MERCANTILE BANK CORP 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates is assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates. We derive our income primarily from the excess of interest collected on our interest-earning assets over the interest paid on our interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness. Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems and internal control procedures are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk, we assess the existing and potential future effects of changes in interest rates on our financial condition, including capital adequacy, earnings, liquidity and asset quality. We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to our net interest margin during periods of changing market interest rates. 59 Table of Contents MERCANTILE BANK CORPORATION The following table depicts our GAP position as of March 31, 2025: Within Three to One to After Three Twelve Five Five (Dollars in thousands) Months Months Years Years Total Assets: Loans (1) $ 2,932,924 $ 163,911 $ 1,058,971 $ 480,743 $ 4,636,549 Securities available for sale (2) 40,379 42,900 342,767 383,050 809,096 Interest-earning deposits 310,634 506 4,000 0 315,140 Mortgage loans held for sale 15,192 0 0 0 15,192 Allowance for credit losses 0 0 0 0 (56,666 ) Other assets 0 0 0 0 421,889 Total assets $ 3,299,129 $ 207,317 $ 1,405,738 $ 863,793 $ 6,141,200 Liabilities: Interest-bearing deposits 2,788,229 455,984 264,073 0 3,508,286 Short-term borrowings 242,102 0 0 0 242,102 Federal Home Loan Bank advances 30,000 60,899 254,004 21,318 366,221 Other borrowed money 51,987 0 89,400 0 141,387 Noninterest-bearing checking 0 0 0 0 1,173,499 Other liabilities 0 0 0 0 101,359 Total liabilities 3,112,318 516,883 607,477 21,318 5,532,854 Shareholders' equity 0 0 0 0 608,346 Total liabilities & shareholders' equity $ 3,112,318 $ 516,883 $ 607,477 $ 21,318 $ 6,141,200 Net asset (liability) GAP $ 186,811 $ (309,566 ) $ 798,261 $ 842,475 Cumulative GAP $ 186,811 $ (122,755 ) $ 675,506 $ 1,517,981 Percent of cumulative GAP to total assets 3.0 % (2.0 )% 11.0 % 24.7 % (1) Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency. (2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of March 31, 2025. 60 Table of Contents MERCANTILE BANK CORPORATION The second interest rate risk measurement we use is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, it serves as our primary interest rate risk measurement technique. The simulation model assesses the direction and magnitude of variations in net interest income resulting from potential changes in market interest rates. Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain, subject to fluctuation and revision in a dynamic environment; therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions and our strategies, among other factors. We conducted multiple simulations as of March 31, 2025, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 400 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $225 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of March 31, 2025. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk. (Dollars in thousands) Dollar Change Percent Change In Net In Net Interest Rate Scenario Interest Income Interest Income Interest rates down 400 basis points $ (29,500 ) (13.1 )% Interest rates down 300 basis points (17,800 ) (7.9 ) Interest rates down 200 basis points (13,800 ) (6.1 ) Interest rates down 100 basis points (6,600 ) (2.9 ) Interest rates up 100 basis points 6,300 2.8 Interest rates up 200 basis points 12,800 5.7 Interest rates up 300 basis points 18,900 8.4 The resulting estimates have been significantly impacted by the current interest rate and economic environments, as adjustments have been made to critical model inputs with regards to traditional interest rate relationships. This is especially important as it relates to floating rate commercial loans, which comprise a sizable portion of our balance sheet. In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; level of nonperforming assets; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors.