MERCANTILE BANK CORP 10-Q

Item 1. Financial Statements CONSOLIDATED BALANCE SHEETS (Unaudited)         September 30,     December 31,       2023     2022   ASSETS                 Cash and due from banks   $ 64,551,000     $ 61,894,000   Interest-earning deposits     201,436,000       34,878,000   Total cash and cash equivalents     265,987,000       96,772,000                     Securities available for sale     592,305,000       602,936,000   Federal Home Loan Bank stock     21,513,000       17,721,000   Mortgage loans held for sale     10,171,000       3,565,000                     Loans     4,104,376,000       3,916,619,000   Allowance for credit losses     ( 48,008,000 )     ( 42,246,000 ) Loans, net     4,056,368,000       3,874,373,000                     Premises and equipment, net     52,231,000       51,476,000   Bank owned life insurance     81,907,000       80,727,000   Goodwill     49,473,000       49,473,000   Core deposit intangible, net     212,000       583,000   Other assets     120,845,000       94,993,000   Total assets   $ 5,251,012,000     $ 4,872,619,000                     LIABILITIES AND SHAREHOLDERS' EQUITY                 Deposits                 Noninterest-bearing   $ 1,309,672,000     $ 1,604,750,000   Interest-bearing     2,591,063,000       2,108,061,000   Total deposits     3,900,735,000       3,712,811,000                     Securities sold under agreements to repurchase     164,082,000       194,340,000   Federal Home Loan Bank advances     457,910,000       308,263,000   Subordinated debentures     49,473,000       48,958,000   Subordinated notes     88,885,000       88,628,000   Accrued interest and other liabilities     106,716,000       78,211,000   Total liabilities     4,767,801,000       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; 16,023,350 shares issued and outstanding at September 30, 2023 and 15,994,884 shares issued and outstanding at December 31, 2022     293,961,000       290,436,000   Retained earnings     262,838,000       216,313,000   Accumulated other comprehensive gain (loss)     ( 73,588,000 )     ( 65,341,000 ) Total shareholders’ equity     483,211,000       441,408,000   Total liabilities and shareholders’ equity   $ 5,251,012,000     $ 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     Nine Months     Nine Months       Ended     Ended     Ended     Ended       September 30, 2023     September 30, 2022     September 30, 2023     September 30, 2022                                     Interest income                                 Loans, including fees   $ 65,073,000     $ 43,807,000     $ 184,232,000     $ 113,061,000   Securities, taxable     2,109,000       2,005,000       5,971,000       5,568,000   Securities, tax-exempt     1,164,000       697,000       3,421,000       1,928,000   Interest-earning deposits     2,807,000       1,620,000       3,932,000       3,004,000   Total interest income     71,153,000       48,129,000       197,556,000       123,561,000                                     Interest expense                                 Deposits     16,143,000       2,299,000       36,429,000       5,997,000   Short-term borrowings     693,000       53,000       2,066,000       153,000   Federal Home Loan Bank advances     3,270,000       1,755,000       8,115,000       5,530,000   Subordinated debt and other borrowings     2,086,000       1,646,000       6,049,000       4,294,000   Total interest expense     22,192,000       5,753,000       52,659,000       15,974,000                                     Net interest income     48,961,000       42,376,000       144,897,000       107,587,000                                     Provision for credit losses     3,300,000       2,900,000       5,900,000       3,500,000                                     Net interest income after provision for credit losses     45,661,000       39,476,000       138,997,000       104,087,000                                     Noninterest income                                 Service charges on deposit and sweep accounts     1,370,000       1,579,000       3,411,000       4,489,000   Credit and debit card income     2,232,000       2,086,000       6,717,000       6,101,000   Mortgage banking income     2,779,000       1,764,000       5,829,000       6,991,000   Interest rate swap fees     937,000       566,000       2,722,000       2,347,000   Payroll services income     591,000       533,000       1,908,000       1,635,000   Earnings on bank owned life insurance     422,000       238,000       1,224,000       1,310,000   Gain on sale of other real estate owned     391,000       27,000       391,000       47,000   Other income     524,000       487,000       1,640,000       1,399,000   Total noninterest income     9,246,000       7,280,000       23,842,000       24,319,000                                     Noninterest expense                                 Salaries and benefits     17,258,000       16,656,000       50,401,000       47,842,000   Occupancy     2,241,000       2,001,000       6,629,000       6,168,000   Furniture and equipment depreciation, rent and maintenance     894,000       953,000       2,594,000       2,822,000   Data processing costs     3,038,000       3,139,000       9,081,000       9,203,000   Charitable foundation contribution     404,000       4,000       416,000       509,000   Other expense     5,085,000       4,030,000       16,228,000       12,943,000   Total noninterest expense     28,920,000       26,783,000       85,349,000       79,487,000                                     Income before federal income tax expense     25,987,000       19,973,000       77,490,000       48,919,000                                     Federal income tax expense     5,132,000       3,943,000       15,303,000       9,659,000                                     Net income   $ 20,855,000     $ 16,030,000     $ 62,187,000     $ 39,260,000                                     Basic earnings per share   $ 1.30     $ 1.01     $ 3.89     $ 2.48   Diluted earnings per share   $ 1.30     $ 1.01     $ 3.89     $ 2.48                                     Average basic shares outstanding     16,018,419       15,861,551       16,006,058       15,850,422   Average diluted shares outstanding     16,018,419       15,861,551       16,006,058       15,850,439     See accompanying notes to consolidated financial statements.   2 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)         Three Months     Three Months     Nine Months     Nine Months       Ended     Ended     Ended     Ended       September 30, 2023     September 30, 2022     September 30, 2023     September 30, 2022                                                                       Net income   $ 20,855,000     $ 16,030,000     $ 62,187,000     $ 39,260,000                                     Other comprehensive income (loss):                                 Unrealized holding gains (losses) on securities available for sale     ( 15,281,000 )     ( 31,387,000 )     ( 10,440,000 )     ( 87,006,000 ) Tax effect of unrealized holding gains (losses) on securities available for sale     3,210,000       6,592,000       2,193,000       18,272,000   Other comprehensive income (loss), net of tax     ( 12,071,000 )     ( 24,795,000 )     ( 8,247,000 )     ( 68,734,000 )                                   Comprehensive income (loss)   $ 8,784,000     $ ( 8,765,000 )   $ 53,940,000     $ ( 29,474,000 )   See accompanying notes to consolidated financial statements.   3 Table of Contents     MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)                                 Accumulated                                       Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income (Loss)     Equity                                             Balances, June 30, 2023   $ 0     $ 292,906     $ 247,313     $ ( 61,517 )   $ 478,702                                             Employee stock purchase plan ( 345 shares)             11                       11                                             Dividend reinvestment plan ( 6,746 shares)             220                       220                                             Stock-based compensation expense             824                       824                                             Cash dividends ($ 0.34 per common share)                     ( 5,330 )             ( 5,330 )                                           Net income for the three months ended September 30, 2023                     20,855               20,855                                             Change in net unrealized holding gain (loss) on securities available for sale, net of tax effect                             ( 12,071 )     ( 12,071 )                                           Balances, September 30, 2023   $ 0     $ 293,961     $ 262,838     $ ( 73,588 )   $ 483,211     See accompanying notes to consolidated financial statements.   4 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) (Unaudited)                                 Accumulated                                       Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income (Loss)     Equity                                             Balances, January 1, 2023   $ 0     $ 290,436     $ 216,313     $ ( 65,341 )   $ 441,408                                             Employee stock purchase plan ( 1,115 shares)             33                       33                                             Dividend reinvestment plan ( 21,447 shares)             670                       670                                             Stock grants to directors for retainer fees ( 10,455 shares)             317                       317                                             Stock-based compensation expense             2,505                       2,505                                             Cash dividends ($ 1.00 per common share)                     ( 15,662 )             ( 15,662 )                                           Net income for the nine months ended September 30, 2023                     62,187               62,187                                             Change in net unrealized holding gain (loss) on securities available for sale, net of tax effect                             ( 8,247 )     ( 8,247 )                                           Balances, September 30, 2023   $ 0     $ 293,961     $ 262,838     $ ( 73,588 )   $ 483,211     See accompanying notes to consolidated financial statements.   5 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) (Unaudited)                                 Accumulated                                       Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income (Loss)     Equity                                             Balances, June 30, 2022   $ 0     $ 288,199     $ 188,452     $ ( 47,668 )   $ 428,983                                             Employee stock purchase plan ( 412 shares)             12                       12                                             Dividend reinvestment plan ( 6,733 shares)             218                       218                                             Stock-based compensation expense             790                       790                                             Cash dividends ($ 0.32 per common share)                     ( 4,977 )             ( 4,977 )                                           Net income for the three months ended September 30, 2022                     16,030               16,030                                             Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect                             ( 24,795 )     ( 24,795 )                                           Balances, September 30, 2022   $ 0     $ 289,219     $ 199,505     $ ( 72,463 )   $ 416,261     See accompanying notes to consolidated financial statements.   6 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued) (Unaudited)                                 Accumulated                                       Other     Total       Preferred     Common     Retained     Comprehensive     Shareholders’   ($ in thousands except per share amounts)   Stock     Stock     Earnings     Income (Loss)     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 ( 1,029 shares)             33                       33                                             Dividend reinvestment plan ( 19,403 shares)             653                       653                                             Stock grants to directors for retainer fees ( 10,837 shares)             347                       347                                             Stock option exercises ( 1,355 shares)             36                       36                                             Stock-based compensation expense             2,398                       2,398                                             Cash dividends ($ 0.94 per common share)                     ( 14,607 )             ( 14,607 )                                           Net income for the nine months ended September 30, 2022                     39,260               39,260                                             Change in net unrealized holding gain/(loss) on securities available for sale, net of tax effect                             ( 68,734 )     ( 68,734 )                                           Balances, September 30, 2022   $ 0     $ 289,219     $ 199,505     $ ( 72,463 )   $ 416,261     See accompanying notes to consolidated financial statements.     7 Table of Contents       MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)         Nine Months     Nine Months       Ended     Ended       September 30, 2023     September 30, 2022                     Cash flows from operating activities                 Net income   $ 62,187,000     $ 39,260,000   Adjustments to reconcile net income to net cash from operating activities                 Depreciation and amortization     8,857,000       9,855,000   Provision for credit losses     5,900,000       3,500,000   Stock-based compensation expense     2,505,000       2,398,000   Stock grants to directors for retainer fee     317,000       347,000   Proceeds from sales of mortgage loans held for sale     143,323,000       195,374,000   Origination of mortgage loans held for sale     ( 144,886,000 )     ( 186,881,000 ) Net gain from sales of mortgage loans held for sale     ( 5,043,000 )     ( 6,787,000 ) Net gain from sales and valuation write-downs of foreclosed assets     ( 391,000 )     ( 47,000 ) Net loss from sales and valuation write-downs of former bank premises     2,000       275,000   Net loss (gain) from sales and write-downs of fixed assets     369,000       ( 18,000 ) Earnings on bank owned life insurance     ( 1,224,000 )     ( 1,310,000 ) Net gain on instruments designated at fair value and related derivatives     ( 21,000 )     ( 149,000 ) Net change in:                 Accrued interest receivable     ( 4,131,000 )     ( 4,677,000 ) Other assets     ( 13,015,000 )     ( 407,000 ) Accrued interest payable and other liabilities     19,163,000       32,060,000   Net cash from operating activities     73,912,000       82,793,000                     Cash flows from investing activities                 Loan originations and payments, net     ( 188,007,000 )     ( 426,842,000 ) Purchases of securities available for sale     ( 13,017,000 )     ( 91,200,000 ) Proceeds from maturities, calls and repayments of securities available for sale     12,856,000       13,262,000   Proceeds from sales of foreclosed assets     452,000       47,000   Proceeds from sales of former bank premises     598,000       2,994,000   Purchases of Federal Home Loan Bank stock     ( 3,792,000 )     0   Proceeds from Federal Home Loan Bank stock redemption     0       281,000   Proceeds from bank owned life insurance death benefits claim     0       628,000   Net purchases of premises and equipment and lease activity     ( 6,141,000 )     ( 2,166,000 ) Net cash for investing activities     ( 197,051,000 )     ( 502,996,000 )   See accompanying notes to consolidated financial statements.   8 Table of Contents   MERCANTILE BANK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Unaudited)         Nine Months     Nine Months       Ended     Ended       September 30, 2023     September 30, 2022                     Cash flows from financing activities                 Net (decrease) increase in time deposits     282,296,000       ( 53,239,000 ) Net decrease in all other deposits     ( 94,372,000 )     ( 183,869,000 ) Net (decrease) increase in securities sold under agreements to repurchase     ( 30,258,000 )     1,142,000   Maturities of Federal Home Loan Bank advances     ( 50,353,000 )     ( 64,000,000 ) Proceeds from Federal Home Loan Bank advances     200,000,000       28,263,000   Net proceeds from subordinated notes issuance     0       14,645,000   Proceeds from stock option exercises, net of cashless exercises     0       36,000   Employee stock purchase plan     33,000       33,000   Dividend reinvestment plan     670,000       653,000   Payment of cash dividends to common shareholders     ( 15,662,000 )     ( 14,607,000 ) Net cash (for) from financing activities     292,354,000       ( 270,943,000 )                   Net change in cash and cash equivalents     169,215,000       ( 691,146,000 ) Cash and cash equivalents at beginning of period     96,772,000       975,160,000   Cash and cash equivalents at end of period   $ 265,987,000     $ 284,014,000                     Supplemental disclosures of cash flows information                 Cash paid during the period for:                 Interest   $ 48,664,000     $ 15,372,000   Federal income tax     18,590,000       6,000,000   Noncash financing and investing activities:                 Transfers from premises and equipment to other assets     0       2,847,000   Transfers from bank premises to other real estate owned     600,000       0   Transfers from loans to foreclosed assets     112,000       0     See accompanying notes to consolidated financial statements.     9 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 nine months ended September 30, 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 subsidiaries, Mercantile Insurance Center, Inc. and Mercantile Community Partners. 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 September 30, 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 345,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2023 . Stock options for 5,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2023 .   Approximately 319,000 unvested restricted shares were included in determining both basic and diluted earnings per share for the three and nine months ended September 30, 2022 . In addition, stock options for approximately 1,000 shares of common stock were included in determining diluted earnings per share for the three and nine months ended September 30, 2022 . Stock options for approximately 5,000 shares of common stock were antidilutive and not included in determining diluted earnings per share for the three and nine months ended September 30, 2022 .   (Continued)   10 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1.      SIGNIFICANT ACCOUNTING POLICIES (Continued)   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.   Changes in the allowance are recorded as provisions for (or reversals of) credit loss expense. Losses are charged against the allowance when the collectability of an available for sale debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At September 30, 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.   Federal Home Loan Bank of Indianapolis (“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 ($ 2.4 ) million and ($ 1.0 ) million at September 30, 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.   (Continued)   11 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1.      SIGNIFICANT ACCOUNTING POLICIES (Continued)   Loans Held for Sale : Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. As of September 30, 2023 and December 31, 2022 , we determined that the fair value of our mortgage loans held for sale totaled $ 10.2  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.   Allowance for Credit Losses ( “ Allowance ” ) : On January 1, 2022, we adopted ASU No. 2016 - 13, Financial Instruments – Credit Losses (Topic 32 ): Measurement of Credit Losses on Financial Instruments , as amended, which replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost and certain off-balance sheet credit exposures.   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 uncollectability of a loan is confirmed.   We estimate the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for changes in current loan-specific risk characteristics such as changes in underwriting standards, portfolio mix, delinquency level or other relevant factors.   We recorded a provision expense of $ 5.9  million during the first nine months of  2023 , generally reflecting allocations necessitated by net loan growth and adjustments to historical loss information to better represent our expectations for future credit losses.  Changes to qualitative factors included a reduction of the historical loss information factor which coincided with adjustments to historical loss information and an allocation considering local economic conditions, particularly the potential impacts of the United Auto Workers strike against the three Detroit-based auto manufacturers.  A higher reserve balance for residential mortgage loans stemming from slower principal prepayment rates and the resulting extended average life of the portfolio also impacted provision expense during the first nine months of 2023.   Net changes in specific reserve balances reduced the reserve balance $ 0.9 million, while updated economic forecasts resulted in a $ 0.1 million reduction during the first nine months of 2023.     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)   12 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1.      SIGNIFICANT ACCOUNTING POLICIES (Continued)   Our loan portfolio segments as of September 30, 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.   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, stock market volatility and property price indices, to quantify the impact of current and forecasted economic conditions on expected loan performance.   (Continued)   13 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1.      SIGNIFICANT ACCOUNTING POLICIES (Continued)   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 September 30, 2023 and December 31, 2022 , we used a one -year reasonable and supportable economic forecast period, with a six -month straight-line reversion period for all loan segments.   We are not required to develop and use our own economic forecast model, and elected to utilize economic forecasts from third -party providers that analyze and develop forecasts of the economy for the entire United States at least quarterly. The economic forecasts used for our September 30, 2023 allowance calculation reflected a decrease in our allowance balance of $ 0.1  million 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   The estimation of future credit losses should reflect consideration of all significant factors that affect the collectability 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.   (Continued)   14 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1.      SIGNIFICANT ACCOUNTING POLICIES (Continued)   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.   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 uncollectable interest.   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 $ 1.39  billion and $ 1.38 billion as of September 30, 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)   15 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 September 30, 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.   (Continued)   16 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     1.     SIGNIFICANT ACCOUNTING POLICIES (Continued)   We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.   The following table depicts our sources of noninterest income presented in the Consolidated Statements of Income that are scoped within Topic 606:       Three Months     Three Months     Nine Months     Nine Months       Ended     Ended     Ended     Ended       September 30, 2023     September 30, 2022     September 30, 2023     September 30, 2022                                     Service charges on deposit and sweep accounts   $ 1,370,000     $ 1,579,000     $ 3,411,000     $ 4,489,000   Credit and debit card fees     2,232,000       2,086,000       6,717,000       6,101,000   Payroll processing     591,000       533,000       1,908,000       1,635,000   Customer service fees     205,000       210,000       612,000       654,000     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.   Standards Recently Adopted : ASU No. 2022 - 02 Financial Instruments – Credit Losses (Topic 326 ): Troubled Debt Restructurings and Vintage Disclosures . This ASU eliminated 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)   17 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)       2.      SECURITIES   The amortized cost and fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income are as follows:               Gross     Gross               Amortized     Unrealized     Unrealized     Fair       Cost     Gains     Losses     Value   September 30, 2023                                 U.S. Government agency debt obligations   $ 452,330,000     $ 0     $ ( 68,251,000 )   $ 384,079,000   Mortgage-backed securities     35,699,000       2,000       ( 7,685,000 )     28,016,000   Municipal general obligation bonds     166,922,000       33,000       ( 13,530,000 )     153,425,000   Municipal revenue bonds     30,004,000       14,000       ( 3,733,000 )     26,285,000   Other investments     500,000       0       0       500,000                                         $ 685,455,000     $ 49,000     $ ( 93,199,000 )   $ 592,305,000                                     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 September 30, 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   September 30, 2023                                                 U.S. Government agency debt obligations   $ 2,679,000     $ 1,124,000     $ 381,400,000     $ 67,127,000     $ 384,079,000     $ 68,251,000   Mortgage-backed securities     26,231,000       7,558,000       1,604,000       127,000       27,835,000       7,685,000   Municipal general obligation bonds     33,136,000       2,992,000       115,872,000       10,538,000       149,008,000       13,530,000   Municipal revenue bonds     6,710,000       1,043,000       18,066,000       2,690,000       24,776,000       3,733,000                                                         $ 68,756,000     $ 12,717,000     $ 516,942,000     $ 80,482,000     $ 585,698,000     $ 93,199,000     (Continued)   18 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     Unrealized     Fair     Unrealized     Fair     Unrealized       Value     Loss     Value     Loss     Value     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 September 30, 2023 , 809  debt securities with estimated fair values totaling $ 586  million had unrealized losses aggregating $ 93.2  million. At December 31, 2022 , 732 debt securities with estimated fair values totaling $ 573 million had unrealized losses aggregating $ 83.3 million. At September 30, 2023 , unrealized losses aggregating $ 75.9  million were attributable to bonds issued or guaranteed by agencies of the U.S. Federal Government, while unrealized losses totaling $ 17.3  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)   19 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 September 30, 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   0.35 %   $ 10,635,000     $ 10,560,000   Due in 2024 through 2028   1.32       319,456,000       289,600,000   Due in 2029 through 2033   2.02       278,377,000       227,860,000   Due in 2034 and beyond   3.68       40,788,000       35,769,000   Mortgage-backed securities   2.18       35,699,000       28,016,000   Other investments   8.42       500,000       500,000                           Total available for sale securities   1.78 %   $ 685,455,000     $ 592,305,000     No securities were sold during the first nine 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 $ 197  million and $ 193 million at September 30, 2023 and  December 31, 2022 , respectively, with estimated market values of $ 180  million and $ 182 million at the respective dates. We had no securities issued by all other states and their political subdivisions as of September 30, 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 obligation securities that are pledged to secure repurchase agreements was $ 164  million and $ 194  million at September 30, 2023 , and December 31, 2022 , respectively. The carrying value of U.S. Government agency debt obligation securities that are pledged to deposits was $ 96.5  million at September 30, 2023 ; we had no securities pledged to deposits as of December 31, 2022 .   (Continued)   20 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)         3.      LOANS AND ALLOWANCE FOR CREDIT LOSSES   Our total loans at September 30, 2023 were $ 4.10  billion compared to $ 3.92  billion at December 31, 2022 , an increase of $ 188  million, or 4.8 %. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at September 30, 2023 and  December 31, 2022 , and the percentage change in loans from the end of 2022 to the end of the  third quarter of 2023 , are as follows:                                       Percent       September 30, 2023     December 31, 2022     Increase       Balance       %   Balance       %   (Decrease)                                             Commercial:                                         Commercial and industrial   $ 1,166,187,000       28.4 %   $ 1,185,083,000       30.3 %     ( 1.6 )% Vacant land, land development, and residential construction     72,921,000       1.7       61,873,000       1.6       17.9   Real estate – owner occupied     671,083,000       16.4       639,192,000       16.3       5.0   Real estate – non-owner occupied *     1,000,411,000       24.4       979,214,000       25.0       2.2   Real estate – multi-family and residential rental *     308,229,000       7.5       266,468,000       6.8       15.7   Total commercial     3,218,831,000       78.4       3,131,830,000       80.0       2.8                                             Retail:                                         1-4 family mortgages     854,175,000       20.8       755,036,000       19.3       13.1   Other consumer loans     31,370,000       0.8       29,753,000       0.7       5.4   Total retail     885,545,000       21.6       784,789,000       20.0       12.8                                             Total loans   $ 4,104,376,000       100.0 %   $ 3,916,619,000       100.0 %     4.8 %     (*) We have made certain reclassifications of how multi-family construction loans are disaggregated by loan segment. The table above reflects an increase of $ 54.5 million in Real Estate – Multi-Family and Residential Rental loans and a corresponding decrease in Real Estate – Non-Owner Occupied loans as of December 31, 2022 . All the tables that follow have been adjusted to reflect the reclassifications as of the applicable dates.   Nonperforming loans as of September 30, 2023 and December 31, 2022 were as follows:       September 30,     December 31,       2023     2022                     Loans past due 90 days or more still accruing interest   $ 0     $ 0   Nonaccrual loans     5,889,000       7,728,000                     Total nonperforming loans   $ 5,889,000     $ 7,728,000     (Continued)   21 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:       September 30,     December 31,       2023     2022   Commercial:                 Commercial and industrial   $ 3,288,000     $ 6,024,000   Vacant land, land development, and residential construction     0       0   Real estate – owner occupied     738,000       248,000   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     4,026,000       6,272,000                     Retail:                 1-4 family mortgages     1,863,000       1,456,000   Other consumer loans     0       0   Total retail     1,863,000       1,456,000                     Total nonperforming loans   $ 5,889,000     $ 7,728,000     (Continued)   22 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 September 30, 2023 :                                                       Recorded                       Greater                             Balance       30 – 59     60 – 89     Than 89                             > 89       Days     Days     Days     Total             Total     Days and       Past Due     Past Due     Past Due     Past Due     Current     Loans     Accruing                                                             Commercial:                                                         Commercial and industrial   $ 4,000     $ 0     $ 249,000     $ 253,000     $ 1,165,934,000     $ 1,166,187,000     $ 0   Vacant land, land development, and residential construction     0       0       0       0       72,921,000       72,921,000       0   Real estate – owner occupied     0       0       70,000       70,000       671,013,000       671,083,000       0   Real estate – non- owner occupied     0       0       0       0       1,000,411,000       1,000,411,000       0   Real estate – multi-family and residential rental     0       0       0       0       308,229,000       308,229,000       0   Total commercial     4,000       0       319,000       323,000       3,218,508,000       3,218,831,000       0                                                             Retail:                                                         1-4 family mortgages     680,000       499,000       132,000       1,311,000       852,864,000       854,175,000       0   Other consumer loans     1,000       0       0       1,000       31,369,000       31,370,000       0   Total retail     681,000       499,000       132,000       1,312,000       884,233,000       885,545,000       0                                                             Total past due loans   $ 685,000     $ 499,000     $ 451,000     $ 1,635,000     $ 4,102,741,000     $ 4,104,376,000     $ 0     (Continued)   23 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 :                                                       Recorded                       Greater                             Balance       30 –59     60 –89     Than 89                             > 89       Days     Days     Days     Total             Total     Days and       Past Due     Past Due     Past Due     Past Due     Current     Loans     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       979,214,000       979,214,000       0   Real estate – multi-family and residential rental     0       0       0       0       266,468,000       266,468,000       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 $ 5.9  million and $ 7.7 million as of September 30, 2023 and December 31, 2022 , respectively.   (Continued)   24 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3.      LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Nonaccrual loans as of September 30, 2023 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     738,000       0   Real estate – non-owner occupied     0       0   Real estate – multi-family and residential rental     0       0   Total commercial     987,000       0                     Retail:                 1-4 family mortgages     1,366,000       0   Other consumer loans     0       0   Total retail     1,366,000       0                     Total with no allowance recorded   $ 2,353,000     $ 0                     With an allowance recorded:                 Commercial:                 Commercial and industrial   $ 3,039,000     $ 1,233,000   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     3,039,000       1,233,000                     Retail:                 1-4 family mortgages     497,000       192,000   Other consumer loans     0       0   Total retail     497,000       192,000                     Total with an allowance recorded   $ 3,536,000     $ 1,425,000                     Total nonaccrual loans:                 Commercial   $ 4,026,000     $ 1,233,000   Retail     1,863,000       192,000   Total nonaccrual loans   $ 5,889,000     $ 1,425,000     No interest income was recognized on nonaccrual loans during the first nine months of  2023 .   (Continued)   25 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)   26 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 uncollectable, 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)   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 basis of loans and year-to-date loan charge-offs as of  September 30, 2023 based on year of origination (dollars in thousands):                                                               Revolving     Grand       2023     2022     2021     2020     2019     Prior     Term Total     Loans     Total   Commercial:                                                                         Commercial and Industrial:                                                                         Grades 1 – 4   $ 94,356     $ 94,042     $ 100,652     $ 25,063     $ 7,012     $ 9,411     $ 330,536     $ 384,697     $ 715,233   Grades 5 – 7     112,012       67,379       32,543       19,118       7,629       154       238,835       180,387       419,222   Grades 8 – 9     3,674       2,439       296       0       0       0       6,409       25,323       31,732   Total   $ 210,042     $ 163,860     $ 133,491     $ 44,181     $ 14,641     $ 9,565     $ 575,780     $ 590,407     $ 1,166,187   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 218     $ 218                                                                             Vacant Land, Land Development and Residential Construction:                                                                         Grades 1 – 4   $ 17,966     $ 15,813     $ 1,751     $ 2,832     $ 0     $ 287     $ 38,649     $ 0     $ 38,649   Grades 5 – 7     13,749       17,194       2,359       319       43       514       34,178       0       34,178   Grades 8 – 9     10       0       0       0       0       84       94       0       94   Total   $ 31,725     $ 33,007     $ 4,110     $ 3,151     $ 43     $ 885     $ 72,921     $ 0     $ 72,921   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0                                                                             Real Estate – Owner Occupied:                                                                         Grades 1 – 4   $ 165,698     $ 117,923     $ 82,222     $ 49,528     $ 17,511     $ 16,968     $ 449,850     $ 456     $ 450,306   Grades 5 – 7     62,259       62,487       36,949       29,235       9,614       10,064       210,608       6,332       216,940   Grades 8 – 9     0       3,727       0       40       0       70       3,837       0       3,837   Total   $ 227,957     $ 184,137     $ 119,171     $ 78,803     $ 27,125     $ 27,102     $ 664,295     $ 6,788     $ 671,083   Current year-to-date gross write offs   $ 0     $ 14     $ 0     $ 0     $ 0     $ 40     $ 54     $ 0     $ 54                                                                             Real Estate – Non-Owner Occupied:                                                                         Grades 1 – 4   $ 92,790     $ 88,742     $ 113,072     $ 101,821     $ 28,307     $ 17,189     $ 441,921     $ 0     $ 441,921   Grades 5 – 7     162,540       126,362       128,389       96,612       6,553       26,013       546,469       0       546,469   Grades 8 – 9     0       6,507       5,514       0       0       0       12,021       0       12,021   Total   $ 255,330     $ 221,611     $ 246,975     $ 198,433     $ 34,860     $ 43,202     $ 1,000,411     $ 0     $ 1,000,411   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   $ 20,509     $ 42,674     $ 61,279     $ 35,615     $ 4,974     $ 5,780     $ 170,831     $ 0     $ 170,831   Grades 5 – 7     52,733       53,171       4,985       9,727       2,783       1,735       125,134       0       125,134   Grades 8 – 9     11,250       0       0       1,014       0       0       12,264       0       12,264   Total   $ 84,492     $ 95,845     $ 66,264     $ 46,356     $ 7,757     $ 7,515     $ 308,229     $ 0     $ 308,229   Current year-to-date gross write offs   $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0     $ 0                                                                             Total Commercial   $ 809,546     $ 698,460     $ 570,011     $ 370,924     $ 84,426     $ 88,269     $ 2,621,636     $ 597,195     $ 3,218,831   Total Commercial current YTD gross write offs   $ 0     $ 14     $ 0     $ 0     $ 0     $ 40     $ 54     $ 218     $ 272     (Continued)   28 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3.      LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)                                                               Revolving     Grand       2023     2022     2021     2020     2019     Prior     Term Total     Loans     Total   Retail:                                                                         1-4 Family Mortgages:                                                                         Performing   $ 104,955     $ 334,373     $ 235,394     $ 83,701     $ 10,833     $ 46,666     $ 815,922     $ 36,390     $ 852,312   Nonperforming     142       313       333       0       11       1,064       1,863       0       1,863   Total   $ 105,097     $ 334,686     $ 235,727     $ 83,701     $ 10,844     $ 47,730     $ 817,785     $ 36,390     $ 854,175   Current year-to-date gross write offs   $ 0     $ 136     $ 0     $ 0     $ 0     $ 239     $ 375     $ 138     $ 513                                                                             Other Consumer Loans:                                                                         Performing   $ 4,449     $ 2,954     $ 1,667     $ 542     $ 658     $ 336     $ 10,606     $ 20,764     $ 31,370   Nonperforming     0       0       0       0       0       0       0       0       0   Total   $ 4,449     $ 2,954     $ 1,667     $ 542     $ 658     $ 336     $ 10,606     $ 20,764     $ 31,370   Current year-to-date gross write offs   $ 2     $ 3     $ 0     $ 0     $ 0     $ 3     $ 8     $ 17     $ 25                                                                             Total Retail   $ 109,546     $ 337,640     $ 237,394     $ 84,243     $ 11,502     $ 48,066     $ 828,391     $ 57,154     $ 885,545   Total Retail Current YTD gross write offs   $ 2     $ 139     $ 0     $ 0     $ 0     $ 242     $ 383     $ 155     $ 538                                                                             Grand Total   $ 919,092     $ 1,036,100     $ 807,405     $ 455,167     $ 95,928     $ 136,335     $ 3,450,027     $ 654,349     $ 4,104,376   Grand Total Current YTD gross write offs   $ 2     $ 153     $ 0     $ 0     $ 0     $ 282     $ 437     $ 373     $ 810     There were no revolving loans converted to term loans during the first nine months of  2023 .   (Continued)   29 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 as of December 31, 2022 based on year of origination (dollars in thousands):                                                               Revolving     Grand       2022     2021     2020     2019     2018     Prior     Term Total     Loans     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   $ 121,281     $ 152,035     $ 89,125     $ 44,196     $ 10,079     $ 12,018     $ 428,734     $ 0     $ 428,734   Grades 5 – 7     176,217       142,645       133,163       35,200       13,456       37,399       538,080       0       538,080   Grades 8 – 9     6,712       5,688       0       0       0       0       12,400       0       12,400   Total   $ 304,210     $ 300,368     $ 222,288     $ 79,396     $ 23,535     $ 49,417     $ 979,214     $ 0     $ 979,214                                                                             Real Estate – Multi-Family and Residential Rental:                                                                         Grades 1 – 4   $ 39,342     $ 49,178     $ 36,348     $ 5,306     $ 3,082     $ 4,003     $ 137,259     $ 0     $ 137,259   Grades 5 – 7     56,018       47,474       19,666       3,162       2,557       283       129,160       0       129,160   Grades 8 – 9     0       0       0       0       0       49       49       0       49   Total   $ 95,360     $ 96,652     $ 56,014     $ 8,468     $ 5,639     $ 4,335     $ 266,468     $ 0     $ 266,468   Total Commercial   $ 1,025,368     $ 770,437     $ 445,326     $ 135,893     $ 64,986     $ 72,100     $ 2,514,110     $ 617,720     $ 3,131,830     (Continued)   30 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3.      LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)                                                               Revolving     Grand       2022     2021     2020     2019     2018     Prior     Term Total     Loans     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     $ 1,016,339     $ 538,302     $ 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 .   (Continued)   31 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 and nine months ended September 30, 2023 is as follows (dollars in thousands):               Commercial                     Commercial                                               vacant land,                     real estate –                                       Commercial     land development     Commercial     Commercial     multi-family             Other                       and     and residential     real estate –     real estate –     and     1-4 family     consumer                       industrial     reconstruction     owner occupied     non-owner occupied     residential rental     mortgages     loans     Unallocated     Total   Allowance for credit losses:                                                                         Balance at 6-30-23   $ 6,472     $ 304     $ 5,838     $ 8,689     $ 3,700     $ 19,498     $ 199     $ 21     $ 44,721   Provision for credit losses     2,500       31       627       564       ( 1,071 )     726       ( 56 )     ( 21 )     3,300   Charge-offs     0       0       ( 40 )     0       0       ( 201 )     ( 2 )     0       ( 243 ) Recoveries     26       22       9       0       6       161       6       0       230   Ending balance   $ 8,998     $ 357     $ 6,434     $ 9,253     $ 2,635     $ 20,184     $ 147     $ 0     $ 48,008                                                                                                                                                       Balance at 12-31-22   $ 10,203     $ 490     $ 5,914     $ 9,242     $ 2,191     $ 14,027     $ 160     $ 19     $ 42,246   Provision for credit losses     ( 1,123 )     ( 167 )     495       11       426       6,317       ( 40 )     ( 19 )     5,900   Charge-offs     ( 218 )     0       ( 54 )     0       0       ( 513 )     ( 25 )     0       ( 810 ) Recoveries     136       34       79       0       18       353       52       0       672   Ending balance   $ 8,998     $ 357     $ 6,434     $ 9,253     $ 2,635     $ 20,184     $ 147     $ 0     $ 48,008     (Continued)   32 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 and  nine months ended September 30, 2022 is as follows (dollars in thousands):               Commercial                     Commercial                                               vacant land,                     real estate –                                       Commercial     land development     Commercial     Commercial     multi-family             Other                       and     and residential     real estate –     real estate –     and     1-4 family     consumer                       industrial     construction     owner occupied     non-owner occupied     residential rental     mortgages     loans     Unallocated     Total   Allowance for credit losses:                                                                         Balance at 6-30-22   $ 8,608     $ 446     $ 5,578     $ 9,249     $ 1,639     $ 10,267     $ 165     $ 22     $ 35,974   Provision for credit losses     1,110       21       372       ( 206 )     77       1,530       ( 13 )     9       2,900   Charge-offs     0       0       0       0       0       0       0       0       0   Recoveries     22       1       22       0       23       154       24       0       246   Ending balance   $ 9,740     $ 468     $ 5,972     $ 9,043     $ 1,739     $ 11,951     $ 176     $ 31     $ 39,120                                                                                                                                                       Balance at 12-31-21   $ 10,782     $ 420     $ 6,045     $ 12,990     $ 2,006     $ 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     518       117       407       ( 1,413 )     317       3,587       ( 74 )     41       3,500   Charge-offs     ( 170 )     ( 29 )     0       0       0       ( 2 )     ( 18 )     0       ( 219 ) Recoveries     181       3       80       0       37       522       53       0       876   Ending balance   $ 9,740     $ 468     $ 5,972     $ 9,043     $ 1,739     $ 11,951     $ 176     $ 31     $ 39,120     (Continued)   33 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3.      LOANS AND ALLOWANCE FOR CREDIT LOSSES  (Continued)   The following table presents the period-end amortized cost basis of modifications to borrowers experiencing financial difficulty by type of modification made during the three months ended September 30, 2023:         Interest Rate       Principal     Reduction   Term Extension   Forgiveness 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   0   0   0 Other consumer loans   0   0   0 Total retail   $ 0   $ 0   $ 0               Total loans   $ 0   $ 0   $ 0   The following table presents the period-end amortized cost basis of modifications to borrowers experiencing financial difficulty by type of modification made during the nine  months ended September 30, 2023:       Interest Rate       Principal     Reduction   Term Extension   Forgiveness Commercial:             Commercial and industrial   $ 0   $ 8,184,000   $ 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   $ 8,184,000   $ 0               Retail:             1-4 family mortgages   0   0   0 Other consumer loans   0   0   0 Total retail   $ 0   $ 0   $ 0               Total loans   $ 0   $ 8,184,000   $ 0   Loans listed under Term Extension were generally granted a series of short-term maturity extensions as part of workout process and associated forbearance agreements.   The following table presents the period-end amortized cost basis of loans that have been modified in the past twelve months to borrowers experiencing financial difficulty by payment status and loan segment:               30 – 89 Days     90 + Days               Current     Past Due     Past Due     Total   Commercial:                                 Commercial and industrial   $ 8,184,000     $ 0     $ 0     $ 8,184,000   Vacant land, land development and residential construction     0       0       0       0   Real estate – owner occupied     0       0       0       0   Real estate – non-owner occupied     0       0       0       0   Real estate – multi-family and residential rental     0       0       0       0   Total commercial   $ 8,184,000     $ 0     $ 0     $ 8,184,000                                     Retail:                                 1-4 family mortgages     0       0       0       0   Other consumer loans     0       0       0       0   Total retail   $ 0     $ 0     $ 0     $ 0                                     Total loans   $ 8,184,000     $ 0     $ 0     $ 8,184,000     (Continued)   34 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3.       LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   Loans modified as troubled debt restructurings during the three months ended  September 30, 2022 were as follows:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     1     $ 19,000     $ 19,000   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     0       0       0   Real estate – non-owner occupied     0       0       0   Real estate – multi-family and residential rental     0       0       0   Total commercial     1       19,000       19,000                             Retail:                         1-4 family mortgages     2       289,000       289,000   Other consumer loans     0       0       0   Total retail     2       289,000       289,000                             Total loans     3     $ 308,000     $ 308,000     Loans modified as troubled debt restructurings during the  nine months ended September 30, 2022 were as follows:               Pre-     Post-               Modification     Modification               Recorded     Recorded       Number of     Principal     Principal       Contracts     Balance     Balance                             Commercial:                         Commercial and industrial     3     $ 6,593,000     $ 6,593,000   Vacant land, land development and residential construction     0       0       0   Real estate – owner occupied     0       0       0   Real estate – non-owner occupied     0       0       0   Real estate – multi-family and residential rental     0       0       0   Total commercial     3       6,593,000       6,593,000                             Retail:                         1-4 family mortgages     5       501,000       500,000   Other consumer loans     0       0       0   Total retail     5       501,000       500,000                             Total loans     8     $ 7,094,000     $ 7,093,000     (Continued)   35 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     3.       LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)   We had no loans modified as troubled debt restructurings within the previous twelve months that became over 30 days past due within the three months or nine months ended September 30, 2022.   Activity for loans categorized as troubled debt restructurings during the three months ended  September 30, 2022 is as follows:               Commercial                                       Vacant Land,                     Commercial               Land                     Real Estate -               Development,     Commercial     Commercial     Multi-Family       Commercial     and     Real Estate -     Real Estate -     and       and     Residential     Owner     Non-Owner     Residential       Industrial     Construction     Occupied     Occupied     Rental                                             Commercial Loan Portfolio:                                         Beginning Balance   $ 9,938,000     $ 0     $ 87,000     $ 139,000     $ 88,000   Charge-Offs     0       0       0       0       0   Payments (net)     ( 891,000 )     0       ( 3,000 )     ( 4,000 )     ( 88,000 ) Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     19,000       0       0       0       0   Ending Balance   $ 9,066,000     $ 0     $ 84,000     $ 135,000     $ 0         Retail     Retail       1-4 Family     Other Consumer       Mortgages     Loans   Retail Loan Portfolio:                 Beginning Balance   $ 2,339,000     $ 3,000   Charge-Offs     0       0   Payments (net)     ( 84,000 )     ( 1,000 ) Transfers to ORE     0       0   Net Additions/Deletions     289,000       0   Ending Balance   $ 2,544,000     $ 2,000     (Continued)   36 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  nine months ended September 30, 2022 is as follows:               Commercial                                       Vacant Land,                     Commercial               Land                     Real Estate -               Development,     Commercial     Commercial     Multi-Family       Commercial     and     Real Estate -     Real Estate -     and       and     Residential     Owner     Non-Owner     Residential       Industrial     Construction     Occupied     Occupied     Rental                                             Commercial Loan Portfolio:                                         Beginning Balance   $ 4,973,000     $ 0     $ 10,435,000     $ 146,000     $ 91,000   Charge-Offs     ( 95,000 )     0       0       0       0   Payments (net)     ( 378,000 )     0       ( 9,682,000 )     ( 11,000 )     ( 91,000 ) Transfers to ORE     0       0       0       0       0   Net Additions/Deletions     4,566,000       0       ( 669,000 )     0       0   Ending Balance   $ 9,066,000     $ 0     $ 84,000     $ 135,000     $ 0         Retail     Retail       1-4 Family     Other Consumer       Mortgages     Loans   Retail Loan Portfolio:                 Beginning Balance   $ 627,000     $ 1,202,000   Charge-Offs     0       0   Payments (net)     ( 253,000 )     ( 13,000 ) Transfers to ORE     0       0   Net Additions/Deletions (1)     2,170,000       ( 1,187,000 ) Ending Balance   $ 2,544,000     $ 2,000       ( 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)   37 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:       September 30,     December 31,       2023     2022                     Land and improvements   $ 13,072,000     $ 13,532,000   Buildings     57,076,000       53,865,000   Furniture and equipment     24,658,000       22,941,000         94,806,000       90,338,000   Less: accumulated depreciation     42,575,000       38,862,000                     Premises and equipment, net   $ 52,231,000     $ 51,476,000     Depreciation expense totaled $ 1.5  million during the third quarters of both  2023 and 2022 . Depreciation expense totaled $ 4.4 million during the first nine months of  2023 , compared to $ 4.5  million during the first nine months of 2022 .   We enter into facility leases in the normal course of business. As of September 30, 2023 , we were under lease contracts for eleven of our banking facilities. The leases have maturity dates ranging from February, 2024 through December, 2029, with a weighted average life of  2.2  years as of September 30, 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 5.9 % as of September 30, 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 $ 4.0  million and $ 3.5 million as of September 30, 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 $ 0.4  million and $ 0.2 million during the third quarters of 2023 and 2022 , respectively, and $ 1.3  million and $ 0.6  million during the first nine months of  2023 and 2022 , respectively.   (Continued)   38 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     4.      PREMISES AND EQUIPMENT, NET (Continued)   Future lease payments were as follows as of September 30, 2023 :   2023   $ 354,000   2024     1,210,000   2025     721,000   2026     612,000   2027     553,000   Thereafter     1,696,000   Total undiscounted lease payments     5,146,000   Less effect of discounting     ( 1,147,000 ) Present value of future lease payments (lease liability)   $ 3,999,000         5.      DEPOSITS   Our total deposits at September 30, 2023 totaled $ 3.90  billion, an increase of $ 188  million, or 5.1 %, from December  31, 2022. The components of our outstanding balances at September 30, 2023 and  December 31, 2022 , and percentage change in deposits from the end of 2022 to the end of the third quarter of 2023, are as follows:                                       Percent       September 30, 2023     December 31, 2022     Increase       Balance     %     Balance     %     (Decrease)                                             Noninterest-bearing checking   $ 1,309,672,000       33.6 %   $ 1,604,750,000       43.2 %     ( 18.4 )% Interest-bearing checking     670,843,000       17.2       575,028,000       15.5       16.7   Money market     976,348,000       25.0       776,723,000       20.9       25.7   Savings     286,868,000       7.4       381,602,000       10.3       ( 24.8 ) Time, under $100,000     155,511,000       4.0       113,099,000       3.0       37.5   Time, $100,000 and over     390,213,000       10.0       261,609,000       7.1       49.2   Total local deposits     3,789,455,000       97.2       3,712,811,000       100.0       2.1                                             Out-of-area time, $100,000 and over     111,280,000       2.8       0       0.0       N/A                                             Total deposits   $ 3,900,735,000       100.0 %   $ 3,712,811,000       100.0 %     5.1 %   (Continued)   39 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)        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:       Nine Months Ended     Twelve Months Ended       September 30, 2023     December 31, 2022                     Outstanding balance at end of period   $ 164,082,000     $ 194,340,000   Average interest rate at end of period     0.74 %     0.75 %                   Average daily balance during the period   $ 211,680,000     $ 200,499,000   Average interest rate during the period     1.22 %     0.15 %                   Maximum daily balance during the period   $ 269,324,000     $ 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.      7.      FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES   FHLBI bullet advances totaled $ 430  million at September 30, 2023 , and were scheduled to mature at varying dates from October 2023  through June 2028 , with fixed rates of interest from 0.55 % to 5.05 % and averaging 2.80 %. 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 September 30, 2023 were as follows:   2023   $ 30,000,000   2024     90,000,000   2025     80,000,000   2026     80,000,000   2027     90,000,000   Thereafter     60,000,000     (Continued)   40 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     7.      FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES (Continued)   FHLBI amortizing advances totaled $ 27.9  million as of September 30, 2023 , with an average rate of 2.52 % and with final maturities in 2042 . FHLBI amortizing advances totaled $ 28.3  million as of December 31, 2022 , with an average rate of 2.52 % and with final maturities in 2042 . FHLBI amortizing advances are obtained periodically to assist in managing interest rate risk associated with certain longer-term fixed rate commercial loans, with annual principal payments that closely align with the scheduled amortization of the underlying commercial loans.   Scheduled principal payments on FHLBI amortizing advances as of  September 30, 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  September 30, 2023 totaled $ 888  million, with remaining availability based on collateral of $ 424  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.   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.   (Continued)   41 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     8.      COMMITMENTS AND OFF-BALANCE SHEET RISK (Continued)   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 $ 0.7  million and $ 0.1  million as of September 30, 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 September 30, 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 September 30, 2023 and  December 31, 2022 is as follows:        September 30,     December 31,       2023     2022                     Commercial unused lines of credit   $ 1,603,414,000     $ 1,283,703,000   Unused lines of credit secured by 1–4 family residential properties     74,130,000       71,972,000   Credit card unused lines of credit     135,886,000       123,687,000   Other consumer unused lines of credit     58,486,000       75,747,000   Commitments to make loans     287,510,000       329,646,000   Standby letters of credit     19,367,000       23,539,000       $ 2,178,793,000     $ 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.   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.   (Continued)   42 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     9.     DERIVATIVES AND HEDGING ACTIVITIES (Continued)   The fair values of derivative instruments as of September 30, 2023 , are reflected in the following table.             Balance Sheet             Notional Amount   Location   Fair Value                       Derivative Assets                   Interest rate swaps   $ 591,790,000   Other Assets   $ 35,060,000                       Derivative Liabilities                   Interest rate swaps     591,790,000   Other Liabilities     35,242,000     The effect of interest rate swaps that are not designated as hedging instruments resulted in income of $ 0.1  million during the first nine 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 $ 35.2  million as of September 30, 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 September 30, 2023 , the gross amount of derivative assets subject to master netting agreements presented on the Consolidated Balance Sheets was $ 34.7  million, while cash collateral reflecting cash requirements from our counterparties to us totaled $ 36.1  million, providing for an over-collateralized position on the Consolidated Balance Sheets of $ 1.4 million. As of September 30, 2023 , the gross amount of derivative liabilities subject to master netting agreements presented on the Consolidated Balance Sheets was $ 0.3  million, while cash collateral reflecting cash requirements from us to our counterparties totaled $ 0.3  million, and the net amount of derivative liabilities not offset on the Consolidated Balance Sheets was less than $ 0.1  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 $ 592 million as of September 30, 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.             Balance Sheet             Notional Amount   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)   43 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)   44 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 September 30, 2023 and December 31, 2022 (dollars in thousands):       Level in     September 30, 2023     December 31, 2022       Fair                                       Value     Carrying     Fair     Carrying     Fair       Hierarchy     Values     Values     Values     Values   Financial assets:                                       Cash and cash equivalents   Level 1     $ 265,987     $ 265,987     $ 96,772     $ 96,772   Securities available for sale   (1)       592,305       592,305       602,936       602,936   FHLBI stock   (2)       21,513       21,513       17,721       17,721   Loans, net   Level 3       4,056,368       3,953,468       3,874,373       3,800,042   Mortgage loans held for sale   Level 2       10,171       10,246       3,565       3,643   Mortgage servicing rights   Level 3       11,391       19,451       11,837       17,727   Accrued interest receivable   Level 2       19,607       19,607       15,476       15,476   Interest rate swaps   Level 2       35,060       35,060       25,697       25,697                                           Financial liabilities:                                       Deposits   Level 2       3,900,735       3,558,860       3,712,811       3,379,403   Repurchase agreements   Level 2       164,082       164,082       194,340       194,340   FHLBI advances   Level 2       457,910       434,992       308,263       292,044   Subordinated debentures   Level 2       49,473       56,009       48,958       49,531   Subordinated notes   Level 2       88,885       77,528       88,628       75,024   Accrued interest payable   Level 2       7,218       7,218       3,223       3,223   Interest rate swaps   Level 2       35,242       35,242       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. As of December 31, 2022 , the 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, while as of September 30, 2023 , the fair value only for time deposits 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)   45 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 September 30, 2023 , or December 31, 2022 . We have no Level 1 securities available for sale.   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.   (Continued)   46 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     11.    FAIR VALUES (Continued)   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 September 30, 2023 and December 31, 2022 , we determined the fair value of our mortgage loans held for sale to be $ 10.2  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  September 30, 2023 are as follows:               Quoted                               Prices in                               Active                               Markets     Significant                       for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)   Available for sale securities                                 U.S. Government agency debt obligations   $ 384,079,000     $ 0     $ 384,079,000     $ 0   Mortgage-backed securities     28,016,000       0       28,016,000       0   Municipal general obligation bonds     153,425,000       0       152,885,000       540,000   Municipal revenue bonds     26,285,000       0       26,285,000       0   Other investments     500,000       0       500,000       0   Interest rate swaps     35,060,000       0       35,060,000       0   Total assets   $ 627,365,000     $ 0     $ 626,825,000     $ 540,000                                     Interest rate swaps     35,242,000       0       35,242,000       0   Total liabilities   $ 35,242,000     $ 0     $ 35,242,000     $ 0     (Continued)   47 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 nine months of  2023 . The $ 0.1 million reduction in Level 3 municipal general obligation bonds during the first nine months of  2023 reflects the scheduled maturities of such bonds.   The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2022 are as follows:               Quoted                               Prices in                               Active                               Markets     Significant                       for     Other     Significant               Identical     Observable     Unobservable               Assets     Inputs     Inputs       Total     (Level 1)     (Level 2)     (Level 3)   Available for sale securities                                 U.S. Government agency debt obligations   $ 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 September 30, 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   $ 3,346,000     $ 0     $ 0     $ 3,346,000   Foreclosed assets     51,000       0       0       51,000   Total   $ 3,397,000     $ 0     $ 0     $ 3,397,000     (Continued)   48 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 September 30, 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 September 30, 2023 , that we believe have changed our bank’s categorization.   (Continued)   49 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   September 30, 2023                                                 Total capital (to risk weighted assets)                                                 Consolidated   $ 692,252       14.1 %   $ 392,930       8.0 %     NA       NA   Bank     675,953       13.8       392,745       8.0       490,931       10.0 % Tier 1 capital (to risk weighted assets)                                                 Consolidated     554,634       11.3       294,697       6.0     NA     NA   Bank     627,220       12.8       294,559       6.0       392,745       8.0   Common equity tier 1 (to risk weighted assets)                                                 Consolidated     507,235       10.3       221,023       4.5     NA     NA   Bank     627,220       12.8       220,919       4.5       319,105       6.5   Tier 1 capital (to average assets)                                                 Consolidated     554,634       10.6       208,523       4.0     NA     NA   Bank     627,220       12.0       208,432       4.0       260,540       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)   50 Table of Contents MERCANTILE BANK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)     12.    REGULATORY MATTERS (Continued)   Our consolidated capital levels as of September 30, 2023 and December 31, 2022 include $ 47.4 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 September 30, 2023 and December 31, 2022 , all $ 47.4 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 September 30, 2023 , our bank meets all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.   Our and our bank’s ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to prudent and sound banking practices. On January 12, 2023, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.33 per share that was paid on March 15, 2023 to shareholders of record as of March 3, 2023. On April 13, 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 June 14, 2023, to shareholders of record as of June 2, 2023. On July 13, 2023, our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.34 per share that was paid on September 13, 2023, to shareholders of record as of September 1, 2023.   As of September 30, 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 nine months 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 October 12, 2023 , our Board of Directors declared a cash dividend on our common stock in the amount of $ 0.34 per share that will be paid on December  13, 2023 , to shareholders of record as of December 1, 2023 .           51 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 (“our bank”) and our bank’s subsidiaries, Mercantile Insurance Center, Inc., and Mercantile Community Partners, at September 30, 2023 and December 31, 2022 and the results of operations for the three months and nine months ended September 30, 2023 and September 30, 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 Policies   Accounting principles generally accepted in the United States of America (“GAAP”) are complex and require us to apply significant judgment to various accounting, reporting and disclosure matters. We must use assumptions and estimates to apply these principles where actual measurements are not possible or practical. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited financial statements included in this report. For a discussion of our significant accounting 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.     52 Table of Contents MERCANTILE BANK CORPORATION     Allowance for Credit Losses ( “ Allowance ” ) : On January 1, 2022, we adopted ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 32): Measurement of Credit Losses on Financial Instruments , as amended, which replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost and certain off-balance sheet credit exposures.   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 uncollectability of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. The allowance is increased through a provision charged to operating expense. Uncollectable loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.   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.   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.     53 Table of Contents MERCANTILE BANK CORPORATION     Financial Overview We reported net income of $20.9 million, or $1.30 per diluted share, for the third quarter of 2023, compared with net income of $16.0 million, or $1.01 per diluted share, during the third quarter of 2022. Net income for the first nine months of 2023 totaled $62.2 million, or $3.89 per diluted share, compared to $39.3 million, or $2.48 per diluted share, during the first nine months of 2022. The improved operating results were in large part driven by higher net interest income stemming from a higher net interest margin and ongoing loan growth, and continued strength in loan quality metrics providing for limited provision expense.   Commercial loans increased $87.0 million during the first nine months of 2023, providing for an annualized growth rate of about 4%. While we experienced strong loan funding activities, the full pay-offs and partial paydowns of certain larger commercial lending relationships, primarily reflecting customers selling assets, refinancing debt on the secondary market, and using excess cash flows generated within their operations to make unscheduled principal payments and line of credit reductions, aggregated $246 million during the first nine months of 2023. As a percentage of total commercial loans, commercial and industrial loans and owner occupied commercial real estate (“CRE”) loans combined equaled 57.1% as of September 30, 2023, compared to 58.2% as of December 31, 2022. The new commercial loan pipeline remains strong, and at September 30, 2023, we had $379 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 $99.9 million during the first nine months of 2023, providing for an annualized growth rate of about 19%. With increased residential mortgage loan rates during 2022 and the first nine months of 2023, we have witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in the previous couple of years. Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet. During the first nine months of 2023 , approximately 49% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to nearly 36% in 2022 and approximately 68% in 2021. The shift in production mix has resulted in residential mortgage loans comprising a larger percentage of total loans, increasing from about 13% at year-end 2021 to about 20% as of September 30, 2023. The shift in product mix also impacts the timing of revenue recognition; it takes an estimated 24 months for the amount of interest income earned on a residential mortgage loan that is retained on our balance sheet to approximate the amount of the immediately recorded gain on sale of a residential mortgage loan that has been sold to an investor.   The overall quality of our loan portfolio remains strong, with nonperforming loans equaling only 0.14% of total loans as of September 30, 2023. Accruing loans past due 30 to 89 days remain very low, and foreclosed properties totaled less than $0.1 million as of September 30, 2023. Gross loan charge-offs totaled $0.8 million during the first nine months of 2023, while recoveries of prior period loan charge-offs aggregated $0.7 million.   We recorded a provision expense of $5.9 million during the first nine months of 2023, generally reflecting allocations necessitated by net loan growth and adjustments to historical loss information to better represent our expectations for future credit losses.  Changes to qualitative factors included a reduction of the historical loss information factor which coincided with adjustments to historical loss information and an allocation considering local economic conditions, particularly the potential impacts of the United Auto Workers strike against the three Detroit-based auto manufacturers.  A higher reserve balance for residential mortgage loans stemming from slower principal prepayment rates and the resulting extended average life of the portfolio also impacted provision expense during the first nine months of 2023.  Net changes in specific reserve balances reduced the reserve balance $0.9 million, while updated economic forecasts resulted in a $0.1 million reduction during the first nine months of 2023.      54 Table of Contents MERCANTILE BANK CORPORATION     Interest-earning deposits, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During the first nine months of 2023, the average balance of these funds equaled $102 million, or 2.2% of average earning assets, compared to $535 million, or 11.2% of average earning assets, during the first nine months of 2022. Typically, we maintain interest-earning deposits at approximately $75 million, or about 2% of average earning assets. The elevated level during the first nine months of 2022 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus payments and reduced business and consumer investing and spending during 2021 and into 2022. The level of interest-earning deposits was on a declining trend throughout 2022 as excess monies were used to fund loan growth and securities purchases, as well as out-of-area deposit and Federal Home Loan Bank of Indianapolis (“FHLBI”) advance maturities. We also experienced a decline in local deposits throughout 2022. Interest-earning deposits totaled $34.9 million at year-end 2022.   Interest-earning deposits totaled $201 million as of September 30, 2023, an increase of $167 million from December 31, 2022, and approximately $100 million higher than the average balance during the first nine months of 2023. We obtained $111 million in brokered deposits and $90.0 million in FHLBI advances during the second quarter of 2023, combined with $70.0 million in FHLBI advances during the first quarter of 2023, to offset the impact of loan fundings and net deposit withdrawals during the first half of 2023, and to rebuild our on-balance sheet liquidity position.  We experienced deposit growth, net of a large transfer from a sweep account to a deposit account, of approximately $100 million during the third quarter of 2023.  We did not obtain any additional brokered deposits or FHLBI advances during the third quarter of 2023.   Total deposits and sweep accounts increased $158 million during the first nine months of 2023, totaling $4.06 billion at September 30, 2023. Local deposits and sweep accounts increased $46.4 million, while out-of-area deposits increased $111 million.    Net interest income increased $6.6 million and $37.3 million during the third quarter and first nine months of 2023, respectively, compared to the respective time periods in 2022. Interest income was $23.0 million and $74.0 million higher during the third quarter and first nine months of 2023, respectively, when compared to the same time periods in 2022, in large part reflecting an increasing rate environment and ongoing loan growth. Interest expense was $16.4 million and $36.7 million higher during the third quarter and first nine months of 2023, respectively, when compared to the respective time periods in 2022, primarily reflecting an increasing interest rate environment.   Noninterest income increased $2.0 million and decreased $0.5 million during the third quarter and first nine months of 2023, respectively, compared to the respective time periods in 2022. Mortgage banking income increased $1.0 million during the respective third quarter periods, while declining $1.2 million during the respective nine month periods, in large part reflecting changes in the volume of refinance activity and residential mortgage loans sold during the various time periods. We continued to record growth in treasury management-related fee income categories, such as credit and debit card income and payroll processing, while service charges on accounts declined due to increased earnings credit rates on noninterest-bearing checking accounts.   Noninterest expense increased $2.1 million and $5.9 million during the third quarter and first nine months of 2023, respectively, compared to the respective time periods in 2022. The increased costs primarily resulted from higher compensation and benefit costs, increased Federal Deposit Insurance Corporation ("FDIC") insurance assessments reflecting the industry-wide adjustments effective January 1, 2023, and higher interest rate swap cash collateral holding costs.   Financial Condition Our total assets increased $378 million during the first nine months of 2023, and totaled $5.25 billion as of September 30, 2023. Total loans were up $188 million, and interest-earning deposits increased $167 million. Total deposits increased $188 million, and FHLBI advances were up $150 million.     55 Table of Contents MERCANTILE BANK CORPORATION     Commercial loans increased $87.0 million during the first nine months of 2023, providing for an annualized growth rate of about 4%. While we experienced strong loan funding activities, the full pay-offs and partial paydowns of certain larger commercial lending relationships, primarily reflecting customers selling assets, refinancing debt on the secondary market, and using excess cash flows generated within their operations to make unscheduled principal payments and line of credit reductions, aggregated $246 million during the first nine months of 2023. Multi-family and residential rental property loans grew $41.8 million, owner-occupied CRE loans were up $31.9 million, non-owner occupied CRE loans increased $21.2 million, and vacant land, land development and residential construction loans were up $11.0 million, while commercial and industrial loans decreased $18.9 million. As a percentage of total commercial loans, commercial and industrial loans and owner occupied CRE loans combined equaled 57.1% as of September 30, 2023, compared to 58.2% as of December 31, 2022. Commercial loans totaled $3.22 billion, or 78.4% of total loans, as of September 30, 2023, compared to $3.13 billion, or 80.0% of total loans, as of December 31, 2022.   As of September 30, 2023, we had $379 million in unfunded commitments on commercial construction and development loans that are in the construction phase which are expected to be drawn over the next 12 to 18 months. Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including approximately $288 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 40% during the first nine months of 2023, which was at the lower end of our historical range of 40% to 45%.   Residential mortgage loans, excluding home equity lines of credit, increased $99.9 million during the first nine months of 2023, providing for an annualized growth rate of about 19%. With increased residential mortgage loan rates during 2022 and the first nine months of 2023, we witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in the previous couple of years. Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet. During the first nine months of 2023 , approximately 49% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to nearly 36% in 2022 and approximately 68% in 2021. The shift in production mix has resulted in residential mortgage loans comprising a larger percentage of total loans, increasing from about 13% at year-end 2021 to about 20% as of September 30, 2023. The shift in product mix also impacts the timing of revenue recognition; it takes an estimated 24 months for the amount of interest income earned on a residential mortgage loan that is retained on our balance sheet to approximate the amount of the immediately recorded gain on sale of a residential mortgage loan that has been sold to an investor.   Home equity lines of credit declined $0.7 million and other consumer-related loans increased $1.6 million during the first nine months of 2023, and at September 30, 2023 totaled $36.7 million and $31.4 million, respectively, or an aggregate 1.7% of total loans. These loan segments equated to 1.7% 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 the commercial and residential mortgage loan portfolios grow.     56 Table of Contents MERCANTILE BANK CORPORATION     The following table summarizes our loan portfolio over the past twelve months:       September 30,     June 30,     March 31,     December 31,     September 30,       2023     2023     2023     2022     2022   Commercial:                                         Commercial & Industrial   $ 1,166,187,000     $ 1,212,196,000     $ 1,173,440,000     $ 1,185,083,000     $ 1,213,630,000   Land Development & Construction     72,921,000       72,682,000       66,233,000       61,873,000       60,970,000   Owner Occupied Commercial RE     671,083,000       659,201,000       630,187,000       639,192,000       643,577,000   Non-Owner Occupied Commercial RE     1,000,411,000       957,221,000       975,735,000       979,214,000       963,144,000   Multi-Family & Residential Rental     308,229,000       287,285,000       294,825,000       266,468,000       263,742,000   Total Commercial     3,218,831,000       3,188,585,000       3,140,420,000       3,131,830,000       3,145,063,000                                             Retail:                                         1-4 Family Mortgages     854,175,000       833,198,000       795,007,000       755,036,000       705,441,000   Other Consumer Loans     31,370,000       30,060,000       30,101,000       29,753,000       30,454,000   Total Retail     885,545,000       863,258,000       825,108,000       784,789,000       735,895,000                                             Total   $ 4,104,376,000     $ 4,051,843,000     $ 3,965,528,000     $ 3,916,619,000     $ 3,880,958,000     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.   Nonperforming loans totaled $5.9 million, or 0.1% of total loans, as of September 30, 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 $5.9 million (0.1% of total assets) as of September 30, 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.     57 Table of Contents MERCANTILE BANK CORPORATION     The following tables provide a breakdown of nonperforming assets by collateral type:   NONPERFORMING LOANS                                                 September 30,     June 30,     March 31,     December 31,     September 30,       2023     2023     2023     2022     2022   Residential Real Estate:                                         Land Development   $ 1,000     $ 2,000     $ 8,000     $ 29,000     $ 30,000   Construction     0       0       0       124,000       0   Owner Occupied / Rental     1,862,000       1,732,000       1,891,000       1,304,000       1,138,000         1,863,000       1,734,000       1,899,000       1,457,000       1,168,000                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     738,000       116,000       229,000       248,000       0   Non-Owner Occupied     0       0       0       0       0         738,000       116,000       229,000       248,000       0                                             Non-Real Estate:                                         Commercial Assets     3,288,000       249,000       5,654,000       6,023,000       248,000   Consumer Assets     0       0       0       0       0         3,288,000       249,000       5,654,000       6,023,000       248,000                                             Total   $ 5,889,000     $ 2,099,000     $ 7,782,000     $ 7,728,000     $ 1,416,000       OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS                                                 September 30,     June 30,     March 31,     December 31,     September 30,       2023     2023     2023     2022     2022   Residential Real Estate:                                         Land Development   $ 0     $ 0     $ 0     $ 0     $ 0   Construction     0       0       0       0       0   Owner Occupied / Rental     51,000       61,000       61,000       0       0         51,000       61,000       61,000       0       0                                             Commercial Real Estate:                                         Land Development     0       0       0       0       0   Construction     0       0       0       0       0   Owner Occupied     0       600,000       600,000       0       0   Non-Owner Occupied     0       0       0       0       0         0       600,000       600,000       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   $ 51,000     $ 661,000     $ 661,000     $ 0     $ 0       58 Table of Contents MERCANTILE BANK CORPORATION     The following tables provide a reconciliation of nonperforming assets:   NONPERFORMING LOANS RECONCILIATION                                                 3rd Qtr     2nd Qtr     1st Qtr     4th Qtr     3rd Qtr       2023     2023     2023     2022     2022                                             Beginning balance   $ 2,099,000     $ 7,782,000     $ 7,728,000     $ 1,416,000     $ 1,787,000   Additions, net of transfers to ORE     4,112,000       273,000       662,000       6,368,000       0   Returns to performing status     0       0       (31,000 )     0       (160,000 ) Principal payments     (166,000 )     (5,525,000 )     (515,000 )     (56,000 )     (211,000 ) Loan charge-offs     (156,000 )     (431,000 )     (62,000 )     0       0                                             Total   $ 5,889,000     $ 2,099,000     $ 7,782,000     $ 7,728,000     $ 1,416,000       OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION                                                 3rd Qtr     2nd Qtr     1st Qtr     4th Qtr     3rd Qtr       2023     2023     2023     2022     2022                                             Beginning balance   $ 661,000     $ 661,000     $ 0     $ 0     $ 0   Additions     51,000       0       661,000       0       0   Sale proceeds     (661,000 )     0       0       0       0   Valuation write-downs     0       0       0       0       0                                             Total   $ 51,000     $ 661,000     $ 661,000     $ 0     $ 0     Loan charge-offs totaled $0.2 million during the third quarter of 2023, and aggregated $0.8 million during the first nine months of 2023, while recoveries of prior period loan charge-offs equaled $0.2 million and $0.7 million during the respective time periods. Net loan charge-offs, as a percentage of average total loans, equaled an annualized 0.01% during both the third quarter and first nine months of 2023  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.     59 Table of Contents MERCANTILE BANK CORPORATION     The allowance equaled $48.0 million, or 1.17% of total loans and over eight times the level of nonperforming loans, as of September 30, 2023. As of September 30, 2023, the allowance was comprised of $46.4 million in general reserves relating to performing loans and $1.6 million in specific reserves on other loans, primarily nonperforming loans. Loans with an aggregate carrying value of $0.4 million as of September 30, 2023 had been subject to previous partial charge-offs aggregating $0.3 million over the past several years. As of September 30, 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 decreased $10.6 million during the first nine months of 2023, totaling $592 million as of September 30, 2023. There were no purchases of U.S. Government agency bonds during the first nine months of 2023.  Proceeds from a matured U.S. Government agency bond totaling $2.0 million were received during the first nine months of 2023.  There were no purchases of U.S. Government agency guaranteed mortgage-backed securities during the first nine months of 2023; however, we received $2.3 million of principal paydowns on U.S. Government agency guaranteed mortgage-backed securities.  Purchases of municipal bonds totaled $13.0 million during the first nine months of 2023; proceeds from matured municipal bonds totaled $8.6 million. At September 30, 2023, the portfolio was primarily comprised of U.S. Government agency bonds (65%), municipal bonds (30%) and U.S. Government agency guaranteed mortgage-backed securities (5%).  All of our securities are currently designated as available for sale, and are therefore stated at fair value. The fair value of securities designated as available for sale at September 30, 2023 totaled $592 million, including a net unrealized loss of $93.2 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 environment. 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 $21.5 million as of September 30, 2023, compared to $17.7 million as of December 31, 2022. The $3.8 million increase reflects additional stock purchased in association with an increase in outstanding advances during the first nine months of 2023. Our investment in FHLBI stock is necessary to engage in their advance and other financing programs. We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.   Interest-earning deposits, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During the first nine months of 2023, the average balance of these funds equaled $102 million, or 2.2% of average earning assets, compared to $535 million, or 11.2% of average earning assets, during the first nine months of 2022. Typically, we maintain interest-earning deposits at approximately $75 million, or about 2% of average earning assets. The elevated level during the first nine months of 2022 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus payments and reduced business and consumer investing and spending during 2021 and into 2022. The level of interest-earning deposits was on a declining trend throughout 2022 as excess monies were used to fund loan growth and securities purchases, as well as out-of-area deposit and FHLBI advance maturities. We also experienced a decline in local deposits throughout 2022. Interest-earning deposits totaled $34.9 million at year-end 2022.   Interest-earning deposits totaled $201 million as of September 30, 2023, an increase of $167 million from December 31, 2022, and approximately $100 million higher than the average balance during the first nine months of 2023. We obtained $111 million in brokered deposits and $90.0 million in FHLBI advances during the second quarter of 2023, combined with $70.0 million in FHLBI advances during the first quarter of 2023, to offset the impact of loan fundings and net deposit withdrawals during the first half of 2023, and to rebuild our on-balance sheet liquidity position.  We experienced deposit growth, net of a large transfer from a sweep account to a deposit account, of approximately $100 million during the third quarter of 2023.  We did not obtain any additional brokered deposits or FHLBI advances during the third quarter of 2023.     60 Table of Contents MERCANTILE BANK CORPORATION     Net premises and equipment equaled $52.2 million at September 30, 2023, an increase of $0.8 million 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 nine months of 2023, comprised of a $0.6 million transfer to foreclosed assets and a write-down of $0.4 million; this facility was sold during the third quarter of 2023 for $0.6 million. Depreciation expense totaled $4.4 million during the first nine months of 2023, while investments associated with the construction and opening of new facilities and the renovation of existing facilities totaled $6.2 million.   Total deposits increased $188 million during the first nine months of 2023, totaling $3.90 billion at September 30, 2023. Local deposits increased $76.6 million, while out-of-area deposits increased $111 million. We experienced a reduction in local deposits during the first part of 2023, reflecting a typical level of customers’ tax and bonus payments and partnership distributions. Local deposits increased $144 million during the third quarter of 2023. Wholesale funds, comprised of out-of-area deposits and FHLBI advances, totaled $569 million, or about 13% of total funds, as of September 30, 2023, compared to $308 million, or about 7% of total funds, at December 31, 2022.   Noninterest-bearing deposits decreased $295 million during the first nine months of 2023, in large part reflecting the aforementioned customary level of customers’ tax and bonus payments and partnership distributions during the first part of 2023, but also includes transfers to interest-bearing deposits and withdrawals associated with the sales of businesses. Interest-bearing checking accounts increased $95.8 million, including the aforementioned transfer from the sweep account product, during the first nine months of 2023.  Savings deposits were down $94.7 million during the first nine months of 2023, primarily reflecting the transfers of funds to higher-paying money market deposit accounts and time deposits. Money market deposit accounts were up $200 million, in large part reflecting growth in deposits from existing and new municipal depositors, as well as from transfers from no- and low-cost deposit products.  Local time deposits increased $171 million during the first nine months of 2023.   Sweep accounts decreased $30.3 million during the first nine months of 2023, totaling $164 million as of September 30, 2023. The decline includes the aforementioned transfer to the interest-bearing checking account product.  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 $212 million during the first nine months of 2023, with a high balance of $269 million and a low balance of $164 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 $150 million during the first nine months of 2023, totaling $458 million as of September 30, 2023. Bullet advances aggregating $200 million were obtained during the first nine months of 2023, consisting of $160 million to fund loan growth and rebuild on-balance sheet liquidity, and $40.0 million to replace FHLBI bullet advance maturities. Payments on amortizing FHLBI advances totaled $0.4 million during the first nine months of 2023. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit as of September 30, 2023 totaled $888 million, with remaining availability based on collateral equaling $424 million.   Shareholders’ equity was $483 million at September 30, 2023, compared to $441 million at December 31, 2022. Negatively impacting shareholders’ equity during the first nine months of 2023 was net income of $62.2 million, which was partially offset by the payment of cash dividends totaling $15.7 million. An $8.2 million after-tax decrease in the market value of our available for sale securities portfolio, reflecting an increase in market interest rates, negatively impacted shareholders’ equity during the first nine months of 2023.     61 Table of Contents MERCANTILE BANK CORPORATION     Liquidity Liquidity is measured by our ability to raise funds through deposits, borrowed funds, and capital, or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, 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 out-of-area deposits and advances from the FHLBI, totaled $569 million, or about 13% of combined deposits and borrowed funds, as of September 30, 2023, compared to $308 million, or about 7% of combined deposits and borrowed funds, as of December 31, 2022.   Sweep accounts decreased $30.3 million during the first nine months of 2023, totaling $164 million as of September 30, 2023. The decline includes the aforementioned transfer to the interest-bearing checking account product.  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 $212 million during the first nine months of 2023, with a high balance of $269 million and a low balance of $164 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 September 30, 2023 and during the first nine months of 2023 is as follows:   Outstanding balance at September 30, 2023   $ 164,082,000   Weighted average interest rate at September 30, 2023     0.74 % Maximum daily balance nine months ended September 30, 2023   $ 269,324,000   Average daily balance for nine months ended September 30, 2023   $ 211,680,000   Weighted average interest rate for nine months ended September 30, 2023     1.22 %   FHLBI advances increased $150 million during the first nine months of 2023, totaling $458 million as of September 30, 2023. Bullet advances aggregating $200 million were obtained during the first nine months of 2023, consisting of $160 million to fund loan growth and rebuild on-balance sheet liquidity, and $40.0 million to replace FHLBI bullet advance maturities. Payments on amortizing FHLBI advances totaled $0.4 million during the first nine months of 2023. Bullet FHLBI advances are generally obtained to provide funds for loan growth and are used to assist in managing interest rate risk, while amortizing FHLBI advances are generally acquired to match-fund specific longer-term fixed rate commercial loans, with the dollar amount and amortization structure of the underlying advances reflective of the associated commercial loans. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank, under a blanket lien arrangement. Our borrowing line of credit as of September 30, 2023 totaled $888 million, with remaining availability based on collateral equaling $424 million.   We also have the ability to borrow up to an aggregate $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit. We accessed one of the lines of credit during the first nine months of 2023, with an average balance of $3.2 million. In contrast, our interest-earning deposit balance with the Federal Reserve Bank of Chicago averaged $95.0 million during the first nine months 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 $25.4 million as of September 30, 2023. We did not utilize this line of credit during the first nine months 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.     62 Table of Contents MERCANTILE BANK CORPORATION     The following table reflects, as of September 30, 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   $ 3,243,731,000     $ 0     $ 0     $ 0     $ 3,243,731,000   Time deposits     493,150,000       105,722,000       58,132,000       0       657,004,000   Short-term borrowings     164,082,000       0       0       0       164,082,000   Federal Home Loan Bank advances     90,826,000       171,762,000       171,917,000       23,405,000       457,910,000   Subordinated debentures     0       0       0       49,473,000       49,473,000   Subordinated notes     0       0       0       88,885,000       88,885,000   Other borrowed money     0       0       0       1,081,000       1,081,000   Property leases     1,105,000       1,159,000       785,000       1,393,000       4,442,000     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 September 30, 2023, we had a total of $1.78 billion in unfunded loan commitments and $19.4 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.49 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $288 million were for loan commitments generally expected to be accepted and closed 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 nine months 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 $483 million at September 30, 2023, compared to $441 million at December 31, 2022. Positively impacting shareholders’ equity during the first nine months of 2023 was net income of $62.2 million, which was partially offset by the payment of cash dividends totaling $15.7 million. An $8.2 million after-tax decrease in the market value of our available for sale securities portfolio, reflecting an increase in market interest rates, negatively impacted shareholders’ equity during the first nine months 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 September 30, 2023, our bank met all capital adequacy requirements under the BASEL III capital rules on a fully phased-in basis.   As of September 30, 2023, our bank’s total risk-based capital ratio was 13.8%, compared to 13.7% as of December 31, 2022. Our bank’s total regulatory capital increased $57.2 million during the first nine months of 2023, in large part reflecting net income totaling $70.0 million, which was partially offset by cash dividends paid to us aggregating $19.5 million. Our bank’s total risk-based capital ratio was also impacted by a $378 million increase in total risk-weighted assets, primarily resulting from net growth in commercial and residential mortgage loans. As of September 30, 2023, our bank’s total regulatory capital equaled $676 million, or $185 million in excess of the 10.0% minimum that is among the requirements to be categorized as “well capitalized.” Our and our bank’s capital ratios as of September 30, 2023 and December 31, 2022 are disclosed in Note 12 of the Notes to Consolidated Financial Statements.     63 Table of Contents MERCANTILE BANK CORPORATION     Results of Operations We recorded net income of $20.9 million, or $1.30 per basic and diluted share, for the third quarter of 2023, compared with net income of $16.0 million, or $1.01 per basic and diluted share, for the third quarter of 2022. We recorded net income of $62.2 million, or $3.89 per basic and diluted share, for the first nine months of 2023, compared with net income of $39.3 million, or $2.48 per basic and diluted share, for the first nine months of 2022. Diluted earnings per share increased $0.29, or 28.7%, during the third quarter of 2023, and $1.41, or 56.9%, during the first nine months of 2023 compared with the respective prior-year periods.   The higher levels of net income during the third quarter and first nine months of 2023 compared to the respective prior-year periods primarily resulted from increased net interest income, which more than offset higher overhead costs and credit loss provisions. The increases in net interest income during the 2023 periods mainly resulted from significantly improved net interest margins and loan growth. The higher levels of overhead costs during the 2023 periods primarily reflected increases in compensation costs, credit reserves for unfunded loan commitments, interest rate swap collateral holding costs, and FDIC deposit insurance premiums. The provision expense recorded during the current-year third quarter mainly reflected the establishment of a specific reserve for a distressed commercial loan relationship, a qualitative factor assessment for local economic conditions, allocations necessitated by net loan growth, and a higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the resulting extended average life of the portfolio. The provision expense recorded during the first nine months of 2023 generally reflected allocations necessitated by net loan growth, adjustments to historical loss information to better represent our expectations for future credit losses, and the previously mentioned higher reserve for residential mortgage loans.  The provision expense recorded during the 2022 periods primarily reflected allocations necessitated by net loan growth, increased specific reserves for certain problem commercial loan relationships, a higher reserve for residential mortgage loans, and a decline in forecasted economic conditions. Continuing strong loan quality measures, including low levels of loan charge-offs, during the 2023 and 2022 periods largely mitigated additional reserves associated with these factors. Excluding the impact of a gain on sale of other real estate owned, noninterest income increased $1.6 million, or nearly 22%, during the third quarter of 2023 compared with the prior-year third quarter.  The higher level of noninterest income mainly stemmed from increased mortgage banking income, interest rate swap income, bank owned life insurance income, credit and debit card income, and payroll servicing fees, which more than offset decreased service charges on accounts.  Noninterest income during the first nine months of 2023 declined in comparison to the first nine months of 2022 as higher levels of credit and debit card income, interest rate swap income, and payroll servicing fees were more than offset by lower levels of mortgage banking income and service charges on accounts.   Interest income during the third quarter of 2023 was $71.1 million, an increase of $23.0 million, or 47.8%, from the $48.1 million earned during the third quarter of 2022.  The increase mainly resulted from a higher yield on average earning assets.  The yield on average earning assets was 5.78% during the third quarter of 2023, up from 4.04% 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 6.37% during the third quarter of 2023, up from 4.56% during the prior-year third 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 375 basis points during the period of July 2022 through July 2023, during which time average variable-rate commercial loans represented approximately 65% of average total commercial loans.  Increased yields on securities and interest earning deposits, reflecting the rising interest rate environment, along with a change in earning asset mix, comprised of an increase in higher-yielding loans as a percentage of earning assets, also contributed to the higher yield on average earning assets.  Average loans represented 82.9% of average earning assets during the third quarter of 2023, up from 80.7% during the third quarter of 2022.   A higher level of earning assets also contributed to the increase in interest income during the third quarter of 2023.  Average earning assets equaled $4.89 billion during the third quarter of 2023, up $163 million, or 3.4%, from the level of $4.73 billion during the prior-year third quarter; average loans and average securities were up $240 million and $8.7 million, respectively, while average interest-earning deposits were down $86.0 million.   Interest income during the first nine months of 2023 was $198 million, an increase of $74.0 million, or 59.9%, from the $124 million earned during the first nine months of 2022.  The increase primarily resulted from a higher yield on average earning assets and loan growth.  The yield on average earning assets was 5.59% during the first nine months of 2023, up from 3.45% during the respective 2022 period.  The higher yield mainly resulted from an increased yield on loans, reflecting the rising interest rate environment.  The yield on loans was 6.16% during the first nine months of 2023, up from 4.15% during the first nine months of 2022 primarily due to higher interest rates on variable-rate commercial loans stemming from FOMC rate hikes, which totaled 525 basis points during the period of March 2022 through July 2023.  A change in earning asset mix, comprised of an increase in higher-yielding loans as a percentage of earning assets, along with increased yields on interest earning deposits and securities, depicting the rising interest rate environment, also contributed to the higher yield on average earning assets.  On an average basis, higher-yielding loans represented 84.5% of earning assets during the first nine months of 2023, up from 76.0% during the first nine months of 2022.     64 Table of Contents MERCANTILE BANK CORPORATION   Average earning assets equaled $4.73 billion during the first nine months of 2023, down $63.3 million, or 1.3%, from the level of $4.80 billion during the first nine months of 2022; average interest-earning deposits declined $432 million, average loans increased $355 million, and average securities were up $13.9 million.   Interest expense during the third quarter of 2023 was $22.2 million, an increase of $16.4 million, or 286%, from the $5.8 million expensed during the third quarter of 2022. The increase is mainly attributable to a higher average weighted cost of interest-bearing liabilities, which rose from 0.81% during the third quarter of 2022 to 2.69% during the current-year third quarter primarily due to increased costs of deposits and borrowings. Reflecting the rising interest rate environment, the cost of interest-bearing, non-time deposits increased from 0.30% during the third quarter of 2022 to 2.17% during the third quarter of 2023, while the cost of time deposits increased from 0.98% to 3.85% 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 1.99% during the third quarter of 2022 to 2.98% during the third quarter of 2023 mainly due to higher costs of FHLBI advances, sweep accounts, and subordinated debentures.  The cost of FHLBI advances increased from 1.98% during the third quarter of 2022 to 2.78% during the third quarter of 2023, while the cost of sweep accounts increased from 0.10% to 1.33% during the respective periods, reflecting the rising interest rate environment.  The cost of subordinated debentures was 9.92% during the third quarter of 2023, up from 6.57% during the respective 2022 period due to increases in the 90-Day Libor Rate.   A change in funding mix, largely consisting of an increase in higher-costing time deposits as a percentage of interest-bearing liabilities, also contributed to the higher cost of interest-bearing liabilities during the third quarter of 2023.  Average interest-bearing liabilities totaled $3.27 billion during the current-year third quarter, compared to $2.83 billion during the third quarter of 2022, representing an increase of $440 million, or 15.5%.     65 Table of Contents MERCANTILE BANK CORPORATION     Interest expense during the first nine months of 2023 was $52.7 million, an increase of $36.7 million, or 230%, from the $16.0 million expensed during the first nine months of 2022. The increase is primarily attributable to a higher average weighted cost of interest-bearing liabilities, which rose from 0.73% during the first nine months of 2022 to 2.28% during the first nine months of 2023 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 0.24% during the first nine months of 2022 to 1.77% during the first nine months of 2023, while the cost of time deposits increased from 0.90% to 3.25% 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 1.90% during the first nine months of 2022 to 2.82% during first nine months of 2023 mainly due to higher costs of sweep accounts, FHLBI advances, and subordinated debentures.  The cost of sweep accounts increased from 0.10% during the first nine months of 2022 to 1.22% during the first nine months of 2023, while the cost of FHLBI advances increased from 2.00% to 2.57% during the respective periods, reflecting the rising interest rate environment.  The cost of subordinated debentures was 9.51% during the first nine months of 2023, up from 5.01% during the respective 2022 period due to increases in the 90-Day Libor Rate.   A change in funding mix, consisting of increases in higher-costing time deposits and borrowings as a percentage of interest-bearing liabilities, also contributed to the higher cost of interest-bearing liabilities during the first nine months of 2023.  Average interest-bearing liabilities totaled $3.08 billion during the first nine months of 2023, up $145 million, or 4.9%, from $2.94 billion during the respective 2022 period.   Net interest income during the third quarter of 2023 was $49.0 million, an increase of $6.6 million, or 15.5%, from the $42.4 million earned during the respective 2022 period. The increase primarily resulted from a significantly improved net interest margin and growth in the loan portfolio. The net interest margin was 3.98% in the third quarter of 2023 up from 3.56% in the prior-year third quarter due to a higher yield on average earning assets, which more than offset an increase in the cost of funds. The increased yield, mainly stemmed from a higher yield on commercial loans. The cost of funds equaled 1.80% in the third quarter of 2023, up from 0.48% in the third quarter of 2022 primarily due to higher costs of deposits and borrowed funds, reflecting the impact of the rising interest rate environment, and a change in funding mix, consisting of a decrease in noninterest-bearing and lower-cost deposits and an increase in higher-cost money market accounts and time deposits, reflecting deposit migration and new deposit relationships.    Net interest income during the first nine months of 2023 was $145 million, an increase of $37.3 million, or 34.7%, from the $108 million earned during the first nine months of 2022. The increase mainly resulted from a substantially improved net interest margin and loan growth. The net interest margin increased from 3.00% in the first nine months of 2022 to 4.10% in the respective 2023 period due to a higher yield on average earning assets, which more than offset an increase in the cost of funds. The increased yield on average earning assets primarily resulted from a higher yield on commercial loans. The cost of funds equaled 1.49% during the first nine months of 2023, up from 0.45% during the respective prior-year period mainly due to higher costs of deposits and borrowed funds, reflecting the impact of the increasing interest rate environment, and a change in funding mix, consisting of a decrease in lower-cost non-time deposits and increases in higher-cost time deposits and borrowings as a percentage of interest-bearing liabilities.    The following tables set forth certain information relating to our consolidated average interest-earning assets and interest-bearing liabilities and reflect the average yield on assets and average cost of liabilities for the third quarters and first nine months of 2023 and 2022. Such yields and costs are derived by dividing income or expense by the average daily balance of assets or liabilities, respectively, for the period presented. Tax-exempt securities interest income and yield for the third quarters and first nine months of 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 third quarter of both 2023 and 2022 and $180,000 in the first nine months of both 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 each of the 2023 and 2022 periods.     66 Table of Contents MERCANTILE BANK CORPORATION         Quarters ended September 30,       2023     2022       Average             Average     Average             Average       Balance     Interest     Rate     Balance     Interest     Rate       (dollars in thousands)   ASSETS                                                 Loans   $ 4,054,279     $ 65,073       6.37 %   $ 3,814,338     $ 43,807       4.56 % Investment securities     626,714       3,333       2.13       618,043       2,762       1.79   Interest-earning deposits     208,932       2,807       5.26       294,969       1,620       2.15   Total interest - earning assets     4,889,925       71,213       5.78       4,727,350       48,189       4.04                                                     Allowance for credit losses     (46,060 )                     (36,924 )                 Other assets     336,982                       335,572                                                                     Total assets   $ 5,180,847                     $ 5,025,998                                                                                                                       LIABILITIES AND SHAREHOLDERS’ EQUITY                                                 Interest-bearing deposits   $ 2,466,834     $ 16,143       2.60 %   $ 2,144,047     $ 2,299       0.43 % Short-term borrowings     207,410       693       1.33       203,431       53       0.10   Federal Home Loan Bank advances     459,649       3,270       2.78       347,328       1,755       1.98   Other borrowings     139,317       2,086       5.86       138,332       1,646       4.66   Total interest-bearing liabilities     3,273,210       22,192       2.69       2,833,138       5,753       0.81                                                     Noninterest-bearing deposits     1,359,238                       1,723,609                   Other liabilities     63,777                       39,158                   Shareholders’ equity     484,622                       430,093                                                                     Total liabilities and shareholders’ equity   $ 5,180,847                     $ 5,025,998                                                                     Net interest income           $ 49,021                     $ 42,436                                                             Net interest rate spread                     3.09 %                     3.23 % Net interest spread on average assets                     3.75 %                     3.35 % Net interest margin on earning assets                     3.98 %                     3.56 %     67 Table of Contents MERCANTILE BANK CORPORATION         Nine months ended September 30,       2023     2022       Average             Average     Average             Average       Balance     Interest     Rate     Balance     Interest     Rate       (dollars in thousands)   ASSETS                                                 Loans   $ 4,000,561     $ 184,232       6.16 %   $ 3,645,354     $ 113,061       4.15 % Investment securities     629,646       9,572       2.03       615,715       7,676       1.66   Interest-earning deposits     102,309       3,932       5.07       534,786       3,004       0.74   Total interest - earning assets     4,732,516       197,736       5.59       4,795,855       123,741       3.45                                                     Allowance for credit losses     (44,398 )                     (35,970 )                 Other assets     321,472                       330,265                                                                     Total assets   $ 5,009,590                     $ 5,090,150                                                                                                                       LIABILITIES AND SHAREHOLDERS’ EQUITY                                                 Interest-bearing deposits   $ 2,311,073     $ 36,429       2.11 %   $ 2,235,952     $ 5,997       0.36 % Short-term borrowings     214,881       2,066       1.29       198,721       153       0.10   Federal Home Loan Bank advances     416,593       8,115       2.57       364,541       5,530       2.00   Other borrowings     139,069       6,049       5.74       137,451       4,294       4.12   Total interest-bearing liabilities     3,081,616       52,659       2.28       2,936,665       15,974       0.73                                                     Noninterest-bearing deposits     1,403,721                       1,685,497                   Other liabilities     53,429                       31,784                   Shareholders’ equity     470,824                       436,204                                                                     Total liabilities and shareholders’ equity   $ 5,009,590                     $ 5,090,150                                                                     Net interest income           $ 145,077                     $ 107,767                                                             Net interest rate spread                     3.30 %                     2.72 % Net interest spread on average assets                     3.87 %                     2.83 % Net interest margin on earning assets                     4.10 %                     3.00 %   Provisions for credit losses of $3.3 million and $2.9 million were recorded during the third quarters of 2023 and 2022, respectively. A provision for credit losses of $5.9 million was recorded during the first nine months of 2023, compared with a provision of $3.5 million during the first nine months of 2022. The provision expense recorded during the current year third quarter mainly reflected the establishment of a specific reserve for a distressed commercial loan relationship, a qualitative factor assessment for local economic conditions reflecting the potential impacts of the United Auto Workers strike against the three Detroit-based auto manufacturers, allocations necessitated by net loan growth, and a higher reserve for residential mortgage loans resulting from slower principal prepayment rates and the related extended average life of the portfolio.  The provision expense recorded during the first nine months of 2023 generally reflected allocations necessitated by net loan growth and adjustments to historical loss information to better represent our expectations for future credit losses.  Changes to qualitative factors during the first nine months of 2023 included a reduction of the historical loss information factor that coincided with adjustments to historical loss information and an allocation considering local economic conditions, particularly the potential impacts of the aforementioned United Auto Workers strike.  An increased reserve balance for residential mortgage loans stemming from slower principal prepayment rates and the resulting extended average life of the portfolio also impacted provision expense during the first nine months of 2023.  Net changes in specific reserve balances reduced the reserve balance $0.9 million, while updated economic forecasts resulted in a $0.1 million reduction to the reserve during the first nine months of 2023.  The provision expense recorded during the third quarter of 2022 mainly reflected allocations necessitated by commercial loan and residential mortgage loan growth, increased specific reserves for certain distressed commercial loan relationships, and a decline in forecasted economic conditions.  The provision expense recorded during the first nine months of 2022 primarily resulted from these factors, along with a higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio.  Sustained strength in loan quality metrics, including low levels of loan charge-offs, during the 2023 and 2022 periods largely mitigated additional reserves associated with the previously mentioned factors.     68 Table of Contents MERCANTILE BANK CORPORATION     Noninterest income during the third quarter of 2023 was $9.2 million, compared to $7.3 million during the respective 2022 period.  Noninterest income during the third quarter of 2023 included a $0.4 million gain on sale of other real estate owned.  Excluding the impact of this transaction, noninterest income increased $1.6 million, or approximately 22%, during the third quarter of 2023 compared with the prior-year third quarter. The higher level of noninterest income mainly stemmed from increased mortgage banking income, interest rate swap income, bank owned life insurance income, credit and debit card income, and payroll servicing fees, which more than offset decreased service charges on accounts.  The increase in mortgage banking income largely reflected a higher loan sold percentage, which increased from approximately 36% in the third quarter of 2022 to approximately 64% in the third quarter of 2023.  The growth in interest rate swap income, credit and debit card income, and payroll servicing fees primarily resulted from the successful marketing of products and services to existing and new customers.  The decline in service charges on accounts reflected increased earnings credit rates in response to the increasing interest rate environment.   Noninterest income during the first nine months of 2023 was $23.8 million, compared to $24.3 million during the first nine months of 2022. The lower level of noninterest income mainly reflected decreased mortgage banking income and service charges on accounts, which more than offset growth in credit and debit card income, interest rate swap income, and payroll servicing fees.  The reduction in mortgage banking income primarily stemmed from lower production, the impact of which was partially offset by a higher loan sold percentage, which increased from approximately 36% during the first nine months of 2022 to nearly 49% during the first nine months of 2023.  The decrease in service charges on accounts reflected the aforementioned increase in earnings credit rates.  Noninterest income during the first nine months of 2023 included a $0.4 million gain on the sale of other real estate owned, while noninterest income during the first nine months of 2022 included a $0.5 million bank owned life insurance claim.    Noninterest expense totaled $28.9 million during the third quarter of 2023, compared to $26.8 million during the prior-year third quarter. The increase in noninterest expense primarily stemmed from larger salary and benefit costs, which outweighed decreased residential mortgage lender commissions and incentives and a lower bonus accrual.  The increase in salary and benefit costs mainly resulted from annual merit pay increases, market adjustments, and higher health insurance accruals, as well as lower residential mortgage loan deferred salary costs.  The decreased residential mortgage lender commissions and incentives primarily stemmed from reduced loan production.  The increase in overhead costs during the third quarter of 2023 also resulted from higher levels of FDIC deposit insurance premiums, reflecting an increased industry-wide assessment rate, contributions to The Mercantile Bank Foundation, and interest rate swap collateral holding costs.   Noninterest expense during the first nine months of 2023 was $85.3 million, compared to $79.5 million during the first nine months of 2022.  The increase in noninterest expense mainly resulted from larger salary and benefit costs, including salary increases and a higher bonus accrual, which outweighed reductions in residential mortgage lender commissions and incentives.  The higher level of salary and benefit costs primarily stemmed from annual merit pay increases, market adjustments, and increased health insurance accruals, along with lower residential mortgage loan deferred salary costs.  The reduced residential mortgage lender commissions and incentives mainly resulted from decreased loan production.  The increase in overhead costs also resulted from the recording of increased credit reserves for unfunded loan commitments and higher levels of FDIC deposit insurance premiums and interest rate swap collateral holding costs.  Overhead costs during the first nine months of 2023 included a $0.4 million write-down of a former branch facility that was recorded in the first quarter of the year, while overhead costs during the first nine months of 2022 included a $0.4 million expense associated with the sale of a branch facility that occurred in the second quarter of the year.    During the third quarter of 2023, we recorded income before federal income tax of $26.0 million and a federal income tax expense of $5.1 million.  During the third quarter of 2022, we recorded income before federal income tax of $20.0 million and a federal income tax expense of $3.9 million.  During the first nine months of 2023, we recorded income before federal income tax of $77.5 million and a federal income tax expense of $15.3 million.  During the first nine months of 2022, we recorded income before federal income tax of $48.9 million and a federal income tax expense of $9.7 million.  The increase in federal income tax expense in both 2023 periods resulted from higher levels of income before federal income tax.  Our effective tax rate was 19.7% during the third quarter and first nine months of 2023 and the respective 2022 periods.     69 Table of Contents MERCANTILE BANK CORPORATION