MERCANTILE BANK CORP 10-Q

Item 1. Financial Statements CONSOLIDATED BALANCE SHEETS (Unaudited)         March 31,     December 31,       2023     2022   ASSETS                 Cash and due from banks   $ 47,151,000     $ 61,894,000   Interest-earning deposits     10,787,000       34,878,000   Total cash and cash equivalents     57,938,000       96,772,000                     Securities available for sale     619,973,000       602,936,000   Federal Home Loan Bank stock     17,721,000       17,721,000   Mortgage loans held for sale     3,821,000       3,565,000                     Loans     3,965,528,000       3,916,619,000   Allowance for credit losses     ( 42,877,000 )     ( 42,246,000 ) Loans, net     3,922,651,000       3,874,373,000                     Premises and equipment, net     51,510,000       51,476,000   Bank owned life insurance     81,113,000       80,727,000   Goodwill     49,473,000       49,473,000   Core deposit intangible, net     424,000       583,000   Other assets     91,250,000       94,993,000   Total assets   $ 4,895,874,000     $ 4,872,619,000                     LIABILITIES AND SHAREHOLDERS' EQUITY                 Deposits                 Noninterest-bearing   $ 1,376,782,000     $ 1,604,750,000   Interest-bearing     2,221,236,000       2,108,061,000   Total deposits     3,598,018,000       3,712,811,000                     Securities sold under agreements to repurchase     227,453,000       194,340,000   Federal funds purchased     17,207,000       0   Federal Home Loan Bank advances     377,910,000       308,263,000   Subordinated debentures     49,130,000       48,958,000   Subordinated notes     88,714,000       88,628,000   Accrued interest and other liabilities     70,070,000       78,211,000   Total liabilities     4,428,502,000       4,431,211,000                     Commitments and contingent liabilities (Note 8)                                       Shareholders' equity                 Preferred stock, no par value; 1,000,000 shares authorized; none issued     0       0   Common stock, no par value; 40,000,000 shares authorized; 16,001,448 shares outstanding at March 31, 2023 and 15,994,884 shares outstanding at December 31, 2022     291,516,000       290,436,000   Retained earnings     232,123,000       216,313,000   Accumulated other comprehensive income (loss)     ( 56,267,000 )     ( 65,341,000 ) Total shareholders’ equity     467,372,000       441,408,000   Total liabilities and shareholders’ equity   $ 4,895,874,000     $ 4,872,619,000     See accompanying notes to consolidated financial statements.     1 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Unaudited)         Three Months     Three Months       Ended     Ended       March 31,     March 31,       2023     2022   Interest income                 Loans, including fees   $ 57,154,000     $ 33,251,000   Securities, taxable     2,131,000       1,665,000   Securities, tax-exempt     876,000       600,000   Interest-earning deposits     324,000       366,000   Total interest income     60,485,000       35,882,000                     Interest expense                 Deposits     7,907,000       1,825,000   Short-term borrowings     459,000       50,000   Federal Home Loan Bank advances     1,794,000       1,864,000   Subordinated debentures and other borrowings     1,941,000       1,258,000   Total interest expense     12,101,000       4,997,000                     Net interest income     48,384,000       30,885,000                     Provision for credit losses     600,000       100,000                     Net interest income after provision for credit losses     47,784,000       30,785,000                     Noninterest income                 Service charges on deposit and sweep accounts     976,000       1,416,000   Credit and debit card income     2,060,000       1,881,000   Mortgage banking income     1,216,000       3,281,000   Interest rate swap fees     1,037,000       1,351,000   Payroll processing     746,000       638,000   Earnings on bank owned life insurance     401,000       287,000   Other income     515,000       423,000   Total noninterest income     6,951,000       9,277,000                     Noninterest expense                 Salaries and benefits     16,682,000       15,510,000   Occupancy     2,289,000       2,104,000   Furniture and equipment depreciation, rent and maintenance     822,000       934,000   Data processing costs     3,162,000       2,973,000   Other expense     5,644,000       4,221,000   Total noninterest expenses     28,599,000       25,742,000                     Income before federal income tax expense     26,136,000       14,320,000                     Federal income tax expense     5,162,000       2,828,000                     Net income   $ 20,974,000     $ 11,492,000                     Basic earnings per share   $ 1.31     $ 0.73   Diluted earnings per share   $ 1.31     $ 0.73   Average basic shares outstanding     15,996,138       15,840,801   Average diluted shares outstanding     15,996,138       15,841,037     See accompanying notes to consolidated financial statements.   2 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)         Three Months Ended March 31, 2023     Three Months Ended March 31, 2022                     Net income   $ 20,974,000     $ 11,492,000                     Other comprehensive income (loss):                 Unrealized holding gains (losses) on securities available for sale     11,486,000       ( 35,650,000 ) Tax effect of unrealized holding gains (losses) on securities available for sale     ( 2,412,000 )     7,487,000   Other comprehensive income (loss), net of tax effect     9,074,000       ( 28,163,000 )                   Comprehensive income (loss)   $ 30,048,000     $ ( 16,671,000 )   See accompanying notes to consolidated financial statements.   3 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)     ($ in thousands except per share amounts)   Preferred Stock     Common Stock     Retained Earnings     Accumulated Other Comprehensive Income (Loss)     Total Shareholders’ Equity                                             Balances, January 1, 2023   $ 0     $ 290,436     $ 216,313     $ ( 65,341 )   $ 441,408                                             Employee stock purchase plan ( 327 shares)             10                       10                                             Dividend reinvestment plan ( 6,880 shares)             217                       217                                             Stock-based compensation expense             853                       853                                             Cash dividends ($ 0.33 per common share)                     ( 5,164 )             ( 5,164 )                                           Net income for the three months ended March 31, 2023                 20,974             20,974                                             Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect                       9,074       9,074                                             Balances, March 31, 2023   $ 0     $ 291,516     $ 232,123     $ ( 56,267 )   $ 467,372     See accompanying notes to consolidated financial statements.   4 Table of Contents   MERCANTILE BANK CORPORATION  CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) (Unaudited)     ($ in thousands except per share amounts)   Preferred Stock     Common Stock     Retained Earnings     Accumulated Other Comprehensive Income (Loss)     Total Shareholders’ Equity                                             Balances, January 1, 2022   $ 0     $ 285,752     $ 174,536     $ ( 3,729 )   $ 456,559                                             Adoption of ASU 2016-13                     316               316                                             Employee stock purchase plan ( 281 shares)             10                       10                                             Dividend reinvestment plan ( 5,835 shares)             222                       222                                             Stock option exercises ( 1,355 shares)             36                       36                                             Stock-based compensation expense             811                       811                                             Cash dividends ($ 0.31 per common share)                     ( 4,812 )             ( 4,812 )                                           Net income for the three months ended March 31, 2022                     11,492               11,492                                             Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect                             ( 28,163 )     ( 28,163 )                                           Balances, March 31, 2022   $ 0     $ 286,831     $ 181,532     $ ( 31,892 )   $ 436,471     See accompanying notes to consolidated financial statements.   5 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)         Three Months     Three Months       Ended     Ended       March 31, 2023     March 31, 2022   Cash flows from operating activities                 Net income   $ 20,974,000     $ 11,492,000   Adjustments to reconcile net income to net cash from operating activities                 Depreciation and amortization     3,049,000       3,458,000   Provision for credit losses     600,000       100,000   Stock-based compensation expense     853,000       811,000   Proceeds from sales of mortgage loans held for sale     25,645,000       79,622,000   Origination of mortgage loans held for sale     ( 24,951,000 )     ( 75,046,000 ) Net gain from sales of mortgage loans held for sale     ( 950,000 )     ( 3,205,000 ) Net gain from sales and valuation write-downs of foreclosed assets     0       ( 13,000 ) Net (gain) loss from sales and write-downs of fixed assets     377,000       ( 1,000 ) Earnings on bank owned life insurance     ( 401,000 )     ( 287,000 ) Net (gain) loss on instruments designated at fair value and related derivatives     180,000       ( 55,000 ) Net change in:                 Accrued interest receivable     ( 1,947,000 )     ( 1,344,000 ) Other assets     131,000       2,589,000   Accrued interest and other liabilities     ( 5,495,000 )     9,767,000   Net cash from operating activities     18,065,000       27,888,000                     Cash flows from investing activities                 Loan originations and payments, net     ( 48,939,000 )     ( 102,241,000 ) Purchases of securities available for sale     ( 7,392,000 )     ( 51,705,000 ) Proceeds from maturities, calls and repayments of securities available for sale     1,703,000       2,854,000   Proceeds from sales of foreclosed assets     0       13,000   Proceeds from Federal Home Loan Bank stock redemption     0       281,000   Net purchases of premises and equipment and lease activity     ( 2,508,000 )     ( 332,000 ) Net cash for investing activities     ( 57,136,000 )     ( 151,130,000 )                   Cash flows from financing activities                 Net increase (decrease) in time deposits     87,115,000       ( 35,861,000 ) Net decrease in all other deposits     ( 201,908,000 )     ( 71,081,000 ) Net increase in securities sold under agreements to repurchase     33,113,000       6,808,000   Net change in federal funds purchased     17,207,000       0   Proceeds from Federal Home Loan Bank advances     80,000,000       28,263,000   Payoffs of and paydowns on Federal Home Loan Bank advances     ( 10,353,000 )     ( 20,000,000 ) Employee stock purchase plan     10,000       10,000   Net proceeds from stock option exercises     0       36,000   Dividend reinvestment plan     217,000       222,000   Proceeds from subordinated notes issuance     0       14,701,000   Payment of cash dividends to common shareholders     ( 5,164,000 )     ( 4,812,000 ) Net cash from (for) financing activities     237,000       ( 81,714,000 )                   Net change in cash and cash equivalents     ( 38,834,000 )     ( 204,956,000 ) Cash and cash equivalents at beginning of period     96,772,000       975,160,000   Cash and cash equivalents at end of period   $ 57,938,000     $ 770,204,000     See accompanying notes to consolidated financial statements.   6 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited)         Three Months     Three Months       Ended     Ended       March 31, 2023     March 31, 2022   Supplemental disclosures of cash flows information                 Cash paid during the period for:                 Interest   $ 11,838,000     $ 4,240,000   Noncash financing and investing activities:                 Transfers from loans to foreclosed assets     61,000       0   Transfers from bank premises to other real estate owned     600,000       0     See accompanying notes to consolidated financial statements.   7 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       1. SIGNIFICANT ACCOUNTING POLICIES   Basis of Presentation : The unaudited financial statements for the three months ended March 31, 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. These consolidated financial statements have been prepared in accordance with the instructions for Form 10 -Q and Item 303 (b) of Regulation S-K and do not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for a complete presentation of our financial condition and results of operations. In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair presentation of the results of operations for such periods. The results for the period ended March 31, 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  31, 2022.   We have five separate business trusts that were formed to issue trust preferred securities. Subordinated debentures were issued to the trusts in return for the proceeds raised from the issuance of the trust preferred securities. The trusts are not consolidated, but instead we report the subordinated debentures issued to the trusts as a liability.   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.   (Continued)   8 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   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 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.   FHLBI stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value.   Loans : Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs. 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. Consumer and credit card loans are typically charged off no later than when they are 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal and interest is considered doubtful.   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. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.   Loans Held for Sale : Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of March 31, 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, 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.   (Continued)   9 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   Allowance for Credit Losses ( “ Allowance ” ) : In June 2016, the FASB issued ASU No. 2016 - 13, Measurement of Credit Losses on Financial Instruments . This ASU (as subsequently amended) significantly changed how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard replaced the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the CECL model, applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also 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.   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. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $ 0.4 million, which included a $ 0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $ 0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.   Accrued interest receivable for loans is included in other assets on our Consolidated Balance Sheet. We elected not to measure an allowance for accrued interest receivable and instead elected to reverse interest income on loans that are placed on nonaccrual status, which is generally when the loan becomes 90 days past due, or earlier if we believe the collection of interest is doubtful. We believe this policy results in the timely reversal of uncollectible interest.   The allowance is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged-off against the allowance when we believe the uncollectibility of a loan balance is confirmed.   The allowance is measured on a collective pool basis when similar risk characteristics exist. Loans with similar risk characteristics are grouped into homogenous segments, or pools, for analysis. Commercial loans are divided among five segments based primarily on collateral type, risk characteristics, and primary and secondary sources of repayment. These segments are then further stratified based on the commercial loan grade that is assigned using our standard loan grading paradigm. Retail loans are divided into one of two groups based on if the loan is secured by residential real estate or not.   (Continued)   10 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   Our loan portfolio segments as of March 31, 2023 and December 31, 2022 were as follows:   o Commercial Loans   ■ Commercial and Industrial : Risks to this loan category include industry concentration and the practical limitations associated with monitoring the condition of the collateral which often consists of inventory, accounts receivable, and other non-real estate assets. Equipment and inventory obsolescence can also pose a risk. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.     ■ Owner Occupied Commercial Real Estate : Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category.     ■ Non-Owner Occupied Commercial Real Estate : Loans in this category are susceptible to declines in occupancy rates, business failure, and general economic conditions. Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category.     ■ Multi-Family and Residential Rental : Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral. Loans in this category are susceptible to weakening general economic conditions and increases in unemployment rates, as well as market demand and supply of similar property and the resulting impact on occupancy rates, market rents, cash flow, and income-based real estate values. Also, the lack of a suitable alternative use for the properties is a risk for loans in this category.     ■ Vacant Land, Land Development and Residential Construction : Risks common to commercial construction loans are cost overruns, changes in market demand for property, inadequate long-term financing arrangements, and declines in real estate values. Residential construction loans are susceptible to those same risks as well as those associated with residential mortgage loans. Changes in market demand for property could lead to longer marketing times resulting in higher carrying costs, declining values, and higher interest rates.     o Retail Loans   ■ 1 - 4 Family Mortgages : 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.   (Continued)   11 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. 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, 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. A baseline loss rate is produced at each reporting date for each loan portfolio segment using bank-specific loan charge-off and recovery data over a defined historical look-back period. The look-back period represents the number of data periods that will be used to calculate a baseline loss rate for each loan portfolio segment. We determined that the look-back period commencing on January 1, 2011 through the current reporting date was reasonable and appropriate.   Reasonable and supportable economic forecasts have to be incorporated in determining expected credit losses. The forecast period represents the time frame from the current period end through the point in time that we can reasonably forecast and support entity and environmental factors that are expected to impact the performance of our loan portfolio. Ideally, the economic forecast period would encompass the contractual terms of all loans; however, the ability to produce a forecast that is considered reasonable and supportable becomes more difficult or may not be possible in later periods.   Subsequent to the end of the forecast period, we revert to historical loan data based on an ongoing evaluation of each economic forecast in relation to then current economic conditions as well as any developing loan loss activity and resulting historical data. As of March 31, 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 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.   During each reporting period, we also consider the need to adjust the historical loss rates as determined by our migration calculations to reflect the extent to which we expect current conditions and reasonable and supportable economic forecasts to differ from the conditions that existed for the period over which the migration-based historical loss information was determined. These qualitative adjustments may increase or decrease our estimate of expected future credit losses.   Traditional qualitative factors include:   o Changes in lending policies and procedures   o Changes in the nature and volume of the loan portfolio and in the terms of loans   o Changes in the experience, ability and depth of lending management and other relevant staff   o Changes in the volume and severity of past due loans, nonaccrual loans and adversely classified loans   o Changes in the quality of the loan review program   o Changes in the value of underlying collateral dependent loans   o Existence and effect of any concentrations of credit and any changes in such   o Effect of other factors such as competition and legal and regulatory requirements   (Continued)   12 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. 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. Effective January 1, 2022, we established a historical loss information factor to address the relatively low level of loan losses during the look-back period.   Expected credit losses are estimated over the contractual terms of the loans, adjusted for expected prepayments when appropriate. The contractual term generally excludes potential extensions, renewals and modifications.   We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via other noninterest expense on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.   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. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.   Servicing fee income is recorded for fees earned for servicing mortgage loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage loan servicing rights is netted against mortgage loan servicing income and recorded in mortgage banking activities in the income statement.   Troubled Debt Restructurings : A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.   In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans. Impairment for these loans is measured on a loan-by-loan basis. Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies. Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.   (Continued)   13 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. 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 : Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have historically generally consisted of interest rate swap agreements that qualified for hedge accounting. We do not use derivatives for trading purposes.   Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense. We had no derivative instruments designated as hedges as of March 31, 2023, and December 31, 2022.   Goodwill and Core Deposit Intangible : 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” (“Topic 606” ). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.   Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary.   We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.   (Continued)   14 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1. SIGNIFICANT ACCOUNTING POLICIES (Continued)   The following table depicts our sources of noninterest income presented in the Consolidated Statements of Income that are scoped within Topic 606:       Three Months Ended March 31, 2023     Three Months Ended March 31, 2022   Service charges on deposit and sweep accounts   $ 976,000     $ 1,416,000   Credit and debit card fees     2,060,000       1,881,000   Payroll processing     746,000       638,000   Customer service fees     220,000       242,000     Service Charges on Deposit and Sweep Accounts: We earn fees from deposit and sweep customers for account maintenance, transaction-based and overdraft services. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of the month reflecting the period over which we satisfy the performance obligation. Transaction-based fees, which include services such as stop payment and returned item charges, are recognized at the time the transaction is executed as that is the point in time we fulfill the customer request. Service charges on deposit and sweep accounts are withdrawn from the customer account balance.   Credit and Debit Card Fees: We earn interchange income on our cardholder debit and credit card usage. Interchange income is primarily comprised of fees whenever our debit and credit cards are processed through card payment networks such as Visa. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.   Payroll Processing Fees: We earn fees from providing payroll processing services for our commercial clients. Fees are assessed for processing weekly or bi-weekly payroll files, reports and documents, as well as year-end tax-related files, reports and documents. Fees are recognized and collected as payroll processing services are completed for each payroll run and year-end processing activities.   Customer Service Fees: We earn fees by providing a variety of other services to our customers, such as wire transfers, check ordering, sales of cashier checks and money orders, and rentals of safe deposit boxes. Generally, fees are recognized and collected daily, concurrently with the point in time we fulfill the customer request. Safe deposit box rentals are on annual contracts, with fees generally earned at the time of the contract signing or renewal. Customer service fees are recorded as other noninterest income on our Consolidated Statements of Income.   Adoption of New Accounting Standards : ASU No. 2022 - 02 Financial Instruments – Credit Losses (Topic 326 ): Troubled Debt Restructurings and Vintage Disclosures . This ASU eliminates the accounting guidance for troubled debt restructurings (“TDRs”) by creditors in Subtopic 310 - 40, Receivables – Troubled Debt Restructurings by Creditors, while adding disclosures for certain loan restructurings by creditors when a borrower is experiencing financial difficulty. This guidance requires an entity to determine whether the modification results in a new loan or a continuation of an existing loan. Additionally, the ASU requires disclosures of current period gross charge-offs by year of origination for financing receivables. This ASU 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.   (Continued)   15 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       2. SECURITIES   The amortized cost and estimated fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:       Amortized Cost     Gross Unrealized Gains     Gross Unrealized Losses     Fair Value   March 31, 2023                                 U.S. Government agency debt obligations   $ 454,000,000     $ 0     $ ( 57,780,000 )   $ 396,220,000   Mortgage-backed securities     37,164,000       22,000       ( 5,596,000 )     31,590,000   Municipal general obligation bonds     168,721,000       1,081,000       ( 6,731,000 )     163,071,000   Municipal revenue bonds     30,812,000       200,000       ( 2,420,000 )     28,592,000   Other investments     500,000       0       0       500,000                                         $ 691,197,000     $ 1,303,000     $ ( 72,527,000 )   $ 619,973,000                                     December 31, 2022                                 U.S. Government agency debt obligations   $ 453,836,000     $ 0     $ ( 65,092,000 )   $ 388,744,000   Mortgage-backed securities     38,002,000       19,000       ( 6,068,000 )     31,953,000   Municipal general obligation bonds     163,041,000       450,000       ( 9,058,000 )     154,433,000   Municipal revenue bonds     30,267,000       102,000       ( 3,063,000 )     27,306,000   Other investments     500,000       0       0       500,000                                         $ 685,646,000     $ 571,000     $ ( 83,281,000 )   $ 602,936,000     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     Total       Fair     Unrealized     Fair     Unrealized     Fair     Unrealized       Value     Loss     Value     Loss     Value     Loss   March 31, 2023                                                 U.S. Government agency debt obligations   $ 14,000,000     $ 755,000     $ 382,220,000     $ 57,025,000     $ 396,220,000     $ 57,780,000   Mortgage-backed securities     29,016,000       5,508,000       1,742,000       88,000       30,758,000       5,596,000   Municipal general obligation bonds     43,446,000       940,000       67,822,000       5,791,000       111,268,000       6,731,000   Municipal revenue bonds     5,404,000       401,000       16,407,000       2,019,000       21,811,000       2,420,000                                                         $ 91,866,000     $ 7,604,000     $ 468,191,000     $ 64,923,000     $ 560,057,000     $ 72,527,000     (Continued)   16 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     2. SECURITIES (Continued)       Less than 12 Months     12 Months or More     Total       Fair Value     Unrealized Loss     Fair Value     Unrealized Loss     Fair Value     Unrealized Loss   December 31, 2022                                                 U.S. Government agency debt obligations   $ 53,019,000     $ 5,713,000     $ 335,725,000     $ 59,379,000     $ 388,744,000     $ 65,092,000   Mortgage-backed securities     31,127,000       6,068,000       12,000       0       31,139,000       6,068,000   Municipal general obligation bonds     97,252,000       4,516,000       32,870,000       4,542,000       130,122,000       9,058,000   Municipal revenue bonds     12,532,000       1,141,000       10,609,000       1,922,000       23,141,000       3,063,000                                                         $ 193,930,000     $ 17,438,000     $ 379,216,000     $ 65,843,000     $ 573,146,000     $ 83,281,000     We evaluate securities in an unrealized loss position at least quarterly. Consideration is given to the financial condition of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.   At 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 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. 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.   (Continued)   17 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     2. 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. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.       Weighted                       Average     Amortized     Fair       Yield (%)     Cost     Value                             Due in 2023     0.98     $ 20,361,000     $ 19,997,000   Due in 2024 through 2028     1.32       319,037,000       293,271,000   Due in 2029 through 2033     2.03       278,488,000       241,115,000   Due in 2034 and beyond     3.58       35,647,000       33,500,000   Mortgage-backed securities     2.12       37,164,000       31,590,000   Other investments     8.00       500,000       500,000                             Total available for sale securities     1.76     $ 691,197,000     $ 619,973,000     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. Government and its agencies and the State of Michigan and all its political subdivisions, did not exceed 10% of shareholders’ equity.   The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $ 227 million and $ 194 million at March 31, 2023, and December 31, 2022, respectively.   (Continued)   18 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       3. 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:                                       Percent       March 31, 2023     December 31, 2022     Increase       Balance     %     Balance     %     (Decrease)                                             Commercial:                                         Commercial and industrial (1)   $ 1,173,440,000       29.6 %   $ 1,185,083,000       30.3 %     ( 1.0 %) Vacant land, land development, and residential construction     66,233,000       1.7       61,873,000       1.6       7.0   Real estate – owner occupied     630,187,000       15.9       639,192,000       16.3       ( 1.4 ) Real estate – non-owner occupied     1,051,221,000       26.5       1,033,734,000       26.4       1.7   Real estate – multi-family and residential rental     219,339,000       5.5       211,948,000       5.4       3.5   Total commercial     3,140,420,000       79.2       3,131,830,000       80.0       0.3                                             Retail:                                         1-4 family mortgages     795,007,000       20.0       755,036,000       19.3       5.3   Other consumer loans     30,101,000       0.8       29,753,000       0.7       1.2   Total retail     825,108,000       20.8       784,789,000       20.0       5.1                                             Total loans   $ 3,965,528,000       100.0 %   $ 3,916,619,000       100.0 %     1.2 %     ( 1 ) 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:       March 31,     December 31,       2023     2022                     Loans past due 90 days or more still accruing interest   $ 0     $ 0   Nonaccrual loans     7,782,000       7,728,000                     Total nonperforming loans   $ 7,782,000     $ 7,728,000     (Continued)   19 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   The recorded principal balance of nonperforming loans was as follows:       March 31,     December 31,       2023     2022   Commercial:                 Commercial and industrial   $ 5,654,000     $ 6,024,000   Vacant land, land development, and residential construction     0       0   Real estate – owner occupied     229,000       248,000   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     5,883,000       6,272,000                     Retail:                 1-4 family mortgages     1,899,000       1,456,000   Other consumer loans     0       0   Total retail     1,899,000       1,456,000                     Total nonperforming loans   $ 7,782,000     $ 7,728,000     (Continued)   20 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   An age analysis of past due loans is as follows as of March 31, 2023:       30 – 59 Days Past Due     60 – 89 Days Past Due     Greater Than 89 Days Past Due     Total Past Due     Current     Total Loans     Recorded Balance > 89 Days and Accruing                                                             Commercial:                                                         Commercial and industrial   $ 95,000     $ 0     $ 272,000     $ 367,000     $ 1,173,073,000     $ 1,173,440,000     $ 0   Vacant land, land development, and residential construction     0       0       0       0       66,233,000       66,233,000       0   Real estate – owner occupied     206,000       44,000       229,000       479,000       629,708,000       630,187,000       0   Real estate – non-owner occupied     0       0       0       0       1,051,221,000       1,051,221,000       0   Real estate – multi-family and residential rental     27,000       0       0       27,000       219,312,000       219,339,000       0   Total commercial     328,000       44,000       501,000       873,000       3,139,547,000       3,140,420,000       0                                                             Retail:                                                         1-4 family mortgages     733,000       235,000       277,000       1,245,000       793,762,000       795,007,000       0   Other consumer loans     41,000       3,000       0       44,000       30,057,000       30,101,000       0   Total retail     774,000       238,000       277,000       1,289,000       823,819,000       825,108,000       0                                                             Total past due loans   $ 1,102,000     $ 282,000     $ 778,000     $ 2,162,000     $ 3,963,366,000     $ 3,965,528,000     $ 0     (Continued)   21 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   An age analysis of past due loans is as follows as of December 31, 2022:       30 – 59 Days Past Due     60 – 89 Days Past Due     Greater Than 89 Days Past Due     Total Past Due     Current     Total Loans     Recorded Balance > 89 Days and Accruing                                                             Commercial:                                                         Commercial and industrial   $ 0     $ 5,705,000     $ 249,000     $ 5,954,000     $ 1,179,129,000     $ 1,185,083,000     $ 0   Vacant land, land development, and residential construction     0       0       0       0       61,873,000       61,873,000       0   Real estate – owner occupied     0       248,000       0       248,000       638,944,000       639,192,000       0   Real estate – non-owner occupied     0       0       0       0       1,033,734,000       1,033,734,000       0   Real estate – multi-family and residential rental     0       0       0       0       211,948,000       211,948,000       0   Total commercial     0       5,953,000       249,000       6,202,000       3,125,628,000       3,131,830,000       0                                                             Retail:                                                         1-4 family mortgages     1,334,000       88,000       116,000       1,538,000       753,498,000       755,036,000       0   Other consumer loans     15,000       1,000       0       16,000       29,737,000       29,753,000       0   Total retail     1,349,000       89,000       116,000       1,554,000       783,235,000       784,789,000       0                                                             Total past due loans   $ 1,349,000     $ 6,042,000     $ 365,000     $ 7,756,000     $ 3,908,863,000     $ 3,916,619,000     $ 0     Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on an internal watch list. Senior management and the Board of Directors review this list regularly. Fair value estimates of collateral on distressed lending relationships, as well as on foreclosed and repossessed assets, are reviewed periodically. We also have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions. Under CECL for collateral dependent loans in instances where the borrower is experiencing financial difficulties, we adopted the practical expedient to measure the allowance based on the fair value of collateral. The allowance is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral and the recorded principal balance. If the fair value of the collateral exceeds the recorded principal balance, no allowance is required. Collateral dependent loans, representing the entire amount of loans on nonaccrual, totaled $ 7.8 million and $ 7.7 million as of March 31, 2023 and December 31, 2022, respectively.   (Continued)   22 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Nonaccrual loans as of March 31, 2023 were as follows:       Amortized     Related       Cost     Allowance   With no allowance recorded:                 Commercial:                 Commercial and industrial   $ 1,986,000     $ 0   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     229,000       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     2,215,000       0                     Retail:                 1-4 family mortgages     1,096,000       0   Other consumer loans     0       0   Total retail     1,096,000       0                     Total with no allowance recorded   $ 3,311,000     $ 0                     With an allowance recorded:                 Commercial:                 Commercial and industrial   $ 3,668,000     $ 2,060,000   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     3,668,000       2,060,000                     Retail:                 1-4 family mortgages     803,000       378,000   Other consumer loans     0       0   Total retail     803,000       378,000                     Total with an allowance recorded   $ 4,471,000     $ 2,438,000                     Total nonaccrual loans:                 Commercial   $ 5,883,000     $ 2,060,000   Retail     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.   (Continued)   23 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Nonaccrual loans as of December 31, 2022 were as follows:       Amortized     Related       Cost     Allowance   With no allowance recorded:                 Commercial:                 Commercial and industrial   $ 249,000     $ 0   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     249,000       0                     Retail:                 1-4 family mortgages     1,064,000       0   Other consumer loans     0       0   Total retail     1,064,000       0                     Total with no allowance recorded   $ 1,313,000     $ 0                     With an allowance recorded:                 Commercial:                 Commercial and industrial   $ 5,775,000     $ 2,051,000   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     248,000       32,000   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     6,023,000       2,083,000                     Retail:                 1-4 family mortgages     392,000       200,000   Other consumer loans     0       0   Total retail     392,000       200,000                     Total with an allowance recorded   $ 6,415,000     $ 2,283,000                     Total nonaccrual loans:                 Commercial   $ 6,272,000     $ 2,083,000   Retail     1,456,000       200,000   Total nonaccrual loans   $ 7,728,000     $ 2,283,000     No interest income was recognized on nonaccrual loans during 2022.   (Continued)   24 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Credit Quality Indicators. We utilize a comprehensive grading system for our commercial loans. All commercial loans are graded on a ten grade rating system. The rating system utilizes standardized grade paradigms that analyze several critical factors such as cash flow, operating performance, financial condition, collateral, industry condition and management. All commercial loans are graded at inception and reviewed and, if appropriate, re-graded at various intervals thereafter. The 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:     Grade 1. “Exceptional”  Loans with this rating contain very little, if any, risk.         Grade 2. “Outstanding”  Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements.         Grade 3. “Very Good”  Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are acceptable.         Grade 4. “Good”  Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are modest.         Grade 5. “Acceptable”  Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements. These are for loans for which repayment risks are satisfactory.         Grade 6. “Monitor”  Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report.         Grade 7. “Special Mention”  Loans with this rating have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.         Grade 8. “Substandard”  Loans with this rate are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any. A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility of loss if the deficiencies are not corrected.         Grade 9. “Doubtful”  Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable.         Grade 10. “Loss”  Loans with this rating are considered uncollectible, and of such little value that continuance as an active asset is not warranted.     The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position. Retail loans that reach 90 days or more past due are generally placed into nonaccrual status and are categorized as nonperforming.   (Continued)   25 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   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):       2023     2022     2021     2020     2019     Prior     Term Total     Revolving Loans     Grand Total   Commercial:                                                                         Commercial and Industrial:                                                                         Grades 1 – 4   $ 38,167     $ 101,497     $ 129,476     $ 38,182     $ 8,393     $ 11,100     $ 326,815     $ 396,886     $ 723,701   Grades 5 – 7     25,597       128,333       42,304       26,770       8,472       512       231,988       194,070       426,058   Grades 8 – 9     9,947       24       249       0       0       43       10,263       13,418       23,681   Total   $ 73,711     $ 229,854     $ 172,029     $ 64,952     $ 16,865     $ 11,655     $ 569,066     $ 604,374     $ 1,173,440   Current year-to-date gross write offs   $ 0     $ 36     $ 0     $ 0     $ 0     $ 0     $ 36     $ 0     $ 36                                                                             Vacant Land, Land Development and Residential Construction:                                                                         Grades 1 – 4   $ 2,916     $ 28,645     $ 5,225     $ 3,121     $ 0     $ 321     $ 40,228     $ 0     $ 40,228   Grades 5 – 7     5,310       11,643       7,602       341       48       586       25,530       374       25,904   Grades 8 – 9     0       0       0       0       0       101       101       0       101   Total   $ 8,226     $ 40,288     $ 12,827     $ 3,462     $ 48     $ 1,008     $ 65,859     $ 374     $ 66,233   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0                                                                             Real Estate – Owner Occupied:                                                                         Grades 1 – 4   $ 39,686     $ 167,851     $ 110,400     $ 51,319     $ 18,545     $ 22,312     $ 410,113     $ 0     $ 410,113   Grades 5 – 7     15,364       97,215       42,009       32,707       9,976       12,171       209,442       0       209,442   Grades 8 – 9     7,500       2,966       0       44       0       122       10,632       0       10,632   Total   $ 62,550     $ 268,032     $ 152,409     $ 84,070     $ 28,521     $ 34,605     $ 630,187     $ 0     $ 630,187   Current year-to-date gross write offs   $ 0     $ 14     $ 0     $ 0     $ 0     $ 0     $ 14     $ 0     $ 14                                                                             Real Estate – Non-Owner Occupied:                                                                         Grades 1 – 4   $ 11,142     $ 114,392     $ 162,687     $ 92,232     $ 47,592     $ 21,345     $ 449,390     $ 0     $ 449,390   Grades 5 – 7     65,990       174,725       156,779       112,205       31,078       48,780       589,557       0       589,557   Grades 8 – 9     0       6,644       5,630       0       0       0       12,274       0       12,274   Total   $ 77,132     $ 295,761     $ 325,096     $ 204,437     $ 78,670     $ 70,125     $ 1,051,221     $ 0     $ 1,051,221   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0                                                                             Real Estate – Multi-Family and Residential Rental:                                                                         Grades 1 – 4   $ 9,717     $ 31,937     $ 39,603     $ 35,737     $ 5,213     $ 6,386     $ 128,593     $ 0     $ 128,593   Grades 5 – 7     5,470       32,355       23,634       12,323       3,041       2,602       79,425       0       79,425   Grades 8 – 9     0       11,250       0       0       0       71       11,321       0       11,321   Total   $ 15,187     $ 75,542     $ 63,237     $ 48,060     $ 8,254     $ 9,059     $ 219,339     $ 0     $ 219,339   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0                                                                             Total Commercial   $ 236,806     $ 909,477     $ 725,598     $ 404,981     $ 132,358     $ 126,452     $ 2,535,672     $ 604,748     $ 3,140,420   Total Comm current YTD gross write offs   $ 0     $ 50     $ 0     $ 0     $ 0     $ 0     $ 50     $ 0     $ 50     (Continued)   26 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)       2023     2022     2021     2020     2019     Prior     Term Total     Revolving Loans     Grand Total   Retail:                                                                         1-4 Family Mortgages:                                                                         Performing   $ 35,010     $ 325,078     $ 240,820     $ 90,565     $ 11,799     $ 52,831     $ 756,103     $ 37,005     $ 793,108   Nonperforming     0       138       385       0       13       1,363       1,899       0       1,899   Total   $ 35,010     $ 325,216     $ 241,205     $ 90,565     $ 11,812     $ 54,194     $ 758,002     $ 37,005     $ 795,007   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 42     $ 42     $ 0     $ 42                                                                             Other Consumer Loans:                                                                         Performing   $ 1,808     $ 3,771     $ 2,409     $ 844     $ 940     $ 605     $ 10,377     $ 19,724     $ 30,101   Nonperforming     0       0       0       0       0       0       0       0       0   Total   $ 1,808     $ 3,771     $ 2,409     $ 844     $ 940     $ 605     $ 10,377     $ 19,724     $ 30,101   Current year-to-date gross write offs   $ 0     $ 3     $ 0     $ 0     $ 0     $ 1     $ 4     $ 10     $ 14                                                                             Total Retail   $ 36,818     $ 328,987     $ 243,614     $ 91,409     $ 12,752     $ 54,799     $ 768,379     $ 56,729     $ 825,108   Total Retail Current YTD gross write offs   $ 0     $ 3     $ 0     $ 0     $ 0     $ 43     $ 46     $ 10     $ 56                                                                             Grand Total   $ 273,624     $ 1,238,464     $ 969,212     $ 496,390     $ 145,110     $ 181,251     $ 3,304,051     $ 661,477     $ 3,965,528   Grand Total Current YTD gross write offs   $ 0     $ 53     $ 0     $ 0     $ 0     $ 43     $ 96     $ 10     $ 106     There were no revolving loans converted to term loans during the first three months of 2023.   (Continued)   27 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   The following table reflects amortized cost of basis of loans as of December 31, 2022 based on year of origination (dollars in thousands):       2022     2021     2020     2019     2018     Prior     Term Total     Revolving Loans     Grand Total   Commercial:                                                                         Commercial and Industrial:                                                                         Grades 1 – 4   $ 115,494     $ 141,481     $ 43,961     $ 9,194     $ 3,230     $ 9,851     $ 323,211     $ 396,372     $ 719,583   Grades 5 – 7     151,783       47,030       31,697       8,870       569       93       240,042       210,363       450,405   Grades 8 – 9     3,784       249       0       0       48       29       4,110       10,985       15,095   Total   $ 271,061     $ 188,760     $ 75,658     $ 18,064     $ 3,847     $ 9,973     $ 567,363     $ 617,720     $ 1,185,083                                                                             Vacant Land, Land Development and Residential Construction:                                                                         Grades 1 – 4   $ 31,756     $ 6,196     $ 3,428     $ 0     $ 0     $ 331     $ 41,711     $ 0     $ 41,711   Grades 5 – 7     10,270       8,760       351       50       0       626       20,057       0       20,057   Grades 8 – 9     0       0       0       0       14       91       105       0       105   Total   $ 42,026     $ 14,956     $ 3,779     $ 50     $ 14     $ 1,048     $ 61,873     $ 0     $ 61,873                                                                             Real Estate – Owner Occupied:                                                                         Grades 1 – 4   $ 194,072     $ 113,528     $ 53,630     $ 19,670     $ 19,279     $ 6,162     $ 406,341     $ 0     $ 406,341   Grades 5 – 7     115,720       56,173       33,913       10,245       12,550       1,165       229,766       0       229,766   Grades 8 – 9     2,919       0       44       0       122       0       3,085       0       3,085   Total   $ 312,711     $ 169,701     $ 87,587     $ 29,915     $ 31,951     $ 7,327     $ 639,192     $ 0     $ 639,192                                                                             Real Estate – Non-Owner Occupied:                                                                         Grades 1 – 4   $ 129,153     $ 163,035     $ 89,125     $ 44,196     $ 10,079     $ 12,018     $ 447,606     $ 0     $ 447,606   Grades 5 – 7     183,388       164,334       139,951       35,200       13,456       37,399       573,728       0       573,728   Grades 8 – 9     6,712       5,688       0       0       0       0       12,400       0       12,400   Total   $ 319,253     $ 333,057     $ 229,076     $ 79,396     $ 23,535     $ 49,417     $ 1,033,734     $ 0     $ 1,033,734                                                                             Real Estate – Multi-Family and Residential Rental:                                                                         Grades 1 – 4   $ 31,470     $ 38,176     $ 36,348     $ 5,306     $ 3,082     $ 4,003     $ 118,385     $ 0     $ 118,385   Grades 5 – 7     48,847       25,786       12,879       3,162       2,557       283       93,514       0       93,514   Grades 8 – 9     0       0       0       0       0       49       49       0       49   Total   $ 80,317     $ 63,962     $ 49,227     $ 8,468     $ 5,639     $ 4,335     $ 211,948     $ 0     $ 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     (Continued)   28 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)       2022     2021     2020     2019     2018     Prior     Term Total     Revolving Loans     Grand Total                                                                             Retail:                                                                         1-4 Family Mortgages:                                                                         Performing   $ 313,611     $ 242,950     $ 91,936     $ 12,094     $ 14,297     $ 41,622     $ 716,510     $ 37,070     $ 753,580   Nonperforming     142       82       0       0       203       1,029       1,456       0       1,456   Total   $ 313,753     $ 243,032     $ 91,936     $ 12,094     $ 14,500     $ 42,651     $ 717,966     $ 37,070     $ 755,036                                                                             Other Consumer Loans:                                                                         Performing   $ 4,349     $ 2,870     $ 1,040     $ 1,074     $ 395     $ 430     $ 10,158     $ 19,595     $ 29,753   Nonperforming     0       0       0       0       0       0       0       0       0   Total   $ 4,349     $ 2,870     $ 1,040     $ 1,074     $ 395     $ 430     $ 10,158     $ 19,595     $ 29,753   Total Retail   $ 318,102     $ 245,902     $ 92,976     $ 13,168     $ 14,895     $ 43,081     $ 728,124     $ 56,665     $ 784,789                                                                             Grand Total   $ 1,343,470     $ 1,016,338     $ 538,303     $ 149,061     $ 79,881     $ 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):       Commercial and industrial     Commercial vacant land, land development and residential construction     Commercial real estate – owner occupied     Commercial real estate – non-owner occupied     Commercial real estate – multi-family and residential rental     1-4 family mortgages     Other consumer loans     Unallocated     Total   Allowance for credit losses:                                                                         Beginning balance   $ 10,203     $ 490     $ 5,914     $ 10,164     $ 1,269     $ 14,027     $ 160     $ 19     $ 42,246   Provision for credit losses     ( 7 )     19       ( 237 )     131       24       618       ( 5 )     57       600   Charge-offs     ( 36 )     0       ( 14 )     0       0       ( 42 )     ( 14 )     0       ( 106 ) Recoveries     21       1       48       0       7       45       15       0       137   Ending balance   $ 10,181     $ 510     $ 5,711     $ 10,295     $ 1,300     $ 14,648     $ 156     $ 76     $ 42,877     (Continued)   29 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Activity in the allowance for credit losses during the three months ended March 31, 2022 is as follows (dollars in thousands):       Commercial and industrial     Commercial vacant land, land development and residential construction     Commercial real estate – owner occupied     Commercial real estate – non-owner occupied     Commercial real estate – multi-family and residential rental     1-4 family mortgages     Other consumer loans     Unallocated     Total   Allowance for credit losses:                                                                         Beginning balance   $ 10,782     $ 420     $ 6,045     $ 13,301     $ 1,695     $ 2,449     $ 626     $ 45     $ 35,363   Adoption of ASU 2016-13     ( 1,571 )     ( 43 )     ( 560 )     ( 2,534 )     ( 621 )     5,395       ( 411 )     ( 55 )     ( 400 ) Provision for credit losses     ( 742 )     106       286       ( 445 )     194       593       ( 33 )     141       100   Charge-offs     ( 170 )     ( 29 )     0       0       0       ( 2 )     ( 4 )     0       ( 205 ) Recoveries     114       1       32       0       8       127       13       0       295   Ending balance   $ 8,413     $ 455     $ 5,803     $ 10,322     $ 1,276     $ 8,562     $ 191     $ 131     $ 35,153     (Continued)   30 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   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:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     0     $ 0     $ 0   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     0       0       0   Real estate – non-owner occupied     0       0       0   Real estate – multi-family and residential rental     0       0       0   Total commercial     0       0       0                             Retail:                         1-4 family mortgages     2       128,000       128,000   Other consumer loans     0       0       0   Total retail     2       128,000       128,000                             Total loans     2     $ 128,000     $ 128,000       The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended March 31, 2022 ( amounts as of period end):               Recorded       Number of     Principal       Contracts     Balance   Commercial:                 Commercial and industrial     0     $ 0   Vacant land, land development and residential construction     0       0   Real estate – owner occupied     0       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     0       0                     Retail:                 1-4 family mortgages     0       0   Other consumer loans     0       0   Total retail     0       0                     Total loans     0     $ 0     (Continued)   31 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3. LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Activity for loans categorized as troubled debt restructurings during the three months ended March 31, 2022 is as follows:       Commercial and Industrial     Commercial Vacant Land, Land Development, and Residential Construction     Commercial Real Estate - Owner Occupied     Commercial Real Estate - Non-Owner Occupied     Commercial Real Estate - Multi-Family and Residential Rental                                             Commercial Loan Portfolio:                                         Beginning Balance   $ 4,973,000     $ 0     $ 10,435,000     $ 146,000     $ 91,000   Charge-Offs     0       0       0       0       0   Payments     ( 212,000 )     0       ( 9,677,000 )     ( 3,000 )     ( 1,000 ) Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     ( 1,932,000 )     0       ( 669,000 )     0       0   Ending Balance   $ 2,829,000     $ 0     $ 89,000     $ 143,000     $ 90,000         Retail     Retail       1-4 Family     Other Consumer       Mortgages     Loans   Retail Loan Portfolio:                 Beginning Balance   $ 627,000     $ 1,202,000   Charge-Offs     0       0   Payments     ( 78,000 )     ( 2,000 ) Transfers to ORE     0       0   Net Additions/Deletions (1)     1,797,000       ( 1,187,000 ) Ending Balance   $ 2,346,000     $ 13,000         ( 1 ) Includes $ 1.2 million in the transfer of home equity lines of credit from other consumer loans to 1 - 4 family mortgages in association with the adoption of the CECL methodology effective January 1, 2022.   (Continued)   32 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       4. PREMISES AND EQUIPMENT, NET   Premises and equipment are comprised of the following:       March 31,     December 31,       2023     2022                     Land and improvements   $ 13,050,000     $ 13,532,000   Buildings     55,527,000       53,865,000   Furniture and equipment     23,064,000       22,941,000         91,641,000       90,338,000   Less: accumulated depreciation     40,131,000       38,862,000                     Premises and equipment, net   $ 51,510,000     $ 51,476,000     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 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, 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. Right-of-use assets represent our right to use an underlying asset for the lease term, while lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the lease commencement date at the estimated present value of lease payments over the lease term. We use our incremental borrowing rate, on a collateralized basis, at lease commencement to calculate the present value of lease payments. The weighted average discount rate for leases was 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:   2023   $ 904,000   2024     1,012,000   2025     578,000   2026     479,000   2027     434,000   Thereafter     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     (Continued)   33 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       5. DEPOSITS   Our total deposits at March 31, 2023 totaled $ 3.60 billion, a decrease of $ 115 million, or 3.1 %, from December  31, 2022. 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:                                       Percent       March 31, 2023     December 31, 2022     Increase       Balance     %     Balance     %     (Decrease)                                             Noninterest-bearing checking   $ 1,376,782,000       38.3 %   $ 1,604,750,000       43.2 %     ( 14.2 %) Interest-bearing checking     576,678,000       16.0       575,028,000       15.5       0.3   Money market     842,557,000       23.4       776,723,000       20.9       8.5   Savings     340,178,000       9.5       381,602,000       10.3       ( 10.9 ) Time, under $100,000     132,482,000       3.7       113,099,000       3.0       17.1   Time, $100,000 and over     329,341,000       9.1       261,609,000       7.1       25.9                                             Total deposits   $ 3,598,018,000       100.0 %   $ 3,712,811,000       100.0 %     ( 3.1 %)       6. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE   Securities sold under agreements to repurchase (“repurchase agreements”) are offered principally to certain large deposit customers. Information relating to our repurchase agreements follows:       Three Months Ended     Twelve Months Ended       March 31, 2023     December 31, 2022                     Outstanding balance at end of period   $ 227,453,000     $ 194,340,000   Average interest rate at end of period     1.44 %     0.75 %                   Average daily balance during the period   $ 195,574,000     $ 200,499,000   Average interest rate during the period     0.84 %     0.15 %                   Maximum daily balance during the period   $ 255,180,000     $ 235,577,000     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.   (Continued)   34 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       7. FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES   Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $ 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:   2023   $ 70,000,000   2024     80,000,000   2025     50,000,000   2026     50,000,000   2027     70,000,000   Thereafter     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 of FHLBI amortizing advances as of March 31, 2023 were as follows:   2023   $ 0   2024     826,000   2025     862,000   2026     899,000   2027     938,000   Thereafter     24,385,000     Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. Our borrowing line of credit as of March 31, 2023 totaled $ 665 million, with remaining availability based on collateral of $ 281 million.       8. COMMITMENTS AND OFF-BALANCE SHEET RISK   We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by our bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.   (Continued)   35 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     8. COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)   These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our 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. 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.   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.   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:        March 31,     December 31,       2023     2022                     Commercial unused lines of credit   $ 1,359,164,000     $ 1,283,703,000   Unused lines of credit secured by 1–4 family residential properties     72,014,000       71,972,000   Credit card unused lines of credit     127,863,000       123,687,000   Other consumer unused lines of credit     62,298,000       75,747,000   Commitments to make loans     347,062,000       329,646,000   Standby letters of credit     22,720,000       23,539,000       $ 1,991,121,000     $ 1,908,294,000       9. DERIVATIVES AND HEDGING ACTIVITIES   We are exposed to certain risks arising from both business operations and economic conditions. We principally manage the exposure to a wide variety of operational risks through core business activities. Economic risks, including interest rate, liquidity and credit risk, are primarily administered via the amount, sources and duration of assets and liabilities. Derivative financial instruments may also be used to assist in managing economic risks.   (Continued)   36 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     9. DERIVATIVES AND HEDGING ACTIVITIES (Continued)   Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers. We execute interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with correspondent banks to offset the impact of the interest rate swaps with the commercial banking customers. The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions.   As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent banks are recognized directly to earnings. 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 March 31, 2023, are reflected in the following table.       Notional Amount   Balance Sheet Location   Fair Value                       Derivative Assets                   Interest rate swaps   $ 470,678,000   Other Assets   $ 22,871,000                       Derivative Liabilities                   Interest rate swaps     470,678,000   Other Liabilities     23,254,000     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 $ 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, 2022, are reflected in the following table.       Notional Amount   Balance Sheet Location   Fair Value                       Derivative Assets                   Interest rate swaps   $ 401,572,000   Other Assets   $ 25,697,000                       Derivative Liabilities                   Interest rate swaps     401,572,000   Other Liabilities     25,900,000     (Continued)   37 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     9. DERIVATIVES AND HEDGING ACTIVITIES (Continued)   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 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. Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $ 402 million as of December 31, 2022. Associated credit exposure is generally mitigated by securing the interest rates swaps with the underlying collateral of the loan instruments.   (Continued)   38 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       10. FAIR VALUES OF FINANCIAL INSTRUMENTS   The carrying amounts, estimated fair values and level within the fair value hierarchy of financial instruments were as follows as of March 31, 2023 and December 31, 2022 ( dollars in thousands):     Level in   March 31, 2023     December 31, 2022     Fair Value   Carrying     Fair     Carrying     Fair     Hierarchy   Values     Values     Values     Values   Financial assets:                                   Cash and cash equivalents Level 1   $ 57,938     $ 57,938     $ 96,772     $ 96,772   Securities available for sale (1)     619,973       619,973       602,936       602,936   FHLBI stock (2)     17,721       17,721       17,721       17,721   Loans, net Level 3     3,922,651       3,837,260       3,874,373       3,800,042   Mortgage loans held for sale Level 2     3,821       3,932       3,565       3,643   Mortgage servicing rights Level 3     11,402       18,726       11,837       17,727   Accrued interest receivable Level 2     17,424       17,424       15,476       15,476   Interest rate swaps Level 2     22,871       22,871       25,697       25,697                                       Financial liabilities:                                   Deposits Level 2     3,598,018       3,330,349       3,712,811       3,379,403   Repurchase agreements Level 2     227,453       227,453       194,340       194,340   FHLBI advances Level 2     377,910       360,723       308,263       292,044   Subordinated debentures Level 2     49,130       49,119       48,958       49,531   Subordinated notes Level 2     88,714       75,911       88,628       75,024   Accrued interest payable Level 2     3,486       3,486       3,223       3,223   Interest rate swaps Level 2     23,254       23,254       25,900       25,900       ( 1 ) See Note 11 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities.     ( 2 ) It is not practical to determine the fair value of FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount.   Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. Fair value for loans is based on an exit price model as required by ASU 2016 - 01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposit accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The fair values of subordinated debentures, subordinated notes, and FHLBI advances are based on current rates for similar financing. The fair values of interest rate swaps are based on discounted cash flows using forecasted yield curves, along with insignificant unobservable inputs, such as borrower credit spreads. The fair value of other off-balance sheet items is estimated to be nominal.   (Continued)   39 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       11. FAIR VALUES   Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.   We are required to use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources, or unobservable, meaning those that reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:   Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.   Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.   Level 3: Significant unobservable inputs that reflect our own conclusions about the assumptions that market participants would use in pricing an asset or liability.   The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities that are recorded at fair value on a recurring or nonrecurring basis:   Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency debt obligations, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal general obligation and revenue bonds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment. There was no such impairment as of March 31, 2023, or December 31, 2022. We have no Level 1 securities available for sale.   (Continued)   40 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11. FAIR VALUES (Continued)   Derivatives . We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves. Insignificant unobservable inputs, such as borrower credit spreads, are also utilized.   Mortgage loans held for sale . Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors, and are measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics. As of March 31, 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.   Loans . We do not record loans at fair value on a recurring basis. However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of 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.   Foreclosed Assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed and repossessed assets, establishing a new cost basis. We subsequently adjust estimated fair value of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.   Assets and Liabilities Measured at Fair Value on a Recurring Basis   The balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2023 are as follows:       Total     Quoted Prices in Active Markets for Identical Assets (Level 1)     Significant Other Observable Inputs (Level 2)     Significant Unobservable Inputs (Level 3)   Available for sale securities                                 U.S. Government agency debt obligations   $ 396,220,000     $ 0     $ 396,220,000     $ 0   Mortgage-backed securities     31,590,000       0       31,590,000       0   Municipal general obligation bonds     163,071,000       0       162,493,000       578,000   Municipal revenue bonds     28,592,000       0       28,592,000       0   Other investments     500,000       0       500,000       0   Interest rate swaps     22,871,000       0       22,871,000       0   Total assets   $ 642,844,000     $ 0     $ 642,266,000     $ 578,000                                     Interest rate swaps     23,254,000       0       23,254,000       0   Total liabilities   $ 23,254,000     $ 0     $ 23,254,000     $ 0     (Continued)   41 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11. 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:       Total     Quoted Prices in Active Markets for Identical Assets (Level 1)     Significant Other Observable Inputs (Level 2)     Significant Unobservable Inputs (Level 3)   Available for sale securities                                 U.S. Government agency debt obligations   $ 388,744,000     $ 0     $ 388,744,000     $ 0   Mortgage-backed securities     31,953,000       0       31,953,000       0   Municipal general obligation bonds     154,433,000       0       153,855,000       578,000   Municipal revenue bonds     27,306,000       0       27,306,000       0   Other investments     500,000       0       500,000       0   Interest rate swaps     25,697,000       0       25,697,000       0   Total assets   $ 628,633,000     $ 0     $ 628,055,000     $ 578,000                                     Interest rate swaps     25,900,000       0       25,900,000       0   Total liabilities   $ 25,900,000     $ 0     $ 25,900,000     $ 0     There were no sales, purchases or transfers in or out of Level 3 during 2022. 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:               Quoted                               Prices in                               Active     Significant                       Markets for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)                                     Collateral Dependent Loans   $ 4,456,000     $ 0     $ 0     $ 4,456,000   Foreclosed assets     661,000       0       0       661,000   Total   $ 5,117,000     $ 0     $ 0     $ 5,117,000     (Continued)   42 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11. FAIR VALUES (Continued)   The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2022 are as follows:               Quoted                               Prices                               in Active     Significant                       Markets for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)                                     Collateral dependent loans   $ 5,290,000     $ 0     $ 0     $ 5,290,000   Foreclosed assets     0       0       0       0   Total   $ 5,290,000     $ 0     $ 0     $ 5,290,000     The carrying values are based on the estimated value of the property or other assets. 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. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. 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.       12. REGULATORY MATTERS   We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on 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. If an institution is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if, after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator. 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.   (Continued)   43 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     12. REGULATORY MATTERS (Continued)   Our actual capital levels (dollars in thousands) and the minimum levels required to be categorized as adequately and well capitalized were:                                       Minimum Required                                       to be Well                       Minimum Required     Capitalized Under                       for Capital     Prompt Corrective       Actual     Adequacy Purposes     Action Regulations       Amount     Ratio     Amount     Ratio     Amount     Ratio   March 31, 2023                                                 Total capital (to risk weighted assets)                                                 Consolidated   $ 652,509       14.1 %   $ 369,891       8.0 %   $ NA       NA   Bank     636,393       13.8       369,708       8.0       462,134       10.0 % Tier 1 capital (to risk weighted assets)                                                 Consolidated     520,918       11.3       277,418       6.0     NA     NA   Bank     593,516       12.8       277,281       6.0       369,708       8.0   Common equity tier 1 (to risk weighted assets)                                                 Consolidated     473,863       10.3       208,064       4.5     NA     NA   Bank     593,516       12.8       207,961       4.5       300,388       6.5   Tier 1 capital (to average assets)                                                 Consolidated     520,918       10.7       195,380       4.0     NA     NA   Bank     593,516       12.2       195,290       4.0       244,112       5.0                                                     December 31, 2022                                                 Total capital (to risk weighted assets)                                                 Consolidated   $ 634,729       14.0 %   $ 362,675       8.0 %   $ NA       NA   Bank     618,709       13.7       362,490       8.0       453,112       10.0 % Tier 1 capital (to risk weighted assets)                                                 Consolidated     503,855       11.1       272,007       6.0     NA     NA   Bank     576,463       12.7       271,868       6.0       362,490       8.0   Common equity tier 1 (to risk weighted assets)                                                 Consolidated     456,970       10.1       204,005       4.5     NA     NA   Bank     576,463       12.7       203,901       4.5       294,523       6.5   Tier 1 capital (to average assets)                                                 Consolidated     503,855       10.1       199,647       4.0     NA     NA   Bank     576,463       11.6       199,563       4.0       249,453       5.0     (Continued)   44 Table of Contents   MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     12. 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. The guidelines provide that the aggregate amount of restricted core elements that may be included in our Tier 1 capital must not exceed 25 % of the sum of all core capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability. Our ability to include the trust preferred securities in Tier 1 capital in accordance with the guidelines is not affected by the provision of the Dodd-Frank Act generally restricting such treatment, because (i) the trust preferred securities were issued before May 19, 2010, and (ii) our total consolidated assets as of December 31, 2009 were less than $ 15.0 billion. As of March 31, 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. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0 %, the Tier 1 capital ratio to 8.5 % and the total capital ratio to 10.5 % on a fully phased-in basis on January 1, 2019. We believe that, as of March 31, 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.   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. 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.       13. SUBSEQUENT EVENTS   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.     45 Table of Contents     MERCANTILE BANK CORPORATION       Item 2. Management ’ s Discussion and Analysis of Financial Condition and Results of Operations   Forward-Looking Statements This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “is likely,” “plans,” “projects,” “indicates,” “strategy,” “future,” “likely,” “may,” “should,” “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.   Future Factors include, among others, adverse changes in interest rates and interest rate relationships; increasing rates of inflation and slower growth rates or recession; significant declines in the value of commercial real estate; market volatility; demand for products and services; 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 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; litigation liabilities; governmental and regulatory policy changes; the outcomes of existing or future contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, and the failure to meet client expectations and other facts; 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.   Introduction The following discussion compares the financial condition of Mercantile Bank Corporation and its consolidated subsidiaries, including Mercantile Bank of Michigan (“our bank”) and our bank’s subsidiary, Mercantile Insurance Center, Inc., at March 31, 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. Unless the text clearly suggests otherwise, references in this report to “us,” “we,” “our” or “the company” include Mercantile Bank Corporation and its consolidated subsidiaries referred to above.   Critical Accounting 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. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting 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. Changes in such estimates may have a significant impact on the financial statements, and actual results may differ from those estimates. We have reviewed the application of these policies with the Audit Committee of our Board of Directors.     46 Table of Contents   MERCANTILE BANK CORPORATION     Allowance for Credit Losses ( “ Allowance ” ) : The allowance is maintained at a level we believe is adequate to absorb estimated credit losses identified and inherent in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Credit losses are charged against the allowance when we believe the uncollectibility of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. The allowance is increased through a provision charged to operating expense. Uncollectible loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.   In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments . This ASU (as subsequently amended by ASU 2018-19) significantly 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” model. 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.   We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.   See Note 1- Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.   Mortgage Servicing Rights : Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage loan prepayment speeds, the remaining life of the mortgage loan pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from servicing each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.     47 Table of Contents   MERCANTILE BANK CORPORATION     Goodwill : 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 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.     48 Table of Contents   MERCANTILE BANK CORPORATION     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 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%. 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 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. Our commercial lenders also report ongoing additional opportunities they are currently discussing with existing and potentially new borrowers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. Usage of existing commercial lines of credit averaged 41% during the first quarter of 2023, similar to the 42% average during all of 2022.     49 Table of Contents   MERCANTILE BANK CORPORATION     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%. 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 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   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:       3/31/23     12/31/22     9/30/22     6/30/22     3/31/22   Commercial:                                         Commercial & Industrial (1)   $ 1,173,440,000     $ 1,185,083,000     $ 1,213,630,000     $ 1,187,650,000     $ 1,153,814,000   Land Development & Construction     66,233,000       61,873,000       60,970,000       57,808,000       52,693,000   Owner Occupied Commercial RE     630,187,000       639,192,000       643,577,000       598,593,000       582,732,000   Non-Owner Occupied Commercial RE     1,051,221,000       1,033,734,000       1,002,638,000       1,003,118,000       1,007,361,000   Multi-Family & Residential Rental     219,339,000       211,948,000       224,248,000       224,591,000       207,962,000   Total Commercial     3,140,420,000       3,131,830,000       3,145,063,000       3,071,760,000       3,004,562,000                                             Retail:                                         1-4 Family Mortgages     795,007,000       755,036,000       705,441,000       623,599,000       522,556,000   Other Consumer Loans     30,101,000       29,753,000       30,454,000       28,441,000       28,672,000   Total Retail     825,108,000       784,789,000       735,895,000       652,040,000       551,228,000                                             Total   $ 3,965,528,000     $ 3,916,619,000     $ 3,880,958,000     $ 3,723,800,000     $ 3,555,790,000       (1) 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. These guidelines include loan review and early identification of problem loans to provide effective loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur quickly because of changing economic conditions or other factors. 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 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. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions.     50 Table of Contents   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:   NONPERFORMING LOANS                                                 3/31/23     12/31/22     9/30/22     6/30/22     3/31/22   Residential Real Estate:                                         Land Development   $ 8,000     $ 29,000     $ 30,000     $ 30,000     $ 31,000   Construction     0       124,000       0       0       0   Owner Occupied / Rental     1,891,000       1,304,000       1,138,000       1,508,000       1,579,000         1,899,000       1,457,000       1,168,000       1,538,000       1,610,000                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     229,000       248,000       0       0       0   Non-Owner Occupied     0       0       0       0       0         229,000       248,000       0       0       0                                             Non-Real Estate:                                         Commercial Assets     5,654,000       6,023,000       248,000       248,000       0   Consumer Assets     0       0       0       1,000       2,000         5,654,000       6,023,000       248,000       249,000       2,000                                             Total   $ 7,782,000     $ 7,728,000     $ 1,416,000     $ 1,787,000     $ 1,612,000       51 Table of Contents   MERCANTILE BANK CORPORATION     OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS                                                 3/31/23     12/31/22     9/30/22     6/30/22     3/31/22   Residential Real Estate:                                         Land Development   $ 0     $ 0     $ 0     $ 0     $ 0   Construction     0       0       0       0       0   Owner Occupied / Rental     61,000       0       0       0       0         61,000       0       0       0       0                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     600,000       0       0       0       0   Non-Owner Occupied     0       0       0       0       0         600,000       0       0       0       0                                             Non-Real Estate:                                         Commercial Assets     0       0       0       0       0   Consumer Assets     0       0       0       0       0         0       0       0       0       0                                             Total   $ 661,000     $ 0     $ 0     $ 0     $ 0       The following tables provide a reconciliation of nonperforming assets:   NONPERFORMING LOANS RECONCILIATION                                                 1st Qtr     4th Qtr     3rd Qtr     2nd Qtr     1st Qtr       2023     2022     2022     2022     2022                                             Beginning balance   $ 7,728,000     $ 1,416,000     $ 1,787,000     $ 1,612,000     $ 2,468,000   Additions, net of transfers to ORE     662,000       6,368,000       0       309,000       93,000   Returns to performing status     (31,000 )     0       (160,000 )     0       (213,000 ) Principal payments     (515,000 )     (56,000 )     (211,000 )     (134,000 )     (641,000 ) Loan charge-offs     (62,000 )     0       0       0       (95,000 )                                           Total   $ 7,782,000     $ 7,728,000     $ 1,416,000     $ 1,787,000     $ 1,612,000       OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION                                                 1st Qtr     4th Qtr     3rd Qtr     2nd Qtr     1st Qtr       2023     2022     2022     2022     2022                                             Beginning balance   $ 0     $ 0     $ 0     $ 0     $ 0   Additions     661,000       0       0       0       0   Sale proceeds     0       0       0       0       0   Valuation write-downs     0       0       0       0       0                                             Total   $ 661,000     $ 0     $ 0     $ 0     $ 0       52 Table of Contents   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 primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers, and we have a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential mortgage loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.   See Note 1- Significant Accounting Policies in this Quarterly Report on Form 10-Q for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in this Quarterly Report on Form 10-Q for further information regarding our loan portfolio and allowance.   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 $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. Government agency guaranteed mortgage-backed securities (5%). All of our securities are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at March 31, 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 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. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies and municipal bonds are generally determined on a monthly basis with the assistance of a third-party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes and issuer spreads. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.   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.     53 Table of Contents   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 $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. 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 March 31, 2023 totaled $665 million, with remaining availability based on collateral equaling $281 million.     54 Table of Contents   MERCANTILE BANK CORPORATION     Shareholders’ 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 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, and operate our company. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold and interest-earning deposits. Asset and liability management is the process of managing our balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.   To assist in providing needed funds and managing interest rate risk, we periodically obtain monies from wholesale funding sources. Wholesale funds, 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 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 $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. 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   $ 227,453,000   Weighted average interest rate at March 31, 2023     1.44 % Maximum daily balance three months ended March 31, 2023   $ 255,180,000   Average daily balance for three months ended March 31, 2023   $ 195,574,000   Weighted average interest rate for three months ended March 31, 2023     0.84 %     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 March 31, 2023 totaled $665 million, with remaining availability based on collateral equaling $281 million.     55 Table of Contents   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 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 $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:        One Year     One to     Three to     Over               or Less     Three Years     Five Years     Five Years     Total                                             Deposits without a stated maturity   $ 3,136,195,000     $ 0     $ 0     $ 0     $ 3,136,195,000   Time deposits     297,371,000       73,475,000       90,977,000       0       461,823,000   Short-term borrowings     244,660,000       0       0       0       244,660,000   Federal Home Loan Bank advances     90,826,000       141,762,000       121,917,000       23,405,000       377,910,000   Subordinated debentures     0       0       0       49,130,000       49,130,000   Subordinated notes     0       0       0       88,714,000       88,714,000   Other borrowed money     0       0       0       1,096,000       1,096,000   Property leases     904,000       1,722,000       870,000       1,549,000       5,045,000     In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. As of March 31, 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’ cash needs vary, and $347 million were for loan commitments generally expected to close and become funded within the next 12 to 18 months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our overall liquidity management.   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. We have developed contingency funding plans that provide a framework for meeting liquidity disruptions.   Capital Resources Shareholders’ 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. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not meet this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in cash dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement raised the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5% and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. We believe that, as of March 31, 2023, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.     56 Table of Contents   MERCANTILE BANK CORPORATION     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.     57 Table of Contents   MERCANTILE BANK CORPORATION     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 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.     58 Table of Contents   MERCANTILE BANK CORPORATION         Quarters ended March 31,       2 0 2 3     2 0 2 2       Average             Average     Average             Average       Balance     Interest     Rate     Balance     Interest     Rate       (dollars in thousands)   ASSETS                                                 Loans   $ 3,928,329     $ 57,154       5.90 %   $ 3,484,511     $ 33,251       3.87 % Investment securities     627,628       3,067       1.95       613,317       2,325       1.52   Other interest-earning assets     31,081       324       4.18       784,193       366       0.19   Total interest - earning assets     4,587,038       60,545       5.35       4,882,021       35,942       2.99                                                     Allowance for credit losses     (43,076 )                     (35,288 )                 Other assets     311,915                       321,829                                                                     Total assets   $ 4,855,877                     $ 5,168,562                                                                                                                       LIABILITIES AND SHAREHOLDERS ’ EQUITY                                                 Interest-bearing deposits   $ 2,184,406     $ 7,907       1.47 %   $ 2,364,437     $ 1,825       0.31 % Short-term borrowings     199,880       459       0.93       198,949       50       0.10   Federal Home Loan Bank advances     338,026       1,794       2.12       372,662       1,864       2.00   Other borrowings     138,818       1,941       5.59       135,867       1,258       3.76   Total interest-bearing liabilities     2,861,130       12,101       1.72       3,071,915       4,997       0.66                                                     Noninterest-bearing deposits     1,491,477                       1,625,453                   Other liabilities     49,746                       21,331                   Shareholders’ equity     453,524                       449,863                                                                     Total liabilities and shareholders’ equity   $ 4,855,877                     $ 5,168,562                                                                     Net interest income           $ 48,444                     $ 30,945                                                             Net interest rate spread                     3.63 %                     2.33 % Net interest spread on average assets                     4.05 %                     2.43 % Net interest margin on earning assets                     4.28 %                     2.57 %   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.     59 Table of Contents   MERCANTILE BANK CORPORATION     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.