<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 September 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 November 10, 2000, there were 2,472,500 shares of Common Stock outstanding.
1
<PAGE> 2
MERCANTILE BANK CORPORATION
INDEX
<TABLE>
<CAPTION>
PART 1. Financial Information Page No.
--------------------- --------
<S> <C>
Item I. Financial Statements
Consolidated Balance Sheets -
September 30, 2000 (Unaudited) and December 31, 1999................................. 3
Consolidated Statements of Income -
Three and Nine Months Ended September 30, 2000 (Unaudited)
and September 30, 1999 (Unaudited)................................................... 4
Consolidated Statements of Changes in Shareholders Equity - Nine
months ended September 30, 2000 (Unaudited) and
September 30, 1999 (Unaudited)....................................................... 5
Consolidated Statements of Cash Flows - Three and
Nine Months Ended September 30, 2000 (Unaudited) and
September 30, 1999 (Unaudited)....................................................... 6
Notes to Consolidated Financial Statements (Unaudited)................................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................................. 13
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 Stockholders...................... 25
Item 5. Other Information............................................................. 25
Item 6. Exhibits and Reports on Form 8-K.............................................. 25
Signatures............................................................................. 26
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
Cash and due from banks $ 10,256,493 $ 6,570,631
Short-term investments 90,981 579,725
Federal funds sold 6,600,000 6,500,000
--------------- ----------------
Total cash and cash equivalents 16,947,474 13,650,356
Securities available for sale 39,963,688 34,115,303
Securities held to maturity (fair value of $12,792,987 at
September 30, 2000 and $6,982,329 at December 31, 1999) 12,651,591 7,056,492
Federal Home Loan Bank stock 784,900 784,900
Total loans 401,054,699 308,006,476
Allowance for loan losses (5,896,496) (4,620,469)
---------------- ----------------
Total loans, net 395,158,203 303,386,007
Premises and equipment - net 4,032,586 3,461,187
Accrued interest receivable 2,538,868 1,842,874
Other assets 3,961,816 3,739,969
--------------- ----------------
Total assets $ 476,039,126 $ 368,037,088
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 26,874,603 $ 19,513,231
Interest-bearing 362,917,759 275,315,741
--------------- ----------------
Total 389,792,362 294,828,972
Securities sold under agreements to repurchase 33,669,424 26,607,289
Other borrowed money 47,605 13,755
Accrued expenses and other liabilities 6,263,007 2,619,203
--------------- ----------------
Total liabilities 429,772,398 324,069,219
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
September 30, 2000 and December 31, 1999 28,181,798 28,181,798
Retained earnings 2,502,563 587,639
Accumulated other comprehensive loss (417,633) (801,568)
---------------- ----------------
Total shareholders' equity 30,266,728 27,967,869
--------------- ----------------
Total liabilities and shareholders' equity $ 476,039,126 $ 368,037,088
=============== ================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Interest income
Loans, including fees $ 8,760,446 $ 5,499,495 $ 23,755,243 $ 14,257,021
Investment securities 848,008 512,152 2,290,541 1,323,849
Federal funds sold 131,860 93,588 403,628 255,080
Short term investments 928 6,143 4,279 19,067
--------------- -------------- -------------- ---------------
Total interest income 9,741,242 6,111,378 26,453,691 15,855,017
Interest expense
Deposits 5,826,330 3,240,960 15,379,568 8,437,644
Short-term borrowings 388,634 216,933 961,117 569,271
Long-term borrowings 393,205 62,461 1,178,519 62,586
--------------- -------------- -------------- ---------------
Total interest expense 6,608,169 3,520,354 17,519,204 9,069,501
--------------- -------------- -------------- ---------------
NET INTEREST INCOME 3,133,073 2,591,024 8,934,487 6,785,516
Provision for loan losses 370,000 526,000 1,315,000 1,461,900
--------------- -------------- -------------- ---------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 2,763,073 2,065,024 7,619,487 5,323,616
Noninterest income
Service charges on accounts 94,099 51,328 252,739 140,994
Gain on termination of interest
rate swap 0 0 275,000 0
Loss on sale of securities 0 0 (275,321) 0
Other income 319,796 222,302 650,668 548,194
--------------- -------------- -------------- ---------------
Total noninterest income 413,895 273,630 903,086 689,188
Noninterest expense
Salaries and benefits 1,167,939 884,825 3,232,703 2,320,194
Occupancy 118,008 111,560 379,081 293,840
Furniture and equipment 112,075 101,715 330,727 233,685
Other expense 618,786 512,214 1,755,138 1,405,372
--------------- -------------- -------------- ---------------
Total noninterest expenses 2,016,808 1,610,314 5,697,649 4,253,091
--------------- -------------- -------------- ---------------
Income before federal income tax 1,160,160 728,340 2,824,924 1,759,713
Federal income tax expense 382,000 166,000 910,000 300,000
--------------- -------------- -------------- ---------------
Net income before cumulative effect
of change in accounting principle 778,160 562,340 1,914,924 1,459,713
Cumulative effect of change in accounting
principle (net of applicable income
taxes) 0 0 0 42,210
--------------- -------------- -------------- ---------------
NET INCOME $ 778,160 $ 562,340 $ 1,914,924 $ 1,417,503
=============== ============== ============== ===============
Comprehensive income $ 1,027,614 $ 480,214 $ 2,298,859 $ 840,137
=============== ============== ============== ===============
Basic and diluted earnings per share
before cumulative effect of change in
accounting principle $ 0.31 $ 0.23 $ 0.77 $ 0.59
Per share cumulative effect of change in
accounting principle 0.00 0.00 0.00 (0.02)
-------------- -------------- -------------- ---------------
Basic and diluted earnings per share $ 0.31 $ 0.23 $ 0.77 $ 0.57
============== ============== ============== ==============
Average shares outstanding 2,472,500 2,472,500 2,472,500 2,472,500
=============== ============== ============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Retained Other Total
Common Earnings Comprehensive Shareholders'
Stock (Deficit) Income (Loss) 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
September 30, 1999 1,417,503 1,417,503
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect (577,366) (577,366)
----------------
Total comprehensive income 840,137
---------------- --------------- ----------- ----------------
BALANCE, SEPTEMBER 30, 1999 $ 28,181,798 $ (95,615) $ (545,530) $ 27,540,653
================ =============== =========== ================
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
September 30, 2000 1,914,924 1,914,924
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect 383,935 383,935
----------------
Total comprehensive income 2,298,859
---------------- --------------- ----------- ----------------
BALANCE, SEPTEMBER 30, 2000 $ 28,181,798 $ 2,502,563 $ (417,633) $ 30,266,728
================ =============== ============ ================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 778,160 $ 562,340 $ 1,914,924 $ 1,417,503
Adjustments to reconcile net income (loss)
to net cash from operating activities
Depreciation and amortization 143,202 131,347 439,285 331,475
Provision for loan losses 370,000 526,000 1,315,000 1,461,900
Loss on sale of securities 0 0 275,321 0
Net change in:
Accrued interest receivable (355,731) (145,537) (695,994) (434,981)
Other assets (207,583) (1,275,564) (561,034) (2,162,294)
Accrued expenses and other liabilities 1,909,838 666,185 3,643,804 1,349,753
-------------- ------------- ------------- --------------
Net cash from operating activities 2,637,886 464,771 6,331,306 1,963,356
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans (26,069,716) (33,838,095) (93,087,196) (95,818,279)
Purchase of:
Securities available for sale (2,981,900) (8,860,730) (14,863,539) (16,765,304)
Securities held to maturity (835,248) (1,496,905) (5,598,550) (1,930,132)
Federal Home Loan Bank stock 0 0 0 (784,900)
Premises and equipment (753,953) (376,926) (895,317) (1,856,744)
Proceeds from:
Sales of available for sale securities 0 0 6,718,120 0
Maturities and repayments of
available for sale securities 871,376 3,218,657 2,632,919 6,133,094
-------------- ------------- ------------- --------------
Net cash from investing activities (29,769,441) (41,353,999) (105,093,563) (111,022,265)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 28,179,519 18,956,932 94,963,390 92,770,162
Net proceeds from the sale of trust preferred
securities 0 16,000,000 0 16,000,000
Net increase in other borrowed money 13,614 0 33,850 13,325
Net increase in securities sold under agreements
to repurchase 4,591,576 2,943,315 7,062,135 3,771,306
-------------- ------------- ------------- --------------
Net cash from financing activities 32,784,709 37,900,247 102,059,375 112,554,793
-------------- ------------- ------------- --------------
Net change in cash and cash equivalents 5,653,154 (2,988,981) 3,297,118 3,495,884
Cash and cash equivalents at beginning of period 11,294,320 12,940,861 13,650,356 6,455,996
-------------- ------------- ------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 16,947,474 $ 9,951,880 $ 16,947,474 $ 9,951,880
============== ============= ============= ==============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 5,044,407 $ 3,245,579 $ 14,044,512 $ 8,493,954
Federal income tax 375,000 430,000 1,167,000 1,160,773
Cash received during the year for
Gain on termination of interest rate swap 0 0 275,000 0
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
<PAGE> 7
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION:
The unaudited financial statements for the three and nine months ended
September 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 Item
303(b) of Regulation S-K 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 period ended
September 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 Mercantile'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 nine months ended September 30:
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Balance at January 1 $ 4,620,469 $ 2,765,100
Charge-offs (49,773) 0
Recoveries 10,800 0
Provision for loan losses charged
to operating expense 1,315,000 1,461,900
-------------- ---------------
Balance at September 30 $ 5,896,496 $ 4,227,000
============== ===============
</TABLE>
(Continued)
7
<PAGE> 8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. LOANS
Total loans at September 30, 2000 were $401.1 million compared to $308.0
million at December 31, 1999, an increase of $93.1 million or 30.2%. The
components of the outstanding balances and percentage increase in loans
from the end of 1999 to the end of the third quarter 2000 are as follows:
<TABLE>
<CAPTION>
Percent
September 30, 2000 December 31, 1999 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Real Estate:
Construction and land
development $ 39,578 9.9% $ 37,225 12.1% 6.3%
Secured by 1-4 family
properties 33,410 8.4 22,535 7.3 48.3
Secured by multi-family
properties 2,179 0.5 2,327 .8 (6.4)
Secured by nonfarm
nonresidential properties 188,408 47.0 157,686 51.2 19.5
Commercial 131,304 32.7 83,908 27.2 56.5
Consumer 6,176 1.5 4,325 1.4 42.8
----------- -------- ----------- ------- -----------
$ 401,055 100.0% $ 308,006 100.0% 30.2%
=========== ======== =========== ======= ===========
</TABLE>
4. PREMISES AND EQUIPMENT - NET
Premises and equipment are comprised of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Land and improvements $ 1,129,848 $ 443,408
Buildings and leasehold improvements 2,194,051 2,111,049
Furniture and equipment 1,542,903 1,417,086
-------------- ---------------
4,866,802 3,971,543
Less accumulated depreciation 834,216 510,536
-------------- ---------------
Premises and Equipment, net $ 4,032,586 $ 3,461,187
============== ===============
</TABLE>
Depreciation expense for the third quarter 2000 amounted to $109,967.
(Continued)
8
<PAGE> 9
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. DEPOSITS
Total deposits at September 30, 2000 were $389.8 million compared to $294.8
million at December 31, 1999, an increase of $95.0 million, or 32.2%. The
components of the outstanding balances at September 30, 2000 and December
31, 1999, and percentage increase in deposits from the end of 1999 to the
end of the third quarter 2000 are as follows:
<TABLE>
<CAPTION>
Percent
September 30, 2000 December 31, 1999 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Noninterest-bearing
demand $ 26,875 6.9% $ 19,513 6.6% 37.7%
Interest-bearing
checking 10,653 2.7 11,040 3.7 (3.5)
Money market 5,437 1.4 5,605 1.9 (3.0)
Savings 34,947 9.0 39,737 13.5 (12.1)
Time, under
$100,000 5,622 1.4 4,873 1.7 15.4
Time, $100,000
and over 34,244 8.8 22,573 7.7 51.7
----------- -------- ----------- ------- -----------
117,778 30.2 103,341 35.1 14.0
Out-of-area time,
under $100,000 56,143 14.4 71,997 24.4 (22.0)
Out-of-area time,
$100,000 and over 215,871 55.4 119,490 40.5 80.7
----------- -------- ----------- ------- -----------
272,014 69.8 191,487 64.9 42.1
----------- -------- ----------- ------- -----------
Total Deposits $ 389,792 100.0% $ 294,828 100.0% 32.2%
=========== ======== =========== ======= ===========
</TABLE>
6. BORROWINGS
Information relating to securities sold under agreements to repurchase
follows:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Outstanding balance at end of period $ 33,669,424 $ 26,607,289
Average interest rate at end of period 4.73% 4.22%
Average balance during the period $ 27,518,684 $ 20,229,314
Average interest rate during the period 4.67% 4.13%
Maximum month end balance during the period $ 33,669,424 $ 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)
9
<PAGE> 10
MERCANTILE BANK CORPORATION
NOTES TO 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 September 30, 2000 and December 31, 1999
follows:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Commercial unused lines of credit $ 86,580,504 $ 87,488,616
Unused lines of credit secured by 1-4 family
residential properties 6,512,350 6,112,897
Credit card unused lines of credit 4,474,360 3,419,628
Other consumer unused lines of credit 3,699,993 3,126,906
Commitments to make loans 27,118,200 26,395,600
Standby letters of credit 36,500,321 28,963,217
-------------- ---------------
$ 164,885,728 $ 155,506,864
============== ===============
</TABLE>
8. REGULATORY MATTERS
Mercantile and 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)
10
<PAGE> 11
MERCANTILE BANK CORPORATION
NOTES TO 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 (dollars in thousands) and minimum required levels
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
------ ----- ------ ----- ------ -----
September 30, 2000
------------------
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk
weighted assets)
Consolidated $ 52,436 11.4% $ 36,794 8.0% $ 45,992 10.0%
Bank 50,420 11.0 36,662 8.0 45,827 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 40,913 8.9 18,403 4.0 27,604 6.0
Bank 44,690 9.8 18,338 4.0 27,506 6.0
Tier 1 capital (to
average assets)
Consolidated 40,913 8.9 18,462 4.0 23,078 5.0
Bank 44,690 9.7 18,395 4.0 22,993 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 September
30, 2000 and year-end 2000.
(Continued)
11
<PAGE> 12
MERCANTILE BANK CORPORATION
NOTES TO 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 September 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 September 30,
2000, approximately $10.2 million of the $16.0 million of the trust
preferred securities were included as Tier 1 capital with the remaining
$5.8 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 that would cause the
Bank's Tier 1 leverage ratio to be less than 8%.
12
<PAGE> 13
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 September
30, 2000 to December 31, 1999 and the results of operations for the three and
nine months ended September 30, 2000 and September 30, 1999. Capital Trust was
formed in September 1999 for the sole purpose of issuing trust preferred
securities. This discussion should be read in conjunction with the interim
consolidated condensed financial statements and footnotes included herein.
During the third quarter, Mercantile Bank Mortgage Company ("Mortgage Company"),
a wholly-owned subsidiary of the Bank, was established. Formed to increase the
profitability, control and quality of its mortgage loan operations, the Mortgage
Company initiated business on October 24, 2000 via the Bank's contribution of
most of its residential mortgage loan portfolio and participation interests in
certain commercial mortgage loans. On the same date the Bank also transferred
its residential mortgage origination function to the Mortgage Company. Mortgage
loans originated and held by the Mortgage Company will be serviced by the Bank
pursuant to a servicing agreement.
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 third 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 Mercantile. 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. Mercantile 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; changes in the national and local economy; and other factors, including
risk factors, referred to from time to time in filings made by Mercantile with
the Securities and Exchange Commission. These are representative of the Future
Factors that could cause a difference between an ultimate actual outcome and a
preceding forward-looking statement.
(Continued)
13
<PAGE> 14
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
During the first nine months of 2000, the assets of Mercantile increased from
$368.0 million on December 31, 1999, to $476.0 million on September 30, 2000.
This represents a total increase in assets of $108.0 million, or 29.3%. The
asset growth was comprised primarily of a $91.8 million increase in net loans, a
$11.4 million increase in investment securities, and a $3.3 million increase in
cash and cash equivalents. The increase in assets was primarily funded by a
$95.0 million growth in deposits and an increase of $7.1 million in securities
sold under agreements to repurchase.
Commercial loans increased by $80.3 million during the first nine months of
2000, and at September 30, 2000 totaled $361.5 million, or 90.1% of the total
loan portfolio. The continued significant concentration in commercial loans and
the rapid growth of this portion of business is in keeping with the stated
strategy of focusing a substantial amount of efforts on "wholesale" banking.
Corporate and business lending is an area of expertise for all of Mercantile's
senior management team. Commercial loans are also the assets most easily
originated and managed by the fewest number of staff, thus reducing overhead
through necessitating fewer full-time equivalents (FTE's)/$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 $10.9 million and $1.9
million, respectively, during the first nine months of 2000, and as of September
30, 2000 totaled a combined $39.6 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 nine months of 2000 totaled $39,000, or only 0.01%
of average total loans. Past due loans and nonaccrual loans at September 30,
2000 totaled $144,000, or only 0.04% 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 $95.0 million during the first nine months of 2000, totaling
$389.8 million at September 30, 2000. Local deposits increased $14.4 million,
while out-of-area deposits increased $80.6 million. Although the level of local
deposits has declined as a percent of total deposits from 35.1% as of December
31, 1999 to 30.2% at September 30, 2000 due to the higher level of growth in
out-of-area deposits, the dollar volume of local deposits has increased 14%.
Noninterest-bearing demand deposits, comprising 6.9% of total deposits,
increased $7.4 million during the first nine months of 2000, while
interest-bearing checking accounts (2.7% of total deposits) declined by $0.4
million and money market deposit accounts (1.4% of total deposits) decreased by
$0.2 million. Savings deposits, comprising 9.0% of total deposits, decreased by
$4.8 million during the first nine months of 2000. The decline in savings
deposits, which took place primarily during the first quarter of 2000, is
primarily due to several business customers using their funds for various
business purposes. Local certificates of deposit, comprising 10.2% of total
deposits, increased by $12.4 million during the first nine months of 2000.
(Continued)
14
<PAGE> 15
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Out-of-area deposits totaled $272.0 million, or 69.8% of total deposits, as of
September 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 relatively high reliance on
out-of-area deposits will likely remain.
Securities sold under agreements to repurchase increased by $7.1 million during
the first nine months of 2000. As 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 September 30, 2000,
out-of-area deposits totaled approximately $272.0 million, or 64.2% 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 nine months
of 2000, but the balance averaged only $0.2 million, or 0.04% of average assets.
Mercantile's federal funds sold position averaged $8.7 million, or 2.0% of
average assets, during the first nine 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 September 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.
(Continue)
15
<PAGE> 16
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 September 30, 2000, Mercantile had a total of
$128.4 million in unfunded loan commitments and $36.5 million in unfunded
standby letters of credit. Of the total unfunded loan commitments, $101.3
million were commitments available as lines of credit to be drawn at any time as
customers' cash needs vary, and $27.1 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.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity was $30.3 million and $28.0
million at September 30, 2000 and December 31, 1999, respectively. The increase
during the first nine months of 2000 is primarily attributable to net income
from operations, which totaled $1.9 million. Shareholders' equity was also
positively impacted during the first nine months of 2000 by a $0.4 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
securities at $10.00 per security. 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 September 30,
2000, $10.2 million of the $16.0 million was considered Tier 1 capital, with the
remaining $5.8 million 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 September 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.
(Continue)
16
<PAGE> 17
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the third quarter of 2000 was $778,160 ($0.31 per basic and
diluted share), which compares favorably to the net income of $562,340 ($0.23
per share) recorded during the third quarter of 1999. Net income for the first
nine months of 2000 was $1,914,924 ($0.77 per share), which also compares
favorably to the net income of $1,417,503 ($0.57 per share) recorded during the
first nine months of 1999. The results of operations for the first nine months
of 1999 includes a one-time $42,210 ($0.02 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 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, increased noninterest income and greater employee
efficiency.
Interest income during the third quarter of 2000 was $9,741,242, a significant
increase over the $6,111,378 earned during the third quarter of 1999. Interest
income during the first nine months of 2000 was $26,453,691, a significant
increase over the $15,855,017 earned during the first nine months of 1999. The
growth in interest income during both time periods is primarily attributable to
an increase in earning assets. During the third quarter of 2000 earning assets
averaged $447.7 million, a level substantially higher than the average earning
assets of $305.5 million during the third quarter of 1999. Increase in total
loans and investment securities accounted for 86.5% and 13.3% of the growth in
average earnings assets, respectively. During the first nine months of 2000
earning assets averaged $416.5 million, a level substantially higher than the
average earning assets of $268.7 million during the same time period in 1999.
Increase in total loans and investment securities accounted for 86.7% and 12.5%
of the growth in average earnings assets, respectively. Also adding to the
growth in interest income during the third quarter of 2000 and the first nine
months of 2000 is the increase in yield on earning assets. During the third
quarter of 2000 and 1999, earnings assets had a weighted average rate of 8.81%
and 7.93%, respectively. During the first nine months of 2000 and 1999 earning
assets had a weighted average rate of 8.63% and 7.89% respectively. This
increase is primarily due to the overall increase of market interest rates
during the last twelve months, in part evidenced by the 125 basis point rise in
the Prime Rate since September 30, 1999.
Interest expense during the third quarter of 2000 was $6,608,169, a significant
increase over the $3,520,354 expensed during the third quarter of 1999. Interest
expense during the first nine months of 2000 was $17,519,204, a significant
increase over the $9,069,501 expensed during the first nine 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 third quarter
of 2000, interest-bearing liabilities averaged $402.7 million, a level
substantially higher than average interest-bearing funds of $267.4 million
during the third quarter of 1999. During the first nine months of 2000,
interest-bearing liabilities averaged $373.6 million, a level substantially
higher than average interest-bearing funds of $232.5 million during the same
time period in 1999. Also adding to the growth in interest expense during the
third quarter of 2000 and the first nine months of 2000 is the increase in cost
of funds. During the third quarter of 2000 and 1999, interest-bearing
liabilities had a weighted average rate of 6.52% and 5.22%, respectively. During
the first nine months of 2000 and 1999 interest-bearing liabilities had a
weighted average rate of 6.26% and 5.21%, 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, the aforementioned
increasing interest rate environment and a reduction of equity capital as a
percent of total assets, as reflected on Table 1.
(Continued)
17
<PAGE> 18
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 62.1% during
the third quarter of 2000, up from the 58.1% during the third quarter of 1999,
and were 58.4% during the first nine months of 2000 compared to 55.9% 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 third quarter of 2000, shareholders' equity
averaged 6.5% of average assets, a decline from the 8.6% level during the third
quarter of 1999. During the first nine months of 2000, shareholders' equity
averaged 6.7% of average assets, a decline from the 9.8% level during the first
nine 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 significant increase in market interest rates, as mentioned previously, has
also added to the level of interest expense.
Net interest income during the third quarter of 2000 was $3,133,073 a
significant increase of 20.9% over the $2,591,024 earned during the third
quarter of 1999. Net interest income during the first nine months of 2000 was
$8,934,487, a significant increase of 31.7% over the $6,785,516 earned during
the same time period in 1999. The net interest margin declined from 3.36% during
the third quarter of 1999 to 2.85% in third quarter of 2000, and declined from
3.37% during the first nine months of 1999 to 2.92% in the first nine months of
2000. Although Mercantile experienced significant asset growth during the third
quarter of 2000 and the first nine months of 2000 when compared to the same time
periods in 1999, the net interest margin declined 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.
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 third 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%.
(Continued)
18
<PAGE> 19
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
TABLE 1
<TABLE>
<CAPTION>
--------------------------Quarters ended September 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 $ 387,793 $ 8,760 8.96% $ 264,747 $ 5,499 8.24%
Investment securities 51,782 915 7.06 32,896 512 6.17
Federal funds sold 8,010 132 6.58 7,362 94 5.07
Short term investments 74 1 5.45 539 6 4.42
----------- ----------- ------- ----------- ----------- -------
Total interest-earning
assets 447,659 9,808 8.81 305,544 6,111 7.93
Allowance for loan losses (5,722) (3,985)
Other assets 19,498 14,123
----------- -----------
Total assets $ 461,435 $ 315,682
=========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 355,293 5,826 6.10 $ 243,952 3,241 5.27%
Short-term borrowings 31,366 389 4.92 23,407 279 4.73
Long-term borrowings 16,040 393 9.79
----------- ----------- ------- ----------- ----------- ------
Total interest-bearing
liabilities 402,699 6,608 6.52 267,359 3,520 5.22
Noninterest-bearing
deposits 23,427 19,530
Other liabilities 5,418 1,497
Shareholders' equity 29,891 27,296
----------- ----------- ------ -----------
Total liability and
shareholders' equity $ 461,435 $ 315,682
=========== ===========
Net interest income $ 3,200 $ 2,591
=========== ===========
Net interest rate spread 2.29% 2.71%
======= =======
Net interest rate spread
on average assets 2.76% 3.26%
======= =======
Net interest margin on
earning assets 2.85% 3.36%
======= =======
</TABLE>
Provisions to the allowance for loan losses during the third quarter of 2000
were $370,000, a decrease from the $526,000 expensed during the same time period
in 1999. Provisions to the allowance for loan losses during the first nine
months of 2000 were $1,315,000, a decline from the $1,461,900 expensed during
the same time period in 1999. The decline in provision expense during both time
periods reflects a reduction in loan growth. Net loan charge-offs during the
third quarter of 2000 were only $1,000 compared to net loan charge-offs of $0
during the third quarter of 1999. During the first nine months of 2000 net loan
charge-offs totaled only $39,000 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 September 30, 2000 was 1.47%.
(Continued)
19
<PAGE> 20
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 91% 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 the Board of Directors and is adjusted
periodically based upon identifiable trends and experience.
Noninterest income during the third quarter of 2000 was $413,895, a significant
increase over the $273,630 earned during the same time period in 1999.
Noninterest income during the first nine months of 2000 was $903,086, a
significant increase over the $689,188 earned during the same time period in
1999. Service charge income on deposits and repurchase agreements increased
$42,771 (83.3%) during the third quarter of 2000 over that earned in the third
quarter of 1999, and during the first nine months of 2000 increased $111,745
(79.3%) 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 and debit card fees. Letter of credit fees during the
third quarter of 2000 increased $86,327 (68.7%) over that earned during the
third quarter of 1999, and during the first nine months of 2000 increased
$76,468 (30.4%) over that earned in the comparable time period in 1999. Credit
and debit card transaction fees during the third quarter of 2000 increased
$17,250 (80.5%) over that earned during the third quarter of 1999, and during
the first nine months of 2000 increased $35,387 (53.3%) over that earned in the
comparable time period in 1999. 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
$17,202 during the third quarter of 2000 over that earned in the third quarter
of 1999, and was down $60,616 (35.1%) during the first nine months of 2000 when
compared to the comparable time period in 1999.
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 reinvestment of the
proceeds is expected to 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 if the bonds had not been sold. At the same time, the interest rate risk
position has improved.
(Continued)
20
<PAGE> 21
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Noninterest expense during the third quarter of 2000 was $2,016,808, a
significant increase over the $1,610,314 expensed during the same time period in
1999. Noninterest expense during the first nine months of 2000 was $5,697,649, a
significant increase over the $4,253,091 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 52 to 66, 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 third quarter of 2000
noninterest costs were 1.7% 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 nine 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 56.9% and 57.9%
during the third quarter and first nine months of 2000, respectively. The
efficiency ratio during the third quarter and first nine months of 1999 were
56.2% and 56.9%, respectively. The slightly increased efficiency ratios are due
entirely from a lower net interest margin (reasons discussed earlier), as
noninterest costs have actually declined as a percent of average assets.
Federal income tax expense was $382,000 and $910,000 during the third quarter
and first nine months of 2000, respectively. Federal income tax expense was
$166,000 and $300,000 during the third quarter and first nine 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.
(Continued)
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.
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 September 30, 2000 (dollars in thousands):
(Continued)
22
<PAGE> 23
MERCANTILE BANK CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
<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 $ 125,185 $ 8,398 $ 215,343 $ 12,543 $ 361,469
Residential real estate loans 9,188 2,377 15,279 6,566 33,410
Consumer loans 1,427 806 3,696 247 6,176
Investment securities (1) 785 103 15,026 37,486 53,400
Federal funds sold 6,600 6,600
Short term investments 91 91
Allowance for loan losses (5,896) (5,896)
Other assets 20,789 20,789
----------- ----------- ----------- ----------- -----------
Total assets 143,276 11,684 249,344 71,735 476,039
Liabilities:
Interest-bearing checking 10,653 10,653
Savings 34,947 34,947
Money market accounts 5,437 5,437
Time deposits < $100,000 21,680 34,143 5,942 61,765
Time deposits $100,000 and over 57,516 154,547 38,052 250,115
Short-term borrowings 33,669 33,669
Long-term borrowings 48 16,000 16,048
Noninterest-bearing checking 26,875 26,875
Other liabilities 6,263 6,263
----------- ----------- ----------- ----------- -----------
Total liabilities 163,950 188,690 43,994 49,138 445,772
Shareholders' equity 30,267 30,267
----------- ----------- ----------- ----------- -----------
Total sources of funds 163,950 188,690 43,994 79,405 476,039
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ (20,674) $ (177,006) $ 205,350 $ (7,670) $ 0
============ ============ =========== ============ ===========
Cumulative GAP $ (20,674) $ (197,680) $ 7,670
============ ============ ===========
Percent of cumulative GAP to
total assets (4.3)% (41.5)% 1.6%
============= ============ ============
</TABLE>
(1) Mortgage-backed securities are categorized by average life calculations
based upon prepayment trends as of September 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 September 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 $ 467,690 3.4%
Interest rates down 100 basis points 231,002 1.7
No change in interest rates (4,780) (0.1)
Interest rates up 100 basis points (86,870) (0.6)
Interest rates up 200 basis points (168,937) (1.2)
</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
are incidental to their 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.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
<S> <C>
3.1 Articles of Incorporation are incorporated by reference to Exhibit 3.1 of Mercantile's Registration
Statement on Form SB-2 (Commission File no. 333-33081) that became effective on October 23, 1997
3.2 Bylaws of Mercantile are incorporated by reference to Exhibit 3.2 of the Mercantile'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
</TABLE>
(Continued)
25
<PAGE> 26
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 November 10, 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)
26
<PAGE> 27
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
<S> <C>
3.1 Articles of Incorporation are incorporated by reference to exhibit 3.1 of Mercantile's Registration
Statement on Form SB-2 (Commission File no. 333-33081) that became effective on October 23, 1997
3.2 Bylaws of Mercantile are incorporated by reference to exhibit 3.2 of the Mercantile'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
</TABLE>
27
