<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-3360865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
216 NORTH DIVISION AVENUE, GRAND RAPIDS, MICHIGAN 49503
(Address of principal executive offices and zip code)
(616) 242-9000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
At August 9, 2000, there were 2,472,500 shares of Common Stock outstanding.
<PAGE> 2
<TABLE>
<CAPTION>
PART 1. Financial Information Page No.
--------------------- --------
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 2000 (Unaudited) and December 31, 1999 3
Condensed Consolidated Statements of Income -
Three and Six Months Ended June 30, 2000 (Unaudited)
and June 30 1999 (Unaudited) 4
Condensed Consolidated Statements of Changes in Shareholders Equity -
Six months ended June 30, 2000 (Unaudited) and December 31, 1999 6
Condensed Consolidated Statements of Cash Flows - Three and
Six Months Ended June 30, 2000 (Unaudited) and June 30, 1999
(Unaudited) 7
Notes to Condensed Consolidated Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
PART II. Other Information
-----------------
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $ 9,020,947 $ 6,570,631
Short-term investments 73,373 579,725
Federal funds sold 2,200,000 6,500,000
--------------- ----------------
Total cash and cash equivalents 11,294,320 13,650,356
Securities available for sale 37,453,401 34,115,303
Securities held to maturity (fair value of $11,768,068 at
June 30, 2000 and $6,982,329 at December 31, 1999) 11,817,215 7,056,492
Federal Home Loan Bank stock 784,900 784,900
Total loans 374,985,972 308,006,476
Allowance for loan losses (5,527,485) (4,620,469)
--------------- ----------------
Total loans, net 369,458,487 303,386,007
Premises and equipment - net 3,388,658 3,461,187
Accrued interest receivable 2,183,137 1,842,874
Other assets 3,936,847 3,739,969
--------------- ----------------
Total assets $ 440,316,965 $ 368,037,088
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 24,630,864 $ 19,513,231
Interest-bearing 336,981,979 275,315,741
--------------- ----------------
Total 361,612,843 294,828,972
Securities sold under agreements to repurchase 29,077,848 26,607,289
Other borrowed money 33,991 13,755
Accrued expenses and other liabilities 4,353,169 2,619,203
--------------- ----------------
Total liabilities 395,077,851 324,069,219
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,000,000 16,000,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value: 9,000,000 shares
authorized; 2,472,500 shares outstanding
at June 30, 2000 and December 31, 1999 28,181,798 28,181,798
Retained earnings 1,724,403 587,639
Accumulated other comprehensive loss (667,087) (801,568)
--------------- ----------------
Total shareholders' equity 29,239,114 27,967,869
--------------- ----------------
Total liabilities and shareholders' equity $ 440,316,965 $ 368,037,088
=============== ================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2000 June 30, 1999 June 30, 2000 June 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Interest income
Loans, including fees $ 7,944,665 $ 4,696,296 $ 14,994,797 $ 8,757,526
Investment securities 755,644 432,875 1,442,533 811,697
Federal funds sold 147,280 76,326 271,768 161,492
Short term investments 679 6,947 3,351 12,924
--------------- -------------- -------------- ---------------
Total interest income 8,848,268 5,212,444 16,712,449 9,743,639
Interest expense
Deposits 5,140,959 2,776,060 9,553,238 5,196,684
Short-term borrowings 301,766 171,670 563,640 352,463
Long-term borrowings 401,543 0 794,157 0
--------------- -------------- -------------- ---------------
Total interest expense 5,844,268 2,947,730 10,911,035 5,549,147
--------------- -------------- -------------- ---------------
NET INTEREST INCOME 3,004,000 2,264,714 5,801,414 4,194,492
Provision for loan losses 360,000 480,900 945,000 935,900
--------------- -------------- -------------- ---------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,644,000 1,783,814 4,856,414 3,258,592
Noninterest income
Services charges on accounts 83,414 48,966 158,640 89,666
Gain on termination of interest
rate swap 275,000 0 275,000 0
Loss on sale of securities (275,321) 0 (275,321) 0
Other income 182,740 156,869 330,872 325,892
--------------- -------------- -------------- ---------------
Total noninterest income 265,833 205,835 489,191 415,558
Noninterest expense
Salaries and benefits 1,126,340 782,457 2,064,764 1,435,369
Occupancy 134,993 92,823 261,073 182,280
Furniture and equipment 113,641 69,547 218,652 131,970
Other expense 595,387 435,350 1,136,352 893,158
--------------- -------------- -------------- ---------------
Total noninterest expenses 1,970,361 1,380,177 3,680,841 2,642,777
--------------- -------------- -------------- ---------------
INCOME BEFORE FEDERAL INCOME TAX 939,472 609,472 1,664,764 1,031,373
Federal income tax expense 303,000 106,000 528,000 134,000
--------------- -------------- -------------- ---------------
NET INCOME BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 636,472 503,472 1,136,764 897,373
Cumulative effect of change in
accounting principle (net of
applicable income taxes) 0 0 0 (42,210)
--------------- -------------- -------------- ---------------
NET INCOME $ 636,472 $ 503,472 $ 1,136,764 $ 855,163
=============== ============== ============== ===============
</TABLE>
(Continued)
4
<PAGE> 5
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2000 June 30, 1999 June 30, 2000 June 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Comprehensive income $ 853,571 $ 102,033 $ 1,271,245 $ 359,923
=============== ============== ============== ===============
Basic and diluted earnings per share
before cumulative effect of change
in accounting principle $ .26 $ .20 $ .46 $ .36
Per share cumulative effect of
change in accounting principle .00 .00 .00 (.01)
-------------- -------------- -------------- --------------
Basic and diluted earnings per share $ .26 $ .20 $ .46 $ .35
============== ============== ============== ==============
Average shares outstanding 2,472,500 2,472,500 2,472,500 2,472,500
=============== ============== ============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income Equity
----- -------- ------ ------
<S> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1999 $ 28,181,798 $ (1,513,118) $ 31,836 $ 26,700,516
Comprehensive income:
Net income for the period from
January 1, 1999 through
June 30, 1999 855,163 855,163
Change in net unrealized gain
(loss) on securities available for
sale, net of tax effect (495,240) (495,240)
----------------
Total comprehensive income 359,923
----------------
BALANCE, JUNE 30, 1999 $ 28,181,798 $ (657,955) $ (463,404) $ 27,060,439
================ =============== =========== ================
BALANCE, JANUARY 1, 2000 $ 28,181,798 $ 587,639 $ (801,568) $ 27,967,869
Comprehensive income:
Net income for the period from
January 1, 2000 through
June 30, 2000 1,136,764 1,136,764
Change in net unrealized gain
(loss) on securities available for
sale, net of tax effect and
reclassification adjustments 134,481 134,481
----------------
Total comprehensive income 1,271,245
----------------
BALANCE, JUNE 30, 2000 $ 28,181,798 $ 1,724,403 $ (667,087) $ 29,239,114
================ =============== =========== ================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
<PAGE> 7
MERCANTILE BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2000 June 30, 1999 June 30, 2000 June 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 636,472 $ 503,472 $ 1,136,764 $ 855,163
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 148,131 98,895 296,083 200,128
Provision for loan losses 360,000 480,900 945,000 935,900
Loss on sale of securities 275,321 0 275,321 0
Net change in:
Accrued interest receivable 52,341 (159,680) (340,263) (289,444)
Other assets (38,968) (602,594) (353,451) (886,730)
Accrued expenses and other liabilities 633,167 462,149 1,733,966 683,568
------------- ------------ ------------ ------------
Net cash from operating activities 2,066,464 783,142 3,693,420 1,498,585
Cash flows from investing activities
Net increase in loans (27,050,755) (32,008,514) (67,017,480) (61,980,184)
Purchase of:
Federal Home Loan Bank stock 0 (784,900) 0 (784,900)
Securities available for sale (7,082,889) (2,965,657) (11,881,639) (7,904,574)
Securities held to maturity (3,409,422) (433,227) (4,763,302) (433,227)
Premises and equipment (66,483) (1,101,317) (141,364) (1,479,818)
Proceeds from:
Maturities and repayments of
available for sale securities 363,442 1,234,209 1,761,543 2,914,437
Sales of available for sale securities 6,718,120 0 6,718,120 0
------------- ------------ ------------ ------------
Net cash from investing activities (30,527,987) (36,059,406) (75,324,122) (69,668,266)
Cash flows from financing activities
Net increase in deposits 27,164,078 28,815,840 66,783,871 73,813,230
Net increase in other borrowed money 20,000 13,325 20,236 13,325
Net increase in securities sold under agreements
to repurchase 1,907,161 870,248 2,470,559 827,991
------------- ------------ ------------ ------------
Net cash from financing activities 29,091,239 29,699,413 69,274,666 74,654,546
Net change in cash and cash equivalents 629,716 (5,576,851) (2,356,036) 6,484,865
Cash and cash equivalents at beginning of period 10,664,604 18,517,712 13,650,356 6,455,996
------------- ------------ ------------ ------------
Cash and cash equivalents at end of period $ 11,294,320 $ 12,940,861 $ 11,294,320 $ 12,940,861
============= ============ ============ ============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 4,857,078 $ 2,759,448 $ 9,000,105 $ 5,248,375
Federal income tax 465,000 496,000 699,773 730,773
Cash received during the year for
Gain on termination of interest rate swap 275,000 0 275,000 0
</TABLE>
See accompanying notes to condensed consolidated financial statements.
7
<PAGE> 8
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION:
The unaudited financial statements for the three and six months ended June
30, 2000 include the consolidated results of operations of Mercantile Bank
Corporation ("Mercantile") and its wholly-owned subsidiaries, Mercantile
Bank of West Michigan ("Bank") and MBWM Capital; Trust I ("Capital Trust").
These consolidated financial statements have been prepared in accordance
with the Instructions for Form 10-Q and Rule 10-01 of Regulation S-X and do
not include all disclosures required by generally accepted accounting
principles for a complete presentation of Mercantile's 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 periods ended June 30, 2000 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 the Corporation's annual report on Form 10-KSB for the year
ended December 31, 1999.
Interest Rate Hedge Agreements: Mercantile may enter into interest rate
hedge agreements which involve the exchange of fixed and floating rate
interest payments over the life of the agreement without the exchange of
the underlying principal amounts. The differential to be paid or received
is accrued as interest rates change and is recognized over the life of the
agreements as an adjustment to interest income.
2. ALLOWANCE FOR LOAN LOSSES
The following is a summary of the activity in the allowance for loan losses
account for the six months ended June 30, 2000 and 1999:
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Balance at January 1 $ 4,620,469 $ 2,765,100
Charge-offs (46,384) 0
Recoveries 8,400 0
Provision for loan losses charged
to operating expense 945,000 935,900
------------- --------------
Balance at June 30 $ 5,527,485 $ 3,701,000
============= ==============
</TABLE>
(Continued)
8
<PAGE> 9
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS
Total loans at June 30, 2000 were $375.0 million compared to $308.0 million
at December 31, 1999, an increase of $67.0 million or 21.7%. The components
of the outstanding balances and percentage increase in loans from the end
of 1999 to the end of the second quarter 2000 are as follows:
<TABLE>
<CAPTION>
Percent
June 30, 2000 December 31, 1999 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Real Estate:
Construction and land
development $ 37,738 10.1% $ 37,225 12.1% 1.4%
Secured by 1-4 family
properties 29,912 8.0 22,535 7.3 32.7
Secured by multi-family
properties 2,229 .6 2,327 .8 (4.2)
Secured by nonfarm
nonresidential properties 179,232 47.8 157,686 51.2 13.7
Commercial 121,080 32.3 83,908 27.2 44.3
Consumer 4,795 1.2 4,325 1.4 10.9
----------- ------ ----------- -------
$ 374,986 100.0% $ 308,006 100.0% 21.7%
=========== ====== =========== =======
</TABLE>
4. PREMISES AND EQUIPMENT - NET
Premises and equipment are comprised of the following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Land and improvements $ 443,408 $ 443,408
Buildings and leasehold improvements 2,162,762 2,111,049
Furniture and equipment 1,506,737 1,417,086
-------------- ---------------
4,112,907 3,971,543
Less accumulated depreciation 724,249 510,356
-------------- ---------------
Premises and Equipment, net $ 3,388,658 $ 3,461,187
============== ===============
</TABLE>
Depreciation expense for the second quarter of 2000 amounted to $107,457.
(Continued)
9
<PAGE> 10
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. DEPOSITS
Total deposits at June 30, 2000 were $361.6 million compared to $294.8 million
at December 31, 1999, an increase of $66.8 million or 22.7%. The components of
the outstanding balances and percentage increase in deposits from the end of
1999 to the end of the second quarter 2000 are as follows:
<TABLE>
<CAPTION>
Percent
June 30, 2000 December 31, 1999 Increase/
Balance % Balance % (Decrease)
------------- ------- ----------- ------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Noninterest-bearing demand $ 24,631 6.8% $ 19,513 6.6% 26.2%
Interest-bearing checking 11,091 3.1 11,040 3.7 .5
Money market 5,051 1.4 5,605 1.9 (9.9)
Savings 33,595 9.3 39,737 13.5 (15.5)
Time, under $100,000 4,833 1.3 4,873 1.7 (.8)
Time, $100,000 and over 42,495 11.8 22,573 7.7 88.3
----------- ------- ----------- ------
121,696 33.7 103,341 35.1 17.8
Out-of-area time,
under $100,000 61,433 17.0 71,997 24.4 (14.7)
Out-of-area time,
$100,000 and over 178,484 49.3 119,490 40.5 49.4
----------- ------- ----------- ------
239,917 66.3 191,487 64.9 25.3
----------- ------- ----------- ------
Total deposits $ 361,613 100.0% $ 294,828 100.0% 22.7%
=========== ======= =========== ======
</TABLE>
6. BORROWINGS
Information relating to securities sold under agreements to repurchase
follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Outstanding balance at end of period $ 29,077,848 $ 26,607,289
Average interest rate at end of period 4.73% 4.22%
Average balance during the period $ 25,574,129 $ 20,229,314
Average interest rate during the period 4.42% 4.13%
Maximum month end balance during the period $ 29,077,848 $ 26,607,289
</TABLE>
Securities sold under agreements to repurchase (repurchase agreements)
generally have original maturities of less than one year. Repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as liabilities. Securities involved with the
agreements are recorded as assets of the Bank and are primarily held in
safekeeping by correspondent banks. Repurchase agreements are offered
principally to certain large deposit customers as deposit equivalent
investments.
(Continued)
10
<PAGE> 11
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. COMMITMENTS AND OFF-BALANCE-SHEET RISK
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
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 the 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. The Bank's
maximum exposure to loan loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount
of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. Collateral, such as accounts receivable, securities,
inventory, property and equipment, is generally obtained based on
management's credit assessment of the borrower.
A summary of the notional or contractual amounts of financial instruments
with off-balance-sheet risk at June 30, 2000 and December 31, 1999 follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Commercial unused lines of credit $ 90,650,474 $ 87,488,616
Unused lines of credit secured by 1-4 family
residential properties 7,066,833 6,112,897
Credit card unused lines of credit 4,254,880 3,419,628
Other consumer unused lines of credit 4,003,411 3,126,906
Commitments to make loans 27,523,000 26,395,600
Standby letters of credit 31,996,366 28,963,217
-------------- ---------------
$ 165,494,964 $ 155,506,864
============== ===============
</TABLE>
8. REGULATORY MATTERS
Mercantile and the Bank 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.
(Continued)
11
<PAGE> 12
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. REGULATORY MATTERS (Continued)
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
adequately capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are required.
Actual capital levels (in thousands) and minimum required levels for
Mercantile and the Bank were:
<TABLE>
<CAPTION>
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
June 30, 2000
-------------
Total capital (to risk
weighted assets)
Consolidated $ 51,265 12.0% $ 34,286 8.0% $ 42,858 10.0%
Bank 49,304 11.6 34,165 8.0 42,706 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 39,875 9.3 17,150 4.0 25,725 6.0
Bank 43,955 10.3 17,090 4.0 25,635 6.0
Tier 1 capital (to
average assets)
Consolidated 39,875 9.3 17,249 4.0 21,561 5.0
Bank 43,955 10.2 17,176 4.0 21,470 5.0
December 31, 1999
-----------------
Total capital (to risk
weighted assets)
Consolidated $ 49,275 13.7% $ 28,830 8.0% $ 36,038 10.0%
Bank 47,402 13.2 28,714 8.0 35,893 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 38,359 10.6 14,420 4.0 21,630 6.0
Bank 42,914 12.0 14,363 4.0 21,544 6.0
Tier 1 capital (to
average assets)
Consolidated 38,359 10.9 14,097 4.0 17,621 5.0
Bank 42,914 12.2 14,042 4.0 17,554 5.0
</TABLE>
Mercantile and the Bank were categorized as well capitalized at June 30, 2000
and year-end 1999.
(Continued)
12
<PAGE> 13
MERCANTILE BANK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. REGULATORY MATTERS (Continued)
Capital Trust, a business trust subsidiary of Mercantile, sold 1.6 million
Cumulative Preferred Securities ("trust preferred securities") at $10.00
per trust preferred security in a September 1999 offering. The proceeds
from the sale were used by Capital Trust to purchase an equivalent amount
of subordinated debentures from Mercantile. The trust preferred securities
carry a fixed rate of 9.60%, have a stated maturity of 30 years, and, in
effect, are guaranteed by Mercantile. The securities are redeemable at par
after 5 years. Distributions on the trust preferred securities are payable
quarterly on January 15, April 15, July 15, and October 15. The first
distribution was paid on October 15, 1999. Under certain circumstances,
distributions may be deferred for up to 20 calendar quarters. However,
during any such deferrals, interest accrues on any unpaid distributions at
the rate of 9.60% per annum.
The capital levels of Mercantile as of June 30, 2000 include an adjustment
for the 1.6 million trust preferred securities issued by Capital Trust
subject to certain limitations. Federal Reserve guidelines limit the amount
of trust preferred securities, which can be included in Tier 1 capital of
Mercantile to 25% of total Tier 1 capital. As of June 30, 2000,
approximately $10.0 million of the $16.0 million of the trust preferred
securities were included as Tier 1 capital with the remaining $6.0 million
included as Tier 2 capital, a component of risk-based capital.
The Bank is generally prohibited from making a dividend payment if
thereafter the Bank would be undercapitalized. Further, in order to comply
with the FDIC order granting it deposit insurance, the Bank may not, prior
to December 15, 2000, pay a dividend in an amount which would cause the
Bank's Tier 1 leverage ratio to be less than 8%.
13
<PAGE> 14
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion compares the financial condition of Mercantile Bank
Corporation ("Mercantile") and its wholly-owned subsidiaries, Mercantile Bank of
West Michigan ("Bank") and MBWM Capital Trust I ("Capital Trust"), at June 30,
2000 to December 31, 1999 and the results of operations for the three and six
months ended June 30, 2000 and June 30, 1999. Capital Trust was formed in
September 1999 for the sole purpose of issuing capital securities. This
discussion should be read in conjunction with the interim consolidated condensed
financial statements and footnotes included herein.
Mercantile's election to become a financial holding company pursuant to Title I
of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board regulations
was effective March 23, 2000. At the present time, Mercantile has no plans to
engage in any of the expanded activities permitted under the new regulations.
During the second quarter Mercantile was engaged in preliminary discussions with
several unaffiliated financial institutions to explore the possibility of an
acquisition by Mercantile. To date the discussions have been exploratory in
nature and no likely acquisition candidate has been identified. Mercantile
expects that such discussions will continue with these or other financial
institutions in future periods.
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 about the Corporation. Words such
as "anticipates", "believes", "estimates", "expects", "forecasts", "intends",
"is likely", "plans", "projects", 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. The Corporation undertakes 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 changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; and changes in the national and local economy. These are representative
of the Future Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement.
FINANCIAL CONDITION
During the first six months of 2000 the assets of the Corporation increased from
$368.0 million on December 31, 1999, to $440.3 million on June 30, 2000. This
represents a total increase in assets of $72.3 million, or 19.6%. The asset
growth was comprised primarily of a $66.1 million increase in net loans and an
increase of $8.1 million in investment securities. The increase in assets was
primarily funded by a $66.8 million growth in deposits, an increase of $2.5
million in securities sold under agreements to repurchase and a decrease in cash
and cash equivalents of $2.4 million.
(Continued)
14
<PAGE> 15
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Commercial loans increased by $59.2 million during the first six months of 2000,
and at June 30, 2000 totaled $340.3 million, or 90.8% of the total loan
portfolio. The continued significant concentration in commercial loans and the
rapid growth of this portion of business is in keeping with the stated strategy
of focusing a substantial amount of efforts on "wholesale" banking. Corporate
and business lending is an area of expertise for all of Mercantile's senior
management team. Commercial loans are also the assets most easily originated and
managed by the fewest number of staff, thus reducing overhead through
necessitating fewer full-time equivalents (FTE's)/$million in assets. It is also
the commercial sector of our business that generates the greatest amount of
local deposits, and it is virtually the only source of significant demand
deposits.
Residential mortgage and consumer loans also increased by $7.4 million and $0.5
million, respectively, during the first six months of 2000, and as of June 30,
2000 totaled a combined $34.7 million. As the extremely rapid growth of our
commercial loans portfolio gradually slows, the retail portion of our loan
assets should increase as a percentage of total loans. However, our strategy for
growth and profitability will result in the commercial sector of the lending
efforts and resultant assets continuing to be the dominant portfolio category.
The quality of Mercantile's loan portfolio remains very strong. Net loan
charge-offs during the first six months of 2000 totaled $37,984, or only 0.01%
of average total loans. Past due loans and nonacccrual loans at June 30, 2000
totaled $120,443, or only 0.03% of total loans. Management believes it has
instilled a strong credit culture within the lending departments as it pertains
to the underwriting and administration processes, which in part is reflected in
the loan charge-off and delinquency ratios. A vast majority of loans are
extended directly to companies and individuals doing business and residing
within the Grand Rapids metropolitan area, although subject to the same
underwriting criteria, Mercantile participates in commercial lending
transactions with certain non-affiliated commercial banks outside the immediate
area.
Deposits increased $66.7 million during the first six months of 2000, totaling
$361.6 million at June 30, 2000. Local deposits increased $18.4 million, or
17.8%, while out-of-area deposits increased $48.4 million, or 25.3%. Although
the level of local deposits has modestly declined as a percent of total deposits
from 35.1% as of December 31, 1999 to 33.7% at June 30, 2000 due to the higher
level of growth in out-of-area deposits, there have been significant dollar
volume increases in local deposits. Noninterest-bearing demand deposits,
comprising 6.8% of total deposits, increased $5.1 million during the first six
months of 2000, while interest-bearing checking accounts (3.1% of total
deposits) remained virtually unchanged and money market deposit accounts (1.4%
of total deposits) decreased by $0.5 million. Savings deposits, comprising 9.3%
of total deposits, decreased by $6.4 million during the first six months of
2000. The decline in savings deposits, which took place primarily during the
first quarter of 2000, is believed to be due to business customers using their
funds for various business purposes. Certificates of deposit, comprising 13.1%
of total deposits, increased by $19.9 million during the first six months of
2000.
Out-of-area deposits totaled $239.9 million, or 66.3% of total deposits, as of
June 30, 2000. Out-of-area deposits consist primarily of certificates of deposit
obtained from depositors located outside the market area and placed by deposit
brokers for a fee, but also include certificates of deposit obtained from the
deposit owners directly. Out-of-area deposits are utilized to support the asset
growth of Mercantile, and are generally a lower cost source of funds when
compared to the interest rates that would have to be offered in the local market
to generate a sufficient level of funds. In addition, the overhead costs
associated with the out-of-area deposits are considerably less than the overhead
costs that would be incurred to administer a similar level of local deposits.
Although local deposits have and are expected to increase as new business,
governmental and consumer deposit relationships are established and as existing
customers increase their deposit accounts, the high reliance on out-of-area
deposits will likely remain.
(Continued)
15
<PAGE> 16
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Securities sold under agreements to repurchase increased by $2.5 million during
the first six months of 2000. Part of Mercantile's sweep account program,
collected funds from certain business noninterest-bearing checking accounts are
invested into over-night interest-bearing repurchase agreements. Although not
considered a deposit account and therefore not afforded federal deposit
insurance, the repurchase agreements have characteristics very similar to that
of business checking deposit accounts.
LIQUIDITY
Liquidity is measured by Mercantile's ability to raise funds through deposits,
borrowed funds, capital or cash flow from the repayment of loans and investment
securities. These funds are used to meet deposit withdrawals, maintain reserve
requirements, fund loans and operate Mercantile. Liquidity is primarily achieved
through the growth of deposits (both local and out-of-area) and liquid assets
such as securities available for sale, matured securities, and federal funds
sold. Asset and liability management is the process of managing the balance
sheet to achieve a mix of earning assets and liabilities that maximizes
profitability, while providing adequate liquidity.
Mercantile's liquidity strategy is to fund loan growth with deposits and
repurchase agreements and to maintain an adequate level of short- and
medium-term investments to meet typical daily loan and deposit activity.
Although deposit and repurchase agreement growth from depositors located in the
market area have consistently increased, the growth has not been sufficient to
meet the substantial loan growth and provide monies for additional investing
activities. To assist in providing the additional needed funds Mercantile has
regularly obtained certificates of deposit from customers outside of the market
area and placed by deposit brokers for a fee, but also included certificates of
deposit obtained from the deposit owners directly. As of June 30, 2000,
out-of-area deposits totaled approximately $239.9 million, or 61.4% of combined
deposits and repurchase agreements, an increase from the $191.5 million, or
59.6% of combined deposits and repurchase agreements, as of December 31, 1999.
Reliance on out-of-area deposits is expected to be ongoing due to the planned
future growth.
Mercantile has the ability to borrow money on a daily basis through
correspondent banks via established federal funds purchased lines; however, this
is viewed as only a secondary and temporary source of funds. The federal funds
purchased lines were utilized on several occasions during the first six months
of 2000, but the balance averaged only $0.3 million, or 0.07% of average assets.
Mercantile's federal funds sold position averaged $9.0 million, or 2.2% of
average assets, during the first six months of 2000. In addition, the Bank
joined the Federal Home Loan Bank of Indianapolis (FHLBI) during 1999, providing
access to the FHLBI's borrowing programs. Based on ownership of FHLBI stock and
available collateral at June 30, 2000, the Bank could borrow up to about $15.0
million. The Bank has yet to use its established borrowing line at the FHLBI.
In addition to normal loan funding and deposit flow, Mercantile also needs to
maintain liquidity to meet the demands of certain unfunded loan commitments and
standby letters of credit. As of June 30, 2000, Mercantile had a total of $133.5
million in unfunded loan commitments and $32.0 million in unfunded standby
letters of credit. Of the total unfunded loan commitments, $106.0 million were
commitments available as lines of credit to be drawn at any time as customers'
cash needs vary, and $27.5 million were for loan commitments scheduled to close
and become funded within the next three months. Mercantile monitors fluctuations
in loan balances and commitment levels, and includes such data in its overall
liquidity management.
(Continued)
16
<PAGE> 17
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity was $29.2 million and $28.0
million at June 30, 2000 and December 31, 1999, respectively. The increase
during the first six months of 2000 is primarily attributable to net income from
operations, which totaled $1.1 million. Shareholders' equity was also positively
impacted during the first six months of 2000 by a $0.1 million mark-to-market
adjustment for available for sale securities as defined in SFAS No. 115. The
adjustment is due solely to changes in the interest rate environment in 2000.
In September 1999 Mercantile, through its wholly-owned business trust subsidiary
Capital Trust, issued 1.6 million shares of trust preferred stock at $10.00 per
share. Substantially all of the net proceeds were ultimately contributed to the
Bank and were used to support anticipated growth in assets, fund investments in
loans and securities, and for general corporate purposes. Although not part of
shareholder's equity, subject to certain limitations the trust preferred
securities are considered a component of capital for purposes of calculating
regulatory capital ratios. At June 30, 2000, $10.0 million of the $16.0 million
was considered Tier 1 capital, with the remaining amount included as Tier 2
capital. The amount includable as Tier 1 capital is expected to gradually
increase in future periods as shareholders' equity increases from anticipated
net income from operations.
Mercantile and the Bank are subject to regulatory capital requirements
administered by the State of Michigan 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. Since the Bank began
operations, both Mercantile and the Bank have been categorized as "Well
Capitalized," the highest classification contained within the banking
regulations. The capital ratios of Mercantile and the Bank as of June 30, 2000
and December 31, 1999 are disclosed under Note 8 of the Notes to Consolidated
Financial Statements.
The ability of Mercantile and the Bank to pay cash and stock dividends is
subject to limitations under various laws and regulations and to prudent and
sound banking practices. No cash or stock dividends have been paid by Mercantile
since inception.
RESULTS OF OPERATIONS
Net operating income for the second quarter of 2000 was $636,472 ($0.26 per
basic and diluted share), which compares favorably to the net income of $503,472
($0.20 per basic and diluted share) recorded during the second quarter of 1999.
Net operating income for the first six months of 2000 was $1,136,764 ($0.46 per
basic and diluted share), which also compares favorably to the net income of
$855,163 ($0.35 per basic and diluted share) recorded during the first six
months of 1999. The results of operations for the first six months of 1999
includes a one-time $42,210 ($0.01 per share) after-tax charge reflecting a
mandated AICPA accounting charge for organization costs. These costs were being
amortized over the then-standard five-year period; however, effective January 1,
1999, the remaining balance was expensed and is reflected in the Consolidated
Financial Statements as a change in accounting principle. The improvement in net
operating income during both time periods is primarily the result of an increase
in net interest income, a reduction of provisions to the allowance for loan
losses and greater employee efficiency.
(Continued)
17
<PAGE> 18
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Interest income during the second quarter of 2000 was $8,848,268, a substantial
increase over the $5,212,444 earned during the second quarter of 1999. Interest
income during the first six months of 2000 was $16,712,449, a significant
increase over the $9,743,639 earned during the first six months of 1999. The
growth in interest income during both time periods is primarily attributable to
an increase in earning assets. During the second quarter of 2000 earning assets
averaged $417.9 million, a level substantially higher than the average earning
assets of $266.1 million during the second quarter of 1999. Increase in total
loans and investment securities accounted for 86.2% and 12.3% of the growth in
average earnings assets, respectively. During the first six months of 2000,
earning assets averaged $400.7 million, a level significantly higher than the
average earning assets of $250.3 million during the same time period in 1999.
Increase in total loans and investment securities accounted for 86.8% and 12.1%
of the growth in average earnings assets, respectively. Also adding to the
growth in interest income during the second quarter of 2000 and the first six
months of 2000 is the increase in yield on earning assets. During the second
quarter of 2000 and 1999, earnings assets had a weighted average rate of 8.56%
and 7.85%, respectively. During the first six months of 2000 and 1999 earning
assets had a weighted average rate of 8.36% and 7.79% respectively. This
increase is primarily due to the overall increase of market interest rates
during the last twelve months, in part evidenced by the 150 basis point rise in
the Prime Rate since June 30, 1999.
Interest expense during the second quarter of 2000 was $5,844,268, a significant
increase over the $2,947,730 expensed during the second quarter of 1999.
Interest expense during the first six months of 2000 was $10,911,035, a
substantial increase over the $5,549,147 expensed during the first six months of
1999. The growth in interest expense is primarily attributable to the growth in
assets, which necessitated an increase in funding liabilities. During the second
quarter of 2000, interest-bearing liabilities averaged $374.5 million, a level
substantially higher than average interest-bearing funds of $230.1 million
during the second quarter of 1999. During the first six months of 2000,
interest-bearing liabilities averaged $358.9 million, a level substantially
higher than average interest-bearing funds of $214.9 million during the same
time period in 1999. Also adding to the growth in interest expense during the
second quarter of 2000 and the first six months of 2000 is the increase in cost
of funds. During the second quarter of 2000 and 1999, interest-bearing
liabilities had a weighted average rate of 6.26% and 5.14%, respectively. During
the first six months of 2000 and 1999 interest-bearing liabilities had a
weighted average rate of 6.10% and 5.18%, respectively. This cost of funds
increase is primarily due to the September 1999 issuance of trust preferred
securities, an increased reliance on out-of-area deposits, an increasing
interest rate environment and a reduction of equity capital as a percent of
total assets, as reflected on Table 1.
To support Mercantile's regulatory capital structure, $16.0 million in trust
preferred securities were issued in September of 1999. Including the
amortization of the broker underwriting fee, the trust preferred securities
carry a relatively high rate of 9.81%. Although deposit and repurchase agreement
growth from depositors located in the market area have consistently increased,
the growth has not been sufficient to meet the substantial loan growth and
provide monies for additional investing activities. As a result, the reliance on
out-of-area deposits has increased. As a percent of total deposits and
repurchase agreements out-of-area deposits comprised an average of 64.1% during
the second quarter of 2000, up from the 54.9% during the second quarter of 1999,
and were 63.2% during the first six months of 2000 compared to 54.1% during the
same time period in 1999. Due to the planned and expected leveraging of
shareholders' equity, the level of shareholders' equity as a percent of average
assets has declined. During the second quarter of 2000, shareholders' equity
averaged 6.7% of average assets, a decline from the 9.9% level during the second
quarter of 1999. During the first six months of 2000, shareholders' equity
averaged 6.9% of average assets, a decline from the 10.4% level during the first
six months of 1999. The decline in shareholders' equity as a percent of average
assets has necessitated an off-setting increase in interest-bearing liabilities.
The increase in market interest rates, as mentioned previously, has also added
to the level of interest expense.
(Continued)
18
<PAGE> 19
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Net interest income during the second quarter of 2000 was $3,004,000, a
significant increase of 32.6% over the $2,264,714 earned during the second
quarter of 1999. Net interest income during the first six months of 2000 was
$5,801,414, a substantial increase of 38.3% over the $4,194,492 earned during
the same time period in 1999. The net interest spread declined from 3.31% during
the second quarter of 1999 to 2.86% in second quarter of 2000, and declined from
3.28% during the first six months of 1999 to 2.87% in the first six months of
2000. Although Mercantile experienced significant asset growth during the second
quarter of 2000 and the first six months of 2000 when compared to the same time
periods in 1999, the net interest spread declined primarily due to the
aforementioned September 1999 issuance of trust preferred securities, an
increased reliance on out-of-area deposits, an increasing interest rate
environment and a reduction of equity capital as a percent of total assets.
The following table (Table 1) sets forth certain information relating to
Mercantile's consolidated average interest earning assets and interest-bearing
liabilities and reflects the average yield on assets and average cost of
liabilities for the second quarter of 2000 and 1999. 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. For tax-exempt securities
interest income and yield have been computed on a tax equivalent basis using a
marginal tax rate of 34%.
<TABLE>
<CAPTION>
TABLE 1
QUARTERS ENDED JUNE 30,
2 0 0 0 1 9 9 9
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Loans $ 361,280 $ 7,945 8.82% $ 230,483 $ 4,696 8.17%
Investment securities 47,303 823 6.96 28,634 433 6.07
Federal funds sold 9,265 147 6.36 6,451 76 4.73
Short term investments 58 1 4.72 586 7 4.79
----------- ----------- ------- ----------- ----------- -------
Total interest-earning
assets 417,906 8,916 8.56 266,154 5,212 7.85
Allowance for loan losses (5,391) (3,393)
Other assets 18,716 11,734
----------- -----------
Total assets $ 431,231 $ 274,495
=========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 331,597 5,141 6.22 $ 213,432 2,776 5.22
Short-term borrowings 26,868 302 4.51 16,674 172 4.14
Long-term borrowings 16,027 401 9.81
----------- ----------- -------
Total interest-bearing
liabilities 374,492 5,844 6.26 230,106 2,948 5.14
Noninterest-bearing
deposits 23,700 16,235
Other liabilities 4,290 1,026
Shareholders' equity 28,749 27,128
----------- -----------
Total liability and
shareholders' equity $ 431,231 $ 274,495
=========== ===========
Net interest income $ 3,072 $ 2,264
=========== ===========
Net interest rate spread 2.30% 2.71%
======= =======
Net interest rate spread
on average assets 2.86% 3.31%
======= =======
Net interest margin on
earning assets 2.95% 3.41%
======= =======
</TABLE>
(Continued)
19
<PAGE> 20
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Provisions to the allowance for loan losses during the second quarter of 2000
were $360,000, a decrease from the $480,900 expensed during the same time period
in 1999. Provisions to the allowance for loan losses during the first six months
of 2000 were $945,000, a level similar to the $935,900 expensed during the same
time period in 1999. The reduction in provision expense during the second
quarter of 2000 reflects a reduction in loan growth experienced during the
quarter when compared to the second quarter of 1999, while the similar level of
provision expense on a year-to-date basis in 2000 and 1999 reflects a similar
level of loan growth during the time periods. Net loan charge-offs during the
second quarter of 2000 were only $20,403 compared to net loan charge-offs of $0
during the second quarter of 1999. During the first six months of 2000 net loan
charge-offs totaled only $37,984 compared to net loan charge-offs of $0 during
the same time period in 1999. The allowance for loan losses as a percentage of
total loans outstanding as of June 30, 2000 was 1.47%.
In each accounting period, the allowance for loan and lease losses (allowance)
is adjusted by management to the amount believed necessary to maintain the
allowance at adequate levels. Through its loan review and credit department,
management attempts to allocate specific portions of the allowance based on
specifically identifiable problem loans. Management's evaluation of the
allowance is further based on, although not limited to, consideration of the
internally prepared Loan Loss Reserve Analysis ("Reserve Analysis"), composition
of the loan portfolio, third party analysis of the loan administration processes
and loan portfolio and general economic conditions. In addition, Mercantile's
status as a de novo banking organization and the rapid loan growth since
inception is taken into account.
The Reserve Analysis, used since the inception of the Bank and completed
monthly, applies reserve allocation factors to outstanding loan balances to
calculate an overall allowance dollar amount. For commercial loans, which have
averaged about 92% of total loans, reserve allocation factors are based upon
the loan ratings as determined by Mercantile's comprehensive loan rating
paradigm which is administered by the loan review function. For retail loans
reserve allocation factors are based upon the type of credit. The reserve
allocation factors are based on the experience of senior management making
similar loans in the same community over the past 12 years. The Reserve
Analysis is under regular review by senior management and Board of Directors
and is adjusted periodically based upon identifiable trends and experience.
Noninterest income during the second quarter of 2000 was $265,833, a significant
increase over the $205,835 earned during the same time period in 1999.
Noninterest income during the first six months of 2000 was $489,191, a
substantial increase over the $415,558 earned during the same time period in
1999. Service charge income on deposits and repurchase agreements increased
$34,448 (70.4%) during the second quarter of 2000 over that earned in the second
quarter of 1999, and during the first six months of 2000 increased $68,974
(76.9%) over that earned in the comparable time period in 1999. The strong
increases during both time periods primarily results from new accounts opened
during the last 12 months. Other increases in noninterest income during both
time periods, also generally reflecting additional new accounts, include letter
of credit fees and credit card fees. Reflecting increasing interest rates and
the resulting decline in residential mortgage loan refinancings, fees earned on
referring residential mortgage loan applicants to various third parties declined
during both time periods.
(Continued)
20
<PAGE> 21
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
To reduce the negative impact of rising interest rates on net interest income,
during the second quarter Mercantile entered into a $50 million two-year
interest rate swap agreement with a correspondent bank. Due to market
expectations and the resulting impact on the value of the interest rate swap
agreement, management decided to terminate the interest rate swap agreement and
"lock-in" the earned benefit shortly thereafter. A termination fee of $275,000
was received from the correspondent bank. At the same time management elected to
sell approximately $7.0 million in relatively low-yielding U.S.
Government-Sponsored Agency callable bonds and reinvest the monies in
higher-yielding U.S. Government-Sponsored mortgage-backed securities. The loss
on the sale of the bonds totaled $275,321; however, the consummation of this
transaction will generate a higher level of interest income than would have
otherwise been earned over at least the next three years on a present value
basis while at the same time the interest rate risk position has been improved.
Noninterest expense during the second quarter of 2000 was $1,970,361, a
significant increase over the $1,380,177 expensed during the same time period in
1999. Noninterest expense during the first six months of 2000 was $3,680,841, a
significant increase over the $2,642,777 expensed during the same time period in
1999. An increase in all major overhead cost categories, including salaries and
benefits, occupancy, and furniture and equipment, was recorded. The increases
primarily result from the hiring of additional staff and the opening of a
combined branch and operations center. During the past 12 months the number of
full time equivalent employees has increased from 47 to 65, while on July 1,
1999 Mercantile's newly constructed combined branch and operations center was
opened. All other noninterest costs have also increased, generally reflecting
additional expenses required to administer the significantly increased loan and
deposit base.
While the dollar volume of noninterest costs have increased, as a percent of
average assets the level has substantially declined as a result of Mercantile's
growth and realized operating efficiencies. During the second quarter of 2000
noninterest costs were 1.8% of average assets on an annualized basis, a
significant decline from the 2.0% level during the same time period in 1999.
During the first six months of 2000, noninterest costs were 1.8% of average
assets on an annualized basis, a significant decline from the 2.1% level during
the same time period in 1999. Monitoring and controlling noninterest costs,
while at the same time providing high quality service to customers, is of utmost
importance to Mercantile. The efficiency ratio, computed by dividing noninterest
expenses by net interest income plus noninterest income, was 60.3% and 58.5%
during the second quarter and first six months of 2000, respectively. The
efficiency ratio during the second quarter and first six months of 1999 were
55.9% and 57.3%, respectively. The increased efficiency ratios are due entirely
from a lower net interest spread (reasons discussed earlier), as noninterest
costs have actually declined as a percent of average assets.
Federal income tax expense was $303,000 and $528,000 during the second quarter
and first six months of 2000, respectively. Federal income tax expense was
$106,000 and $134,000 during the second quarter and first six months of 1999,
respectively. During fiscal 1999 Mercantile used tax-loss carryforwards
generated in 1997 and 1998 to reduce federal income tax expense. These tax-loss
carryforwards were fully utilized over the course of fiscal 1999. Due to
continued profitable growth, Mercantile is now required to expense the full
statutory tax rate in fiscal 2000.
21
<PAGE> 22
MERCANTILE BANK CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Mercantile's primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. All of Mercantile's transactions are denominated in U.S.
dollars with no specific foreign exchange exposure. Mercantile has only limited
agricultural-related loan assets and therefore has no significant exposure to
changes in commodity prices. Any impact that changes in foreign exchange rates
and commodity prices would have on interest rates are assumed to be
insignificant. Interest rate risk is the exposure of Mercantile's financial
condition to adverse movements in interest rates. Mercantile derives its income
primarily from the excess of interest collected on its interest-earning assets
over the interest paid on its interest-bearing liabilities. The rates of
interest Mercantile earns on its assets and owes on its liabilities generally
are established contractually for a period of time. Since market interest rates
change over time, Mercantile is exposed to lower profitability if it 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 Mercantile's earnings and
capital base. Accordingly, effective risk management that maintains interest
rate risk at prudent levels is essential to Mercantile's 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. Mercantile's interest rate risk management process seeks to
ensure that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk Mercantile assesses the existing and potential future effects
of changes in interest rates on its financial condition, including capital
adequacy, earnings, liquidity and asset quality.
(Continued)
22
<PAGE> 23
MERCANTILE BANK CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There are two interest rate risk measurement techniques used by Mercantile. 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 the net interest margin
during periods of changing market interest rates. The following table depicts
Mercantile's GAP position as of June 30, 2000 (dollars in thousands):
<TABLE>
<CAPTION>
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
<S> <C> <C> <C> <C> <C>
Assets:
Commercial loans $ 118,105 $ 9,925 $ 202,427 $ 9,822 $ 340,279
Residential real estate loans 7,457 1,961 14,262 6,232 29,912
Consumer loans 868 740 3,047 140 4,795
Investment securities (1) 785 103 15,638 33,530 50,056
Federal funds sold 2,200 2,200
Short term investments 73 73
Allowance for loan losses (5,527) (5,527)
Other assets 18,529 18,529
-----------
Total assets 129,488 12,729 235,374 62,726 440,317
Liabilities:
Interest-bearing checking 11,091 11,091
Savings 33,595 33,595
Money market accounts 5,051 5,051
Time deposits < $100,000 19,533 40,070 6,663 66,266
Time deposits $100,000 and over 69,024 125,637 26,318 220,979
Short-term borrowings 29,078 29,078
Long-term borrowings 34 16,000 16,034
Noninterest-bearing checking 24,631 24,631
Other liabilities 4,353 4,353
----------- -----------
Total liabilities 167,406 165,707 32,981 44,984 411,078
Shareholders' equity 29,239 29,239
----------- ----------- ----------- ----------- -----------
Total sources of funds 167,406 165,707 32,981 74,223 440,317
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ (37,918) $ (152,978) $ 202,393 $ (11,497) $ 0
=========== =========== =========== =========== ===========
Cumulative GAP $ (37,918) $ (190,896) $ 11,497
=========== =========== ===========
Percent of cumulative GAP to
total assets (8.6)% (43.3)% 2.6%
=========== =========== ===========
</TABLE>
(1) Mortgage-backed securities are categorized by expected final maturities
based upon prepayment trends as of June 30, 2000
(Continued)
23
<PAGE> 24
MERCANTILE BANK CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The second interest rate risk measurement used is commonly referred to as net
interest income simulation analysis. Mercantile believes that this methodology
provides a more accurate measurement of interest rate risk than the GAP
analysis, and therefore, serves as the primary interest rate risk measurement
technique used by Mercantile. 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
Mercantile's strategies, among other factors.
Mercantile conducted multiple simulations as of June 30, 2000, whereby it was
assumed that a simultaneous, instant and sustained change in market interest
rates occurred. The following table reflects the suggested impact on net
interest income over the next twelve months, which are well within the policy
parameters established to manage and monitor interest rate risk.
<TABLE>
<CAPTION>
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
---------------------- ------------------- -------------------
<S> <C> <C>
Interest rates down 200 basis points $ 302,835 2.3%
Interest rates down 100 basis points 34,043 0.3
No change in interest rates (235,786) (1.7)
Interest rates up 100 basis points (367,431) (2.7)
Interest rates up 200 basis points (495,154) (3.7)
</TABLE>
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; economic and competitive conditions; potential
changes in lending, investing and deposit gathering strategies; client
preferences; and other factors.
24
<PAGE> 25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, Mercantile may be involved in various legal proceedings that
is incidental to its business. In the opinion of management, Mercantile is not a
party to any current legal proceedings that are material to the financial
condition of Mercantile, either individually or in the aggregate.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At its Annual Meeting held on April 20, 2000, Mercantile's stockholders voted to
elect four directors, Susan K. Jones, Lawrence W. Larsen, Michael H. Price and
Dale J. Visser, each for a three year term expiring at the Annual Meeting of the
stockholders of the Corporation in 2003. The results of the election were as
follows:
<TABLE>
<CAPTION>
Votes Votes Broker
Nominee For Withheld Non Votes
------- --- -------- ---------
<S> <C> <C> <C>
Susan K. Jones 2,295,486 14,210 0
Lawrence W. Larsen 2,295,486 14,210 0
Michael H. Price 2,295,486 14,210 0
Dale J. Visser 2,294,246 15,210 0
</TABLE>
The terms of office of the following directors (who were not up for election)
continued after the Annual Meeting: Betty S. Burton, Edward J. Clark, Peter A.
Cordes, C. John Gill, David M. Hecht, Gerald R. Johnson, Jr., Calvin D. Murdock,
Donald Williams, Sr. and Robert M. Wynalda.
Also at its Annual Meeting held on April 20, 2000, Mercantile's stockholders
voted to approve the 2000 Employee Stock Option Plan (the "Plan"). The Plan is
intended to make additional stock options, not to exceed 120,000 shares,
available to be granted by the Board of Directors to present and new employees
of Mercantile or any subsidiary. The results of the vote were as follows:
<TABLE>
<CAPTION>
Votes Votes Votes Broker
For Against Abstained Non Votes
--- ------- --------- ---------
<S> <C> <C> <C>
2,151,286 141,590 16,820 0
</TABLE>
ITEM 5. OTHER INFORMATION.
Not applicable.
(Continued)
25
<PAGE> 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit No. EXHIBIT DESCRIPTION
3.1 Articles of Incorporation are incorporated by reference
to Exhibit 3.1 of the Corporation's Registration
Statement on Form SB-2 (Commission File no. 333-33081)
that became effective on October 23, 1997
3.2 Bylaws of the Corporation are incorporated by reference
to Exhibit 3.2 of the Corporation's Registration
Statement on Form SB-2 (Commission File No. 333-33081)
that became effective on October 23, 1997
11 Statement re Computation of Per Share Earnings
27 Financial Data Schedule
26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 11, 2000.
MERCANTILE BANK CORPORATION
By: /s/ Gerald R. Johnson, Jr.
----------------------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Michael H. Price
------------------------------------------
Michael H. Price
President and Chief Operating Officer
By: /s/ Charles E. Christmas
------------------------------------------
Charles E. Christmas
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
27
<PAGE> 28
EXHIBIT INDEX
Exhibit No. EXHIBIT DESCRIPTION
3.1 Articles of Incorporation are incorporated by reference
to Exhibit 3.1 of the Corporation's Registration
Statement on Form SB-2 (Commission File no. 333-33081)
that became effective on October 23, 1997
3.2 Bylaws of the Corporation are incorporated by reference
to Exhibit 3.2 of the Corporation's Registration
Statement on Form SB-2 (Commission File No. 333-33081)
that became effective on October 23, 1997
11 Statement re Computation of Per Share Earnings
27 Financial Data Schedule
