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 March 31, 2004
[ ] 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 May 3, 2004, there were 7,170,510 shares of Common Stock outstanding.
MERCANTILE BANK CORPORATION
INDEX
Page No.
--------
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2004 (Unaudited) and December 31, 2003................................... 1
Consolidated Statements of Income and Comprehensive Income -
Three Months Ended March 31, 2004 (Unaudited) and
March 31, 2003 (Unaudited)......................................................... 2
Consolidated Statement of Changes in Shareholders' Equity -
Three Months Ended March 31, 2004 (Unaudited) and
March 31, 2003 (Unaudited)......................................................... 3
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2004 (Unaudited) and
March 31, 2003 (Unaudited)......................................................... 4
Notes to Consolidated Financial Statements (Unaudited)................................. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 21
Item 4. Controls and Procedures....................................................... 23
PART II. Other Information
Item 1. Legal Proceedings............................................................. 24
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities.................................................................. 24
Item 3. Defaults upon Senior Securities............................................... 24
Item 4. Submission of Matters to a Vote of Security Holders........................... 24
Item 5. Other Information............................................................. 25
Item 6. Exhibits and Reports on Form 8-K.............................................. 25
Signatures............................................................................. 26
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2004 2003
--------------- ---------------
(Unaudited)
ASSETS
Cash and due from banks $ 29,948,000 $ 16,309,000
Short-term investments 717,000 255,000
Federal funds sold 5,000,000 0
--------------- ---------------
Total cash and cash equivalents 35,665,000 16,564,000
Securities available for sale 64,974,000 71,421,000
Securities held to maturity (fair value of $49,401,000 at
March 31, 2004 and $47,102,000 at December 31, 2003) 46,531,000 45,112,000
Federal Home Loan Bank stock 5,784,000 4,977,000
Total loans and leases 1,111,152,000 1,035,963,000
Allowance for loan and lease losses (15,337,000) (14,379,000)
--------------- ---------------
Total loans and leases, net 1,095,815,000 1,021,584,000
Premises and equipment, net 16,580,000 15,305,000
Bank owned life insurance policies 16,618,000 16,441,000
Accrued interest receivable 4,824,000 4,098,000
Other assets 7,140,000 7,835,000
--------------- ---------------
Total assets $ 1,293,931,000 $ 1,203,337,000
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 85,900,000 $ 76,579,000
Interest-bearing 909,434,000 826,313,000
--------------- ---------------
Total deposits 995,334,000 902,892,000
Securities sold under agreements to repurchase 41,613,000 49,545,000
Federal funds purchased 0 6,000,000
Federal Home Loan Bank advances 100,000,000 90,000,000
Subordinated debentures 16,495,000 16,495,000
Other borrowed money 1,361,000 1,114,000
Accrued expenses and other liabilities 6,057,000 7,090,000
--------------- ---------------
Total liabilities 1,160,860,000 1,073,136,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued 0 0
Common stock, no par value: 9,000,000 shares authorized;
7,168,592 shares outstanding at March 31, 2004 and
6,805,914 shares outstanding at December 31, 2003 130,795,000 118,560,000
Retained earnings 1,666,000 11,421,000
Accumulated other comprehensive income 610,000 220,000
--------------- ---------------
Total shareholders' equity 133,071,000 130,201,000
--------------- ---------------
Total liabilities and shareholders' equity $ 1,293,931,000 $ 1,203,337,000
=============== ===============
See accompanying notes to consolidated financial statements.
1.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Three Months
Ended Ended
March 31, March 31,
2004 2003
------------ ------------
Interest income
Loans and leases, including fees $13,908,000 $11,443,000
Investment securities 1,426,000 1,216,000
Federal funds sold 19,000 16,000
Short-term investments 1,000 0
----------- -----------
Total interest income 15,354,000 12,675,000
Interest expense
Deposits 4,750,000 5,236,000
Short-term borrowings 170,000 171,000
Federal Home Loan Bank advances 529,000 74,000
Long-term borrowings 416,000 410,000
----------- -----------
Total interest expense 5,865,000 5,891,000
----------- -----------
NET INTEREST INCOME 9,489,000 6,784,000
Provision for loan and lease losses 1,244,000 625,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 8,245,000 6,159,000
Noninterest income
Service charges on accounts 299,000 269,000
Net gain on sales of securities 78,000 0
Other income 662,000 718,000
----------- -----------
Total noninterest income 1,039,000 987,000
Noninterest expense
Salaries and benefits 3,283,000 2,497,000
Occupancy 386,000 334,000
Furniture and equipment 273,000 221,000
Other expense 1,213,000 977,000
----------- -----------
Total noninterest expenses 5,155,000 4,029,000
----------- -----------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 4,129,000 3,117,000
Federal income tax expense 1,156,000 884,000
----------- -----------
NET INCOME $ 2,973,000 $ 2,233,000
=========== ===========
COMPREHENSIVE INCOME $ 3,363,000 $ 2,099,000
=========== ===========
Basic earnings per share $ 0.42 $ 0.39
=========== ===========
Diluted earnings per share $ 0.41 $ 0.38
=========== ===========
Average basic shares outstanding 7,158,971 5,683,147
=========== ===========
Average diluted shares outstanding 7,314,127 5,811,925
=========== ===========
See accompanying notes to consolidated financial statements.
2.
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, 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
March 31, 2003 2,233,000 2,233,000
Change in net unrealized gain
(loss) on securities available
for sale, net of reclassifications
and tax effect (134,000) (134,000)
-----------------
Total comprehensive income 2,099,000
Common stock cash dividend (433,000) (433,000)
Employee stock purchase plan, 442 shares 10,000 10,000
Stock option exercises, 12,111 shares 20,000 20,000
---------------- --------------- ----------- ----------------
BALANCE, MARCH 31, 2003 $ 75,560,000 $ 5,050,000 $ 920,000 $ 81,530,000
================ =============== =========== ================
BALANCE, JANUARY 1, 2004 $ 118,560,000 $ 11,421,000 $ 220,000 $ 130,201,000
Comprehensive income:
Net income for the period from
January 1, 2004 through
March 31, 2004 2,973,000 2,973,000
Change in net unrealized gain
(loss) on securities available
for sale, net of reclassifications
and tax effect 390,000 390,000
----------------
Total comprehensive income 3,363,000
Payment of 5% stock dividend, 341,337 shares 12,111,000 (12,115,000) (4,000)
Common stock cash dividend (613,000) (613,000)
Employee stock purchase plan, 504 shares 17,000 17,000
Dividend reinvestment plan, 556 shares 19,000 19,000
Stock option exercises, 21,322 shares 88,000 88,000
---------------- --------------- ----------- ----------------
BALANCE, MARCH 31, 2004 $ 130,795,000 $ 1,666,000 $ 610,000 $ 133,071,000
================ =============== =========== ================
See accompanying notes to consolidated financial statements.
3.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Three Months
Ended Ended
March 31, 2004 March 31, 2003
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,973,000 $ 2,233,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 412,000 451,000
Provision for loan and lease losses 1,244,000 625,000
Net gain on sales of securities (78,000) 0
Net change in:
Accrued interest receivable (726,000) (524,000)
Bank owned life insurance policies (177,000) (208,000)
Other assets 431,000 516,000
Accrued expenses and other liabilities (1,033,000) 86,000
------------ ------------
Net cash from operating activities 3,046,000 3,179,000
CASH FLOWS FROM INVESTING ACTIVITIES
Loan and lease originations and payments, net (75,475,000) (41,042,000)
Purchases of:
Securities available for sale (2,994,000) (8,749,000)
Securities held to maturity (1,426,000) (2,681,000)
Federal Home Loan Bank stock (807,000) 0
Proceeds from:
Sales of available for sale securities 1,748,000 0
Maturities, calls and repayments of
available for sale securities 8,324,000 6,574,000
Purchases of premises and equipment, net (1,579,000) (551,000)
Purchases of bank owned life insurance policies 0 (300,000)
------------ ------------
Net cash from investing activities (72,209,000) (46,749,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 92,442,000 46,984,000
Stock option exercises 88,000 20,000
Employee stock purchase plan 17,000 10,000
Dividend reinvestment plan 19,000 0
Cash paid in lieu of fractional shares on stock dividend (4,000) 0
Payment of cash dividend (613,000) (433,000)
Net increase in Federal Home Loan Bank advances 10,000,000 0
Net increase (decrease) in federal funds purchase (6,000,000) 2,000,000
Net increase in other borrowed money 247,000 263,000
Net decrease in securities sold under agreements to repurchase (7,932,000) (5,097,000)
------------ ------------
Net cash from financing activities 88,264,000 43,747,000
------------ ------------
Net change in cash and cash equivalents 19,101,000 177,000
Cash and cash equivalents at beginning of period 16,564,000 28,117,000
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 35,665,000 $ 28,294,000
============ ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 5,951,000 $ 5,430,000
Federal income tax 375,000 225,000
See accompanying notes to consolidated financial statements.
4.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The unaudited financial statements for the three
months ended March 31, 2004 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 four subsidiaries, Mercantile Bank Mortgage Company, LLC ("our
mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO"), Mercantile Bank
Real Estate Co., LLC ("our real estate company"), and Mercantile Insurance
Center, Inc. ("our insurance center"). 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 period ended March 31, 2004 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,
2003.
MBWM Capital Trust I ("the trust"), a business trust formed by Mercantile
Bank Corporation, sold 1.6 million trust preferred securities at $10.00 per
trust preferred security in a September 1999 offering. Mercantile Bank
Corporation issued subordinated debentures to the trust in exchange for the
proceeds of the offering; the debentures and related debt issuance costs
represent the sole assets of the trust. Prior to 2004, the trust was
consolidated in our financial statements, with the trust preferred
securities issued by the trust reported in liabilities as "Trust preferred
securities" and the subordinated debentures eliminated in the
consolidation. Under new accounting guidance, FASB Interpretation No. 46,
as revised in December 2003, the trust is no longer consolidated.
Accordingly, Mercantile Bank Corporation does not report the securities
issued by the trust as liabilities, and instead reports as liabilities the
subordinated debentures issued by Mercantile Bank Corporation and held by
the trust, as these are no longer eliminated in consolidation. Amounts
previously reported as "Trust preferred securities" in liabilities has been
recaptioned "Subordinated debentures" and continue to be presented in
liabilities on the balance sheet. The effect of no longer consolidating the
trust does not significantly change the amounts reported as Mercantile Bank
Corporation's assets, liabilities, equity or interest expense.
Stock Dividend: All per share amounts and average shares outstanding have
been adjusted for all periods presented to reflect the 5% stock dividend
distributed on May 3, 2004. The Statement of Changes in Shareholders'
Equity reflects the change in retained earnings and common stock for the
value of the dividends paid.
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.
(Continued)
5.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
Three Months Three Months
Ended Ended
March 31, 2004 March 31, 2003
------------- -------------
Net income as reported $ 2,973,000 $ 2,233,000
Deduct: Stock-based compensation expense
determined under fair value based method 63,000 81,000
------------- -------------
Pro forma net income 2,910,000 2,152,000
Basic earnings per share as reported $ 0.42 $ 0.39
Pro forma basic earnings per share 0.41 0.38
Diluted earnings per share as reported $ 0.41 $ 0.38
Pro forma diluted earnings per share 0.40 0.37
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
Risk-free interest rate 3.65% 3.90%
Expected option life 7 Years 7 Years
Expected stock price volatility 25% 22%
Dividend yield 1.00% 1.30%
(Continued)
6.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. LOANS
Our total loans at March 31, 2004 were $1,111.2 million compared to
$1,036.0 million at December 31, 2003, an increase of $75.2 million, or
7.3%. The components of our outstanding balances at March 31, 2004 and
December 31, 2003, and percentage increase in loans from the end of 2003 to
the end of the first quarter 2004 are as follows:
Percent
March 31, 2004 December 31, 2003 Increase/
Balance % Balance % (Decrease)
-------------- -------------- -------------- -------------- --------------
Real Estate:
Construction and land
development $ 128,915,000 11.6% $ 117,649,000 11.4% 9.6%
Secured by 1-4 family
properties 97,294,000 8.8 92,339,000 8.9 5.4
Secured by multi-family
properties 29,350,000 2.6 28,950,000 2.8 1.4
Secured by nonresidential
properties 531,987,000 47.9 485,080,000 46.8 9.7
Commercial 316,128,000 28.5 304,800,000 29.4 3.7
Leases 2,632,000 0.2 2,309,000 0.2 14.0
Consumer 4,846,000 0.4 4,836,000 0.5 0.2
-------------- -------------- -------------- -------------- --------------
Total loans and leases $1,111,152,000 100.0% $1,035,963,000 100.0% 7.3%
============== ============== ============== ============== ==============
3. ALLOWANCE FOR LOAN AND LEASE LOSSES
The following is a summary of the change in our allowance for loan and
lease losses account for the three months ended March 31:
2004 2003
---- ----
Balance at January 1 $ 14,379,000 $ 10,890,000
Charge-offs (298,000) (132,000)
Recoveries 12,000 23,000
Provision for loan and lease losses 1,244,000 625,000
------------ ------------
Balance at March 31 $ 15,337,000 $ 11,406,000
============ ============
(Continued)
7.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. PREMISES AND EQUIPMENT, NET
Premises and equipment are comprised of the following:
March 31, December 31,
2004 2003
----------- -----------
Land and improvements $ 5,753,000 $ 5,745,000
Buildings and leasehold improvements 9,639,000 8,183,000
Furniture and equipment 5,050,000 4,935,000
----------- -----------
20,442,000 18,863,000
Less accumulated depreciation 3,862,000 3,558,000
----------- -----------
Premises and equipment, net $16,580,000 $15,305,000
=========== ===========
Depreciation expense amounted to $304,000 during the first quarter of 2004,
compared to $266,000 in the first quarter of 2003.
5. DEPOSITS
Our total deposits at March 31, 2004 were $995.3 million compared to $902.9
million at December 31, 2003, an increase of $92.4 million, or 10.2%. The
components of our outstanding balances at March 31, 2004 and December 31,
2003, and percentage increase in deposits from the end of 2003 to the end
of the first quarter 2004 are as follows:
Percent
March 31, 2004 December 31, 2003 Increase/
Balance % Balance % (Decrease)
----------- ----- ------------ ----- ----------
Noninterest-bearing demand $ 85,900,000 8.6% $ 76,579,000 8.5% 12.2%
Interest-bearing checking 35,373,000 3.6 34,241,000 3.8 3.3
Money market 9,402,000 0.9 8,290,000 0.9 13.4
Savings 120,183,000 12.1 101,710,000 11.3 18.2
Time, under $100,000 7,819,000 0.8 8,163,000 0.9 (4.2)
Time, $100,000 and over 93,565,000 9.4 82,288,000 9.1 13.7
------------ ----- ------------ ----- ----
352,242,000 35.4 311,271,000 34.5 13.2
Out-of-area time,
under $100,000 108,553,000 10.9 98,079,000 10.9 10.7
Out-of-area time,
$100,000 and over 534,539,000 53.7 493,542,000 54.6 8.3
------------ ----- ------------ ----- ----
643,092,000 64.6 591,621,000 65.5 8.7
------------ ----- ------------ ----- ----
Total deposits $995,334,000 100.0% $902,892,000 100.0% 10.2%
============ ===== ============ ===== ====
(Continued)
8.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. SHORT-TERM BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
March 31, December 31,
2004 2003
----------- -----------
Outstanding balance at end of period $41,613,000 $49,545,000
Average interest rate at end of period 1.36% 1.38%
Average balance during the period $47,129,000 $45,865,000
Average interest rate during the period 1.39% 1.45%
Maximum month end balance during the period $50,138,000 $55,270,000
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 March 31, 2004 and December 31, 2003 were as
follows.
March 31, December 31,
2004 2003
---- ----
Maturities April 2004 through September 2006,
fixed rates from 1.46% to 3.21%, averaging 2.11% $100,000,000
Maturities January 2004 through September 2006,
fixed rates from 1.54% to 3.21%, averaging 2.07% $ 90,000,000
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, first mortgage liens on commercial
real estate property loans, and substantially all other assets of our bank,
under a blanket lien arrangement. Our borrowing line of credit as of March
31, 2004 totaled $174.4 million, with availability approximating $66.0
million.
Maturities of currently outstanding FHLB advances during the next five
years are:
2004 $ 35,000,000
2005 45,000,000
2006 20,000,000
2007 0
2008 0
(Continued)
9.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 contractual amounts of our financial instruments with
off-balance sheet risk at March 31, 2004 and December 31, 2003 follows:
March 31, December 31,
2004 2003
------------ ------------
Commercial unused lines of credit $193,021,000 $176,943,000
Unused lines of credit secured by 1 - 4 family
residential properties 20,413,000 19,020,000
Credit card unused lines of credit 10,957,000 8,990,000
Other consumer unused lines of credit 6,978,000 5,569,000
Commitments to make loans 68,587,000 73,570,000
Standby letters of credit 57,704,000 57,918,000
------------ ------------
$357,660,000 $342,010,000
============ ============
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.
(Continued)
10.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. 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:
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
March 31, 2004
Total capital (to risk
weighted assets)
Consolidated $163,802 13.2% $ 99,055 8.0% $123,819 10.0%
Bank 160,249 13.0 98,924 8.0 123,655 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 148,465 12.0 49,528 4.0 74,292 6.0
Bank 144,912 11.7 49,462 4.0 74,193 6.0
Tier 1 capital (to
average assets)
Consolidated 148,465 11.9 50,030 4.0 62,537 5.0
Bank 144,912 11.6 49,954 4.0 62,442 5.0
December 31, 2003
Total capital (to risk
weighted assets)
Consolidated $160,360 13.8% $ 92,711 8.0% $115,888 10.0%
Bank 156,950 13.6 92,556 8.0 115,695 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 145,981 12.6 46,356 4.0 69,533 6.0
Bank 142,571 12.3 46,278 4.0 69,417 6.0
Tier 1 capital (to
average assets)
Consolidated 145,981 12.5 46,756 4.0 58,444 5.0
Bank 142,571 12.2 46,703 4.0 58,378 5.0
(Continued)
11.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS (Continued)
Our capital levels as of March 31, 2004 include the $16.0 million in 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 March 31, 2004, 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 April 7, 2004, that
was paid on May 3, 2004 to record holders as of April 16, 2004. All
earnings per share and dividend per share information have been adjusted
for the payment of the 5% stock dividend. On January 6, 2004, we declared a
$0.09 per share cash dividend on our common stock, which was paid on March
10, 2004 to record holders as of February 10, 2004. The $0.09 per share
cash dividend represents an 18.4% increase from the $0.076 per share cash
dividend that was paid during each of the four quarters during 2003. On
April 7, 2004, we declared a $0.09 per share cash dividend on our common
stock, which is payable on June 10, 2004 to record holders as of May 10,
2004.
10. BENEFIT PLANS
We sponsor an employee stock purchase plan which allows employees to defer
after-tax payroll dollars and purchase our stock on a quarterly basis. We
have registered 26,250 shares of common stock to be issued and purchased
under the plan; however, the plan allows for shares to be purchased
directly from us or on the open market. During the three months ended March
31, 2004, we issued 504 shares under the plan.
(Continued)
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 consolidated subsidiaries, Mercantile Bank of West Michigan
("our bank"), our bank's four subsidiaries Mercantile Bank Mortgage Company
("our mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO"), Mercantile Bank
Real Estate Co., LLC ("our real estate company") and Mercantile Insurance
Center, Inc. ("our insurance company"), at March 31, 2004 to December 31, 2003
and the results of operations for the three months ended March 31, 2004 and
March 31, 2003. 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.
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 in this
report. For a complete discussion of our significant accounting policies, see
footnotes to our Consolidated Financial Statements included on pages F-27
through F-31 in our Form 10-K for the fiscal year ended December 31, 2003
(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.
13.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 three months of 2004, our assets increased from $1,203.3
million on December 31, 2003, to $1,293.9 million on March 31, 2004. This
represents a total increase in assets of $90.6 million, or 7.5%. The asset
growth was comprised primarily of a $74.2 million increase in net loans and a
$19.1 million increase in cash and cash equivalents. The increase in total
assets was primarily funded by a $92.4 million increase in deposits.
Commercial loans and leases increased by $70.2 million during the first three
months of 2004, and at March 31, 2004 totaled $1,009.1 million, or 90.8% 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 almost 200 years of combined commercial
lending experience, eight of whom have 15 years or more experience. Of each of
the loan categories that we originate, commercial loans and leases are most
efficiently originated and managed, thus limiting overhead costs by
necessitating the attention of fewer full-time employees. Our commercial lending
business generates the greatest amount of local deposits and is virtually our
only source of significant demand deposits.
Residential mortgage loans increased by $5.0 million during the first three
months of 2004, while the balance of our consumer loan portfolio was unchanged.
As of March 31, 2004, residential mortgage and consumer loans totaled a combined
$102.1 million, or 9.2% 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 the lending
efforts and resultant assets to remain the dominant loan portfolio category.
14.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Management believes the quality of our loan and lease portfolio remains strong.
Net loan and lease charge-offs during the first three months of 2004 totaled
$286,000, or 0.11% of average total loans and leases on an annualized basis.
During 2003, net loan and lease charge-offs equaled 0.04% of average total loans
and leases. Past due loans and nonaccrual loans and leases at March 31, 2004
totaled $3.1 million, or 0.28% of period-ending total loans and leases. At
December 31, 2003, past due loans and nonaccrual loans and leases totaled $1.8
million, or 0.17% of period-ending total loans and leases. The $1.3 million
increase during the first quarter of 2004, as well as a vast majority of the
$286,000 net loan and lease charge-off figure noted above, is primarily
attributable to one commercial credit relationship. 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 and lease charge-off and delinquency ratios. Over 98% of the loan and lease
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 commercial banks outside the
immediate area, which we underwrite using the same loan underwriting criteria as
though our bank was the originating bank.
Securities decreased by $4.2 million during the first three months of 2004.
Purchases during the first three months of 2004 totaled $5.2 million. Proceeds
from the sales of securities totaled $1.7 million, while proceeds from the
maturities, calls and repayments of securities totaled $8.3 million. Our
securities portfolio consists of U.S. Government Agency bonds, mortgage-backed
securities issued or guaranteed by U.S. Government Agencies, investment-grade
tax-exempt municipal securities and Federal Home Loan Bank of Indianapolis
("FHLBI") stock.
Cash and cash equivalents increased $19.1 million during the first three months
of 2004, totaling $35.7 million on March 31, 2004. Cash and due from bank
balances were up $13.7 million and federal funds sold increased $5.0 million.
Our commercial lending and wholesale funding focus results in relatively large
day-to-day fluctuations of our cash and cash equivalent balances. The average
cash and cash equivalents during the first three months of 2004 equaled $33.6
million, well above the relatively low balance of $16.6 million on December 31,
2003.
Premises and equipment at March 31, 2004 equaled $16.6 million, an increase of
$4.1 million over the past twelve months. The majority of the increase relates
to our bank's construction of two new banking facilities. 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 $1.3 million. The
building has been demolished, and we are now in the construction phase of
building a new four-story facility on this property. This facility will serve as
the new location for our current downtown leased 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 is mid-2005. On September 29, 2003, our bank purchased
ten acres of land located in Holland, Michigan for $0.9 million. We are now in
the construction phase of building a new two-story facility on this property.
This facility will serve as the new location for our current full-service branch
and lending office which currently operates out of a leased facility. Expected
completion date is during the fourth quarter of 2004.
15.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Deposits increased $92.4 million during the first three months of 2004, totaling
$995.3 million at March 31, 2004. Local deposits increased $40.9 million, while
out-of-area deposits increased $51.5 million. As a percent of total deposits,
local deposits increased from 34.5% on December 31, 2003, to 35.4% at March 31,
2004. Noninterest-bearing demand deposits, comprising 8.6% of total deposits,
increased $9.3 million during the first three months of 2004. Savings deposits
(12.1% of total deposits) increased $18.5 million, interest-bearing checking
accounts (3.6% of total deposits) increased $1.1 million and money market
deposit accounts (0.9% of total deposits) increased $1.1 million during the
first three months of 2004. Local certificates of deposit, comprising 10.2% of
total deposits, increased by $10.9 million during the first three months of
2004.
Out-of-area deposits increased $51.5 million during the first three months of
2004, totaling $643.1 million at March 31, 2004. 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 interest rates that would have to be
offered in the local market to generate a sufficient level of funds. During the
first three months of 2004 rates paid on new out-of-area certificates of deposit
were generally slightly 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, our relatively high reliance on
out-of-area deposits will likely continue.
Securities sold under agreements to repurchase ("repurchase agreements")
decreased by $7.9 million during the first three months of 2004, totaling $41.6
million as of March 31, 2004. 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.
FHLBI advances increased by $10.0 million during the first three months of 2004,
totaling $100.0 million as of March 31, 2004. The advances are collateralized by
residential mortgage loans, first mortgage liens on multi-family residential
property loans, first mortgage liens on commercial real estate property loans,
and substantially all other assets of our bank, under a blanket lien
arrangement. Our borrowing line of credit as of March 31, 2004 totaled $174.4
million, with availability approximating $66.0 million. FHLBI 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 FHLBI, 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 the balance sheet to achieve a mix of earning assets and liabilities
that maximizes profitability, while providing adequate liquidity.
16.
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 our market area have
generally consistently increased, this 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 monies from wholesale funding sources. Wholesale funds,
comprised of certificates of deposit from customers outside our market area and
advances from the FHLBI, totaled $743.1 million, or 64.3% of combined deposits
and borrowed funds as of March 31, 2004. As of December 31, 2003, wholesale
funds totaled $681.6 million, or 63.9% of combined deposits and borrowed funds.
Reliance on wholesale funds is expected to continue due to our anticipated
future asset growth.
As a member of the FHLBI, our bank has access to the FHLBI's borrowing programs.
At March 31, 2004, advances from the FHLBI totaled $100.0 million, up from the
$90.0 million outstanding at December 31, 2003. Based on available collateral at
March 31, 2004, our bank could borrow an additional $66.0 million.
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established unsecured federal funds purchased lines, totaling $35.0
million as of March 31, 2004. The average balance of federal funds purchased
during the first three months of 2004 equaled $2.4 million, compared to a $8.0
million average federal funds sold position.
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 March 31, 2004, our bank had a total of $300.0 million in unfunded
loan commitments and $57.7 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $231.4 million were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $68.6
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 overall liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $2.9 million during
the first three months of 2004, from $130.2 million on December 31, 2003, to
$133.1 million at March 31, 2004. The increase is primarily attributable to net
income of $3.0 million recorded during the first quarter of 2004. Shareholders'
equity was negatively impacted during the first quarter of 2004 by the payment
of cash dividends totaling $0.6 million, but was positively impacted by a $0.4
million mark-to-market adjustment for available for sale securities as defined
in SFAS No. 115. Shareholders' equity also increased $0.1 million from the
issuance of a total of 21,316 new shares of common stock resulting from our
dividend reinvestment plan, employee stock purchase plan and stock option
exercises.
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. The capital ratios of the company and our
bank as of March 31, 2004 and December 31, 2003 are disclosed under Note 9 of
the Notes to Consolidated Financial Statements.
17.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 paid a $0.09 per share cash dividend on March 10, 2004, and on
April 7, 2004, we declared a $0.09 per share cash dividend payable on June 10,
2004 to record holders as of May 10, 2004. We declared a 5% stock dividend on
April 7, 2004, that was paid on May 3, 2004 to record holders as of April 16,
2004.
RESULTS OF OPERATIONS
Net income for the first quarter of 2004 was $3.0 million ($0.42 per basic share
and $0.41 per diluted share after adjusting for 5% stock dividend), which
represents a 33.1% increase over net income of $2.2 million ($0.39 per basic
share and $0.38 per diluted after adjusting for 5% stock dividend) recorded
during the first quarter of 2003. The 7.7% increase in basic earnings per share
and the 7.9% increase in diluted earnings per share were lower than the
percentage growth in net income due to the dilution impact of the common stock
sale completed during the latter part of 2003. Average basic and diluted shares
outstanding during the first quarter of 2004 were up 26.0% and 25.8% over the
levels during the same time period in 2003, respectively. The improvement in net
income is primarily the result of an increase in net interest income and greater
operating efficiency.
Interest income during the first quarter of 2004 was $15.4 million, an increase
of 21.1% over the $12.7 million earned during the first quarter of 2003. The
growth in interest income is primarily attributable to an increase in earning
assets, which more than offset the negative impact of a declining interest rate
environment. During the first three months of 2004 earning assets averaged
$1,196.9 million, $304.2 million higher than the average earning assets of
$892.7 million during the same time period in 2003. Average loans were up $281.3
million and securities increased $19.6 million. Negatively impacting the growth
in interest income was the decline in yield on earning assets. During the first
three months of 2004 and 2003, earning assets had a weighted average rate (tax
equivalent-adjusted basis) of 5.24% and 5.84%, respectively. The decrease in the
weighted average yield is primarily due to the decline in market interest rates.
Interest expense during the first quarter of 2004 was $5.87 million, a slight
decline from the $5.89 million expensed during the first quarter of 2003. The
slight decrease in interest expense is primarily attributable to a decline in
market interest rates, which offset an increase in interest-bearing liabilities
necessitated by asset growth. During the first three months of 2004
interest-bearing liabilities averaged $1,043.3 million, $246.0 million higher
than the average interest-bearing liabilities of $797.3 million during the same
time period in 2003. Average interest-bearing deposits were up $156.4 million
and FHLBI advances increased $84.8 million. Positively impacting interest
expense was the decline in the cost of interest-bearing liabilities. During the
first three months of 2004 and 2003, interest-bearing liabilities had a weighted
average rate of 2.20% and 3.00%, respectively. The decrease in the weighted
average cost of interest-bearing liabilities is primarily due to the decline in
market interest rates.
Net interest income during the first quarter of 2004 was $9.5 million, an
increase of 39.9% over the $6.8 million earned during the first quarter of 2003.
The increase in net interest income was due to the growth in earning assets and
improved net interest margin. The net interest margin increased from 3.17%
during the first three months of 2003 to 3.26% during the first three months of
2004, primarily reflecting the overall positive impact of the declining interest
rate environment.
18.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 first
quarter of 2004 and 2003. 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 $226,000 and $189,000 in the first
quarter of 2004 and 2003, respectively, for this adjustment.
Quarters ended March 31,
2004 2003
------------------------------------------ ------------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------------- ------------ ------ -------------- ------------- -------
(dollars in thousands)
Loans and leases $ 1,067,710 $ 13,908 5.24 $ 786,406 $ 11,443 5.90
Investment securities 120,344 1,652 5.49 100,700 1,405 5.58
Federal funds sold 8,033 19 0.94 5,351 16 1.19
Short-term investments 850 1 0.30 203 0 0.75
-------------- ------------ ------- -------------- ------------- ----
Total interest -
earning assets 1,196,937 15,580 5.24 892,660 12,864 5.84
Allowance for loan
and lease losses (14,825) (11,175)
Other assets 68,621 57,147
-------------- --------------
Total assets $ 1,250,733 $ 938,632
============== ==============
Interest-bearing
deposits $ 876,239 $ 4,750 2.18 $ 719,789 $ 5,236 2.95
Short-term borrowings 49,505 170 1.38 45,327 171 1.53
Federal Home Loan
Bank advances 99,780 529 2.12 15,000 74 1.97
Long-term borrowings 17,736 416 9.38 17,207 410 9.57
-------------- ------------ ---- -------------- ------------- ----
Total interest-bearing
liabilities 1,043,260 5,865 2.20 797,323 5,891 3.00
Noninterest-bearing
deposits 70,323 55,048
Other liabilities 5,789 5,656
Shareholders' equity 131,361 80,605
-------------- ------------ ---- -------------- ------------- ----
Total liabilities and
shareholders' equity $ 1,250,733 $ 938,632
============== ==============
Net interest income $ 9,715 $ 6,973
============ =============
Net interest rate spread 3.04% 2.84%
==== ====
Net interest rate spread
on average assets 3.12 3.01
==== ====
Net interest margin on
earning assets 3.26 3.17
==== ====
19.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Provisions to the allowance for loan and lease losses during the first quarter
of 2004 were $1.2 million, compared to the $0.6 million that was expensed during
the first quarter of 2003. The increase primarily reflects the higher volume of
loan and lease growth and net loan and lease charge-offs during the first three
months of 2004 compared to the first three months of 2003, slightly offset by a
decline in the reserve coverage ratio. Loan and lease growth during the first
quarter of 2004 was $75.2 million, compared to loan and lease growth of $40.9
million during the same time period in 2003. Net loan and lease charge-offs of
$286,000 were recorded during the first three months of 2004, compared to net
loan and lease charge-offs of $109,000 during the same time period in 2003. The
allowance for loan and lease losses as a percentage of total loans outstanding
as of March 31, 2004 was 1.38%, compared to 1.40% at March 31, 2003.
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 Allowance Analysis,
composition of the loan and lease portfolio, third party analysis of the
administration processes and loan and lease portfolio and general economic
conditions. In addition, the rapid growth of the loan and lease portfolio is
taken into account.
The Allowance Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan and lease
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. 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 Allowance 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 first quarter of 2004 was $1,039,000, an increase
of 5.3% over the $987,000 earned during the first quarter of 2003. Service
charge income on deposit and repurchase agreements increased $30,000 (11.2%)
during the first quarter of 2004 when compared to the same time period in 2003
due primarily to new accounts opened during the last twelve months and
adjustments in our deposit fee structure. Commercial letter of credit fees
increased $66,000 (188.6%) during the first quarter of 2004 when compared to the
same time period in 2003, primarily reflecting an accounting change in
recognizing fee income and an increase in the dollar volume of commercial
letters of credit outstanding. Primarily reflecting the recent increased
interest rate environment and resulting decrease in residential mortgage loan
refinancings, residential mortgage loan fees decreased $145,000 (51.6%) during
the first quarter of 2004 when compared to the same time period in 2003.
20.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Noninterest expense during the first quarter of 2004 was $5.2 million, an
increase of 27.9% over the $4.0 million expensed during the first quarter of
2003. Employee salary and benefit expenses were $0.8 million higher during the
first quarter of 2004 than the level expensed during the same time period in
2003, primarily reflecting the hiring of additional staff and merit annual pay
raises. The level of full-time equivalent employees increased from 128 at the
end of the first quarter in 2003 to 167 at the end of the first quarter in 2004,
an increase of 30.5%. Occupancy and furniture and equipment costs increased
$104,000 during the first quarter of 2004 over the level expensed during the
same time period of 2003, primarily reflecting the addition of two branch
offices. General overhead costs also increased, primarily reflecting the
additional expenses required to administer the 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 $1.1 million during the first quarter
of 2004 over the amount expensed during the first quarter of 2003; however, net
revenues (net interest income plus noninterest income) increased at a
substantially higher level of $2.8 million during the same time period.
Federal income tax expense was $1.2 million during the first three months of
2004, an increase of 30.8% over the $0.9 million expensed during the same time
period in 2003. The increase is primarily due to the higher level of 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.
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.
21.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 March 31,
2004 (dollars in thousands):
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
Assets:
Commercial loans and leases (1) $ 448,063 $ 29,623 $ 472,814 $ 58,512 $ 1,009,012
Residential real estate loans 50,327 4,256 32,524 10,187 97,294
Consumer loans 1,242 439 3,060 105 4,846
Investment securities (2) 7,903 651 20,538 88,197 117,289
Federal funds sold 5,000 5,000
Short-term investments 717 717
Allowance for loan and lease losses (15,337) (15,337)
Other assets 75,114 75,114
----------- ----------- ----------- ----------- -----------
Total assets 513,252 34,969 528,936 216,778 1,293,935
Liabilities:
Interest-bearing checking 35,373 35,373
Savings 120,183 120,183
Money market accounts 9,402 9,402
Time deposits less than $100,000 27,115 58,877 30,380 116,372
Time deposits $100,000 and over 164,214 304,682 159,208 628,104
Short-term borrowings 41,613 41,613
FHLB advances 5,000 40,000 55,000 100,000
Long-term borrowings 1,361 16,495 17,856
Noninterest-bearing checking 85,900 85,900
Other liabilities 6,057 6,057
----------- ----------- ----------- ----------- -----------
Total liabilities 404,261 403,559 244,588 108,452 1,160,860
Shareholders' equity 133,075 133,075
----------- ----------- ----------- ----------- -----------
Total sources of funds 404,261 403,559 244,588 241,527 1,293,935
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 108,991 $ (368,590) $ 284,348 $ (24,749)
=========== =========== =========== ===========
Cumulative GAP $ 108,991 $ (259,599) $ 25,749
=========== =========== ===========
Percent of cumulative GAP to
total assets 8.4% (20.1)% 2.0%
=========== =========== ===========
(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 repricing
frequency.
(2) Mortgage-backed securities are categorized by average life calculations
based upon prepayment trends as of March 31, 2004.
22.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 our strategies, among other factors.
We conducted multiple simulations as of March 31, 2004, 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 are well within the policy parameters
established to manage and monitor interest rate risk.
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
---------------------- ------------------- -------------------
Interest rates down 200 basis points $(1,452,000) (3.5%)
Interest rates down 100 basis points (450,000) (1.1)
No change in interest rates 213,000 0.5
Interest rates up 100 basis points 1,216,000 3.0
Interest rates up 200 basis points 2,227,000 5.4
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.
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2004, 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 March
31, 2004.
23.
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, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On February 12, 2004, we issued 7,753 shares of our common stock to one of our
employees upon their exercise of employee stock options issued under our 1997
Employee Stock Option Plan. We received a weighted average exercise price of
$10.96 per share aggregating $84,964 for these shares. The exercise price for
these shares was substantially paid by the employee delivering to us common
stock of the company that they already owned having an aggregate value of
$84,942, with the difference paid in cash. On February 17, 2004, we issued 9,900
shares of our common stock to one of our employees upon their exercise of
employee stock options issued under our 1997 Employee Stock Option Plan. We
received a weighted average exercise price of $9.07 per share aggregating
$89,793 for these shares. The exercise price for these shares was substantially
paid by the employee delivering to us common stock of the company that they
already owned having an aggregate value of $89,760, with the difference paid in
cash. The shares issued under the 1997 Employee Stock Option Plan were issued in
reliance on an exemption from registration under the Securities Act of 1933
based on Section 4(2) of that Act, and Regulation D issued under that Act.
Issuer Purchases of Equity Securities
(c) Total Number of
(a) Total Shares Purchased as (d) Maximum Number
Number of (b) Average Part of Publicly of Shares that May Yet
Shares Price Paid Per Announced Plans or Be Purchased Under the
Period Purchased Share Programs Plans or Programs
------ --------- ----- -------- -----------------
January 1 - 31 328 $ 35.893 0 0
February 1 - 29 4,873 35.851 0 0
March 1 - 31 0 N/A 0 0
Total 5,201 35.854 0 0
The shares shown in column (a) above as having been purchased were acquired from
four of our employees when they used shares of common stock that they already
owned to pay part of the exercise price when exercising stock options issued
under our employee stock option plans.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
24.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit No. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Our 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 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
(b) Reports on Form 8-K.
During the first quarter of 2004, the Company furnished the following
report on Form 8-K:
i) Dated January 7, 2004, pertaining to the Company's press
release issued January 7, 2004 reporting financial results and
earnings for the quarter and year ended December 31, 2003
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 May 3, 2004.
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)
EXHIBIT INDEX
Exhibit No. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Our 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 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification