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, 2001
[ ] 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)
5650 BYRON CENTER AVENUE SW, WYOMING, MICHIGAN 49509
(Address of principal executive offices and zip code)
(616) 406-3777
(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 9, 2001, there were 4,722,702 shares of Common Stock outstanding.
MERCANTILE BANK CORPORATION
INDEX
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<Table>
<Caption>
PART I. Financial Information Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2001 (Unaudited) and December 31, 2000................................. 3
Consolidated Statements of Income -
Three and Nine Months Ended September 30, 2001 (Unaudited)
and September 30, 2000 (Unaudited)................................................... 4
Consolidated Statements of Changes in Shareholders' Equity -
Nine months Ended September 30, 2001 (Unaudited) and
September 30, 2000 (Unaudited)....................................................... 5
Consolidated Statements of Cash Flows -
Three and Nine Months Ended September 30, 2001 (Unaudited)
and September 30, 2000 (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 Holders........................... 25
Item 5. Other Information............................................................. 25
Item 6. Exhibits and Reports on Form 8-K.............................................. 25
Signatures............................................................................. 26
</Table>
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- -------------
(Unaudited)
ASSETS
Cash and due from banks $ 18,206,017 $ 11,692,825
Short-term investments 156,782 108,846
Federal funds sold 5,100,000 6,300,000
------------- -------------
Total cash and cash equivalents 23,462,799 18,101,671
Securities available for sale 47,343,818 45,147,493
Securities held to maturity (fair value of $23,985,943 at
September 30, 2001 and $14,942,311 at December 31, 2000) 23,166,442 14,524,341
Federal Home Loan Bank stock 784,900 784,900
Total loans 540,691,940 429,804,105
Allowance for loan losses (7,929,830) (6,301,805)
------------- -------------
Total loans, net 532,762,110 423,502,300
Premises and equipment, net 8,410,282 4,119,385
Accrued interest receivable 3,066,267 2,758,054
Other assets 7,636,790 3,808,218
------------- -------------
Total assets $ 646,633,408 $ 512,746,362
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 39,891,409 $ 27,368,257
Interest-bearing 478,844,282 398,372,056
------------- -------------
Total 518,735,691 425,740,313
Securities sold under agreements to repurchase 37,940,792 32,151,391
Other borrowed money 204,641 56,510
Accrued expenses and other liabilities 6,342,699 6,944,262
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,000,000 16,000,000
------------- -------------
Total liabilities 579,223,823 480,892,476
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value: 9,000,000 shares authorized;
4,722,702 shares outstanding at September 30, 2001 and
2,596,102 shares outstanding at December 31, 2000 61,807,269 29,935,401
Retained earnings 4,658,214 1,628,277
Accumulated other comprehensive income 944,102 290,208
------------- -------------
Total shareholders' equity 67,409,585 31,853,886
------------- -------------
Total liabilities and shareholders' equity $ 646,633,408 $ 512,746,362
============= =============
</Table>
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See accompanying notes to condensed consolidated financial statements.
3
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,
2001 2000 2001 2000
------------- ------------- ------------- -------------
Interest income
Loans, including fees $ 10,340,809 $ 8,760,446 $ 29,766,854 $ 23,755,243
Investment securities 1,048,440 848,008 3,127,029 2,290,541
Federal funds sold 139,927 131,860 499,948 403,628
Short term investments 1,002 928 3,239 4,279
------------- ------------- ------------- -------------
Total interest income 11,530,178 9,741,242 33,397,070 26,453,691
Interest expense
Deposits 6,475,171 5,826,330 19,753,793 15,379,568
Short-term borrowings 307,634 388,634 948,996 961,117
Long-term borrowings 394,725 393,205 1,182,165 1,178,519
------------- ------------- ------------- -------------
Total interest expense 7,177,530 6,608,169 21,884,954 17,519,204
------------- ------------- ------------- -------------
NET INTEREST INCOME 4,352,648 3,133,073 11,512,116 8,934,487
Provisions to the allowance for
loan losses 455,000 370,000 1,635,000 1,315,000
------------- ------------- ------------- -------------
NET INTEREST INCOME AFTER PROVISIONS
TO THE ALLOWANCE FOR LOAN LOSSES 3,897,648 2,763,073 9,877,116 7,619,487
Noninterest income
Service charges on accounts 130,083 94,099 356,241 252,739
Interest rate swap termination fee 0 0 0 275,000
Net gain (loss) on sales of securities 0 0 99,594 (275,321)
Other income 307,684 319,796 756,890 650,668
------------- ------------- ------------- -------------
Total noninterest income 437,767 413,895 1,212,725 903,086
Noninterest expense
Salaries and benefits 1,467,167 1,167,939 4,112,686 3,232,703
Occupancy 143,509 118,008 395,900 379,081
Furniture and equipment 123,581 112,075 335,030 330,727
Other expense 658,401 618,786 1,884,288 1,755,138
------------- ------------- ------------- -------------
Total noninterest expenses 2,392,658 2,016,808 6,727,904 5,697,649
------------- ------------- ------------- -------------
INCOME BEFORE FEDERAL INCOME TAX 1,942,757 1,160,160 4,361,937 2,824,924
Federal income tax expense 605,000 382,000 1,332,000 910,000
------------- ------------- ------------- -------------
NET INCOME $ 1,337,757 $ 778,160 $ 3,029,937 $ 1,914,924
============= ============= ============= =============
COMPREHENSIVE INCOME $ 1,839,121 $ 1,027,614 $ 3,683,831 $ 2,298,859
============= ============= ============= =============
Basic earnings per share $ 0.33 $ 0.30 $ 0.92 $ 0.74
============= ============= ============= =============
Diluted earnings per share $ 0.33 $ 0.30 $ 0.91 $ 0.74
============= ============= ============= =============
Average basic shares outstanding 4,041,724 2,596,102 3,281,830 2,596,102
============= ============= ============= =============
Average diluted shares outstanding 4,103,727 2,603,086 3,335,399 2,602,289
============= ============= ============= =============
</Table>
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See accompanying notes to condensed consolidated financial statements.
4
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
----------------- ----------------- ----------------- -----------------
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
================= ================= ================= =================
BALANCE, JANUARY 1, 2001 $ 29,935,401 $ 1,628,277 $ 290,208 $ 31,853,886
Comprehensive income:
Net income for the period from
January 1, 2001 through
September 30, 2001 3,029,937 3,029,937
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect 653,894 653,894
-----------------
Total comprehensive income 3,683,831
-----------------
Common stock sales, net proceeds 31,871,868 31,871,868
----------------- ----------------- ----------------- -----------------
BALANCE, SEPTEMBER 30, 2001 $ 61,807,269 $ 4,658,214 $ 944,102 $ 67,409,585
================= ================= ================= =================
</Table>
- --------------------------------------------------------------------------------
See accompanying notes to condensed consolidated financial statements.
5
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,
2001 2000 2001 2000
------------- ------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,337,757 $ 778,160 $ 3,029,937 $ 1,914,924
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 166,118 143,202 367,542 439,285
Provision for loan losses 455,000 370,000 1,635,000 1,315,000
Net (gain) loss on sales of available
for sale securities 0 0 (99,594) 275,321
Net change in:
Accrued interest receivable (322,673) (355,731) (308,213) (695,994)
Other assets (581,054) (207,583) (4,286,373) (561,034)
Accrued expenses and other liabilities 23,656 1,909,838 (601,563) 3,643,804
------------- ------------- ------------- -------------
Net cash from operating activities 1,078,804 2,637,886 (263,264 6,331,306
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans (32,568,655) (26,069,716) (110,894,810) (93,087,196)
Purchase of:
Securities available for sale (3,009,027) (2,981,900) (20,178,843) (14,863,539)
Securities held to maturity (3,368,217) (835,248) (8,748,055) (5,598,550)
Premises and equipment (2,283,978) (753,953) (4,628,788) (895,317)
Proceeds from:
Sales of available for sale securities 0 0 5,361,961 6,718,120
Maturities, calls and repayments of
available for sale securities 3,469,509 871,376 13,806,649 2,632,919
Maturities, calls and repayments of
held to maturity securities 0 0 101,500 0
------------- ------------- ------------- -------------
Net cash from investing activities (37,760,368) (29,769,441) (125,180,386) (105,093,563)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits (1,486,355) 28,179,519 92,995,378 94,963,390
Net proceeds from the sale of common stock 25,123,149 0 31,871,868 0
Net increase in other borrowed money 93,014 13,614 148,131 33,850
Net increase in securities sold under agreements
to repurchase 3,153,149 4,591,576 5,789,401 7,062,135
------------- ------------- ------------- -------------
Net cash from financing activities 26,882,957 32,784,709 130,804,778 102,059,375
------------- ------------- ------------- -------------
Net change in cash and cash equivalents (9,798,607) 5,653,154 5,361,128 3,297,118
Cash and cash equivalents at beginning of period 33,261,406 11,294,320 18,101,671 13,650,356
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 23,462,799 $ 16,947,474 $ 23,462,799 $ 16,947,474
============= ============= ============= =============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 7,316,872 $ 5,044,407 $ 22,333,536 $ 14,044,512
Federal income tax 475,000 375,000 1,863,110 1,167,000
Cash received during the year for
Interest rate swap termination fee 0 0 0 275,000
</Table>
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See accompanying notes to condensed consolidated financial statements.
6
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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1. BASIS OF PRESENTATION:
The unaudited financial statements for the three and nine months ended
September 30, 2001 include the consolidated results of operations of
Mercantile Bank Corporation and its wholly-owned subsidiaries, Mercantile
Bank of West Michigan ("our bank") and MBWM Capital Trust I ("the trust"),
and of Mercantile Bank Mortgage Company ("our mortgage company"), a
wholly-owned subsidiary of our bank. 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 our financial condition and results of operations. In the
opinion of management, the information reflects all adjustments (consisting
only of normal recurring adjustments) which are necessary in order to make
the financial statements not misleading and for a fair presentation of the
results of operations for such periods. The results for the period ended
September 30, 2001 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 company's annual report on Form
10-K for the year ended December 31, 2000.
2. LOANS
Our total loans at September 30, 2001 were $540.7 million compared to
$429.8 million at December 31, 2000, an increase of $110.9 million or
25.8%. The components of the outstanding balances and percentage increase
in loans from the end of 2000 to the end of the third quarter 2001 are as
follows:
<Table>
<Caption>
Percent
September 30, 2001 December 31, 2000 Increase/
Balance % Balance % (Decrease)
------------- ------------- ------------- ------------- -------------
(dollars in thousands)
Real Estate:
Construction and land
development $ 53,797 9.9% $ 38,815 9.0% 38.6%
Secured by 1-4 family
properties 39,270 7.3 33,709 7.8 16.5
Secured by multi-family
properties 1,481 0.3 2,127 0.5 (30.4)
Secured by nonfarm
nonresidential properties 248,312 45.9 197,018 45.9 26.0
Commercial 190,466 35.2 151,344 35.2 25.8
Consumer 7,366 1.4 6,791 1.6 8.5
------------- ------------- ------------- ------------- -------------
$ 540,692 100.0% $ 429,804 100.0% 25.8%
============= ============= ============= ============= =============
</Table>
- --------------------------------------------------------------------------------
(Continued)
7
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
3. ALLOWANCE FOR LOAN LOSSES
The following is a summary of the activity in our allowance for loan losses
account for the three months ended September 30:
<Table>
<Caption>
2001 2000
------------ ------------
Balance at July 1 $ 7,462,092 $ 5,527,485
Charge-offs 0 (3,389)
Recoveries 12,738 2,400
Provision to the allowance for loan losses 455,000 370,000
------------ ------------
Balance at September 30 $ 7,929,830 $ 5,896,496
============ ============
</Table>
The following is a summary of the activity in our allowance for loan losses
account for the nine months ended September 30:
<Table>
<Caption>
2001 2000
----------- -----------
Balance at January 1 $ 6,301,805 $ 4,620,469
Charge-offs (64,831) (49,773)
Recoveries 57,856 10,800
Provision to the allowance for loan losses 1,635,000 1,315,000
----------- -----------
Balance at September 30 $ 7,929,830 $ 5,896,496
=========== ===========
</Table>
4. PREMISES AND EQUIPMENT - NET
Premises and equipment are comprised of the following:
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- -------------
Land and improvements $ 1,173,165 $ 1,134,548
Buildings and leasehold improvements 5,019,469 2,128,353
Construction in process 881,818 220,797
Furniture and equipment 2,624,433 1,586,621
------------- -------------
9,698,885 5,070,319
Less accumulated depreciation 1,288,603 950,934
------------- -------------
Premises and Equipment, net $ 8,410,282 $ 4,119,385
============= =============
</Table>
Depreciation expense amounted to $121,939 during the second quarter of 2001
and $337,891 during the first nine months of 2001.
- --------------------------------------------------------------------------------
(Continued)
8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
5. DEPOSITS
Our total deposits at September 30, 2001 were $518.7 million compared to
$425.7 million at December 31, 2000, an increase of $93.0 million, or
21.8%. The components of our outstanding balances at September 30, 2001 and
December 31, 2000, and percentage increase in deposits from the end of 2000
to the end of the third quarter 2001 are as follows:
<Table>
<Caption>
Percent
September 30, 2001 December 31, 2000 Increase/
Balance % Balance % (Decrease)
------------- ------------- ------------- ------------- -------------
(dollars in thousands)
Noninterest-bearing
demand $ 39,892 7.7% $ 27,368 6.4% 45.8%
Interest-bearing
checking 16,899 3.2 12,968 3.1 30.3
Money market 5,068 1.0 5,196 1.2 (2.5)
Savings 43,583 8.4 36,331 8.6 20.0
Time, under $100,000 6,444 1.2 6,165 1.4 4.5
Time, $100,000
and over 51,175 9.9 38,682 9.1 32.3
------------- ------------- ------------- ------------- -------------
163,061 31.4 126,710 29.8 28.7
Out-of-area time,
under $100,000 82,590 15.9 55,260 13.0 49.5
Out-of-area time,
$100,000 and over 273,085 52.7 243,770 57.2 12.0
------------- ------------- ------------- ------------- -------------
355,675 68.6 299,030 70.2 18.9
------------- ------------- ------------- ------------- -------------
Total Deposits $ 518,736 100.0% $ 425,740 100.0% 21.8%
============= ============= ============= ============= =============
</Table>
6. BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- -------------
Outstanding balance at end of period $ 37,940,792 $ 32,151,391
Average interest rate at end of period 3.49% 4.63%
Average balance during the period $ 33,283,470 $ 29,190,780
Average interest rate during the period 4.28% 4.66%
Maximum month end balance during the period $ 40,060,845 $ 35,473,498
</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 our 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
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
7. COMMITMENTS AND OFF-BALANCE-SHEET RISK
Our bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of our customers.
These financial instruments include commitments to extend credit and
standby letters of credit. Loan commitments to extend credit are agreements
to lend to a customer as long as there is no violation of any condition
established in the contract. Standby letters of credit are conditional
commitments issued by our bank to guarantee the performance of a customer
to a third party. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in
excess of the amount recognized, if any, in the balance sheet. Our 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. Our 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 our financial
instruments with off-balance-sheet risk at September 30, 2001 and December
31, 2000 follows:
<Table>
<Caption>
September 30, December 31,
2001 2000
------------- -------------
Commercial unused lines of credit $ 120,110,848 $ 87,121,094
Unused lines of credit secured by 1-4 family
residential properties 8,617,569 7,641,057
Credit card unused lines of credit 5,907,353 4,578,325
Other consumer unused lines of credit 3,787,403 2,062,084
Commitments to make loans 26,570,800 20,110,500
Standby letters of credit 38,474,347 36,889,288
------------- -------------
$ 203,468,320 $ 158,402,348
============= =============
</Table>
8. REGULATORY MATTERS
We are subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain
cases. Failure to meet various capital requirements can initiate regulatory
action that could have a direct material effect on the financial
statements.
- --------------------------------------------------------------------------------
(Continued)
10
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
Our 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, 2001
- ------------------
Total capital (to risk
weighted assets)
Consolidated $ 90,268 14.5% $ 49,933 8.0% $ 62,416 10.0%
Bank 87,615 14.1 49,767 8.0 62,208 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 82,465 13.2 24,972 4.0 37,457 6.0
Bank 79,837 12.8 24,890 4.0 37,334 6.0
Tier 1 capital (to
average assets)
Consolidated 82,465 13.1 25,245 4.0 31,556 5.0
Bank 79,837 12.7 25,163 4.0 31,454 5.0
December 31, 2000
- -----------------
Total capital (to risk
weighted assets)
Consolidated $ 53,685 11.0% $ 39,163 8.0% $ 48,953 10.0%
Bank 51,596 10.6 39,017 8.0 48,771 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 42,085 8.6 19,589 4.0 29,383 6.0
Bank 45,497 9.3 19,517 4.0 29,275 6.0
Tier 1 capital (to
average assets)
Consolidated 42,085 8.6 19,601 4.0 24,502 5.0
Bank 45,497 9.3 19,528 4.0 24,410 5.0
</Table>
We were categorized as well capitalized at September 30, 2001 and year-end
2000.
- --------------------------------------------------------------------------------
(Continued)
11
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
8. REGULATORY MATTERS (Continued)
During the third quarter of 2001 we sold 1,610,000 shares of common stock
in an underwritten public offering, raising $25.2 million in net proceeds.
During the first quarter of 2001 we sold a combined 516,600 shares of
common stock in two private placement offerings, raising $6.7 million in
net proceeds. We contributed substantially all of the net proceeds to our
bank as capital.
The trust 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 the trust
to purchase an equivalent amount of subordinated debentures from the
company. The trust preferred securities carry a fixed rate of 9.60%, have a
stated maturity of 30 years, and, in effect, are guaranteed by the company.
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.
Our capital levels as of September 30, 2001 include an adjustment for the
1.6 million trust preferred securities issued by the trust. Federal Reserve
guidelines limit the amount of trust preferred securities which can be
included in our Tier 1 capital to 25% of total Tier 1 capital. As of
September 30, 2001, the entire $16.0 million of the trust preferred
securities were included as Tier 1 capital.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound
banking practices. We declared a 5% stock dividend on January 10, 2001,
that was paid on February 1, 2001 to record holders as of January 19, 2001.
We have not paid cash dividends on our common stock since our formation in
1997, and we currently have no intention of doing so in the foreseeable
future.
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12
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
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 our company. 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. We undertake no obligation to update, amend, or
clarify forward looking statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.
Future Factors include 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.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its wholly-owned subsidiaries, Mercantile Bank of West Michigan
("our bank") and MBWM Capital Trust I ("the trust"), and of Mercantile Bank
Mortgage Company ("our mortgage company"), a wholly-owned subsidiary of our
bank, at September 30, 2001 to December 31, 2000 and the results of operations
for the three and nine months ended September 30, 2001 and September 30, 2000.
This discussion should be read in conjunction with the interim consolidated
condensed financial statements and footnotes included herein. Unless the text
clearly suggests otherwise, references in this report to "us," "we," "our," or
"the company" include Mercantile Bank Corporation and its wholly-owned
subsidiaries referred to above.
Subsequent to September 30, 2001, our bank filed a license application with the
Michigan Office of Financial and Insurance Services to operate a new subsidiary
as a Michigan Business and Industrial Development Company under the name
Mercantile BIDCO, Inc. When approved Mercantile BIDCO, Inc., a non-depository
Michigan financial institution, expects to offer equipment lease financing,
asset based loans, junior debt facilities and other financing where equity
features may be part of the facility pricing.
During the past year, we were engaged in preliminary discussions with several
unaffiliated financial institutions to explore the possibility of an acquisition
by us. To date the discussions have been exploratory in nature and no likely
candidate has been identified. We expect that such discussions may occur from
time-to-time with these or other financial institutions in future periods.
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(Continued)
13
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
FINANCIAL CONDITION
During the first nine months of 2001, our assets increased from $512.7 million
on December 31, 2000, to $646.6 million on September 30, 2001. This represents a
total increase in assets of $133.9 million, or 26.1%. The asset growth was
comprised primarily of a $109.3 million increase in net loans, a $10.8 million
increase in investment securities and a $5.4 million increase in cash and cash
equivalents. The increase in assets was primarily funded by a $93.0 million
growth in deposits and an increase of $5.8 million in securities sold under
agreements to repurchase, along with the receipt of $31.9 million in net
proceeds from our sales of common stock.
Commercial loans increased by $104.8 million during the first nine months of
2001, and at September 30, 2001 totaled $494.1 million, or 91.4% of the total
loan portfolio. The continued significant concentration of the loan portfolio in
commercial loans and the rapid growth of this portion of business is consistent
with our stated strategy of focusing a substantial amount of efforts on
"wholesale" banking. Corporate and business lending continues to be an area of
expertise of our senior management team, and our eight commercial lenders have
over 110 years of combined commercial lending experience. Of each of the loan
categories that we originate, commercial loans are the most efficiently
originated and managed, thus reducing overhead by necessitating the attention of
fewer employees. Our commercial lending business generates the greatest amount
of local deposits, and is virtually the only source of significant demand
deposits.
Residential mortgage and consumer loans also increased by $5.6 million and $0.6
million, respectively, during the first nine months of 2001. As of September 30,
2001, these loan types totaled a combined $46.6 million, or 8.6% of the total
loan portfolio. Although the residential mortgage loan and consumer loan
portfolios are expected to increase in future periods, given our wholesale
banking strategy, the commercial sector of the lending efforts and resultant
assets are expected to remain the dominant loan portfolio category.
The quality of our loan portfolio remains strong. Net loan charge-offs during
the first nine months of 2001 totaled $6,975, or less than 0.01% of average
total loans. Past due loans and nonaccrual loans at September 30, 2001 totaled
$880,562, or only 0.16% of total loans. We believe we have instilled a very
strong credit culture within our lending departments as it pertains to the
underwriting and administration processes, which in part is reflected in our
loan charge-off and delinquency ratios. Over 97% of the loan portfolio consists
of loans extended directly to companies and individuals doing business and
residing within our market area. The remaining portion is comprised of
commercial loans participated with certain non-affiliated commercial banks
outside the immediate area, which are underwritten using the same loan criteria
as though our bank was the originating bank.
Net premises and fixed assets have increased from $4.1 million on December 31,
2000, to $8.4 million on September 30, 2001. The increase is primarily
attributable to the construction of two facilities on a 4-acre parcel of land
located in the city of Wyoming, a southwest suburb of Grand Rapids. We acquired
the land in 2000. The larger of the two buildings, a two-story facility with
approximately 25,000 square feet of usable space, serves as the new location for
our operations and accounting departments and includes a full service branch.
This facility opened in September, 2001. The other building, a single story
facility with approximately 7,000 square feet of usable space, accommodates our
administration function. This facility opened in October, 2001. The cost of the
facilities, including land, totals about $5.5 million.
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(Continued)
14
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Other assets increased from $3.8 million on December 31, 2000, to $7.6 million
on September 30, 2001. The increase is primarily attributable to our purchase of
bank owned life insurance policies for selected officers. These single premium
insurance policies, that include term insurance coverage, were purchased mainly
to provide funding for our non-qualified deferred compensation plan made
available to selected officers. It is estimated that the cash surrender value of
each of the individual insurance policies will approximate the ending balance in
the deferred compensation plan of each of the respective officers upon them
reaching retirement age.
Deposits increased $93.0 million during the first nine months of 2001, totaling
$518.7 million at September 30, 2001. Local deposits increased $36.4 million, or
28.7%, while out-of-area deposits increased $56.6 million, or 18.9%. As a
percent of total deposits, local deposits increased from 29.8% on December 31,
2000, to 31.4% on September 30, 2001. Noninterest-bearing demand deposits,
comprising 7.7% of total deposits, increased $12.5 million during the first nine
months of 2001. Savings deposits (8.4% of total deposits) increased $7.3
million, and interest-bearing checking deposits (3.2% of total deposits)
increased $3.9 million during the first nine months of 2001. Money market
deposit accounts (1.0% of total deposits) decreased by $0.1 million during the
first nine months of 2001. Local certificates of deposit, comprising 11.1% of
total deposits, increased by $12.8 million during the first nine months of 2001.
Out-of-area deposits totaled $355.7 million, or 68.6% of total deposits, as of
September 30, 2001. 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
our asset growth, 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. During the first nine months of 2001 rates
paid on new out-of-area certificates of deposit were very similar to rates paid
on new certificates of deposit issued to local customers. 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. While the business plan anticipated the reliance on out-of-area
deposits in the early stages of our development, our longer-term strategy for
funding is to increase local deposits and lower our reliance on out-of-area
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 ("repurchase agreements")
increased by $5.8 million during the first nine months of 2001. As part of our
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 our business checking deposit accounts.
LIQUIDITY
Liquidity is measured by our 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 support our operations. 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.
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(Continued)
15
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Our 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, we have regularly obtained
certificates of deposit from customers outside of the market area and placed by
deposit brokers for a fee, as well as certificates of deposit obtained from the
deposit owners directly. As of September 30, 2001, out-of-area deposits totaled
$355.7 million, or 63.9% of combined deposits and repurchase agreements,
compared to $299.0 million, or 65.3% of combined deposits and repurchase
agreements, as of December 31, 2000. Reliance on out-of-area deposits is
expected to be ongoing due to our planned future growth.
Our bank 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 for only one business day during the first nine months of
2001. Our bank's federal funds sold position averaged $15.0 million, or 2.6% of
average assets, during the first nine months of 2001. In addition, as a member
of the Federal Home Loan Bank of Indianapolis ("FHLBI"), our bank has access to
the FHLBI's borrowing programs. Based on ownership of FHLBI stock and available
collateral at September 30, 2001, the Bank could borrow up to about $15.0
million. Our bank has yet to use its established borrowing line at the FHLBI. We
have also been extended a $10.0 million unsecured line of credit from a
correspondent bank. Proceeds from the credit facility may be used for working
capital, investment in our bank or acquisition of financial institutions. The
line, which has yet to be utilized, matures on February 27, 2002.
In addition to normal loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of September 30, 2001, our bank had a total of $165.0 million in
unfunded loan commitments and $38.5 million in unfunded standby letters of
credit. Of the total unfunded loan commitments, $138.4 million were commitments
available as lines of credit to be drawn at any time as customers' cash needs
vary, and $26.6 million were for loan commitments scheduled to close and become
funded within the next three months. We monitor fluctuations in loan balances
and commitment levels, and include such data in managing overall liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity was $67.4 million and $31.9
million at September 30, 2001 and December 31, 2000, respectively. The increase
during the first nine months of 2001 is primarily attributable to the sale of
common stock and net income. During the first quarter we sold a total of 516,600
shares of common stock in two private placement offerings, raising $6.7 million
in net proceeds. During the third quarter we sold 1,610,000 shares of common
stock in an underwritten public offering, raising $25.2 million in net proceeds.
We contributed substantially all of the net proceeds to our bank as capital. Net
income equaled $3.0 million during the first nine months of 2001. In addition,
shareholders' equity was also positively impacted during the first nine months
of 2001 by a $0.7 million mark-to-market adjustment for available for sale
securities as defined in SFAS No. 115. The adjustment was due to the decline in
the interest rate environment during the first nine months of 2001.
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(Continued)
16
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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In September 1999 the company, through the trust, issued 1.6 million shares of
trust preferred securities at $10.00 per share. Substantially all of the net
proceeds were contributed to our bank as capital and were used to support 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, 2001,
the entire $16.0 million of trust preferred securities were included as Tier 1
capital.
We 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 our bank commenced operations, both
the company and our bank have been categorized as "Well Capitalized," the
highest classification contained within the banking regulations. The capital
ratios of the company and our bank as of September 30, 2001 and December 31,
2000 are disclosed under Note 8 of the Notes to Consolidated Financial
Statements.
Our and the bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. We declared a 5% stock dividend on January 10, 2001, which was paid
on February 1, 2001 to record holders as of January 19, 2001. We have not paid
cash dividends on our common stock since our formation in 1997, and we currently
have no intention of doing so in the foreseeable future.
RESULTS OF OPERATIONS
Net income for the third quarter of 2001 was $1,337,757 ($0.33 per basic and
diluted share), which represents a 71.9% increase over net income of $778,160
($0.30 per basic and diluted share) recorded during the third quarter of 2000.
The 10.0% growth in basic and diluted earnings per share was less than the 71.9%
increase in the dollar volume of net income due to the dilution impact of the
common stock sales during the first and third quarters of 2001. Net income for
the first nine months of 2001 was $3,029,937 ($0.92 per basic share and $0.91
per diluted share), which represents a 58.2% increase over net income of
$1,914,924 ($0.74 per basic and diluted share) recorded during the first nine
months of 2000. The 23.0% growth in diluted earnings per share was less than the
58.2% increase in the dollar volume of net income due to the dilution impact of
the common stock sales during the first and third quarters of 2001. The
improvement in net income during both time periods is primarily the result of an
increase in net interest income, higher noninterest income and greater employee
efficiency.
Interest income during the third quarter of 2001 was $11,530,178, an increase of
18.4% over the $9,741,242 earned during the third quarter of 2000. Interest
income during the first nine months of 2001 was $33,397,070, an increase of
26.2% over the $26,453,691 earned during the first nine months of 2000. The
growth in interest income during both time periods is primarily attributable to
an increase in earning assets. During the third quarter of 2001 earning assets
averaged $607.0 million, a level substantially higher than the average earning
assets of $447.7 million during the third quarter of 2000. Increase in total
loans and investment securities accounted for 84.6% and 10.7% of the growth in
average earnings assets, respectively. During the first nine months of 2001
earning assets averaged $562.1 million, a level significantly higher than the
average earning assets of $416.5 million during the same time period in 2000.
Increase in total loans and investment securities accounted for 83.3% and 12.4%
of the growth in average earnings assets, respectively.
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(Continued)
17
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Negatively impacting the growth in interest income during the third quarter of
2001 and the first nine months of 2001 was the decline in yield on earning
assets. During the third quarter of 2001 and 2000, earning assets had a weighted
average yield of 7.61% and 8.81%, respectively. During the first nine months of
2001 and 2000 earning assets had a weighted average yield of 7.65% and 8.51%,
respectively. The decrease in weighted average yields is primarily due to the
overall decline in market interest rates during the first nine months of 2001,
in part evidenced by the 375 basis point drop in the prime rate since January 3,
2001.
Interest expense during the third quarter of 2001 was $7,177,530, an increase of
8.6% over the $6,608,169 expensed during the third quarter of 2000. Interest
expense during the first nine months of 2001 was $21,884,954, an increase of
24.9% over the $17,519,204 expensed during the first nine months of 2000. 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 2001, interest-bearing liabilities averaged $535.1 million, a level
substantially higher than average interest-bearing funds of $402.7 million
during the third quarter of 2000. During the first nine months of 2001,
interest-bearing liabilities averaged $501.3 million, a level substantially
higher than average interest-bearing funds of $373.6 million during the same
time period in 2000. Positively impacting the growth in interest expense during
the third quarter of 2001 and the first nine months of 2001 was the decline in
the cost of interest-bearing funds. During the third quarter of 2001 and 2000,
interest-bearing liabilities had a weighted average rate of 5.32% and 6.52%,
respectively. During the first nine months of 2001 and 2000 interest-bearing
liabilities had a weighted average rate of 5.84% and 6.25%, respectively. The
decrease in cost of interest-bearing liabilities is primarily due to the overall
decline in market interest rates.
Net interest income during the third quarter of 2001 was $4,352,648, an increase
of 38.9% over the $3,133,073 earned during the third quarter of 2000. Net
interest income during the first nine months of 2001 was $11,512,116, an
increase of 28.9% over the $8,934,487 earned during the same time period in
2000. The net interest margin increased from 2.85% during the third quarter of
2000 to 2.92% in third quarter of 2001, but declined from 2.95% during the first
nine months of 2000 to 2.81% in the first nine months of 2001. The decline is
primarily due to the rapid decline in market interest rates that occurred during
the first nine months of 2001 and our vulnerability to such an event in the
short term horizon.
The level of loans tied to the prime rate is approximately double the level of
non-certificate of deposit funding products. As a result, and despite the fact
that most of the major interest rate indices have declined in a similar manner
to that of the prime rate, each time market interest rates have declined our net
interest margin has been negatively impacted. However, this repricing gap is
short term in nature. As interest rates stabilize or decline at a slower pace
and/or magnitude, and a significant volume of local and out-of-area certificates
of deposit mature and reprice to much lower rates, it is expected that the net
interest margin would be positively impacted. In fact, the third quarter of 2001
net interest margin of 2.92% was significantly higher than the net interest
margin for the second quarter of 2001 of 2.73% due in part to the slower pace
and magnitude of interest rate declines. Also benefiting the third quarter net
interest margin was the $25.2 million in net proceeds we received in August from
the sale of common stock. If interest rates continue to stabilize or decline at
a slower pace and/or magnitude, and as local and out-of-area certificates of
deposit continue to mature and reprice to much lower rates, we expect our net
interest margin to improve throughout the remainder of 2001 and into 2002. This
expectation is further supported by the results of the net interest income
simulation analysis completed as of September 30, 2001, as presented and
discussed under the heading "Item 3 Quantitative and Qualitative Disclosures
About Market Risk" starting on page 22.
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(Continued)
18
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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The following table sets forth certain information relating our 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 2001 and 2000. 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>
Quarters ended September 30,
-----------------------------------------------------------------------------------------------
2001 2000
--------------------------------------------- ---------------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ------------ ------------ ------------ ------------ ------------
(dollars in thousands)
ASSETS
Loans $ 522,615 $ 10,341 7.85% $ 387,793 $ 8,760 8.96%
Investment securities 68,902 1,162 6.75 51,782 915 7.06
Federal funds sold 15,376 140 3.56 8,010 132 6.58
Short term investments 143 1 2.79 74 1 5.45
------------ ------------ ------------ ------------ ------------ ------------
Total interest-earning
assets 607,036 11,644 7.61 447,659 9,808 8.81
Allowance for loan losses (7,704) (5,722)
Other assets 31,592 19,498
------------ ------------
Total assets $ 630,924 $ 461,435
============ ============
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 482,430 6,475 5.32 $ 355,293 5,826 6.10
Short-term borrowings 36,427 308 3.35 31,366 389 4.92
Long-term borrowings 16,161 395 9.70 16,040 393 9.79
------------ ------------ ------------ ------------ ------------ ------------
Total interest-bearing
liabilities 535,018 7,178 5.32 402,699 6,608 6.52
Noninterest-bearing
deposits 34,138 23,427
Other liabilities 5,935 5,418
Shareholders' equity 55,833 29,891
------------ ------------ ------------ ------------ ------------ ------------
Total liability and
shareholders' equity $ 630,924 $ 461,435
============ ============
Net interest income $ 4,466 $ 3,200
============ ============
Net interest rate spread 2.29% 2.29%
============ ============
Net interest rate spread
on average assets 2.81% 2.76%
============ ============
Net interest margin on
earning assets 2.92% 2.85%
============ ============
</Table>
Provisions to the allowance for loan losses during the third quarter of 2001
were $455,000, an increase from the $370,000 expensed during the same time
period in 2000. Provisions to the allowance for loan losses during the first
nine months of 2001 were $1,635,000, an increase from the $1,315,000 expensed
during the same time period in 2000. The increase during both time periods
reflects the higher volume of loan growth. We had no loan charge-offs during the
third quarter of 2001, but did recognize $12,739 in recoveries from prior loan
charge-offs. During the third quarter of 2000 net loan charge-offs totaled only
$989. During the first nine months of 2001 net loan charge-offs totaled only
$6,975 compared to net loan charge-offs of only $38,973 during the same time
period in 2000. The allowance for loan losses as a percentage of total loans
outstanding as of September 30, 2001 was 1.47%, unchanged from the level at
December 31, 2000.
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(Continued)
19
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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In each accounting period, the allowance for loan losses is adjusted to the
amount believed necessary to maintain the allowance for loan losses at adequate
levels. Through the loan review and credit departments, we attempt to allocate
specific portions of the allowance for loan losses based on specifically
identifiable problem loans. The evaluation of the allowance for loan losses 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, our bank's status
as a relatively new banking organization and the rapid loan growth since
inception is taken into account.
The Reserve Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan balances to
calculate an overall allowance dollar amount. For commercial loans, which
continue to comprise a vast majority of our total loans, reserve allocation
factors are based upon the loan ratings as determined by our comprehensive loan
rating paradigm that is administered by our 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 15 years. The Reserve Analysis
is reviewed regularly 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 2001 was $437,767, an increase of
5.8% over the $413,895 earned during the same time period in 2000. Noninterest
income, excluding the net gains on sales of securities, during the first nine
months of 2001 was $1,113,131, an increase of 23.3% over the $903,086 earned
during the same time period in 2000. Service charge income on deposits and
repurchase agreements increased $35,984 (38.2%) during the third quarter of 2001
over that earned in the third quarter of 2000, and during the first nine months
of 2001 increased $103,502 (41.0%) over that earned in the comparable time
period in 2000. The strong increases during both time periods primarily results
from new accounts opened during the last 12 months. Reflecting declining
interest rates and the resulting increase in residential mortgage loan
refinancings, fees earned on referring residential mortgage loan applicants to
various third parties increased $23,932 (55.7%) during the third quarter of 2001
over that earned during the third quarter of 2000, and increased $133,454
(119.3%) during the first nine months of 2001 over that earned during the first
nine months of 2000. Reflecting the reduction in letter of credit issuances and
resulting origination fees, letter of credit fees decreased $73,142 (34.5%)
during the third quarter of 2001 over that earned during the third quarter of
2000, and were down $38,450 (11.7%) during the first nine months of 2001 when
compared to the first nine months of 2000.
Noninterest expense during the third quarter of 2001 was $2,392,658, an increase
of 18.6% over the $2,016,808 expensed during the same time period in 2000.
Noninterest expense during the first nine months of 2001 was $6,727,904, an
increase of 18.1% over the $5,697,649 expensed during the same time period in
2000. An increase in all major overhead cost categories was recorded, but was
primarily related to salaries and benefits and general overhead costs. The
increases in salaries and benefits primarily resulted from the hiring of
additional staff and annual pay increases. General overhead costs have also
increased reflecting the additional expenses required to administer our
significantly increased assets.
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(Continued)
20
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
While the dollar volume of noninterest costs have increased, as a percent of
average assets the level has substantially declined as a result of our growth
and the realization of operating efficiencies. During the third quarter of 2001
noninterest costs were 1.50% of average assets on an annualized basis, a decline
from the 1.72% level during the same time period in 2000. During the first nine
months of 2001, noninterest costs were 1.55% of average assets on an annualized
basis, a decline from the 1.77% level during the same time period in 2000.
Monitoring and controlling noninterest costs, while at the same time providing
high quality service to customers, is one of our priorities. Our efficiency
ratio, computed by dividing noninterest expenses by net interest income plus
noninterest income, was 50.0% and 52.9% during the third quarter and first nine
months of 2001, respectively. These levels compare favorably to our efficiency
ratio 56.9% and 57.9% during the third quarter and first nine months of 2000,
respectively. A higher level of net revenue growth (net interest income plus
noninterest expense) when compared to the growth in overhead costs has led to
improved efficiency ratios and overall profitability.
Federal income tax expense was $605,000 and $1,332,000 during the third quarter
and first nine months of 2001, respectively. Federal income tax expense was
$382,000 and $910,000 during the third quarter and first nine months of 2000,
respectively.
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21
MERCANTILE BANK CORPORATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity risk. All of our transactions are denominated in U.S. dollars with no
specific foreign exchange exposure. We have only limited agricultural-related
loan assets and therefore have no significant exposure to changes in commodity
prices. Any impact that changes in foreign exchange rates and commodity prices
would have on interest rates are assumed to be insignificant. Interest rate risk
is the exposure of our financial condition to adverse movements in interest
rates. We derive our income primarily from the excess of interest collected on
our interest-earning assets over the interest paid on our interest-bearing
liabilities. The rates of interest we earn on our assets and owe on our
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, we are exposed to lower profitability if
we cannot adapt to interest rate changes. Accepting interest rate risk can be an
important source of profitability and shareholder value; however, excessive
levels of interest rate risk could pose a significant threat to our earnings and
capital base. Accordingly, effective risk management that maintains interest
rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. Our interest rate risk management process seeks to ensure
that appropriate policies, procedures, management information systems and
internal 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, we assess the existing and potential future effects of
changes in interest rates on our financial condition, including capital
adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is
commonly referred to as GAP analysis, measures the difference between the dollar
amounts of interest sensitive assets and liabilities that will be refinanced or
repriced during a given time period. A significant repricing gap could result in
a negative impact to our net interest margin during periods of changing market
interest rates. The following table depicts our GAP position as of September 30,
2001 (dollars in thousands):
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(Continued)
22
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
----------- ----------- ----------- ----------- -----------
Assets:
Commercial loans $ 224,153 $ 4,824 $ 256,272 $ 8,807 $ 494,056
Residential real estate loans 12,168 1,021 17,214 8,867 39,270
Consumer loans 1,637 1,045 4,614 70 7,366
Investment securities (1) 1,287 1,108 27,635 41,265 71,295
Federal funds sold 5,100 5,100
Short term investments 157 157
Allowance for loan losses (7,930) (7,930)
Other assets 37,319 37,319
----------- ----------- ----------- ----------- -----------
Total assets 244,502 7,998 305,735 88,398 646,633
Liabilities:
Interest-bearing checking 16,899 16,899
Savings 43,583 45,583
Money market accounts 5,068 5,068
Time deposits < $100,000 28,596 31,650 28,788 89,034
Time deposits $100,000 and over 99,064 123,977 101,219 324,260
Short-term borrowings 37,941 37,941
Long-term borrowings 205 16,000 16,205
Noninterest-bearing checking 39,892 39,892
Other liabilities 6,342 6,342
----------- ----------- ----------- ----------- -----------
Total liabilities 231,356 155,627 130,007 62,234 579,224
Shareholders' equity 67,409 67,409
----------- ----------- ----------- ----------- -----------
Total sources of funds 231,356 155,627 130,007 129,643 646,633
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 13,146 $ (147,629) $ 175,728 $ (41,245)
=========== ============ =========== ============
Cumulative GAP $ 13,146 $ (134,483) $ 41,245
=========== ============ ===========
Percent of cumulative GAP to
total assets 2.0% (20.8)% 6.4%
=========== =========== ===========
</Table>
(1) Mortgage-backed securities are categorized by average life calculations
based upon prepayment trends as of September 30, 2001.
- --------------------------------------------------------------------------------
(Continued)
23
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. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, serves as our primary interest rate risk measurement technique. The
simulation model assesses the direction and magnitude of variations in net
interest income resulting from potential changes in market interest rates. Key
assumptions in the model include prepayment speeds on various loan and
investment assets; cash flows and maturities of interest-sensitive assets and
liabilities; and changes in market conditions impacting loan and deposit volume
and pricing. These assumptions are inherently uncertain, subject to fluctuation
and revision in a dynamic environment; therefore, the model cannot precisely
estimate net interest income or exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes and
changes in market conditions and our strategies, among other factors.
We conducted multiple simulations as of September 30, 2001, 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 our 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
---------------------- ------------------- -------------------
Interest rates down 200 basis points $ 3,060,000 17.5%
Interest rates down 100 basis points 2,999,000 17.2
No change in interest rates 2,933,000 16.8
Interest rates up 100 basis points 3,048,000 17.4
Interest rates up 200 basis points 3,161,000 18.1
</Table>
The increase in our net interest income under all interest rate scenarios
reflects the expected repricing of local and out-of-area certificates of deposit
during the next twelve months. Unlike interest rates on our floating rate loans
that declined throughout the first nine months of 2001 as the prime rate
declined, our certificates of deposit have fixed interest rates and only reprice
at maturity. Throughout the remainder of 2001 and into 2002 we have a large
volume of certificates of deposit that will mature and are expected to be
refinanced at significantly lower interest rates.
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
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that are
incidental to our business. In our opinion, we are not a party to any current
legal proceedings that are material to our financial condition, 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
- ----------- -------------------
3.1 Articles of Incorporation are incorporated by reference to
Exhibit 3.1 of our Registration Statement on Form SB-2
(Commission File no. 333-33081) that became effective on October
23, 1997
3.2 Our bylaws are incorporated by reference to Exhibit 3.2 of our
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
</Table>
- --------------------------------------------------------------------------------
(Continued)
25
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 9, 2001.
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
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
- --------------------------------------------------------------------------------
26
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 Articles of Incorporation are incorporated by reference to
exhibit 3.1 of our Registration Statement on Form SB-2
(Commission File no. 333-33081) that became effective on October
23, 1997
3.2 Our bylaws are incorporated by reference to exhibit 3.2 of our
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
</Table>
- --------------------------------------------------------------------------------
27