U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
[ ] 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, MI 49509
(Address of principal executive offices) (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 preceding 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
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
At August 7, 2003, there were 5,422,773 shares of Common Stock outstanding.
1
MERCANTILE BANK CORPORATION
INDEX
PART I. Financial Information Page No.
--------------------- --------
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2003 (Unaudited) and December 31, 2002..................................... 3
Consolidated Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 2003 (Unaudited) and
June 30, 2002 (Unaudited)........................................................... 4
Consolidated Statements of Changes in Shareholders' Equity -
Six Months Ended June 30, 2003 (Unaudited) and
June 30, 2002 (Unaudited)........................................................... 5
Consolidated Statements of Cash Flows -
Three and Six Months Ended June 30, 2003 (Unaudited) and
June 30, 2002 (Unaudited)........................................................... 6
Notes to Consolidated Financial Statements (Unaudited)................................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................. 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 24
Item 4. Controls and Procedures....................................................... 27
PART II. Other Information
Item 1. Legal Proceedings............................................................. 28
Item 2. Changes in Securities and Use of Proceeds..................................... 28
Item 3. Defaults upon Senior Securities............................................... 28
Item 4. Submission of Matters to a Vote of Security Holders........................... 28
Item 5. Other Information............................................................. 28
Item 6. Exhibits and Reports on Form 8-K.............................................. 29
Signatures............................................................................. 30
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
--------------- ----------------
(Unaudited)
ASSETS
Cash and due from banks $ 34,202,000 $ 23,404,000
Short-term investments 137,000 213,000
Federal funds sold 3,000,000 4,500,000
--------------- ----------------
Total cash and cash equivalents 37,339,000 28,117,000
Securities available for sale 60,980,000 59,614,000
Securities held to maturity (fair value of $43,435,000
at June 30, 2003 and $37,985,000 at December 31, 2002) 40,587,000 36,493,000
Federal Home Loan Bank stock 2,250,000 786,000
Total loans and leases 866,009,000 771,554,000
Allowance for loan and lease losses (12,158,000) (10,890,000)
---------------- -----------------
Total loans and leases, net 853,851,000 760,664,000
Premises and equipment, net 14,171,000 12,174,000
Bank owned life insurance policies 15,581,000 14,876,000
Accrued interest receivable 3,461,000 3,336,000
Other assets 6,554,000 5,795,000
--------------- ----------------
Total assets $ 1,034,774,000 $ 921,855,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 77,025,000 $ 62,405,000
Interest-bearing 766,562,000 691,708,000
--------------- ----------------
Total deposits 843,587,000 754,113,000
Securities sold under agreements to repurchase 39,690,000 50,335,000
Federal Home Loan Bank advances 45,000,000 15,000,000
Other borrowed money 922,000 576,000
Accrued expenses and other liabilities 6,118,000 5,997,000
Trust preferred securities 16,000,000 16,000,000
--------------- ----------------
Total liabilities 951,317,000 842,021,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value: 9,000,000 shares authorized;
5,422,644 shares outstanding at June 30, 2003 and
5,405,706 shares outstanding at December 31, 2002 75,595,000 75,530,000
Retained earnings 7,157,000 3,250,000
Accumulated other comprehensive income 705,000 1,054,000
--------------- ----------------
Total shareholders' equity 83,457,000 79,834,000
--------------- ----------------
Total liabilities and shareholders' equity $ 1,034,774,000 $ 921,855,000
=============== ================
See accompanying notes to consolidated financial statements.
3
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Interest income
Loans and leases, including fees $ 12,223,000 $ 10,514,000 $ 23,666,000 $ 20,421,000
Investment securities 1,186,000 1,103,000 2,402,000 2,200,000
Federal funds sold 23,000 22,000 39,000 57,000
Short-term investments 1,000 0 1,000 1,000
--------------- -------------- -------------- ---------------
Total interest income 13,433,000 11,639,000 26,108,000 22,679,000
Interest expense
Deposits 5,165,000 5,281,000 10,401,000 10,690,000
Short-term borrowings 173,000 225,000 344,000 426,000
Federal Home Loan Bank advances 183,000 0 257,000 0
Long-term borrowings 401,000 398,000 801,000 794,000
--------------- -------------- -------------- ---------------
Total interest expense 5,922,000 5,904,000 11,803,000 11,910,000
--------------- -------------- -------------- ---------------
NET INTEREST INCOME 7,511,000 5,735,000 14,305,000 10,769,000
Provision for loan and lease losses 845,000 682,000 1,470,000 1,142,000
--------------- -------------- -------------- ---------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 6,666,000 5,053,000 12,835,000 9,627,000
Noninterest income
Services charges on accounts 280,000 223,000 549,000 417,000
Net gain on sales of securities 212,000 0 212,000 149,000
Other income 743,000 338,000 1,451,000 564,000
--------------- -------------- -------------- ---------------
Total noninterest income 1,235,000 561,000 2,212,000 1,130,000
Noninterest expense
Salaries and benefits 2,759,000 1,950,000 5,256,000 3,628,000
Occupancy 345,000 266,000 679,000 531,000
Furniture and equipment 245,000 189,000 466,000 362,000
Other expense 1,012,000 776,000 1,989,000 1,525,000
--------------- -------------- -------------- ---------------
Total noninterest expenses 4,361,000 3,181,000 8,390,000 6,046,000
--------------- -------------- -------------- ---------------
INCOME BEFORE FEDERAL INCOME
TAX EXPENSE 3,540,000 2,433,000 6,657,000 4,711,000
Federal income tax expense 1,000,000 717,000 1,884,000 1,391,000
--------------- -------------- -------------- ---------------
NET INCOME $ 2,540,000 $ 1,716,000 $ 4,773,000 $ 3,320,000
=============== ============== ============== ===============
COMPREHENSIVE INCOME $ 2,325,000 $ 2,275,000 $ 4,424,000 $ 3,592,000
=============== ============== ============== ===============
Basic earnings per share $ 0.47 $ 0.32 $ 0.88 $ 0.61
============== ============== ============== ==============
Diluted earnings per share $ 0.46 $ 0.31 $ 0.86 $ 0.60
============== ============== ============== ==============
Average basic shares outstanding 5,421,120 5,405,759 5,416,844 5,405,647
=============== ============== ============== ===============
Average diluted shares outstanding 5,545,892 5,510,003 5,540,705 5,503,754
=============== ============== ============== ===============
See accompanying notes to consolidated financial statements.
4
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income Equity
----------------- --------------- ----------- -----------------
BALANCE, JANUARY 1, 2002 $ 69,406,000 $ 1,649,000 $ 408,000 $ 71,463,000
Comprehensive income:
Net income for the period from
January 1, 2002 through
June 30, 2002 3,320,000 3,320,000
Change in net unrealized gain
(loss) on securities available for
sale, net of reclassifications
and tax effect 272,000 272,000
----------------
Total comprehensive income 3,592,000
Stock option exercise, 578 shares 6,000 6,000
Issuance costs from December 2001
common stock sale (37,000) (37,000)
----------------- --------------- ----------- -----------------
BALANCE, JUNE 30, 2002 $ 69,375,000 $ 4,969,000 $ 680,000 $ 75,024,000
================ =============== =========== ================
BALANCE, JANUARY 1, 2003 $ 75,530,000 $ 3,250,000 $ 1,054,000 $ 79,834,000
Comprehensive income:
Net income for the period from
January 1, 2003 through
June 30, 2003 4,773,000 4,773,000
Change in net unrealized gain
(loss) on securities available for
sale, net of reclassifications
and tax effect (349,000) (349,000)
-----------------
Total comprehensive income 4,424,000
Common stock cash dividends, $0.16 per share (866,000) (866,000)
Cash dividend reinvestment plan, 567 shares 14,000 14,000
Employee stock purchase plan, 935 shares 24,000 24,000
Stock option exercises, 15,436 shares 27,000 27,000
---------------- --------------- ----------- ----------------
BALANCE, JUNE 30, 2003 $ 75,595,000 $ 7,157,000 $ 705,000 $ 83,457,000
================ =============== =========== ================
See accompanying notes to consolidated financial statements.
5
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,540,000 $ 1,716,000 $ 4,773,000 $ 3,320,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 516,000 308,000 967,000 609,000
Provision for loan and lease losses 845,000 682,000 1,470,000 1,142,000
Net gain on sales of securities (212,000) 0 (212,000) (149,000)
Net change in:
Accrued interest receivable 399,000 206,000 (125,000) (154,000)
Bank owned life insurance policies (197,000) (46,000) (405,000) (92,000)
Other assets (1,217,000) (1,302,000) (701,000) (994,000)
Accrued expenses and other liabilities 35,000 (724,000) 121,000 (512,000)
------------- ------------- ------------ -------------
Net cash used in operating activities 2,709,000 840,000 5,888,000 3,170,000
CASH FLOWS FROM INVESTING ACTIVITIES
Loan and leases originations and payments, net (53,615,000) (46,606,000) (94,657,000) (80,688,000)
Purchases of:
Securities available for sale (16,380,000) (7,094,000) (25,129,000) (18,971,000)
Securities held to maturity (1,958,000) (2,710,000) (4,639,000) (4,781,000)
Federal Home Loan Bank stock (1,464,000) (1,000) (1,464,000) (1,000)
Proceeds from:
Maturities, calls and repayments of
available for sale securities 8,253,000 2,944,000 14,827,000 7,904,000
Maturities, calls and repayments of
held to maturity securities 534,000 1,005,000 534,000 1,005,000
Sales of available for sale securities 8,336,000 0 8,336,000 10,572,000
Purchases of premises and equipment, net (1,997,000) (1,185,000) (2,548,000) (1,812,000)
Purchases of bank owned life insurance policies 0 0 (300,000) 0
------------- ------------ ------------- ------------
Net cash used in investing activities (58,291,000) (53,647,000) (105,040,000) (86,772,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 42,490,000 48,672,000 89,474,000 75,571,000
Issuance costs of prior period common stock sales 0 (22,000) 0 (37,000)
Stock option exercises 7,000 0 27,000 6,000
Employee stock purchase plan 14,000 0 24,000 0
Cash dividend reinvestment plan 14,000 0 14,000 0
Payment of cash dividends (433,000) 0 (866,000) 0
Advances from Federal Home Loan Bank 30,000,000 0 30,000,000 0
Net increase (decrease) in other borrowed money (1,917,000) 1,357,000 346,000 1,524,000
Net increase (decrease) in securities sold under
agreements to repurchase (5,548,000) 2,363,000 (10,645,000) 3,151,000
-------------- ------------ ------------- ------------
Net cash from financing activities 64,627,000 52,370,000 108,374,000 80,215,000
------------- ------------ ------------ ------------
Net change in cash and cash equivalents 9,045,000 (437,000) 9,222,000 (3,387,000)
Cash and cash equivalents at beginning of period 28,294,000 16,988,000 28,117,000 19,938,000
------------- ------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 37,339,000 $ 16,551,000 $ 37,339,000 $ 16,551,000
============= ============ ============ ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 6,294,000 $ 6,913,000 $ 11,724,000 $ 12,375,000
Federal income tax 2,350,000 1,955,000 2,575,000 1,955,000
See accompanying notes to consolidated financial statements.
6
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The unaudited financial statements for the three
and six months ended June 30, 2003 include the consolidated results of
operations of Mercantile Bank Corporation and its consolidated
subsidiaries. These subsidiaries include Mercantile Bank of West Michigan
("our bank"), our bank's three wholly-owned subsidiaries, Mercantile Bank
Mortgage Company ("our mortgage company"), Mercantile BIDCO, Inc. ("our
BIDCO") and Mercantile Insurance Center, Inc. ("our insurance center"),
and our subsidiary MBWM Capital Trust I ("the 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 accounting principles generally
accepted in the United States of America 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 periods ended
June 30, 2003 should not be considered as indicative of results for a full
year. For further information, refer to the consolidated financial
statements and footnotes included in our annual report on Form 10-K for
the year ended December 31, 2002.
Allowance for Loan and Lease Losses: The allowance for loan and lease
losses is a valuation allowance for probable incurred credit losses,
increased by the provision for loan and lease losses and recoveries, and
decreased by charge-offs. Management estimates the allowance balance
required based on past loan loss experience, the nature and volume of the
portfolio, information about specific borrower situations and estimated
collateral values, and economic conditions. Allocations of the allowance
may be made for specific loans and leases, but the entire allowance is
available for any loan or lease that, in management's judgment, should be
charged-off. Loan and lease losses are charged against the allowance when
management believes the uncollectibility of a loan or lease balance is
confirmed.
A loan or lease is impaired when full payment under the loan or lease
terms is not expected. Impairment is evaluated in aggregate for
smaller-balance loans of similar nature such as residential mortgage,
consumer and credit card loans, and on an individual loan basis for other
loans. If a loan or lease is impaired, a portion of the allowance is
allocated so that the loan or lease is reported, net, at the present value
of estimated future cash flows using the loan's or lease's existing rate
or at the fair value of collateral if repayment is expected solely from
the collateral. Loans and leases are evaluated for impairment when
payments are delayed, typically 90 days or more, or when the internal
grading system indicates a doubtful classification.
Stock Compensation: Employee compensation expense under stock option plans
is reported using the intrinsic value method. No stock-based compensation
cost is reflected in net income, as all options granted had an exercise
price equal to or greater than the market price of the underlying common
stock at date of grant. The following table illustrates the effect on net
income and earnings per share if expense was measured using the fair value
recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation.
(Continued)
7
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Quarter ended Six months ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
Net income as reported $ 2,540,000 $ 1,716,000 $ 4,773,000 $ 3,320,000
Deduct: Stock-based compensation
expense determined under fair
value based method 81,000 63,000 163,000 126,000
---------- ---------- ---------- ---------
Pro forma net income 2,459,000 1,653,000 4,610,000 3,194,000
========= ========= ========= =========
Basic earnings per share as reported $ 0.47 $ 0.32 $ 0.88 $ 0.61
Pro forma basic earnings per share 0.45 0.31 0.85 0.59
Diluted earnings per share
as reported $ 0.46 $ 0.31 $ 0.86 $ 0.60
Pro forma diluted earnings per share 0.44 0.30 0.83 0.58
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
Quarter ended Six months ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------- ------------- ------------- -------------
Risk-free interest rate 3.25% 5.25% 3.25% 5.25%
Expected option life 7 Years 10 Years 7 Years 10 Years
Expected stock price volatility 20% 29% 20% 29%
Dividend yield 1.30% 0% 1.30% 0%
Newly Issued But Not Yet Effective Accounting Standards: The Financial
Accounting Standards Board ("FASB") recently issued two new accounting
standards, Statement 149, Amendment of Statement 133 on Derivative and
Hedging Activities, and Statement 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equities, both of
which generally become effective in the quarter beginning July 1, 2003.
Management determined that adopting Statement 149 will not materially
effect the Company's operating results or financial condition because the
Company does not currently have these instruments or engage in these
activities. Management is evaluating the impact of Statement 150 on the
Company's operating results and financial condition and has determined
that adoption will not impact the classification of these instruments as
the Company currently classifies its trust preferred securities as
liabilities and not equity capital.
(Continued)
8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. LOANS AND LEASES
Our total loans and leases at June 30, 2003 were $866.0 million compared
to $771.6 million at December 31, 2002, an increase of $94.4 million, or
12.2%. The components of our outstanding balances at June 30, 2003 and
December 31, 2002, and the percentage changes in loans and leases from the
end of 2002 to the end of the second quarter 2003 are as follows:
Percent
June 30, 2003 December 31, 2002 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
(dollars in thousands)
Real Estate:
Construction and land
development $ 116,535 13.5% $ 103,900 13.5% 12.2%
Secured by 1-4 family
properties 72,166 8.3 60,828 7.9 18.6
Secured by multi-family
properties 18,854 2.2 13,025 1.7 44.8
Secured by nonresidential
properties 413,018 47.7 357,431 46.3 15.6
Commercial 239,431 27.6 230,662 29.9 3.8
Leases 968 0.1 850 0.1 13.9
Consumer 5,037 0.6 4,858 0.6 3.7
------------- ------- ------------- -------- --------
Total loans and leases $ 866,009 100.0% $771,554 100.0% 12.2%
=============== ======= ======== ========= ========
3. ALLOWANCE FOR LOAN AND LEASE LOSSES
The following is a summary of the change in our allowance for loan and
lease losses for the three and six months ended June 30:
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
Balance at beginning of
period $ 11,406,000 $ 8,925,000 $ 10,890,000 $ 8,494,000
Charge-offs (297,000) (76,000) (429,000) (169,000)
Recoveries 204,000 31,000 227,000 95,000
Provision for loan and
lease losses 845,000 682,000 1,470,000 1,142,000
------------- ------------- ------------- --------------
Balance at June 30 $ 12,158,000 $ 9,562,000 $ 12,158,000 $ 9,562,000
============= ============= ============= ==============
(Continued)
9
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. PREMISES AND EQUIPMENT - NET
Premises and equipment are comprised of the following:
June 30, December 31,
2003 2002
---- ----
Land and improvements $ 4,603,000 $ 3,234,000
Buildings and leasehold improvements 7,733,000 7,009,000
Furniture and equipment 4,782,000 4,327,000
-------------- ---------------
17,118,000 14,570,000
Less accumulated depreciation 2,947,000 2,396,000
-------------- ---------------
Premises and equipment, net $ 14,171,000 $ 12,174,000
============== ===============
Depreciation expense amounted to $285,000 during the second quarter of
2003, compared to $219,000 in the second quarter of 2002. Depreciation
expense amounted to $551,000 during the first six months of 2003, compared
to $436,000 during the first six months of 2002.
5. DEPOSITS
Our total deposits at June 30, 2003 were $843.6 million compared to $754.1
million at December 31, 2002, an increase of $89.5 million, or 11.9%. The
components of our outstanding balances at June 30, 2003 and December 31,
2002, and percentage change in deposits from the end of 2001 to the end of
the second quarter 2003 are as follows:
Percent
June 30, 2003 December 31, 2002 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
(dollars in thousands)
Noninterest-bearing demand $ 77,025 9.1% $ 62,405 8.3% 23.4%
Interest-bearing checking 26,939 3.2 28,130 3.7 (4.2)
Money market 8,626 1.0 8,592 1.1 0.4
Savings 74,345 8.8 69,461 9.2 7.0
Time, under $100,000 8,006 1.0 7,002 0.9 14.3
Time, $100,000 and over 90,305 10.7 66,005 8.8 36.8
------------- ------ --------------- ------ ------
285,246 33.8 241,595 32.0 18.1
Out-of-area time,
under $100,000 97,211 11.5 85,557 11.4 13.6
Out-of-area time,
$100,000 and over 461,130 54.7 426,961 56.6 8.0
------------- ------ --------------- ------ ------
558,341 66.2 512,518 68.0 8.9
------------- ------ --------------- ------ ------
Total deposits $ 843,587 100.0% $ 754,113 100.0% 11.9%
============ ====== ============== ====== =====
(Continued)
10
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. SHORT-TERM BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
June 30, December 31,
2003 2002
---- ----
Outstanding balance at end of period $ 39,690,000 $ 50,335,000
Average interest rate at end of period 1.36% 1.54%
Average balance during the period $ 43,493,000 $ 43,468,000
Average interest rate during the period 1.52% 2.03%
Maximum month end balance during the period $ 45,238,000 $ 52,000,000
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.
7. FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at June 30, 2003 and December 31, 2002 were as
follows.
June 30, December 31,
2003 2002
---- ----
Maturities September 2003 through April 4, 2005,
fixed rates from 1.53% to 2.39%, averaging 1.76% $ 45,000,000 0
Maturities September 2003 through December 2004,
fixed rates from 1.69% to 2.39%, averaging 1.97% 0 $ 15,000,000
------------- -------------
Total Federal Home Loan Bank advances $ 45,000,000 $ 15,000,000
============= =============
Each advance is payable at its maturity date, and is subject to a
prepayment fee if paid prior to the maturity date. The advances are
collateralized by residential mortgage loans, first mortgage liens on
multi-family residential property loans and first mortgage liens on
commercial real estate property loans under a blanket lien arrangement.
Our borrowing line of credit as of June 30, 2003 totaled approximately
$130.0 million, with availability approximating about $85.0 million.
(Continued)
11
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. FEDERAL HOME LOAN BANK ADVANCES (Continued)
Maturities of FHLB advances currently outstanding during the next five
years are:
2003 $ 20,000,000
2004 20,000,000
2005 5,000,000
2006 0
2007 0
8. 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 June 30, 2002 and December 31,
2001 follows:
June 30, December 31,
2003 2002
---- ----
Commercial unused lines of credit $ 144,789,000 $ 131,161,000
Unused lines of credit secured by 1-4 family
residential properties 15,944,000 12,381,000
Credit card unused lines of credit 7,926,000 5,824,000
Other consumer unused lines of credit 4,876,000 4,415,000
Commitments to make loans 97,773,000 24,267,000
Standby letters of credit 44,154,000 39,338,000
-------------- ---------------
Total loan and leases commitments $ 315,462,000 $ 217,386,000
============== ===============
(Continued)
12
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. 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 our
financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent overall financial condition. If not
well 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.
(Continued)
13
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS (Continued)
Our actual capital levels and minimum required levels were (dollars in
thousands):
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
June 30, 2003
Total capital (to risk
weighted assets)
Consolidated $ 110,909 11.4% $ 77,981 8.0% $ 97,476 10.0%
Bank 107,940 11.1 77,796 8.0 97,245 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 98,751 10.1 38,991 4.0 58,486 6.0
Bank 95,784 9.9 38,898 4.0 58,347 6.0
Tier 1 capital (to
average assets)
Consolidated 98,751 9.9 40,084 4.0 50,105 5.0
Bank 95,784 9.6 40,027 4.0 50,033 5.0
December 31, 2002
Total capital (to risk
weighted assets)
Consolidated $ 105,671 12.1% $ 69,862 8.0% $ 87,328 10.0%
Bank 102,810 11.8 69,728 8.0 87,160 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 94,781 10.9 34,931 4.0 52,397 6.0
Bank 91,920 10.6 34,864 4.0 52,296 6.0
Tier 1 capital (to
average assets)
Consolidated 94,781 10.7 35,355 4.0 44,193 5.0
Bank 91,920 10.4 35,313 4.0 44,142 5.0
Both the Company and our bank were categorized as well capitalized at June
30, 2003 and year-end 2002.
(Continued)
14
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS (Continued)
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 June 30, 2003 include an adjustment for the 1.6
million trust preferred securities issued by the trust subject to certain
limitations. 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 June 30, 2003, 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 6, 2003,
that was paid on February 3, 2003, to record holders as of January 17,
2003. We have also paid two cash dividends on our common stock during
2003. On January 6, 2003, we declared a $0.08 per share cash dividend
payable on March 10, 2003, to record holders as of February 10, 2003, and
on April 8, 2003, we declared a $0.08 per share cash dividend payable on
June 10, 2003, to record holders as of May 12, 2003. On July 8, 2003, we
declared a $0.08 per share cash dividend payable on September 10, 2003, to
record holders as of August 11, 2003.
10. BENEFIT PLANS
We sponsor an employee stock purchase plan which allows employees to defer
after-tax payroll dollars and purchase our common stock on a quarterly
basis. We have registered 25,000 shares of common stock to be issued and
purchased under the plan, although the plan does allow for shares to be
purchased directly from us or on the open market. During the six months
ended June 30, 2003, we issued the first 935 shares under the plan.
15
MERCANTILE BANK CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
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, among others, 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 forward-looking statement.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, Mercantile Bank of West Michigan
("our bank"), our bank's three wholly-owned subsidiaries, Mercantile Bank
Mortgage Company ("our mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO")
and Mercantile Insurance Center, Inc. ("our insurance center"), and our
subsidiary MBWM Capital Trust I ("the trust"), at June 30, 2003 to December 31,
2002 and the results of operations for the three and six months ended June 30,
2003 and June 30, 2002. This discussion should be read in conjunction with the
interim consolidated 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 consolidated
subsidiaries referred to above.
During the second quarter of 2003, we were engaged in preliminary discussions
with a few unaffiliated financial institutions to explore the possibility of an
acquisition by us. To date the discussions have been exploratory in nature and
no likely acquisition candidate has been identified. We expect that such
discussions may occur from time-to-time with these or other financial
institutions in future periods.
16
MERCANTILE BANK CORPORATION
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles are complex and require management to
apply significant judgment to various accounting, reporting and disclosure
matters. Management must use assumptions and estimates to apply these principles
where actual measurements are not possible or practical. The Management's
Discussion and Analysis of Financial Condition and Results of Operations should
be read in conjunction with our unaudited financial statements included herein.
For a complete discussion of our significant accounting policies, see footnotes
to our Consolidated Financial Statements included on pages F-28 through F-32 in
our Form 10-K for the fiscal year ended December 31, 2002 (Commission file
number 000-26719). Below is a discussion of our Allowance for Loan and Lease
Losses policy. This policy is critical because it is highly dependent upon
subjective or complex judgments, assumptions and estimates. Changes in such
estimates may have a significant impact on the financial statements, and actual
results may differ from those estimates. Management has reviewed the application
of this policy with the Audit Committee of the Company's Board of Directors.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is
a valuation allowance for probable incurred credit losses, increased by the
provision for loan and lease losses and recoveries, and decreased by
charge-offs. Management estimates the allowance balance required based on past
loan loss experience, the nature and volume of the portfolio, information about
specific borrower situations and estimated collateral values, and economic
conditions. Allocations of the allowance may be made for specific loans and
leases, but the entire allowance is available for any loan or lease that, in
management's judgment, should be charged-off. Loan and lease losses are charged
against the allowance when management believes the uncollectibility of a loan or
lease balance is confirmed.
A loan or lease is impaired when full payment under the loan or lease terms is
not expected. Impairment is evaluated in aggregate for smaller-balance loans of
similar nature such as residential mortgage, consumer and credit card loans, and
on an individual loan basis for other loans. If a loan or lease is impaired, a
portion of the allowance is allocated so that the loan or lease is reported,
net, at the present value of estimated future cash flows using the loan's or
lease's existing rate or at the fair value of collateral if repayment is
expected solely from the collateral. Loans and leases are evaluated for
impairment when payments are delayed, typically 90 days or more, or when the
internal grading system indicates a doubtful classification.
FINANCIAL CONDITION
During the first six months of 2003, our assets increased from $921.9 million on
December 31, 2002, to $1,034.8 million on June 30, 2003. This represents a total
increase in assets of $112.9 million, or 12.2%. The asset growth was comprised
primarily of a $93.2 million increase in net loans, an increase of $9.2 million
in cash and cash equivalents and a $6.9 million increase in securities. The
increase in assets was primarily funded by an $89.5 million growth in deposits
and an increase of $30.0 million in Federal Home Loan Bank advances.
Commercial loans and leases increased by $82.9 million, or 11.7%, during the
first six months of 2003, and at June 30, 2003 totaled $788.8 million, or 91.1%
of the total loan and lease portfolio. The continued significant concentration
of the loan and lease portfolio in commercial loans and leases and the rapid
growth of this portion of our lending 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 13 commercial lenders have an average commercial
lending experience of approximately 15 years. Of each of the loan categories
that we originate, we originate and manage commercial loans and leases most
efficiently; thus reducing overhead costs by necessitating the attention of
fewer employees. Our commercial lending business generates the greatest amount
of local deposits, and is virtually our only source of significant demand
deposits.
17
MERCANTILE BANK CORPORATION
Residential mortgage loans increased by $11.3 million and consumer loans
increased by $0.2 million during the first six months of 2003. As of June 30,
2003, residential mortgage and consumer loans totaled a combined $77.2 million,
or 8.9% of the total loan and lease portfolio. Although we plan to increase our
non-commercial loan portfolios in future periods, given our wholesale banking
strategy, we expect the commercial sector of our lending efforts and resultant
assets to remain the dominant loan portfolio category.
Management believes the quality of our loan portfolio remains strong. Net loan
charge-offs during the first six months of 2003 totaled $202,000, or 0.05% of
average total loans on an annualized basis. Past due loans and nonaccrual loans
at June 30, 2003 totaled $495,000, or 0.06% of period-ending total loans and
leases. We believe we have instilled a 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
98% 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 unaffiliated
commercial banks outside of the immediate area, which we underwrite using the
same loan underwriting criteria as though our bank was the originating bank.
Securities increased $6.9 million, or 7.1%, during the first six months of 2003.
Purchases during the first six months of 2003 totaled $31.2 million. Proceeds
from the sales of securities totaled $8.3 million, while proceeds from the
maturities, calls and principal repayments of securities totaled $15.4 million.
Our securities portfolio consists of U.S. Government Agency bonds,
mortgage-backed securities issued or guaranteed by U.S. Governments Agencies,
investment-grade tax-exempt municipal securities and Federal Home Loan Bank
stock.
The total balance of cash and cash equivalents increased $9.2 million, or 32.8%,
during the first six months of 2003. Cash and due from bank balances were up
$10.8 million, while federal funds sold decreased $1.5 million. The increase in
cash and due from bank balances is primarily due to a relatively large outgoing
cash letter (deposits made by our depositors consisting of checks drawn on other
financial institutions) on June 30, 2003. The outgoing cash letter on June 30,
2003 equaled $27.6 million, compared to the $13.2 million outgoing cash letter
on December 31, 2002 and the $12.6 million average daily outgoing cash letter
during the first six months of 2003.
On April 30, 2003, our bank purchased an existing building situated on 2.75
acres of land located about two miles north of the center of downtown Grand
Rapids for approximately $1.3 million. Subject to regulatory approvals, we plan
to demolish the existing building and design and construct a four-story facility
on this property. This facility will serve as the new location for our current
downtown facility, which includes a vast majority of our commercial lending
function, and will house the administration and loan operations functions
currently housed at other of our locations. Expected completion date of the new
facility is during the first six months of 2005.
Deposits increased $89.5 million during the first six months of 2003, totaling
$843.6 million at June 30, 2003. Local deposits increased $43.6 million, or
18.1%, while out-of-area deposits increased $45.8 million, or 8.9%. As a percent
of total deposits, local deposits increased from 32.0% on December 31, 2002, to
33.8% on June 30, 2003. Noninterest-bearing demand deposits, comprising 9.1% of
total deposits, increased $14.6 million during the first six months of 2003.
Savings deposits (8.8% of total deposits) increased $4.8 million,
interest-bearing checking deposits (3.2% of total deposits) decreased $1.2
million and money market deposit accounts (1.0% of total deposits) was
relatively unchanged during the first six months of 2003. Local certificates of
deposit, comprising 11.7% of total deposits, increased by $25.3 million during
the first six months of 2003.
18
MERCANTILE BANK CORPORATION
Out-of-area deposits increased $45.8 million during the first six months of
2003, totaling $558.3 million, or 66.2% of total deposits, as of June 30, 2003.
Out-of-area deposits consist primarily of certificates of deposit obtained from
depositors located outside our 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 deposit interest
rates that would have to be offered in the local market to generate a sufficient
level of funds. During the first six months of 2003 rates paid on new
out-of-area certificates of deposit were generally lower than 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. 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, our relatively high reliance
on out-of-area deposits will likely continue.
Securities sold under agreements to repurchase ("repurchase agreements")
decreased by $10.6 million during the first six months of 2003, totaling $39.7
million as of June 30, 2003. 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.
Federal Home Loan Bank ("FHLB") advances increased by $30.0 million during the
first six months of 2003, totaling $45.0 million as of June 30, 2003. The
advances are collateralized by residential mortgage loans, first mortgage liens
on multi-family residential property loans and first mortgage liens on
commercial real estate property loans under a blanket lien arrangement. Our
borrowing line of credit with the FHLB as of June 30, 2003 totaled up to an
aggregate of approximately $130.0 million, with availability of approximately
$85.0 million. FHLB advances, along with out-of-area deposits, are the primary
components of our wholesale funding program.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment of loans and 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 advances from the Federal
Home Loan Bank of Indianapolis, as well as liquid assets such as securities
available for sale, matured securities, and federal funds sold. Asset and
liability management is the process of managing our balance sheet to achieve a
mix of earning assets and liabilities that maximizes profitability, while
providing adequate liquidity.
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 our market area has
consistently increased, this growth has not been sufficient to meet our
substantial loan growth and provide monies for additional investing activities.
To assist in providing the additional needed funds, we have regularly obtained
monies from wholesale fundings sources. Wholesale funds, comprised of
certificates of deposit from customers outside of our market area, and since the
fourth quarter of 2002, advances from the Federal Home Loan Bank of
Indianapolis, totaled $603.3 million, or 64.9% of combined deposits and borrowed
funds as of June 30, 2003. As of December 31, 2002, wholesale funds totaled
$527.5 million, or 64.3% of combined deposits and borrowed funds. Reliance on
wholesale funds is expected to continue due to our anticipated future asset
growth.
19
MERCANTILE BANK CORPORATION
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established federal funds purchased lines; however, we view these
funds as only a secondary and temporary source of funds and our bank was
generally in a federal funds sold position during the first six months of 2003.
The average balance of federal funds purchased during the first six months of
2003 equaled $2.1 million, compared to a $6.6 million average balance of federal
funds sold position.
As a member of the FHLB of Indianapolis, our bank has access to the FHLB of
Indianapolis' borrowing programs. At June 30, 2003, advances from the FHLBI of
Indianapolis totaled $45.0 million, up from the $15.0 million outstanding at
December 31, 2002. Based on available collateral at June 30, 2003, our bank
could borrow up to an aggregate of approximately $130.0 million.
In addition to typical 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 June 30, 2003, our bank had a total of $271.3 million in unfunded
loan commitments and $44.2 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $173.5 million were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $97.8
million were for loan commitments expected to close and become funded within the
next three to six months. We monitor fluctuations in loan balances and
commitment levels, and include such data in managing our overall liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $3.7 million during
the first six months of 2003, from $79.8 million on December 31, 2002, to $83.5
million at June 30, 2003. The increase is primarily attributable to net income
of $4.8 million recorded during the first six months of 2003. Shareholders'
equity was negatively impacted during the first six months of 2003 by the
payment of cash dividends totaling $0.9 million and a $0.3 million
mark-to-market adjustment for available for sale securities as defined in SFAS
No. 115.
In September 1999 we, through the trust, issued 1.6 million shares of trust
preferred securities at $10.00 per trust preferred security. 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 June 30,
2003, the entire $16.0 million of trust preferred securities were included as
Tier 1 capital.
We are subject to regulatory capital requirements primarily administered by
federal bank regulatory 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 June 30, 2003 and December 31, 2002 are
disclosed under Note 9 of the Notes to Consolidated Financial Statements.
20
MERCANTILE BANK CORPORATION
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 6, 2003, that was paid on
February 3, 2003, to record holders as of January 17, 2003. We have also paid
two cash dividends on our common stock during 2003. On January 6, 2003, we
declared a $0.08 per share cash dividend payable on March 10, 2003, to record
holders as of February 10, 2003, and on April 8, 2003 we declared a $0.08 per
share cash dividend payable on June 10, 2003, to record holders as of May 12,
2003. On July 8, 2003, we declared a $0.08 per share cash dividend payable on
September 10, 2003, to record holders as of August 11, 2003.
RESULTS OF OPERATIONS
Net income for the second quarter of 2003 was $2.5 million ($0.47 per basic
share and $0.46 per diluted share), which represents a 48.0% increase over net
income of $1.7 million ($0.32 per basic share and $0.31 per diluted share)
recorded during the second quarter of 2002. Net income for the first six months
of 2003 was $4.8 million ($0.88 per basic share and $0.86 per diluted share),
which represents a 43.8% increase over net income of $3.3 million ($0.61 per
basic share and $0.60 per diluted share) recorded during the first six months of
2002. The improvement in net income during both time periods is primarily due to
an increase in net interest income resulting from growth in earning assets and
an improved net interest margin, and an increase in noninterest income.
Interest income during the second quarter of 2003 was $13.4 million, an increase
of 15.4% over the $11.6 million earned during the second quarter of 2002.
Interest income during the first six months of 2003 was $26.1 million, an
increase of 15.1% over the $22.7 million earned during the first six months of
2002. The growth in interest income during both time periods is primarily
attributable to an increase in earning assets, which more than offset the
negative impact of a declining interest rate environment. During the second
quarter of 2003 earning assets averaged $953.9 million, $221.8 million higher
than the average earning assets of $732.1 million during the second quarter of
2002. Average loans were up $195.6 million and securities increased $23.4
million. During the first six months of 2003, earning assets averaged $923.4
million, $211.1 million higher than the average earning assets of $712.3 million
during the same time period in 2002. Average loans were up $187.9 million and
securities increased $23.3 million. During the second quarter of 2003 and 2002,
earning assets had a weighted average yield (tax equivalent-adjusted basis) of
5.73% and 6.46%, respectively. During the first six months of 2003 and 2002
earning assets had a weighted average yield of 5.86% and 6.59%, respectively.
The decrease in weighted average yields is primarily due to the continued
decline in market interest rates, resulting in many interest rate indices
currently near historic lows.
Interest expense during the second quarter of 2003 was $5.9 million, virtually
unchanged from the amount expensed during the second quarter of 2002. Interest
expense during the first six months of 2003 was $11.8 million, a decrease of
0.9% from the $11.9 million expensed during the first six months of 2002. The
relatively stable level of interest expense is primarily attributable to the
overall decline of market interest rates, which offset the increase in funding
liabilities necessitated by the growth in assets. During the second quarter of
2003, interest-bearing liabilities averaged $854.8 million, $214.1 million
higher than average interest-bearing liabilities of $640.7 million during the
second quarter of 2002. Interest-bearing deposits were up $168.2 million and
Federal Home Loan Bank advances increased $40.6 million. During the first six
months of 2003, interest-bearing liabilities averaged $826.0 million, $203.5
million higher than average interest-bearing liabilities of $622.5 million
during the same time period in 2002. Interest-bearing deposits were up $168.5
million and Federal Home Loan Bank advances increased $27.9 million. During the
second quarter of 2003 and 2002, interest-bearing liabilities had a weighted
average rate of 2.78% and 3.70%, respectively. During the first six months of
2003 and 2002, interest-bearing liabilities had a weighted average rate of 2.88%
and 3.86%, respectively. The decrease in the weighted average cost of
interest-bearing liabilities in 2003 is primarily due to the decline in market
interest rates.
21
MERCANTILE BANK CORPORATION
Net interest income during the second quarter of 2003 was $7.5 million, an
increase of 31.0% over the $5.7 million earned during the second quarter of
2002. Net interest income during the first six months of 2003 was $14.3 million,
an increase of 32.8% over the $10.8 million earned during the same time period
in 2002. The increase in net interest income is due to the growth in earning
assets and an improved net interest margin. The net interest margin improved
from 3.22% during the second quarter of 2002 to 3.24% in the second quarter of
2003, and increased from 3.13% during the first six months of 2002 to 3.21% in
the first six months of 2003. The improved net interest margin is primarily the
result of the overall positive impact of the declining and low interest rate
environment.
The following table sets forth certain information relating to our consolidated
average interest earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the second
quarter of 2003 and 2002. Such yields and costs are derived by dividing income
or expense by the average daily balance of assets or liabilities, respectively,
for the period presented. Tax-exempt securities interest income and yield have
been computed on a tax equivalent basis using a marginal tax rate of 34%.
Securities interest income was increased by $193,000 and $148,000 in the second
quarter of 2003 and 2002, respectively, for this adjustment.
Quarters ended June 30,
-----------------------
---------------- 2003 -------------- ---------------- 2002 --------------
---- ----
Average Average Average Average
Balance Interest Rate Balance Interest Rate
--------- --------- --------- --------- --------- ---------
(dollars in thousands)
ASSETS
Loans and leases $ 842,370 $ 12,223 5.82% $ 646,844 $ 10,514 6.52%
Securities 103,480 1,379 5.36 80,097 1,251 6.25
Federal funds sold 7,796 23 1.20 4,957 22 1.69
Short term investments 205 1 0.75 182 0 1.25
---------- --------- --------- ---------
Total interest-earning
assets 953,851 13,626 5.73 732,080 11,787 6.46
Allowance for loan losses (11,845) (9,305)
Other assets 60,081 38,634
---------- ---------
Total assets $1,002,087 $ 761,409
========== =========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 751,592 $ 5,165 2.76% $ 583,415 $ 5,281 3.63%
Short-term borrowings 45,774 173 1.52 40,886 225 2.21
FHLB advances 40,604 183 1.78 0 0 NA
Long-term borrowings 16,870 401 9.51 16,428 398 9.72
--------- --------- --------- --------- ---------
Total interest-bearing
liabilities 854,840 5,922 2.78 640,729 5,904 3.70
Noninterest-bearing
deposits 58,394 40,588
Other liabilities 6,443 6,266
Shareholders' equity 82,410 73,826
---------- ---------
Total liabilities and
shareholders' equity $1,002,087 $ 761,409
========== --------- ========= ----------
Net interest income $ 7,704 $ 5,883
--------- ---------
Net interest rate spread 2.95% 2.76%
========= =========
Net interest rate spread
on average assets 3.08% 3.10%
========= =========
Net interest margin on
earning assets 3.24% 3.22%
========= =========
22
MERCANTILE BANK CORPORATION
Provisions to the allowance for loan and lease losses during the second quarter
of 2003 were $845,000, compared to the $682,000 that was expensed during the
first quarter of 2002. Provisions to the allowance for loan and lease losses
during the first six months of 2003 were $1.5 million, compared to the $1.1
million that was expensed during the same time period in 2002. The increase
during both time periods primarily reflects the higher volume of loan growth,
and to a lesser degree the higher level of net loan charge-offs. Net loan
charge-offs during the second quarter of 2003 were $93,000, compared to net loan
charge-offs of $45,000 during the second quarter of 2002. During the first six
months of 2003 net loan charge-offs totaled $202,000, compared to net loan
charge-offs of $74,000 during the same time period in 2002. The allowance for
loan and lease losses as a percentage of total loans outstanding as of June 30,
2003 was 1.40%, compared to 1.43% at June 30, 2002.
In each accounting period, the allowance for loan and lease losses is adjusted
to the amount believed necessary to maintain the allowance for loan and lease
losses at adequate levels. Through the loan review and credit departments, we
attempt to allocate specific portions of the allowance for loan and lease losses
based on specifically identifiable problem loans and leases. The evaluation of
the allowance for loan and lease losses is further based on, although not
limited to, consideration of the internally prepared Loan Loss Reserve Analysis
("Reserve Analysis"), composition of the loan and lease portfolio, third party
analysis of the loan administration processes and loan portfolio and general
economic conditions. In addition, the rapid growth of the loan and lease
portfolio 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 and leases,
which continue to comprise a vast majority of our loan and lease portfolio,
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. All 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 second quarter of 2003 was $1.2 million, an
increase of 120.1% over the $561,000 earned during the second quarter of 2002.
Noninterest income during the first six months of 2003 was $2.2 million, an
increase of 95.8% over the $1.1 million earned during the same time period in
2002. Service charge income on deposits and repurchase agreements increased
$57,000 (25.6%) during the second quarter of 2003 over that earned in the second
quarter of 2002, and during the first six months of 2003 increased $132,000
(31.7%) over that earned in the comparable time period in 2002. The increases
during both time periods primarily results from new accounts opened during the
last 12 months, decline in the earnings credit rate and adjustments in our
deposit account fee structure. Primarily reflecting the low and declining
interest rate environment and resulting increase in residential mortgage loan
refinancings, fees earned on referring residential mortgage loan applicants to
various third parties increased from $75,000 earned during the second quarter of
2002 to $295,000 recorded during the second quarter of 2003, and increased from
$171,000 earned during the first six months of 2002 to $576,000 recorded during
the first six months of 2003. Noninterest income related to an increase in the
cash surrender value of bank owned life insurance policies ("BOLI") totaled
$196,000 during the second quarter of 2003 compared to $47,000 earned during the
second quarter of 2002, and totaled $405,000 during the first six months of 2003
compared to $92,000 earned during the first six months of 2002. The growth in
income related to BOLI primarily results from additional BOLI policies purchased
subsequent to the end of the second quarter of 2002.
23
MERCANTILE BANK CORPORATION
Gains recognized on the sales of securities totaled $212,000 during the second
quarter of 2003, resulting from the sale of 15 mortgage-backed securities with
an aggregate book value of $8.3 million. The sales were transacted as part of
our interest rate risk management program. The sales proceeds were used to
purchase mortgage-backed securities with different underlying interest rate risk
characteristics than those contained in the securities that were sold.
Noninterest expense during the second quarter of 2003 was $4.4 million, an
increase of 37.1% over the $3.2 million expensed during the second quarter of
2002. Noninterest expense during the first six months of 2003 was $8.4 million,
an increase of 38.8% over the $6.0 million expensed during the same time period
in 2002. Employee salary and benefit expenses were $0.8 million higher during
the second quarter of 2003 than the level expensed during the second quarter of
2002, and were $1.7 million higher during the first six months of 2003 than the
level expensed during the first six months of 2002. The increases during both
time periods primarily resulted from the hiring of additional staff and merit
annual pay increases. The level of full-time equivalent employees increased from
106 at June 30, 2002 to 147 as of June 30, 2003. Occupancy and furniture and
equipment costs increased $135,000 in the second quarter of 2003 over the level
expensed in the second quarter of 2002, and increased $252,000 during the first
six months of 2003 over the level expensed during the first six months of 2002
primarily reflecting the opening of two new branch facilities. General overhead
costs also increased, reflecting the additional expenses required to administer
our significantly increased asset base.
Monitoring and controlling noninterest costs, while at the same time providing
high quality service to customers, is a key component to our business strategy.
While the dollar volume of noninterest costs has increased, the rate of growth
has been lower than the rate of increase in net interest income and noninterest
income. Noninterest expenses increased by $1.2 million during the second quarter
of 2003 over the amount expensed during the second quarter of 2002, and
increased by $2.3 million during the first six months of 2003 over the amount
expensed during the first six months of 2002. However, net revenues (net
interest income plus noninterest income) increased at a substantially higher
level of $2.5 million and $4.6 million during the same time periods,
respectively.
Federal income tax expense was $1.0 million and $1.9 million during the second
quarter and first six months of 2003, respectively. Federal income tax expense
was $0.7 million and $1.4 million during the second quarter and first six months
of 2002, respectively. The increases during both time periods primarily results
from the increase in net income before federal income tax.
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.
24
MERCANTILE BANK CORPORATION
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 June 30, 2003
(dollars in thousands):
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
--------- --------- --------- --------- ---------
Assets:
Commercial loans and leases (1) $ 320,975 $ 37,561 $ 370,517 $ 59,753 $ 788,806
Residential real estate loans 33,531 1,448 29,743 7,444 72,166
Consumer loans 1,249 599 3,118 71 5,037
Investment securities (2) 2,250 4,676 33,275 63,616 103,817
Federal funds sold 3,000 3,000
Short-term investments 137 137
Allowance for loan and leases losses (12,158) (12,158)
Other assets 73,969 73,969
----------- ----------- ----------- ----------- -----------
Total assets 361,142 44,284 436,653 192,695 1,034,774
Liabilities:
Interest-bearing checking 26,939 26,939
Savings 74,345 74,345
Money market accounts 8,626 8,626
Time deposits < $100,000 28,737 37,262 39,218 105,217
Time deposits $100,000 and over 133,943 110,970 306,522 551,435
Short-term borrowings 39,690 39,690
FHLB advances 5,000 30,000 10,000 45,000
Long-term borrowings 922 16,000 16,922
Noninterest-bearing checking 77,025 77,025
Other liabilities 6,118 6,118
----------- ----------- ----------- ----------- -----------
Total liabilities 318,202 178,232 355,740 99,143 951,317
Shareholders' equity 83,457 83,457
----------- ----------- ----------- ----------- -----------
Total sources of funds 318,202 178,232 355,740 182,600 1,034,774
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 42,940 $ (133,948) $ 80,913 $ 10,095
=========== =========== =========== ==========-
Cumulative GAP $ 42,940 $ (91,008) $ (10,095)
=========== =========== ===========
Percent of cumulative GAP to
total assets 4.1% (8.8)% (1.0)%
=========== =========== ===========
(1) Floating rate loans that are currently at interest rate floors are treated
as fixed rate loans and are reflected using maturity date and not next
repricing date.
(2) Mortgage-backed securities are categorized by expected final maturities
based upon prepayment trends as of June 30, 2003
25
MERCANTILE BANK CORPORATION
The second interest rate risk measurement we use is commonly referred to as net
interest income simulation analysis. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, 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 the company's strategies, among other factors.
We conducted multiple simulations as of June 30, 2003, whereby it was assumed
that a simultaneous, instant and sustained change in market interest rates
occurred. The following table reflects the suggested impact on our net interest
income over the next twelve months, which is well within our policy parameters
and similar to the results of the multiple simulations as of December 31, 2002.
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
---------------------- ------------------- -------------------
Interest rates down 200 basis points $ (146,000) (0.5)%
Interest rates down 100 basis points 532,000 1.7
No change in interest rates 1,037,000 3.3
Interest rates up 100 basis points 1,832,000 5.8
Interest rates up 200 basis points 2,641,000 8.4
The increase in our net interest income under all interest rate scenarios except
the down 200 basis points scenario 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 have declined since the beginning
of 2001 as market interst rates began to decline, our certificates of deposit
have fixed interest rates and only reprice at maturity. Throughout most of the
remainder of 2003 and into 2004 we have a large volume of certificates of
deposit that will mature and are expected to be refinanced at 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.
26
MERCANTILE BANK CORPORATION
ITEM 4. CONTROLS AND PROCEDURES
As of June 30, 2003, an evaluation was performed under the supervision of and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures. Based on that evaluation, our
management, including our Chief Executive Officer and Chief Financial Officer,
concluded that our disclosure controls and procedures were effective as of June
30, 2003.
27
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 we believe will have a material adverse affect on our
financial condition, results of operations or cash flow, either individually or
in the aggregate.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At our Annual Meeting held on April 17, 2003, our shareholders voted to elect
five directors, Doyle A. Hayes, Susan K. Jones, Lawrence W. Larsen, Michael H.
Price and Dale J. Visser, each for a three year term expiring at the Annual
Meeting of the shareholders of the company in 2006. The results of the election
were as follows:
Votes Votes Votes Broker
Nominee For Against Withheld Non-Votes
------- -------- ------- -------- ---------
Doyle A. Hayes 4,520,396 0 48,014 0
Susan K. Jones 4,519,584 0 48,826 0
Lawrence W. Larsen 4,530,882 0 37,526 0
Michael H. Price 4,530,485 0 37,925 0
Dale J. Visser 4,341,522 0 226,888 0
The terms of office of the following directors (who were not up for election)
continued after the Annual Meeting: Betty S. Burton, David M. Cassard, Edward J.
Clark, Peter A. Cordes, C. John Gill, David M. Hecht, Gerald R. Johnson, Jr.,
Calvin D. Murdock, Donald Williams, Sr and Robert M. Wynalda.
ITEM 5. OTHER INFORMATION.
Not applicable.
28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
3.1 Articles of Incorporation are incorporated by reference to
Exhibit 3.1 of our Registration Statement on Form SB-2
(Commission File no. 333-33081) that became effective on
October 23, 1997
3.2 are incorporated by reference to Exhibit 3.2 of our
Registration Statement on Form S-3 (Commission File No.
333-103376) that became effective on February 21, 2003
11 Statement re Computation of Per Share Earnings
31.1 Rule 13a-14(a) Certification of Gerald R. Johnson, Jr.
Chairman and Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Charles E. Christmas Senior Vice
President, Chief Financial Officer
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
(b) Reports of Form 8-K
During the second quarter of 2003, the Company filed the following
reports of Form 8-K:
i) Dated April 9, 2003, pertaining to the Company's press release
issued on April 9, 2003 reporting financial results and
earnings for its first quarter of 2003
ii) Dated May 13, 2003, pertaining to the Company's press release
issued on May 13, 2003 reporting that it had reached $1
billion in assets.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 7, 2003.
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/ Charles E. Christmas
-------------------------------------------------
Charles E. Christmas
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
30
EXHIBIT INDEX
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 Amended and Restated Bylaws dated as of January 16, 2003
are incorporated by reference to Exhibit 3.2 of our
Registration Statement on Form S-3 (Commission File No.
333-103376) that became effective on February 21, 2003
11 Statement re Computation of Per Share Earnings
31.1 Rule 13a-14(a) Certification of Gerald R. Johnson, Jr.
Chairman and Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Charles E. Christmas Senior
Vice President, Chief Financial Officer
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
31