one loan with a balance of less than $ 0.1 million modified as a troubled debt restructuring within the previous twelve months that became over 30 days past due within the three months ended September 30, 2021;

this loan was the only troubled debt restructured loan that became over 30 days past due within the first nine months of 2021.

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2022 is as follows:

Real Estate -

Commercial Loan Portfolio:

$ 115,181  

$ 3,242,234  

$ 674,385  

$ 3,916,619  

There were no revolving loans converted to term loans during 2022.

Activity in the allowance for credit losses during the three months ended March 31, 2023 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

3 unchanged sentences

$ 1,269  

Payments (net)

Transfers to ORE

Net Additions/Deletions

$ 14,027  

Ending Balance

$ 42,246  

Provision for credit losses

( 237 )  

( 36 )  

Other Consumer

Retail Loan Portfolio:

Beginning Balance

( 14 )  

( 42 )  

Payments (net)

Transfers to ORE

Net Additions/Deletions

( 14 )  

2 unchanged sentences

$ 5,711  

$ 10,295  

$ 1,300  

$ 14,648  

$ 42,877  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the nine months ended September 30, 2022 is as follows:

Real Estate -

Commercial Loan Portfolio:

Activity in the allowance for credit losses during the three months ended March 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

3 unchanged sentences

$ 1,695  

Payments (net)

( 9,682,000 )

Transfers to ORE

Net Additions/Deletions

$ 2,449  

Ending Balance

$ 35,363  

Adoption of ASU 2016-13

( 1,571 )  

( 43 )  

Other Consumer

Retail Loan Portfolio:

Beginning Balance

( 560 )  

( 2,534 )  

Payments (net)

Transfers to ORE

Net Additions/Deletions (1)

( 621 )  

( 1,187,000 )

Ending Balance

( 411 )  

( 55 )  

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the three months ended September 30, 2021 is as follows:

Real Estate -

Commercial Loan Portfolio:

Beginning Balance

Provision for credit losses

( 742 )  

1 unchanged sentence

( 33 )  

Payments (net)

Transfers to ORE

Net Additions/Deletions

( 170 )  

5 unchanged sentences

$ 1,276  

Retail Loan Portfolio:

Beginning Balance

$ 8,562  

$ 35,153  

Payments (net)

Transfers to ORE

Net Additions/Deletions

Ending Balance

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

There were no loans modified to borrowers experiencing financial difficulty during the first three months of 2023.

Loans modified as troubled debt restructurings during the three months ended March 31, 2022 were as follows:

Commercial and industrial

Vacant land, land development and residential construction

Real estate –

owner occupied

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

1-4 family mortgages

128,000  

Other consumer loans

128,000  

$ 128,000  

The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2022 ( amounts as of period end):

Commercial and industrial

Vacant land, land development and residential construction

Real estate –

owner occupied

Real estate –

non-owner occupied

Real estate –

multi-family and residential rental

Total commercial

1-4 family mortgages

Other consumer loans

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

Activity for loans categorized as troubled debt restructurings during the nine months ended September 30, 2021 is as follows:

Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2022 is as follows:

Land Development,

and Residential Construction

Real Estate -

1 unchanged sentence

Real Estate -

and Residential

Commercial Loan Portfolio:

3 unchanged sentences

$ 146,000  

Payments (net)

( 3,596,000 )

$ 91,000  

( 9,677,000 )

1 unchanged sentence

Net Additions/Deletions

2,854,000  

686,000  

92,000  

( 1,932,000 )

Ending Balance

3 unchanged sentences

$ 90,000  

Other Consumer

Retail Loan Portfolio:

2 unchanged sentences

$ 1,202,000  

Payments (net)

Transfers to ORE

1 unchanged sentence

1,797,000  

46,000  

( 1,187,000 )

Ending Balance

1 unchanged sentence

$ 13,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

PREMISES AND EQUIPMENT, NET

Premises and equipment are comprised of the following:

September 30,

Land and improvements

14 unchanged sentences

$ 51,476,000  

Depreciation expense totaled $ 1.5 million during the third quarters of 2022 and 2021.

Depreciation expense totaled $ 4.5 million during the first nine months of 2022, compared to $ 4.3 million during the first nine months of 2021.

Depreciation expense totaled $ 1.5 million and $ 1.6 million during the first quarters of 2023 and 2022, respectively.

We enter into facility leases in the normal course of business.

As of September 30, 2022 and December 31, 2021, we were under lease contracts for ten of our banking facilities.

The leases had maturity dates ranging from June, 2023 through December, 2026, with a weighted average life of 2.7 years and 2.8 years as of September 30, 2022 and December 31, 2021, respectively.

As of March 31, 2023, we were under lease contracts for eleven of our branch facilities.

The leases have maturity dates ranging from February, 2024 through December, 2029, with a weighted average life of 2.7 years as of March 31, 2023.

All of our leases have multiple three - to five -year extensions;

however, those were not factored in the lease maturities and weighted average lease term as it is not reasonably certain we will exercise the options.

Leases are classified as either operating or finance leases at the lease commitment date, with all of our current leases determined to be operating leases.

however, these were not factored in the lease maturities and weighted average lease term as it was not reasonably certain we would exercise the options on the dates we entered into the lease agreements.

Leases are classified as either operating or finance leases at the lease commencement date, with all of our current leases determined to be operating leases.

Lease expense for operating leases is recognized on a straight-line basis over the lease term.

2 unchanged sentences

We use our incremental borrowing rate, on a collateralized basis, at lease commencement to calculate the present value of lease payments.

The weighted average discount rate for leases was 5.40 % and 4.70 % as of September 30, 2022 and December 31, 2021, 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, each totaled $ 4.1 million as of September 30, 2022, and $ 3.6 million as of December 31, 2021.

As permitted by applicable accounting standards, we have elected not to recognize short-term leases with original terms of twelve months or less on our Consolidated Balance Sheets.

Total operating lease expense associated with the leases aggregated $ 0.2 million during the third quarters of 2022 and 2021, and $ 0.6 million and $ 0.5 million during the first nine months of 2022 and 2021, respectively.

Future lease payments at September 30, 2022 totaled $ 4.7 million, comprised of $ 1.0 million in one year, $ 1.4 million in one to three years, $ 0.7 million in three to five years and $ 1.6 million in over five years.

Future lease payments at December 31, 2021 totaled $ 3.6 million, comprised of $ 0.8 million in one year, $ 1.4 million in one to three years, $ 0.3 million in three to five years and $ 1.1 million in over five years.

As part of the relocation of our Lansing operations, we completed the sale of our Lansing facility on July 14, 2022.

Net proceeds totaled $ 2.9 million, with a $ 0.3 million loss on sale recorded during the second quarter of 2022.

The weighted average discount rate for leases was 5.79 % as of March 31, 2023.

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 $ 3.9 million and $ 3.5 million as of March 31, 2023, and December 31, 2022, 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 $ 0.3 million during the first three months of 2023 and $ 1.3 million during the full year 2022.

Future lease payments were as follows as of March 31, 2023:

$ 904,000  

1,012,000  

578,000  

479,000  

434,000  

1,638,000  

Total undiscounted lease payments

5,045,000  

Less effect of discounting

( 1,169,000 )

Present value of future lease payments (lease liability)

3,876,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Our total deposits at September 30, 2022 totaled $ 3.85 billion, a decrease of $ 237 million, or 5.8 %, from December 

The components of our outstanding balances at September 30, 2022 and December 31, 2021, and percentage change in deposits from the end of 2021 to the end of the third quarter of 2022, are as follows:

September 30, 2022

Our total deposits at March 31, 2023 totaled $ 3.60 billion, a decrease of $ 115 million, or 3.1 %, from December 

The components of our outstanding balances at March 31, 2023 and December 31, 2022, and percentage change in deposits from the end of 2022 to the end of the first quarter of 2023, are as follows:

March 31, 2023

December 31, 2022

Noninterest-bearing demand

Noninterest-bearing checking

1,376,782,000

1 unchanged sentence

Interest-bearing checking

1,040,176,000

Time, under $100,000

Time, $100,000 and over

Total local deposits

3,846,085,000

4,059,280,000

Out-of-area time, $100,000 and over

Total deposits

1 unchanged sentence

3,712,811,000

Total time deposits of more than $250,000 totaled $ 187 million and $ 207 million at September 30, 2022 and December 31, 2021, respectively.

SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

1 unchanged sentence

Information relating to our repurchase agreements follows:

September 30,

Twelve Months

Three Months Ended

Twelve Months Ended

March 31, 2023

December 31, 2022

Outstanding balance at end of period

9 unchanged sentences

$ 235,577,000  

Repurchase agreements generally have original maturities of less than one year.

Repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as liabilities.

Securities involved with the agreements are recorded as assets of our bank and are held in safekeeping by a correspondent bank.

Repurchase agreements are secured by securities with an aggregate market value equal to the aggregate outstanding balance.

Repurchase agreements have maturities of one business day.

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 U.S.

Government agency 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.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES

Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $ 310 million at September 30, 2022, and were expected to mature at varying dates from October 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 1.92 %.

FHLBI bullet advances totaled $ 374 million at December 31, 2021, and were expected to mature at varying dates from January 2022 through June 2027, with fixed rates of interest from 0.55 % to 3.18 % and averaging 2.00 %.

Maturities of FHLBI bullet advances as of September 30, 2022 were as follows:

FHLBI amortizing advances totaled $ 28.3 million as of September 30, 2022, with an average rate of 2.52 %.

We had no FHLBI amortizing advances outstanding as of December 31, 2021.

Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $ 350 million at March 31, 2023, and were scheduled to mature at varying dates from April 2023 through March 2028, with fixed rates of interest from 0.55 % to 4.37 % and averaging 2.31 %.

FHLBI bullet advances totaled $ 280 million at December 31, 2022, and were scheduled 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 %.

Maturities of FHLBI bullet advances as of March 31, 2023 were as follows:

$ 70,000,000  

80,000,000  

50,000,000  

70,000,000  

30,000,000  

FHLBI amortizing advances totaled $ 27.9 million as of March 31, 2023, with an average rate of 2.52 % and with final maturities in 2042.

FHLBI amortizing advances total $ 28.3 million as of December 31, 2022, with an average rate of 2.52 % and with final maturities in 2042.

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 September 30, 2022 were as follows:

Scheduled principal payments of FHLBI amortizing advances as of March 31, 2023 were as follows:

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 September 30, 2022 totaled $ 1.0 billion, with remaining availability based on collateral equaling $ 659 million.

Our borrowing line of credit as of March 31, 2023 totaled $ 665 million, with remaining availability based on collateral of $ 281 million.

COMMITMENTS AND OFF-BALANCE SHEET RISK

Our bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers.

These financial instruments include commitments to extend credit and standby letters of credit.

5 unchanged sentences

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)

These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet.

Our bank’s maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.

Our bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on our credit assessment of the borrower.

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.

We are required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us.

The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives.

The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.

We have determined that our commercial-related lending commitments are unconditionally cancellable.

Additionally, the vast majority of unfunded commercial loan commitments consist of revolving lines of credit wherein the aggregate amounts outstanding and available remain relatively stable, and any seasonality of line usage is nominal.

Line of credit draws, irrespective of the maximum credit or individual note amount, are governed by borrowing or advance formulas, while draws off of commercial and residential construction loans are governed by the receipt and satisfactory review of contractor and subcontractor sworn statements, lien waivers and title insurance company endorsements.

For commercial lines of credit, retail lines of credit and credit card average outstanding balances, we determined allowance requirements by calculating the difference between the average percent outstanding of the funded commitments over the past several years to actual percent outstanding at the end of the period and applying the respective expected loss allocation factors to the difference as this difference represents the average of unfunded commitments we expect to eventually be drawn upon.

The calculated allowance aggregated $ 0.2 million and $ 0.1 million as of March 31, 2023 and December 31, 2022, respectively.

We do not reserve for residential mortgage construction loans, as the loans are for one year or less and draws are governed by the receipt and satisfactory review of contractor and subcontractor sworn statements, lien waivers and title insurance company endorsements.

Letters of credit are rarely drawn.

For retail lines of credit, including home equity lines of credit, overdraft protection lines of credit and personal unsecured lines of credit, and credit cards, average outstanding balances as a percent of total available credit have remained relatively steady over the past several years.

We determined allowance requirements for these credit types by calculating the difference between the average percent outstanding of the funded commitments over the past several years to actual percent outstanding as of September 30, 2022 and applying the respective expected loss allocation factors to the difference as this difference represents the average of unfunded commitments we expect to eventually be drawn upon.

The calculated allowance for the retail lines of credit and credit cards as of September 30, 2022 was $ 0.3 million.

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at September 30, 2022 and December 31, 2021 follows:

September 30,

At March 31, 2023, and December 31, 2022, the rates on existing off-balance sheet instruments were substantially equivalent to current market rates, considering the underlying credit standing of the counterparties.

A summary of the contractual amounts of our financial instruments with off-balance sheet risk at March 31, 2023 and December 31, 2022 is as follows: 

Commercial unused lines of credit

1 unchanged sentence

$ 1,283,703,000  

Unused lines of credit secured by 1 –

4 family residential properties

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

72,014,000  

14 unchanged sentences

$ 1,908,294,000  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DERIVATIVES AND HEDGING ACTIVITIES

3 unchanged sentences

Derivative financial instruments may also be used to assist in managing economic risks.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DERIVATIVES AND HEDGING ACTIVITIES (Continued)

Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers.

3 unchanged sentences

Fees paid to us by the correspondent banks are recognized as noninterest income on our Consolidated Statements of Income on the settlement date.

The fair values of derivative instruments as of September 30, 2022 are reflected on a gross basis in the following table.

The fair values of derivative instruments as of March 31, 2023, are reflected in the following table.

Notional Amount

9 unchanged sentences

23,254,000  

The effect of interest rate swaps that are not designated as hedging instruments resulted in income of $ 0.2 million during the first nine months of 2022 that was recorded in other noninterest expense on our Consolidated Statements of Income.

The value of interest rate swaps in a liability position, which includes accrued interest, was $ 28.5 million as of September 30, 2022.

We have master netting arrangements with our correspondent banks.

Cash collateral totaling $ 28.0 million was provided to us by the counterparty correspondent banks as of September 30, 2022.

The effect of interest rate swaps that are not designated as hedging instruments resulted in expense of $ 0.2 million during the first three months of 2023 that was recorded in other noninterest expense on our Consolidated Statements of Income.

The fair value of interest rate swaps in a liability position, which includes accrued interest, was $ 23.3 million as of March 31, 2023.

We have master netting arrangements with our correspondent banks that allow us to net receivables and payables.

The netting agreement also allows us to net related cash collateral received and transferred up to the fair value exposure amount.

We have elected to not offset these transactions on the Consolidated Balance Sheets.

As of March 31, 2023, the gross amount of derivative assets subject to master netting agreements presented on the Consolidated Balance Sheets was $ 19.6 million, while cash collateral reflecting cash requirements from our counterparties to us totaled $ 20.8 million, providing for an over-collateralized position on the Consolidated Balance Sheets of $ 1.2 million.

As of March 31, 2023, the gross amount of derivative liabilities subject to master netting agreements presented on the Consolidated Balance Sheets was $ 3.3 million, while cash collateral reflecting cash requirements from us to our counterparties totaled $ 3.0 million, and the net amount of derivative liabilities not offset on the Consolidated Balance Sheets was $ 0.3 million.

Cash collateral amounts, which are based on daily fair value calculations, are adjusted daily if fair value changes exceed an aggregate of $250,000.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 360 million as of September 30, 2022.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 471 million as of March 31, 2023.

Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instruments.

The fair values of derivative instruments as of December 31, 2021 are reflected on a gross basis in the following table.

The fair values of derivative instruments as of December 31, 2022, are reflected in the following table.

Notional Amount

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DERIVATIVES AND HEDGING ACTIVITIES (Continued)

The effect of interest rate swaps that are not designated as hedging instruments resulted in expense of $ 0.2 million during the year-ended December 31, 2021 recognized in other noninterest expense on our Consolidated Statements of Income.

The effect of interest rate swaps that are not designated as hedging instruments resulted in income of less than $ 0.1 million during the year-ended December 31, 2022 that was recorded in other noninterest expense on our Consolidated Statements of Income.

The fair value of interest rate swaps in a liability position, which includes accrued interest, was $ 25.9 million as of December 31, 2022.

We have master netting arrangements with our correspondent banks.

Cash collateral totaling $ 3.6 million was provided to the counterparty correspondent banks as of December 31, 2021.

We have master netting arrangements with our correspondent banks that allow us to net receivables and payables.

The netting agreement also allows us to net related cash collateral received and transferred up to the fair value exposure amount.

We have elected to not offset these transactions on the Consolidated Balance Sheets.

As of December 31, 2022, the gross amount of derivative assets subject to master netting agreements presented on the Consolidated Balance Sheets was $ 25.3 million, while cash collateral reflecting cash requirements from our counterparties to us totaled $ 25.2 million, and the net amount of derivative assets not offset in the Consolidated Balance Sheets was $ 0.1 million.

As of December 31, 2022, the gross amount of derivative liabilities subject to master netting agreements presented on the Consolidated Balance Sheets was $ 0.4 million, while cash collateral reflecting cash requirements from us to our counterparties totaled $ 0.4 million, and the net amount of derivative liabilities not offset on the Consolidated Balance Sheets was $ 0 .

Cash collateral amounts, which are based on daily fair value calculations, are adjusted daily if fair value changes exceed an aggregate of $250,000.

1 unchanged sentence

Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instruments.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FAIR VALUES OF FINANCIAL INSTRUMENTS

The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of September 30, 2022 and December 31, 2021 ( dollars in thousands):

September 30, 2022

The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of March 31, 2023 and December 31, 2022 ( dollars in thousands):

March 31, 2023

December 31, 2022

Financial assets:

$ 17,016  

$ 17,872  

Cash equivalents

Cash and cash equivalents

$ 57,938  

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Mortgage loans held for sale

Mortgage servicing rights

11,402  

2 unchanged sentences

17,727  

Mortgage servicing rights

Accrued interest receivable

17,424  

2 unchanged sentences

15,476  

Accrued interest receivable

Interest rate swaps

22,871  

Interest rate swaps

25,697  

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23,254  

25,900  

See Note 11 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities.

1 unchanged sentence

therefore, fair value is estimated at carrying amount.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase.

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The fair value of other off-balance sheet items is estimated to be nominal.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

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Significant unobservable inputs that reflect our own conclusions about the assumptions that market participants would use in pricing an asset or liability.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FAIR VALUES (Continued)

The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities that are recorded at fair value on a recurring or nonrecurring basis:

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Level 2 securities include U.S.

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

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

Government agencies, and municipal general obligation and revenue bonds.

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We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment.

There was no such impairment as of September 30, 2022 or December 31, 2021.

There was no such impairment as of March 31, 2023, or December 31, 2022.

We have no Level 1 securities available for sale.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FAIR VALUES (Continued)

Derivatives .

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Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics.

As of September 30, 2022 and December 31, 2021, we determined the fair value of our mortgage loans held for sale to be $ 14.7 million and $ 16.7 million, respectively.

As of March 31, 2023 and December 31, 2022, we determined the fair value of our mortgage loans held for sale to be $ 3.9 million and $ 3.6 million, respectively.

We do not record loans at fair value on a recurring basis.

However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral.

These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge-off.

The fair values of impaired loans are determined using either the sales comparison approach or income approach;

These loans are reported in the nonrecurring table below at initial recognition of significant borrower distress and on an ongoing basis until recovery or charge-off.

The fair values of distressed loans are determined using either the sales comparison approach or income approach;

respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.

4 unchanged sentences

respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FAIR VALUES (Continued)

The balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2022 are as follows:

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2023 are as follows:

Available for sale securities

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$ 23,254,000  

There were no sales, purchases or transfers in or out of Level 3 during the first nine months of 2022.

The less than $ 0.1 million reduction in Level 3 municipal general obligation bonds during the first nine months of 2022 reflects the scheduled maturities of such bonds.

MERCANTILE BANK CORPORATION

1 unchanged sentence

FAIR VALUES (Continued)

There were no sales, purchases or transfers in or out of Level 3 during the first quarter of 2023.

The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2022 are as follows:

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There were no sales, purchases or transfers in or out of Level 3 during 2022.

The less than $ 0.1 million reduction in Level 3 municipal general obligation bonds during 2021 reflects the scheduled maturities of such bonds.

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2022 are as follows:

Markets for Identical

The $ 0.1 million reduction in Level 3 municipal general obligation bonds during 2022 reflects the scheduled maturities of such bonds.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2023 are as follows:

Collateral Dependent Loans

4 unchanged sentences

661,000  

$ 5,117,000  

MERCANTILE BANK CORPORATION

2 unchanged sentences

The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2022 are as follows:

Impaired Loans

Quoted  

Collateral dependent loans

$ 5,290,000  

4 unchanged sentences

The carrying values are based on the estimated value of the property or other assets.

Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically.

Fair value estimates of collateral on nonperforming loans and foreclosed assets are reviewed periodically.

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

1 unchanged sentence

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

For real estate dependent loans and foreclosed assets, we generally assign a 15 % to 25 % discount factor for commercial-related properties, and a 25 % to 50 % discount factor for residential-related properties.

We generally assign a discount factor range of 25 % to 35 % for commercial real estate dependent loans and foreclosed assets, and a discount factor range of 25 % to 50 % for residential-related properties.

In a vast majority of cases, we assign a 10 % discount factor for estimated selling costs.

EARNINGS PER SHARE

Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period.

Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans and are determined using the treasury stock method.

In the event of a net loss, our unvested restricted shares are excluded from the calculation of both basic and diluted earnings per share.

Approximately 319,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2022.

In addition, stock options for approximately 1,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2022.

Stock options for approximately 5,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2022.

Approximately 260,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2021.

In addition, stock options for approximately 3,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2021.

Stock options for approximately 7,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2021.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REGULATORY MATTERS

2 unchanged sentences

Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases.

Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements.

Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition.

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In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator.

At September 30, 2022 and December 31, 2021, our bank was in the well capitalized category under the regulatory framework for prompt corrective action.

There are no conditions or events since September 30, 2022 that we believe have changed our bank’s categorization.

As of March 31, 2023 and December 31, 2022, our bank was in the well capitalized category under the regulatory framework for prompt corrective action.

There are no conditions or events since March 31, 2023 that we believe have changed our bank’s categorization.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REGULATORY MATTERS (Continued)

Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:

Minimum Required

Adequacy Purposes

Minimum Required

1 unchanged sentence

Prompt Corrective

Adequacy Purposes

Action Regulations

September 30, 2022

March 31, 2023

Total capital (to risk weighted assets)

Consolidated  

$ 652,509  

3 unchanged sentences

369,708  

462,134  

Tier 1 capital (to risk weighted assets)

16 unchanged sentences

244,112  

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REGULATORY MATTERS (Continued)

Actual  

Minimum Required

Adequacy Purposes

Minimum Required

Capitalized Under

Prompt Corrective

Action Regulations

Amount  

December 31, 2022

Total capital (to risk weighted assets)

Consolidated  

$ 634,729  

3 unchanged sentences

362,490  

453,112  

Tier 1 capital (to risk weighted assets)

16 unchanged sentences

249,453  

Our consolidated capital levels as of September 30, 2022 and December 31, 2021 include $ 46.7 million and $ 46.2 million, respectively, of trust preferred securities.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REGULATORY MATTERS (Continued)

Our consolidated capital levels as of March 31, 2023 and December 31, 2022 include $ 47.1 million and $ 46.9 million, respectively, of trust preferred securities.

Under applicable Federal Reserve guidelines, the trust preferred securities constitute a restricted core capital element.

1 unchanged sentence

Our ability to include the trust preferred securities in Tier 1 capital in accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated assets as of December 31, 2009 were less than $ 15.0 billion.

As of September 30, 2022 and December 31, 2021, all $ 46.7 million and $ 46.2 million, respectively, of the trust preferred securities were included in our consolidated Tier 1 capital.

As of March 31, 2023 and December 31, 2022, all $ 47.1 million and $ 46.9 million, respectively, of the trust preferred securities were included in our consolidated Tier 1 capital.

Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5 % of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule.

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The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0 %, the Tier 1 capital ratio to 8.5 % and the total capital ratio to 10.5 % on a fully phased-in basis on January 1, 2019.

We believe that, as of September 30, 2022, our bank met all capital adequacy requirements under the BASEL III capital rules.

MERCANTILE BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REGULATORY MATTERS (Continued)

We believe that, as of March 31, 2023, our bank meets all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.

Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices.

On January 12, 2023, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.33 per share that was paid on March 15, 2023 to shareholders of record as of March 3, 2023.

On April 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $0.31 per share that was paid on June 15, 2022 to shareholders of record as of June 3, 2022.

On July 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.32 per share that was paid on September 14, 2022 to shareholders of record as of September 2, 2022.

As of September 30, 2022, we had the ability to repurchase up to $ 6.8 million in common stock shares from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations as part of a $ 20.0 million common stock repurchase program announced in May 2021.

No shares were repurchased during the first nine months of 2022.

As of March 31, 2023, we had the ability to repurchase up to $ 6.8 million in common stock shares from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations as part of a $ 20.0 million common stock repurchase program announced in May 2021.

No shares were repurchased during the first quarter of 2023.

Historically, stock repurchases have been funded from cash dividends paid to us from our bank.

Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank.

SUBORDINATED NOTES

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

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

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

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

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

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

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

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

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

The actual timing, number and value of shares repurchased will be determined by us in our discretion and will depend on a number of factors, including the stock price, capital position, financial performance, general market and economic conditions, alternative uses of capital and applicable legal requirements.

SUBSEQUENT EVENTS

On October 13, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.32 per share that will be paid on December 14, 2022 to shareholders of record as of December 2, 2022.

On April 13, 2023, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.33 per share that will be paid on June 14, 2023, to shareholders of record as of June 2, 2023.

MERCANTILE BANK CORPORATION

23 unchanged sentences

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

increasing rates of inflation and slower growth rates;

increasing rates of inflation and slower growth rates or recession;

significant declines in the value of commercial real estate;

1 unchanged sentence

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 tax laws and other laws and regulations applicable to us;

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 markets and other economic activity 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, 2021.

the transition from Libor to SOFR;

changes in the national and local economies;

unstable political and economic environments;

disease outbreaks, such as the COVID-19 pandemic or similar public health threats, and measures implemented to combat them;

and other risk factors, including those 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.

The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank (“our bank”) and our bank’s subsidiary Mercantile Insurance Center, Inc., at September 30, 2022 and December 31, 2021 and the results of operations for the three months and nine months ended September 30, 2022 and September 30, 2021.

The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank of Michigan (“our bank”) and our bank’s subsidiary, Mercantile Insurance Center, Inc., at March 31, 2023 and December 31, 2022 and the results of operations for the three months ended March 31, 2023 and March 31, 2022.

This discussion should be read in conjunction with the interim consolidated financial statements and footnotes included in this report.

4 unchanged sentences

include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.

Critical Accounting Policies  

Critical Accounting Estimates  

Accounting principles generally accepted in the United States of America (“GAAP”) are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters.

1 unchanged sentence

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report.

For a discussion of our significant accounting policies, see Note 1 of the Notes to our Consolidated Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2021 (Commission file number 000-26719).

For a discussion of our significant accounting estimates, see Note 1 of the Notes to our Consolidated Financial Statements included in our Form 10-K for the fiscal year ended December 31, 2022 (Commission file number 000-26719).

Our critical accounting policies are highly dependent upon subjective or complex judgments, assumptions and estimates.

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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”

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”

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

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

In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination.

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.

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

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.

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Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.

MERCANTILE BANK CORPORATION

Income Tax Accounting :

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

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

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

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

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

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

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

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

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

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

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

Debt Securities Available for Sale :

Debt securities available for sale consist of bonds which might be sold prior to maturity due to a number of factors, including changes in interest rates, prepayment risks, yield and availability of alternative investments or liquidity needs.

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

If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance.

For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors.

In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors.

If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.

Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Changes in the allowance for credit losses under CECL are recorded as provision for (or reversal of) credit loss expense.

At September 30, 2022, there was no allowance for credit losses related to the available for sale debt securities portfolio.

Mortgage Servicing Rights :

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We utilize a discounted cash flow model to determine the value of our servicing rights.

The valuation model utilizes mortgage prepayment speeds, the remaining life of the mortgage pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from servicing each grouping of loans.

The valuation model utilizes mortgage loan prepayment speeds, the remaining life of the mortgage loan pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from servicing each grouping of loans.

These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans.

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MERCANTILE BANK CORPORATION

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

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

For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculation of the value.

In other cases, where the value is not easily determined, we consult with outside parties to determine the fair value of the asset or liability.

Once valuations have been adjusted, the net difference between the price paid for the acquired company and the value of its balance sheet is recorded as goodwill.

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

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

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

Coronavirus Pandemic

Although there has been an easing of Covid-19 pandemic-related restrictions, there remains a significant amount of stress and uncertainty across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”).

This uncertainty is heightened as certain geographic areas continue to experience surges in Covid-19 cases and governments at all levels continue to react to changes in circumstances, including 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 capable of evading vaccinations, booster shots and prior immunity.

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

Paycheck Protection Program

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

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

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

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

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

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

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

The program ended on August 8, 2020.

We originated approximately 2,200 loans aggregating $553 million.

As of September 30, 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 the first nine months of 2022.

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

The program ended on May 31, 2021.

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

As of September 30, 2022, we recorded forgiveness transactions on all but seven loans aggregating $2.1 million.

Net loan origination fees of $0.9 million were recorded during the first nine months of 2022.

MERCANTILE BANK CORPORATION

Individual Economic Impact Payments

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

From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings.

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

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

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

Current Expected Credit Loss Methodology Delay  

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.

Financial Overview

We reported net income of $16.0 million, or $1.01 per diluted share, for the third quarter of 2022, compared with net income of $15.1 million, or $0.95 per diluted share, during the third quarter of 2021.

Net income for the first nine months of 2022 totaled $39.3 million, or $2.48 per diluted share, compared to $47.4 million, or $2.95 per diluted share, during the first nine months of 2021.

Higher net interest income, stemming from an improving net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and increases in several key fee income revenue streams, in large part mitigated 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 refinance activity.

Our earnings performance in the 2021 periods also benefited from lower loan loss provisions reflecting improved economic conditions and expectations during those time periods.

Commercial loans increased $195 million during the first nine months of 2022, reflecting the net impact of growth in core commercial loans and payment activities under the PPP.

Core commercial loans increased $232 million, or almost 11% on an annualized basis, while PPP payment activities aggregated $37.5 million, during the first nine months of 2022.

Core commercial and industrial loans increased $114 million, owner-occupied commercial real estate (“CRE”) loans grew $77.8 million, multi-family and residential rental property loans increased $47.7 million, and vacant land, land development and residential construction loans increased $17.7 million, while non-owner occupied CRE loans were down $24.8 million.

As a percentage of total commercial loans, commercial and industrial loans (excluding PPP loans) and owner occupied CRE loans combined equaled 59.0% as of September 30, 2022, compared to 57.1% at December 31, 2021.

The new commercial loan pipeline remains strong, and at September 30, 2022, we had $169 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 $227 million during the first nine months of 2022, representing a growth rate of over 68% on an annualized basis.

With the increase in residential mortgage loan rates during the first nine months of 2022, we have witnessed a shift in borrowers primarily now selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in the previous couple of 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 the first nine months of 2022, approximately 29% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to about 61% during the first nine months of 2021.

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.

First Quarter 2023 Financial Overview

We reported net income of $21.0 million, or $1.31 per diluted share, for the first quarter of 2023, compared with net income of $11.5 million, or $0.73 per diluted share, during the first quarter of 2022.

The improved operating results were in large part driven by higher net interest income, stemming from an improved net interest margin and ongoing robust loan growth, and continued strength in asset quality metrics providing for limited provision expense.

Commercial loans increased $8.6 million during the first quarter of 2023, providing for an annualized growth rate of about 1%.

Full payoffs and partial paydowns of certain larger commercial loan relationships, primarily reflecting customers selling businesses and assets and using excess cash flows generated within their operations to make unscheduled principal payments and line of credit reductions, totaled about $65 million during the first quarter of 2023.

Non-owner occupied commercial real estate (“CRE”) loans increased $17.5 million, multi-family and residential rental property loans grew $7.4 million, vacant land, land development and residential construction loans increased $4.4 million, commercial and industrial loans declined $11.6 million and owner occupied CRE loans were down $9.0 million.

As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 57.4% as of March 31, 2023, compared to 58.2% at December 31, 2022.

The new commercial loan pipeline remains strong, and as of March 31, 2023, we had $285 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 $40.1 million during the first quarter of 2023, representing an annualized growth rate of approximately 23%.

With increased residential mortgage loans rates during 2022 and into 2023, we have witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans.

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

During the first quarter of 2023, approximately 35% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to a similar level during 2022 but about 68% in 2021.

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

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

MERCANTILE BANK CORPORATION

The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.04% of total loans as of September 30, 2022.

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

We had no loan charge-offs during the third quarter of 2022, and an aggregated $0.2 million for the first nine months of the year, while recoveries of prior period loan charge-offs equaled $0.2 million and $0.9 million during the respective time periods.

A net loan recovery, as a percentage of average total loans, equaled an annualized 0.03% and 0.02% during the third quarter and first nine months of 2022, respectively.

A provision for credit losses of $2.9 million was recorded during the third quarter of 2022, compared to a provision expense of $1.9 million during the third quarter of 2021. 

A provision for credit losses of $3.5 million was recorded during the first nine months of 2022, compared to a negative provision of $0.9 million during the first nine months of 2021. 

The required reserve allocations resulting from these factors were partially mitigated by the positive impact of a change in the Covid-19 environmental factor during the second quarter, along with the recording of net loan recoveries and ongoing strong loan quality metrics during the periods. 

Our adoption of Accounting Standards Update No.

2016-13, Measurement of Credit Losses on Financial Instruments , on January 1, 2022, resulted in a $0.4 million one-time reduction to the allowance for credit losses. 

The lower provision expense recorded in the 2021 periods was mainly comprised of a reduced reserve allocation associated with the economic and business conditions environmental factor, reflecting improvement in both current and forecasted economic conditions.

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

During the first nine months of 2022, the average balance of these funds equaled $535 million, or 11.2% of average earning assets, compared to $649 million, or 14.6% of average earning assets, during the first nine months of 2021;

these levels are substantially higher than our typical average balance of $75 million, or approximately 2% of average earning assets.

The elevated levels during 2021 and through the first nine months of 2022 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus payments and reduced business and consumer investing and spending, and have had a significant negative impact on our net interest margin.

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

Average interest-earning balances equaled $295 million during the third quarter of 2022, compared to $531 million and $784 million during the second and first quarters of 2022, respectively.

Total deposits decreased $237 million during the first nine months of 2022, totaling $3.85 billion at September 30, 2022.

Local deposits decreased $213 million and out-of-area deposits declined $23.9 million.

The reduced level of local deposits primarily reflected a single customer’s anticipated withdrawal of a majority of funds that were obtained from the sale of a business and deposited in late 2021;

excluding this withdrawal, total local deposits were relatively steady during the first nine months of 2022.

Net interest income increased $11.3 million and $16.1 million during the third quarter and first nine months of 2022, respectively, compared to the respective time periods in 2021.

Interest income was $12.2 million and $17.1 million higher during the third quarter and first nine months of 2022, respectively, when compared to the same time periods in 2021, in large part reflecting an increasing interest rate environment and higher average balances of earning assets.

Interest expense was $1.0 million and $1.1 million higher during the third quarter and first nine months of 2022, respectively, when compared to the corresponding time periods in 2021, generally reflecting the net impact of lower deposit interest costs and increased costs on borrowed funds mainly resulting from a higher cost of subordinated debentures and the issuance of $90.0 million in subordinated notes in December 2021 and January 2022.

it takes an estimated 24 months for the amount of net interest income earned on a residential mortgage loan 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 only 0.20% of total loans as of March 31, 2023.

Accruing loans past due 30 to 89 days remain very low, and foreclosed properties excluding the former branch facility totaled less than $0.1 million as of March 31, 2023.

Gross loan charge-offs totaled $0.1 million during the first quarter of 2023, while recoveries of prior period loan charge-offs also totaled $0.1 million.

We recorded a provision expense of $0.6 million during the first quarter of 2023, compared to $0.1 million during the prior-year first quarter.

The provision expense recorded during both periods mainly reflected allocations necessitated by net loan growth;

nominal loan charge-offs and continued strong loan quality metrics during the periods in large part mitigated additional reserves associated with loan growth.

We did not adjust any qualitative reserve factors during the first quarter of 2023, and the impact of the updated economic forecast was less than $0.1 million.

Total deposits decreased $115 million during the first three months of 2023, providing for an annualized reduction rate of approximately 12%.

The reduction primarily reflected a customary level of customers’

tax and bonus payments and partnership distributions, as well as transfers to the repurchase agreement (“sweep account”) product.

Wholesale funds, comprised of Federal Home Loan Bank of Indianapolis (“FHLBI”) advances, totaled $378 million, or about 9% of total funds, as of March 31, 2023, compared to $308 million, or about 7% of total funds, at December 31, 2022.

MERCANTILE BANK CORPORATION

Noninterest income decreased $8.3 million and $19.3 million during the third quarter and first nine months of 2022, respectively, compared to the corresponding time periods in 2021.

Mortgage banking income was $4.8 million and $16.1 million lower during the third quarter and first nine months of 2022, respectively, when compared to the same time periods in 2021, in large part reflecting increased residential mortgage loan rates which substantially reduced the volume of refinance activity.

We continued to record growth in treasury management-related fee income categories, such as service charges on accounts, credit and debit card income and payroll processing.

Combined, we recorded growth of approximately 15% when comparing the third quarter and first nine months of 2022 with the respective time periods in 2021.

Noninterest expense increased $0.5 million and $1.9 million during the third quarter and first nine months of 2022, respectively, compared to the respective time periods in 2021.

During the second quarter of 2022, we contributed $0.5 million to The Mercantile Bank Foundation.

Excluding the charitable contribution, overhead costs were up slightly during the 2022 periods when compared to the 2021 periods, in large part reflecting increased compensation costs.

Net interest income increased $17.5 million during the first quarter of 2023 compared to the first quarter of 2022.

Interest income was up $24.6 million, while interest expense increased $7.1 million.

Interest income on loans increased significantly quarter-over-quarter, reflecting the increased interest rate environment and strong commercial and residential mortgage loan growth over the past twelve months.

Our yield on loans was 5.90% during the first quarter of 2023, compared to 3.87% during the first quarter of 2022.

We also recorded growth in interest income on securities, reflecting portfolio growth and the higher interest rate environment.

Interest expense on deposits increased due to the increased interest rate environment and enhanced competition for deposits.

We also recorded higher interest costs on borrowed funds, in large part reflecting increased costs of our floating rate subordinated debentures.

Noninterest income totaled $7.0 million during the first quarter of 2023, compared to $9.3 million during the first quarter of 2022.

The lower level of noninterest income primarily stemmed from decreased mortgage banking income, service charges on accounts and interest rate swap income, which more than offset growth in credit and debit card income and payroll servicing fees.

Higher residential mortgage loan rates negatively affected mortgage banking income during the first quarter of 2023.

The decline in service charge income reflected increased earnings credit rates in response to the higher interest rate environment, while the decrease in interest rate swap income mainly reflected a lower volume of transactions.

Noninterest expense totaled $28.6 million during the first quarter of 2023, compared to $25.7 million during the same time period in 2022.

Overhead costs during the first three months of 2023 included a $0.4 million write-down of a former branch facility that is under contract to sell.

The higher level of noninterest expense primarily resulted from increased compensation costs, including a $1.4 million bonus accrual;

no bonus accrual was recorded during the first quarter of 2022.

Lower residential mortgage lender commissions mitigated the impact of merit pay increases, market adjustments and promotions over the past twelve months.

Financial Condition

Our total assets decreased $241 million during the first nine months of 2022, and totaled $5.02 billion as of September 30, 2022.

Total loans increased $427 million, while interest-earning deposits declined $695 million and securities available for sale were down $9.7 million.

Total deposits decreased $237 million.

Commercial loans increased $195 million during the first nine months of 2022, reflecting the net impact of growth in core commercial loans and payment activities under the PPP.

Core commercial loans increased $232 million, or almost 11% on an annualized basis, while PPP payment activities aggregated $37.5 million, during the first nine months of 2022.

Core commercial and industrial loans increased $114 million, owner-occupied CRE loans grew $77.8 million, multi-family and residential rental property loans increased $47.7 million, and vacant land, land development and residential construction loans increased $17.7 million, while non-owner occupied CRE loans were down $24.8 million.

As of September 30, 2022, availability on existing commercial construction and development loans totaled $169 million, with most of those funds expected to be drawn over the next 12 to 18 months.

Our total assets increased $23.3 million during the first quarter of 2023, and totaled $4.90 billion as of March 31, 2023.

Total loans increased $48.9 million and securities available for sale grew $17.0 million, while interest-earning deposits declined $24.1 million.

Total deposits decreased $115 million, while FHLBI advances increased $69.6 million and sweep accounts grew $33.1 million during the first three months of 2023.

Commercial loans increased $8.6 million during the first quarter of 2023, providing for an annualized growth rate of about 1%.

Non-owner occupied CRE loans increased $17.5 million, multi-family and residential rental property loans grew $7.4 million, vacant land, land development and residential construction loans increased $4.4 million, commercial and industrial loans declined $11.6 million and owner occupied CRE loans were down $9.0 million.

As a percent of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 57.4% as of March 31, 2023, compared to 58.2% at December 31, 2022.

We believe our loan portfolio remains well diversified.

As of March 31, 2023, we had $285 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase which we expect to be drawn over the next 12 to 18 months.

Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including approximately $347 million in new lending commitments, a majority of which we expect to be accepted and funded over the next 12 to 18 months.

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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 averaged 36% during the first nine months of 2022.

Historically, the level of commercial lines of credit usage equaled 40% to 45%;

however, the level averaged approximately 32% since the onset of the Coronavirus Pandemic through the end of the third quarter of 2021.

Residential mortgage loans, excluding home equity lines of credit, increased $227 million during the first nine months of 2022, totaling $670 million, or 17.3% of total loans, as of September 30, 2022.

The increasing interest rate environment has had a significant impact on our residential mortgage banking operations, especially in regards to the volume of refinance activity and the borrower selection of fixed rate versus adjustable rate residential mortgage products which combined have resulted in a material decline in the volume of residential mortgage loans being sold.

Residential mortgage loan volume totaled $523 million during the first nine months of 2022, compared to $742 million during the same time period in 2021, a decline of $219 million, or almost 30%.

Refinance volume declined $249 million, while home purchase and construction loan activity increased $30.1 million.

Residential mortgage loans originated for sale generally consist of longer-term fixed rate residential mortgage loans, while adjustable rate residential mortgage loans are maintained in the residential mortgage loan portfolio.

We have experienced a significant pattern shift as it pertains to the type of residential mortgage loan product selected by our borrowers with a majority now selecting adjustable rate offerings compared to the past couple of years when a longer-term fixed rate was the most popular selection.

During the first nine months of 2022, approximately 29% of residential mortgage loan production consisted of longer-term fixed rate loans, compared to a level of about 61% during the first nine months of 2021.

Usage of existing commercial lines of credit averaged 41% during the first quarter of 2023, similar to the 42% average during all of 2022.

MERCANTILE BANK CORPORATION

Home equity lines of credit and other consumer-related loans increased $5.6 million during the first nine months of 2022, and at September 30, 2022 totaled $66.1 million, or 1.7% of total loans.

Home equity lines of credit and other consumer-related loans comprised 1.8% of total loans as of December 31, 2021.

We expect the dollar volume of this loan portfolio segment to remain relatively stable in future periods.

Residential mortgage loans, excluding home equity lines of credit, increased $40.1 million during the first three months of 2023, representing an annualized growth rate of approximately 23%.

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

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

Home equity lines of credit declined $0.1 million, while other consumer-related loans increased $0.3 million during the first quarter of 2023, and at March 31, 2023 totaled $37.3 million and $30.1 million, respectively, or an aggregate 1.7% of total loans.

These loan segments equated to 1.8% of total loans as of December 31, 2022.

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

The following table summarizes our loan portfolio over the past twelve months:

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1,003,118,000

1,007,361,000

Multi-Family & Residential Rental

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3,555,790,000

Includes $2.6 million, $2.9 million, $12.2 million, $40.1 million, and $116 million in loans originated under the Paycheck Protection Program for September 30, 2022, June 30, 2022, March 31, 2022, December 31, 2021, and September 30, 2021, respectively.

For September 30, 2022, June 30, 2022, and March 31, 2022, home equity lines of credit balances are included in 1-4 family mortgage loans.

For prior periods, home equity lines of credit balances are included in other consumer loans.

Includes $0.4 million, $0.9 million, $2.6 million, $2.9 million, and $12.2 million in loans originated under the Paycheck Protection Program for March 31, 2023, December 31, 2022, September 30, 2022, June 30, 2022, and March 31, 2022, respectively.

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.

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

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

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

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

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

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

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

Nonperforming loans, comprised of nonaccrual loans and loans past due 90 days or more and accruing interest, totaled $1.4 million (less than 0.1% of total loans) as of September 30, 2022, compared to $2.5 million (less than 0.1% of total loans) as of December 31, 2021.

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

We had no foreclosed properties as of September 30, 2022 or December 31, 2021.

MERCANTILE BANK CORPORATION

Nonperforming loans totaled $7.8 million, or 0.2% of total loans, as of March 31, 2023, compared to $7.7 million, or 0.2% of total loans, as of December 31, 2022.

Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $8.4 million (0.2% of total assets) as of March 31, 2023, compared to $7.7 million (0.2% of total assets) as of December 31, 2022.

The volume of nonperforming assets has remained under 0.3% of total assets since year-end 2015.

Given the low levels 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 collateral type:

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Consumer Assets

MERCANTILE BANK CORPORATION

OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS

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Consumer Assets

MERCANTILE BANK CORPORATION

The following tables provide a reconciliation of nonperforming assets:

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Valuation write-downs

We had no loan charge-offs during the third quarter of 2022, and an aggregated $0.2 million during the first nine months of 2022.

Recoveries of prior period loan charge-offs equaled $0.2 million and $0.9 million during the respective time periods.

A net loan recovery, as a percentage of average total loans, equaled an annualized 0.03% and 0.02% during the third quarter and first nine months of 2022, respectively.

MERCANTILE BANK CORPORATION

During the first quarter of 2023, loan charge-offs totaled $0.1 million, while recoveries of prior period loan charge-offs also equaled $0.1 million.

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

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

The allowance equaled $39.1 million, or 1.01% of total loans, and over 2,700% of nonperforming loans as of September 30, 2022.

We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures.

Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards.

The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, which included a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.

The allowance for loan loss accounting in effect at December 31, 2021 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date (“incurred loss”

methodology).

Under the CECL methodology, our allowance is based on the total amount of credit losses that are expected over the remaining life of the loan portfolio.

Our estimate of credit losses under CECL is determined using a complex model that relies on historical loss information, reasonable and supportable economic forecasts, and various qualitative factors.

MERCANTILE BANK CORPORATION

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.

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See Note 1- Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance.

See also Note 3 - Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.

As of September 30, 2022, the allowance was comprised of $37.6 million in general reserves relating to performing loans and $1.5 million in specific reserves on other loans, primarily accruing loans designated as troubled debt restructurings.

Specific reserve allocations relating to nonaccrual loans were nominal in amount.

Troubled debt restructurings totaled $11.8 million at September 30, 2022, consisting of $0.4 million that are on nonaccrual status and $11.4 million that are on accrual status.

The latter are not included in our nonperforming loan totals.

Loans with an aggregate carrying value of $0.4 million as of September 30, 2022 had been subject to previous partial charge-offs aggregating $0.4 million over the past several years.

As of September 30, 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 decreased $9.7 million during the first nine months of 2022, totaling $583 million as of September 30, 2022.

Purchases of U.S.

Government agency bonds totaled $54.5 million during the first nine months of 2022.

Purchases of U.S.

Government agency guaranteed mortgage-backed securities totaled $2.1 million during the first nine months of 2022, consisting of investments in CRA-qualified securities, generally reflecting the partial reinvestment of $4.9 million from principal paydowns on U.S.

See also Note 3 –

Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.

The allowance equaled $42.9 million, or 1.08% of total loans, and 551% of nonperforming loans, as of March 31, 2023.

As of March 31, 2023, the allowance was comprised of $40.2 million in general reserves relating to performing loans and $2.7 million in specific reserves on other loans, primarily nonperforming loans.

Loans with an aggregate carrying value of $0.6 million as of March 31, 2023 had been subject to previous partial charge-offs aggregating $0.3 million over the past several years.

As of March 31, 2023, there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.

Although we believe the allowance is adequate to absorb loan losses in our 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 $17.0 million during the first three months of 2023, totaling $620 million as of March 31, 2023.

There were no purchases or maturities of U.S.

Government agency bonds during the first quarter of 2023.

There were no purchases of U.S.

Government agency guaranteed mortgage-backed securities during the first three months of 2023;

however, we did receive $0.8 million in principal paydowns on U.S.

Government agency guaranteed mortgage-backed securities.

Purchases of municipal bonds totaled $34.6 million during the first nine months of 2022;

proceeds from matured and called municipal bonds totaled $8.3 million.

At September 30, 2022, the portfolio was primarily comprised of U.S.

Purchases of municipal bonds totaled $7.4 million during the first quarter of 2023;

proceeds from matured municipal bonds totaled $0.9 million.

At March 31, 2023, the portfolio was primarily comprised of U.S.

Government agency bonds (64%), municipal bonds (31%) and U.S.

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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 September 30, 2022 totaled $583 million, including a net unrealized loss of $91.8 million.

The fair value of securities designated as available for sale at March 31, 2023 totaled $620 million, including a net unrealized loss of $71.2 million.

The net unrealized loss equaled $82.7 million as of December 31, 2022.

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.

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

In addition, the securities portfolio serves a primary interest rate risk management function.

We expect purchases during the remainder of 2022 to generally consist of municipal bonds, with the securities portfolio maintained at about 12% of total assets.

MERCANTILE BANK CORPORATION

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

Market values on our U.S.

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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.

FHLBI stock totaled $17.7 million as of September 30, 2022, compared to $18.0 million as of December 31, 2021.

The reduction reflects the FHLBI’s repurchase of excess stock.

FHLBI stock totaled $17.7 million as of March 31, 2023, unchanged from December 31, 2022.

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.

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.

these levels are substantially higher than our typical average balance of $75 million, or approximately 2% of average earning assets.

The level of interest-earning balances has been on a declining trend during 2022, as excess monies have been used to fund loan growth as well as brokered deposit and FHLBI advance maturities.

Average interest-earning balances equaled $295 million during the third quarter of 2022, compared to $531 million and $784 million during the second and first quarters of 2022, respectively.

Net premises and equipment equaled $52.1 million at September 30, 2022, representing a decrease of $5.2 million during the first nine months of 2022.

The decline primarily reflects 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 September 30, 2022, unchanged from December 31, 2021.

Other assets equaled $97.7 million at September 30, 2022, reflecting an increase of $43.5 million during the first nine months of 2022.

The increase is primarily associated with $23.8 million of growth in the fair value of interest rates swaps and an $18.3 million increase in a deferred tax benefit related to unrealized losses on available for sale securities.

Total deposits decreased $237 million during the first nine months of 2022, totaling $3.85 billion at September 30, 2022.

Local deposits decreased $213 million and out-of-area deposits declined $23.9 million.

The reduced level of local deposits primarily reflected a single customer’s expected withdrawal of a majority of funds that were obtained from the sale of a business and deposited in late 2021;

excluding this withdrawal, total local deposits were relatively steady during the first nine months of 2022.

Noninterest-bearing deposits increased $39.0 million and savings deposits were up $18.2 million, while interest-bearing checking accounts were down $9.5 million, during the first nine months of 2022.

Money market deposit balances were down $231 million, in large part reflecting the large withdrawal from a single customer.

Local time deposits declined $29.3 million during the first nine months of 2022.

We had no out-of-area deposits as of September 30, 2022, compared to $23.9 million as of December 31, 2021.

Sweep accounts increased $1.1 million during the first nine months of 2022, totaling $199 million as of September 30, 2022.

MERCANTILE BANK CORPORATION

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

During the first three months of 2023, the average balance of these funds equaled $31.1 million, or 0.7% of average earning assets, compared to $784 million, or 16.1% of average earning assets, during the first quarter of 2022.

Historically, we maintained interest-earning deposits at approximately 2% of average earning assets.

The elevated level during the first quarter of 2022 primarily reflected increased local deposits stemming from COVID-19-related federal government stimulus programs and reduced business and consumer investing and spending.

The level of interest-earning deposits declined throughout 2022 and into the first quarter of 2023 as we used the excess monies to fund loan growth as well as brokered deposit and FHLBI advance maturities.

We also experienced a net decline in local deposit balances during that time period.

Our deposit balance at the Federal Reserve Bank of Chicago equaled $5.5 million as of March 31, 2023.

Net premises and equipment equaled $51.5 million at March 31, 2023, unchanged from December 31, 2022.

We recorded a reduction of $1.0 million associated with the planned sale of a former branch facility during the first quarter, comprised of a $0.6 million transfer to foreclosed assets and a write-down of $0.4 million.

Depreciation expense totaled $1.5 million during the first quarter of 2023, while investments associated with the construction and opening of new facilities and the renovation of existing facilities totaled $2.5 million.

Total deposits decreased $115 million during the first three months of 2023, providing for an annualized reduction rate of approximately 12%.

The reduction primarily reflected a customary level of customers’

tax and bonus payments and partnership distributions, as well as transfers to the sweep account product.

Wholesale funds, comprised of FHLBI advances, totaled $378 million, or about 9% of total funds, as of March 31, 2023, compared to $308 million, or about 7% of total funds, at December 31, 2022.

Noninterest-bearing deposits decreased $228 million during the first three months of 2023, in large part reflecting the aforementioned customary level of customers’

tax and bonus payments and partnership distributions and transfers to the sweep account, but also includes transfers to interest-bearing deposits and withdrawals associated with the sales of businesses.

Identified deposit withdrawals associated with the heightened concern over the health of the banking industry stemming from the failure of two large financial institutions in March, 2023 were limited at less than 1% of total deposits.

Interest-bearing checking accounts and money market deposit accounts were up $1.7 million and $65.8 million, respectively, while savings deposits declined $41.4 million.

Local time deposits increased $87.1 million.

Sweep accounts increased $33.1 million during the first three months of 2023, totaling $227 million as of March 31, 2023.

The increase is primarily related to transfers from interest-bearing deposit accounts.

The aggregate balance of this funding type is subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances maintained by many of the customers.

The average balance of sweep accounts equaled $199 million during the first nine months of 2022, with a high balance of $233 million and a low balance of $173 million.

Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements.

The average balance of sweep accounts equaled $196 million during the first quarter of 2023, with a high balance of $255 million and a low balance of $181 million.

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

Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings.

MERCANTILE BANK CORPORATION

FHLBI advances decreased $35.7 million during the first nine months of 2022, totaling $338 million as of September 30, 2022.

Amortizing FHLBI advances aggregating $28.3 million were obtained, while bullet advances aggregating $64.0 million matured.

Amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans.

Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk.

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

FHLBI advances increased $69.6 million during the first quarter of 2023, totaling $378 million as of March 31, 2023.

Bullet advances aggregating $80.0 million were obtained during the first quarter of 2023, consisting of $70.0 million to fund loan growth and mitigate a portion of the decline in total deposits and $10.0 million to replace a scheduled FHLBI bullet advance maturity.

Payments on amortizing FHLBI advances totaled $0.4 million during the first quarter of 2023.

Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans.

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

Our borrowing line of credit as of September 30, 2022 totaled $1.0 billion, with remaining availability based on collateral equaling $659 million.

On January 14, 2022, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $15.0 million in aggregate principal amount of its 3.25% fixed-to-floating rate subordinated notes (“Notes”).

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

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

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

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

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

This $15.0 million issuance was a follow-on to the $75.0 million issuance that was completed on December 15, 2021, in which $70.0 million of the issuance proceeds were injected into our bank as an increase to equity capital.

Shareholders’

equity was $416 million at September 30, 2022, compared to $457 million at December 31, 2021.

Our borrowing line of credit as of March 31, 2023 totaled $665 million, with remaining availability based on collateral equaling $281 million.

MERCANTILE BANK CORPORATION

Shareholders’

equity was positively impacted by net income of $39.3 million, which was partially offset by payments of cash dividends totaling $14.6 million.

A $68.7 million after-tax decline in the market value of our available for sale securities portfolio, reflecting significant increases in market interest rates, negatively impacted shareholders’

equity during the first nine months of 2022.

equity was $467 million at March 31, 2023, compared to $441 million at December 31, 2022.

Positively impacting shareholders’

equity during the first quarter was net income of $21.0 million, which was partially offset by the payment of a cash dividend totaling $5.2 million.

A $9.1 million after-tax increase in the market value of our available for sale securities portfolio, reflecting a decline in market interest rates, positively impacted shareholders’

equity during the first quarter of 2023.

Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and capital, or cash flow from the repayment of loans and securities.

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

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

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

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To assist in providing needed funds and managing interest rate risk, we periodically obtain monies from wholesale funding sources.

Wholesale funds, primarily comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $338 million, or 7.7% of combined deposits and borrowed funds, as of September 30, 2022, compared to $398 million, or 8.5% of combined deposits and borrowed funds, as of December 31, 2021.

Sweep accounts increased $1.1 million during the first nine months of 2022, totaling $199 million as of September 30, 2022.

Wholesale funds, comprised of advances from the FHLBI, totaled $378 million, or about 9% of combined deposits and borrowed funds, as of March 31, 2023, compared to $308 million, or about 7% of combined deposits and borrowed funds, as of December 31, 2022.

Sweep accounts increased $33.1 million during the first three months of 2023, totaling $227 million as of March 31, 2023.

The increase is primarily related to transfers from interest-bearing deposit accounts.

The average balance of sweep accounts equaled $199 million during the first nine months of 2022, with a high balance of $233 million and a low balance of $173 million.

Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts and savings deposits into over-night interest-bearing repurchase agreements.

The average balance of sweep accounts equaled $196 million during the first quarter of 2023, with a high balance of $255 million and a low balance of $181 million.

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

Such sweep accounts are not deposit accounts and are not afforded federal deposit insurance, and are accounted for as secured borrowings.

MERCANTILE BANK CORPORATION

Information regarding our repurchase agreements as of September 30, 2022 and during the first nine months of 2022:

Outstanding balance at September 30, 2022

Weighted average interest rate at September 30, 2022

Maximum daily balance nine months ended September 30, 2022

Average daily balance for nine months ended September 30, 2022

Weighted average interest rate for nine months ended September 30, 2022

FHLBI advances decreased $35.7 million during the first nine months of 2022, totaling $338 million as of September 30, 2022.

Amortizing FHLBI advances aggregating $28.3 million were obtained, while bullet advances aggregating $64.0 million matured.

Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk.

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

Information regarding our repurchase agreements as of March 31, 2023 and during the first three months of 2023 is as follows:

Outstanding balance at March 31, 2023

Weighted average interest rate at March 31, 2023

Maximum daily balance three months ended March 31, 2023

Average daily balance for three months ended March 31, 2023

Weighted average interest rate for three months ended March 31, 2023

FHLBI advances increased $69.6 million during the first quarter of 2023, totaling $378 million as of March 31, 2023.

Payments on amortizing FHLBI advances totaled $0.4 million during the first quarter of 2023.

Our borrowing line of credit as of September 30, 2022 totaled $1.0 billion, with remaining availability based on collateral equaling $659 million.

Our borrowing line of credit as of March 31, 2023 totaled $665 million, with remaining availability based on collateral equaling $281 million.

MERCANTILE BANK CORPORATION

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

We did not access these lines of credit during the first nine months of 2022.

In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged $528 million during the first nine months of 2022.

We accessed one of the lines of credit during the first quarter of 2023, with an average balance of $4.3 million.

In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged $25.4 million during the first quarter of 2023.

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

Using certain municipal bonds as collateral, we could have borrowed up to $26.2 million as of September 30, 2022.

We did not utilize this line of credit during the first nine months of 2022 or at any time during the previous 13 fiscal years, and do not plan to access this line of credit in future periods.

The following table reflects, as of September 30, 2022, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:

Using certain municipal bonds as collateral, we could have borrowed up to $27.6 million as of March 31, 2023.

We did not utilize this line of credit during the first quarter of 2023 or at any time during the previous 14 fiscal years, and do not plan to access this line of credit in future periods.

The following table reflects, as of March 31, 2023, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest: 

Deposits without a stated maturity

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In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit.

As of September 30, 2022, we had a total of $1.77 billion in unfunded loan commitments and $24.5 million in unfunded standby letters of credit.

As of March 31, 2023, we had a total of $1.97 billion in unfunded loan commitments and $22.7 million in unfunded standby letters of credit.

Of the total unfunded loan commitments, $1.62 billion were commitments available as lines of credit to be drawn at any time as customers’

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

While we have observed the well-publicized liquidity problems at certain financial institutions during the first quarter of 2023, we do not believe that we are subject to the same circumstances that apparently caused those crises.

We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, changes in economic or market conditions, a reduction in earnings performance, declining capital levels or situations beyond our control could cause liquidity challenges.

While we believe it is unlikely that a funding crisis of any significant degree is likely to materialize, we have developed a comprehensive contingency funding plan that provides a framework for meeting liquidity disruptions.

MERCANTILE BANK CORPORATION

We have developed contingency funding plans that provide a framework for meeting liquidity disruptions.

Capital Resources

Shareholders’

equity was $416 million at September 30, 2022, compared to $457 million at December 31, 2021.

Shareholders’

equity was positively impacted by net income of $39.3 million, which was partially offset by payments of cash dividends totaling $14.6 million.

A $68.7 million after-tax decline in the market value of our available for sale securities portfolio, reflecting significant increases in market interest rates, negatively impacted shareholders’

equity during the first nine months of 2022.

equity was $467 million at March 31, 2023, compared to $441 million at December 31, 2022.

Positively impacting shareholders’

equity during the first quarter was net income of $21.0 million, which was partially offset by the payment of a cash dividend totaling $5.2 million.

A $9.1 million after-tax increase in the market value of our available for sale securities portfolio, reflecting a decline in market interest rates, positively impacted shareholders’

equity during the first quarter of 2023.

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

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The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019.

We believe that, as of September 30, 2022, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.

As of September 30, 2022, our bank’s total risk-based capital ratio was 13.4%, compared to 13.6% at December 31, 2021.

Our bank’s total regulatory capital increased $46.0 million during the first nine months of 2022, in large part reflecting net income totaling $46.0 million and a $15.0 million equity injection associated with the Notes issuance, which was partially offset by cash dividends paid to us aggregating $19.5 million.

Our bank’s total risk-based capital ratio was also impacted by a $428 million increase in total risk-weighted assets, primarily resulting from net growth in commercial loans and residential mortgage loans.

As of September 30, 2022, our bank’s total regulatory capital equaled $598 million, or $150 million in excess of the 10.0% minimum that is among the requirements to be categorized as “well capitalized.”

Our and our bank’s capital ratios as of September 30, 2022 and December 31, 2021 are disclosed in Note 13 of the Notes to Consolidated Financial Statements.

Results of Operations

We recorded net income of $16.0 million, or $1.01 per basic and diluted share, for the third quarter of 2022, compared to net income of $15.1 million, or $0.95 per basic and diluted share, for the third quarter of 2021.

We recorded net income of $39.3 million, or $2.48 per basic and diluted share, for the first nine months of 2022, compared to net income of $47.4 million, or $2.95 per basic and diluted share, for the first nine months of 2021.

The higher level of net income during the third quarter of 2022 compared to the third quarter of 2021 resulted from increased net interest income, which more than offset decreased noninterest income, a higher credit loss provision, and increased overhead costs during the quarter.

The lower level of net income during the first nine months of 2022 compared to the first nine months of 2021 reflected decreased noninterest income, a higher credit loss provision, and increased overhead costs, which more than offset improved net interest income during the nine-month period.

The higher levels of net interest income during the 2022 periods resulted from an increased net interest margin and earning asset growth.

The reduction in noninterest income during the current-year periods primarily reflected decreased mortgage banking income and interest rate swap income, which outweighed increases in several key fee income categories.

The credit loss provisions recorded during the 2022 periods mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, a higher reserve for residential mortgage loans resulting from an increase in the average life of the portfolio, and a deterioration in forecasted economic conditions.

A negative loan loss provision was recorded during the first nine months of 2021, primarily reflecting a reduced allocation associated with the economic and business conditions environmental factor.

The slight increase in overhead costs during the third quarter of 2022 mainly reflected higher compensation costs.

Excluding nonrecurring transactions, overhead costs during the first nine months of 2022 were up less than 3% compared to the respective 2021 period, primarily reflecting higher data processing and compensation costs.

We believe that, as of March 31, 2023, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.

MERCANTILE BANK CORPORATION

Interest income during the third quarter of 2022 was $48.1 million, an increase of $12.2 million, or 34.1%, from the $35.9 million earned during the third quarter of 2021.

Interest income during the first nine months of 2022 was $124 million, an increase of $17.1 million, or 16.1%, from the $106 million earned during the respective 2021 period.

The increases resulted from a higher yield on, and growth in, average earning assets.

The yield on average earning assets was 4.04% and 3.45% during the third quarter and first nine months of 2022, respectively, up from 3.13% and 3.21% during the respective prior-year periods.

The higher yields primarily resulted from increased yields on loans and other interest-earning assets, reflecting the rising interest rate environment, and a change in earning asset mix, comprised of a decrease in lower-yielding other interest-earning assets and an increase in higher-yielding loans as a percentage of earning assets.

The yield on loans was 4.56% and 4.15% during the third quarter and first nine months of 2022, respectively, up from 4.07% and 4.06% during the respective 2021 periods mainly due to higher interest rates on variable-rate commercial loans stemming from the Federal Open Market Committee (“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 300 basis points during the period of March 2022 through September 2022.

As of September 30, 2022, approximately 64% of the commercial loan portfolio consisted of variable-rate loans.

The increases in loan yield were achieved despite significant reductions in PPP net loan fee accretion.

A nominal level of net loan fee accretion was recorded during the current-year third quarter, compared to $2.8 million during the third quarter of 2021;

accretion totaled $1.0 million during the first nine months of 2022, down from $8.5 million during the respective 2021 period.

On average, lower-yielding other interest-earning assets represented 6.2% and 11.2% of earning assets during the third quarter and first nine months of 2022, respectively, down from 16.1% and 14.6% during the respective prior-year periods, while higher-yielding loans represented 80.7% and 76.0% of earning assets during the current-year third quarter and year-to-date period, respectively, up from 71.9% and 74.5% during the respective 2021 periods.

Average earning assets equaled $4.73 billion during the current-year third quarter, up $169 million, or 3.7%, from the level of $4.56 billion during the respective 2021 period;

average loans and average securities were up $537 million and $70.7 million, respectively, while average other interest-earning assets decreased $439 million.

Average earning assets equaled $4.80 billion during the first nine months of 2022, up $355 million, or 8.0%, from the level of $4.44 billion during the respective prior-year period;

average loans and average securities were up $337 million and $132 million, respectively, while average other interest-earning assets declined $114 million.

A significant volume of excess on-balance sheet liquidity, which initially surfaced in the second quarter of 2020 as a result of the Covid-19 environment and has persisted since that time, negatively impacted the yield on average earning assets by 10 basis points and 51 basis points during the third quarters of 2022 and 2021, respectively, and 29 basis points and 46 basis points during the first nine months of 2022 and 2021, respectively.

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

Interest expense during the third quarter of 2022 was $5.8 million, an increase of $1.0 million, or 20.8%, from the $4.8 million expensed during the third quarter of 2021.

The increase is attributable to a higher average weighted cost of, and to a much lesser extent, growth in, interest-bearing liabilities.

The weighted average cost of interest-bearing liabilities was 0.81% during the third quarter of 2022, up from 0.69% during the third quarter of 2021 mainly due to higher costs of borrowings and non-time deposits.

The cost of borrowed funds increased from 1.67% during the third quarter of 2021 to 1.99% during the third quarter of 2022 primarily due to a higher cost of subordinated debentures and the issuance of $90.0 million in subordinated notes in December of 2021 and January of 2022.

The cost of subordinated debentures was 6.57% during the third quarter of 2022, up from 3.70% during the respective 2021 period due to increases in the 90-Day Libor Rate.

The cost of non-time deposits increased from 0.20% during the third quarter of 2021 to 0.30% during the current-year third quarter, reflecting the increasing interest rate environment.

Average interest-bearing liabilities totaled $2.83 billion during the current-year third quarter compared to $2.74 billion during the prior-year third quarter, representing an increase of $93.2 million, or 3.4%.

As of March 31, 2023, our bank’s total risk-based capital ratio was 13.8%, compared to 13.7% at December 31, 2022.

Our bank’s total regulatory capital increased $17.7 million during the first quarter of 2023, in large part reflecting net income totaling $23.6 million, which was partially offset by cash dividends paid to us aggregating $6.5 million.

Our bank’s total risk-based capital ratio was also impacted by a $90.2 million increase in total risk-weighted assets, primarily resulting from net growth in commercial and residential mortgage loans.

As of March 31, 2023, our bank’s total regulatory capital equaled $636 million, or $174 million in excess of the 10.0% minimum that is among the requirements to be categorized as “well capitalized.”

Our and our bank’s capital ratios as of March 31, 2023 and December 31, 2022 are disclosed in Note 12 of the Notes to Consolidated Financial Statements.

Results of Operations

We recorded net income of $21.0 million, or $1.31 per basic and diluted share, for the first quarter of 2023, compared to net income of $11.5 million, or $0.73 per basic and diluted share, for the first quarter of 2022.

Diluted earnings per share increased $0.58, or 79.5%, during the first quarter of 2023 compared to the prior-year first quarter.

The higher level of net income during the first quarter of 2023 compared to the first quarter of 2022 resulted from a significant increase in net interest income, primarily reflecting a substantially improved net interest margin and loan growth.

The credit loss provisions recorded during the first quarters of 2023 and 2022 mainly reflected reserve allocations necessitated by commercial loan and residential mortgage loan growth;

sustained strength in asset quality metrics and low levels of charge-offs during both periods partially mitigated the amount of reserve allocations associated with loan growth.

Noninterest income declined during the first three months of 2023 compared to the respective 2022 period primarily due to lower levels of mortgage banking income, service charges on accounts, and interest rate swap income, which more than offset growth in credit and debit card income and payroll servicing fees.

Overhead expenses were up in the first quarter of 2023 compared to the prior-year first quarter mainly due to increased compensation costs, including higher bonus accruals and salary outlays.

Interest income during the first quarter of 2023 was $60.5 million, an increase of $24.6 million, or 68.6%, from the $35.9 million earned during the first quarter of 2022.

The increase resulted from a higher yield on average earning assets.

The yield on average earning assets was 5.35% during the first three months of 2023, up from 2.99% during the respective 2022 period.

The higher yield primarily resulted from an increased yield on loans, reflecting the rising interest rate environment.

The yield on loans was 5.90% during the first quarter of 2023, up from 3.87% during the prior-year first quarter mainly due to higher interest rates on variable-rate commercial loans stemming from the Federal Open Market Committee (“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 475 basis points during the period of March 2022 through March 2023.

As of March 31, 2023, approximately 64% of the commercial loan portfolio consisted of variable-rate loans.

A change in earning asset mix, comprised of a decrease in lower-yielding interest-earning deposits and an increase in higher-yielding loans as a percentage of earning assets, along with increased yields on securities and interest-earning deposits, reflecting the rising interest rate environment, also contributed to the higher yield on average earning assets.

On average, lower-yielding interest-earning deposits represented 0.7% of earning assets during the first quarter of 2023, down from 16.1% during the respective 2022 period, while higher-yielding loans represented 85.6% of earning assets during the current-year first quarter, up from 71.4% during the first quarter of 2022.

Average earning assets equaled $4.59 billion during the first quarter of 2023, down $295 million, or 6.0%, from the level of $4.88 billion during the first quarter of 2022;

average loans and average securities were up $444 million and $14.3 million, respectively, while average interest-earning deposits were down $753 million.

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 45 basis points during the first quarter of 2022.

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 Paycheck Protection Program loan forgiveness activities.

MERCANTILE BANK CORPORATION

Interest expense during the first nine months of 2022 was $16.0 million, an increase of $1.1 million, or 7.1%, from the $14.9 million expensed during the first nine months of 2021.

The increase is attributable to growth in interest-bearing liabilities, which more than offset a slight decrease in the weighted average cost of interest-bearing liabilities.

Average interest-bearing liabilities were $2.94 billion during the first nine months of 2022, up $265 million, or 9.9%, from the $2.67 billion average during the respective 2021 period.

The weighted average cost of interest-bearing liabilities decreased slightly from 0.75% during the first nine months of 2021 to 0.73% during the respective current-year period mainly due to a lower cost of time deposits, which more than offset increases in the costs of borrowings and non-time deposits.

The cost of time deposits decreased from 1.30% during the first nine months of 2021 to 0.90% during the first nine months of 2022 primarily due to lower interest rates paid on local time deposits.

Net interest income during the third quarter of 2022 was $42.4 million, an increase of $11.3 million, or 36.2%, from the $31.1 million earned during the respective 2021 period.

The increase resulted from an improved net interest margin, and to a much lesser extent, growth in average earning assets.

The net interest margin increased from 2.71% in the third quarter of 2021 to 3.56% in the current-year third quarter due to a higher yield on average earning assets.

The higher yield primarily resulted from increased yields on loans and other interest-earning assets, reflecting the rising interest rate environment, and a change in earning asset mix, comprised of a decrease in lower-yielding other interest-earning assets and an increase in higher-yielding loans as a percentage of earning assets.

The cost of funds equaled 0.48% in the third quarter of 2022, up from 0.42% during the prior-year third quarter mainly due to increased costs of borrowings and non-time deposits.

The significant level of excess on-balance sheet liquidity negatively impacted the net interest margin by 7 basis points and 44 basis points during the third quarters of 2022 and 2021, respectively.

Net interest income during the first nine months of 2022 was $108 million, an increase of $16.1 million, or 17.5%, from the $91.5 million earned during the first nine months of 2021.

The increase resulted from a higher net interest margin and growth in average earning assets.

The net interest margin improved from 2.76% in the first nine months of 2021 to 3.00% in the respective 2022 period due to a higher yield on average earning assets.

The increased yield primarily resulted from higher yields on loans and other interest-earning assets, reflecting the rising interest rate environment, and a change in earning asset mix, consisting of a decline in lower-yielding other interest-earning assets and an increase in higher-yielding loans as a percentage of earning assets.

The cost of funds equaled 0.45% during the first nine months of 2022, unchanged from the respective prior-year period as increases in the costs of borrowings and non-time deposits were offset by a lower cost of time deposits.

The significant level of excess on-balance sheet liquidity negatively impacted the net interest margin by 24 basis points and 40 basis points during the first nine months of 2022 and 2021, respectively.

The following tables set forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflect the average yield on assets and average cost of liabilities for the third quarters and first nine months of 2022 and 2021.

Interest expense during the first quarter of 2023 was $12.1 million, an increase of $7.1 million, or 142%, from the $5.0 million expensed during the first quarter of 2022.

The increase is attributable to a higher average weighted cost of interest-bearing liabilities, which rose from 0.66% during the first quarter of 2022 to 1.72% during the respective 2023 period mainly due to increased costs of deposits and borrowings.

Reflecting the rising interest rate environment, the cost of interest-bearing, non-time deposits increased from 0.20% during the first quarter of 2022 to 1.27% during the current-year first quarter, while the cost of time deposits increased from 0.89% to 2.29% during the respective periods.

The higher cost of interest-bearing, non-time deposits primarily resulted from increased rates paid on money market accounts.

The cost of borrowed funds increased from 1.82% during the first quarter of 2022 to 2.51% during the first quarter of 2023 mainly due to higher costs of subordinated debentures and sweep accounts.

The cost of subordinated debentures was 9.05% during the first quarter of 2023, up from 3.80% during the respective 2022 period due to increases in the 90-Day Libor Rate.

The cost of sweep accounts increased from 0.10% during the first quarter of 2022 to 0.84% during the first quarter of 2023, reflecting the rising interest rate environment.

A change in borrowing mix, consisting of an increase in higher-costing subordinated debentures and subordinated notes as a percentage of average total borrowings, also contributed to the increased cost of borrowings during the first quarter of 2023.

Average interest-bearing liabilities totaled $2.86 billion during the current-year first quarter, compared to $3.07 billion during the prior-year first quarter, representing a decrease of $211 million, or 6.9%.

Net interest income during the first quarter of 2023 was $48.4 million, an increase of $17.5 million, or 56.7%, from the $30.9 million earned during the respective 2022 period.

The increase resulted from a significantly improved net interest margin and loan growth.

The net interest margin increased from 2.57% in the first quarter of 2022 to 4.28% in the current-year first quarter due to a higher yield on average earning assets.

The increased yield primarily resulted from a higher yield on loans, reflecting the rising interest rate environment.

The cost of funds equaled 1.07% in the first quarter of 2023, up from 0.42% during the prior-year first quarter mainly due to higher costs of deposits and borrowings, reflecting the impact of the increasing interest rate environment.

The significant level of excess on-balance sheet liquidity negatively impacted the net interest margin by approximately 40 basis points during the first quarter of 2022.

The following table sets forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the first quarters of 2023 and 2022.

Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented.

Tax-exempt securities interest income and yield for the third quarters and first nine months of 2022 and 2021 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%.

Securities interest income was increased by $60,000 in the third quarter of both 2022 and 2021 and $180,000 in the first nine months of both 2022 and 2021 for this non-GAAP, but industry standard, adjustment.

These adjustments equated to increases in our net interest margin of less than one basis point for each of the 2022 and 2021 periods.

MERCANTILE BANK CORPORATION

Quarters ended September 30,

(dollars in thousands)

Investment securities

Other interest-earning assets

Total interest - earning assets

Allowance for credit losses

LIABILITIES AND SHAREHOLDERS ’

Interest-bearing deposits

Short-term borrowings

Federal Home Loan Bank advances

Other borrowings

Total interest-bearing liabilities

Noninterest-bearing deposits

Other liabilities

Shareholders’

Total liabilities and shareholders’

Net interest income

Net interest rate spread

Net interest spread on average assets

Net interest margin on earning assets

Tax-exempt securities interest income and yield for the first quarters of 2023 and 2022 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%.

Securities interest income was increased by $60,000 in the first quarters of 2023 and 2022 for this non-GAAP, but industry standard, adjustment.

These adjustments equated to increases in our net interest margin of less than one basis point for both periods.

MERCANTILE BANK CORPORATION

Nine months ended September 30,

Quarters ended March 31,

(dollars in thousands)

17 unchanged sentences

Net interest margin on earning assets

MERCANTILE BANK CORPORATION

A provision for credit losses of $2.9 million was recorded during the third quarter of 2022, compared to a provision expense of $1.9 million during the third quarter of 2021. 

A provision for credit losses of $3.5 million was recorded during the first nine months of 2022, compared to a negative provision of $0.9 million during the first nine months of 2021. 

The Covid-19 environmental factor was added in the second quarter of 2020 to address the unique challenges and economic uncertainty resulting from the pandemic and its potential impact on the collectability of the loan portfolio. 

Improvement in overall Covid-19 conditions, including increased vaccination rates, the availability of booster shots, and the lifting of many economic growth-restraining restrictions, lessened the required credit reserve amount related to the Covid-19 environmental factor. 

The provision expense recorded during the third quarter of 2021 primarily reflected allocations associated with commercial loan growth, while the negative provision expense recorded during the first nine months of 2021 mainly reflected a reduced allocation associated with the economic and business conditions environmental factor, reflecting improvement in both current and forecasted economic conditions, and the recording of net loan recoveries, which more than offset required reserve allocations necessitated by growth in commercial loans.

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 $0.4 million decrease in the allowance 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.

During the third quarter of 2022, no loans were charged off, while recoveries of prior period loan charge-offs were $0.2 million, providing for net loan recoveries of $0.2 million, or an annualized 0.03% of average total loans.

During the third quarter of 2021, loan charge-offs totaled $0.8 million, while recoveries of prior period loan charge-offs equaled $0.4 million, providing for net loan charge-offs of $0.4 million, or an annualized 0.05% of average total loans.

During the first nine months of 2022, loan charge-offs totaled $0.2 million, while recoveries of prior period loan charge-offs equaled $0.9 million, providing for net loan recoveries of $0.7 million, or an annualized 0.02% of average total loans.

During the first nine months of 2021, loan charge-offs totaled $0.9 million, while recoveries of prior period loan charge-offs equaled $1.2 million, providing for net loan recoveries of $0.3 million, or an annualized 0.01% of average total loans.

The allowance for credit losses, as a percentage of total loans, was 1.0% as of September 30, 2022 and December 31, 2021, and 1.1% as of September 30, 2021.

Noninterest income during the third quarter of 2022 was $7.3 million, down $8.3 million from the $15.6 million recorded during the prior-year third quarter.

Noninterest income during the third quarter of 2021 included a recovery of loan collection costs totaling $0.6 million.

Excluding the impact of this transaction, noninterest income decreased $7.7 million during the third quarter of 2022 compared to the respective 2021 period.

Noninterest income during the first nine months of 2022 was $24.3 million, compared to $43.6 million during the first nine months of 2021.

During the first nine months of 2022, noninterest income included a $0.5 million bank owned life insurance claim, while noninterest income during the respective prior-year period included a $1.1 million gain on the sale of a branch and the aforementioned recovery of loan collection costs.

Excluding the impacts of these transactions, noninterest income decreased $18.2 million during the first nine months of 2022 compared to the respective 2021 period.

The lower levels of noninterest income almost exclusively reflected decreased mortgage banking income and interest rate swap income, which more than offset increases in several key fee income sources, including service charges on accounts, credit and debit card income, and payroll service fees.

Continued strength in purchase residential mortgage loan originations during the third quarter and first nine months of 2022 partially mitigated the negative impacts of higher interest rates, reduced refinance activity, lower sold percentages, and decreased gain on sale rates on mortgage banking income during the periods when compared to the respective prior-year periods.

Mercantile recorded provisions for credit losses of $0.6 million and $0.1 million during the first quarters of 2023 and 2022, respectively.

The provision expense recorded during both periods mainly reflected allocations necessitated by loan growth;

ongoing strong loan quality metrics and low levels of loan charge-offs during the periods in large part mitigated additional reserves associated with loan growth.

MERCANTILE BANK CORPORATION

The residential mortgage loan sold percentage declined from approximately 69% during the second quarter and first nine months of 2021 to approximately 36% during the respective current-year periods.

The decreased sold percentages in large part reflect customers’

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

The declines in interest rate swap income reflect lower transaction volumes.

In aggregate, service charges on accounts, credit and debit card income, and payroll processing fees were up 14% and 15% during the third quarter and first nine months of 2022, respectively, compared to the corresponding prior-year periods.

Noninterest expense totaled $26.8 million during the third quarter of 2022, up from $26.2 million during the prior-year third quarter.

Noninterest expense during the first nine months of 2022 was $79.4 million, compared to $77.5 million during the respective prior-year period.

Overhead costs during the first nine months of 2022 included a $0.5 million contribution to The Mercantile Bank Foundation and a $0.3 million net loss on the sale of a former branch facility, while overhead costs during the first nine months of 2021 included $0.6 million in net losses on sales and write-downs of former branch facilities.

Excluding these transactions, noninterest expense increased $1.7 million in the first nine months of 2022 compared to the respective 2021 period.

The higher levels of expense in the 2022 periods mainly reflected increased salary costs, in large part reflecting annual employee merit pay increases, a larger bonus accrual, and higher stock-based compensation costs, which more than offset higher residential mortgage loan deferred salary costs as well as decreased residential mortgage lender commissions and associated incentives.

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 refinance activity.

Data processing costs, primarily reflecting higher transaction volume and software support costs, and other employee costs, consisting mainly of meals, entertainment, training, travel, and mileage, increased in the 2022 periods.

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

During the third quarter of 2022, we recorded income before federal income tax of $20.0 million and a federal income tax expense of $3.9 million.

During the third quarter of 2021, we recorded income before federal income tax of $18.6 million and a federal income tax expense of $3.5 million.

During the first nine months of 2022, we recorded income before federal income tax of $48.9 million and a federal income tax expense of $9.7 million.

During the first nine months of 2021, we recorded income before federal income tax of $58.5 million and a federal income tax expense of $11.1 million.

The increased federal income tax expense in the third quarter of 2022 resulted from the higher level of income before federal income tax, while the decreased federal income tax expense in the first nine months of 2022 stemmed from the lower level of income before federal income tax.

Our effective tax rate was 19.8% during the third quarter and first nine months of 2022 and 19.0% during the respective 2021 periods.

Noninterest income during the first quarter of 2023 was $7.0 million, compared to $9.3 million during the respective 2022 period.

The lower level of noninterest income primarily stemmed from decreased mortgage banking income, service charges on accounts, and interest rate swap income, which more than offset growth in credit and debit card income and payroll servicing fees.

Higher residential mortgage loan rates in the rising interest rate environment negatively affected mortgage banking income in the first quarter of 2023.

Residential mortgage loan production totaled $72.0 million during the first quarter of 2023, down $96.2 million, or 57.2%, from $168 million during the prior-year first quarter;

refinance activity and purchase activity declined $51.5 million and $44.7 million, respectively.

The decline in service charges on accounts reflected increased earnings credit rates in response to the increasing interest rate environment, while the decrease in interest rate swap income mainly reflected a lower volume of transactions.

Noninterest expense totaled $28.6 million during the first quarter of 2023, compared to $25.7 million during the prior-year first quarter.

Overhead costs during the first quarter of 2023 included a $0.4 million write-down of a former branch facility.

Excluding this transaction, noninterest expense increased $2.5 million in the first quarter of 2023 compared to the respective 2022 period.

The higher noninterest expense mainly resulted from increased compensation costs, including a $1.4 million bonus accrual and salary increases, which outweighed reductions in residential mortgage lender commissions and incentives and higher residential mortgage loan deferred salary costs.

No bonus accrual was recorded during the first quarter of 2022.

The higher level of salary costs primarily stemmed from annual merit pay increases and market adjustments.

The decreased residential mortgage lender commissions and incentives resulted from reduced loan production, while 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.

A $0.5 million aggregate increase in interest rate swap reserves and collateral costs, along with a $0.3 million increase in FDIC deposit insurance premiums, reflecting a higher industry-wide assessment rate that became effective on January 1, 2023, also contributed to the higher level of overhead costs during the first quarter of 2023.

During the first quarter of 2023, we recorded income before federal income tax of $26.1 million and a federal income tax expense of $5.1 million.

During the first quarter of 2022, we recorded income before federal income tax of $14.3 million and a federal income tax expense of $2.8 million.

The increase in federal income tax expense in the first three months of 2023 resulted from the higher level of income before federal income tax.

Our effective tax rate was 19.8% during both the first quarter of 2023 and the prior-year first quarter.

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-Q

Item 1. Financial Statements