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, 2006
[ ] 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)
310 LEONARD STREET, NW, GRAND RAPIDS, MI 49504
(Address of principal executive offices) (Zip Code)
(616) 406-3000
(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 a large accelerated filer, an
accelerated filer, or a non accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large Accelerated filer Accelerated filer X Non-Accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
At May 8, 2006, there were 8,000,633 shares of Common Stock outstanding.
MERCANTILE BANK CORPORATION
INDEX
Page No.
--------
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2006 (Unaudited) and December 31, 2005.................. 1
Consolidated Statements of Income and Comprehensive Income -
Three Months Ended March 31, 2006 (Unaudited) and
March 31, 2005 (Unaudited)........................................ 2
Consolidated Statement of Changes in Shareholders' Equity -
Three Months Ended March 31, 2006 (Unaudited) and
March 31, 2005 (Unaudited)........................................ 3
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2006 (Unaudited) and
March 31, 2005 (Unaudited)........................................ 4
Notes to Consolidated Financial Statements (Unaudited)............... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 23
Item 4. Controls and Procedures...................................... 25
PART II. Other Information
Item 1. Legal Proceedings............................................ 26
Item 1A. Risk Factors................................................ 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.. 26
Item 3. Defaults upon Senior Securities.............................. 26
Item 4. Submission of Matters to a Vote of Security Holders.......... 27
Item 5. Other Information............................................ 27
Item 6. Exhibits..................................................... 27
Signatures
MERCANTILE BANK CORPORATION
PART I- FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2006 2005
-------------- --------------
(Unaudited)
ASSETS
Cash and due from banks $ 38,247,000 $ 36,208,000
Short-term investments 389,000 545,000
-------------- --------------
Total cash and cash equivalents 38,636,000 36,753,000
Securities available for sale 118,103,000 112,961,000
Securities held to maturity (fair value of $64,179,000 at
March 31, 2006 and $62,850,000 at December 31, 2005) 62,179,000 60,766,000
Federal Home Loan Bank stock 7,887,000 7,887,000
Total loans and leases 1,612,351,000 1,561,812,000
Allowance for loan and lease losses (20,995,000) (20,527,000)
-------------- --------------
Total loans and leases, net 1,591,356,000 1,541,285,000
Premises and equipment, net 29,885,000 30,206,000
Bank owned life insurance policies 28,360,000 28,071,000
Accrued interest receivable 9,374,000 8,274,000
Other assets 11,194,000 12,007,000
-------------- --------------
Total assets $1,896,974,000 $1,838,210,000
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 114,880,000 $ 120,828,000
Interest-bearing 1,367,339,000 1,298,524,000
-------------- --------------
Total deposits 1,482,219,000 1,419,352,000
Securities sold under agreements to repurchase 67,956,000 72,201,000
Federal funds purchased 6,600,000 9,600,000
Federal Home Loan Bank advances 130,000,000 130,000,000
Subordinated debentures 32,990,000 32,990,000
Other borrowed money 2,791,000 2,347,000
Accrued expenses and other liabilities 15,508,000 16,595,000
-------------- --------------
Total liabilities 1,738,064,000 1,683,085,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued 0 0
Common stock, no par value: 20,000,000 shares authorized;
7,976,829 shares outstanding at March 31, 2006 and
7,590,526 shares outstanding at December 31, 2005 160,648,000 148,533,000
Retained earnings 0 8,000,000
Accumulated other comprehensive income (loss) (1,738,000) (1,408,000)
-------------- --------------
Total shareholders' equity 158,910,000 155,125,000
-------------- --------------
Total liabilities and shareholders' equity $1,896,974,000 $1,838,210,000
============== ==============
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,
2006 2005
------------ ------------
Interest income
Loans and leases, including fees $28,727,000 $19,772,000
Investment securities 2,237,000 1,887,000
Federal funds sold 132,000 44,000
Short-term investments 3,000 2,000
----------- -----------
Total interest income 31,099,000 21,705,000
Interest expense
Deposits 13,485,000 7,440,000
Short-term borrowings 601,000 338,000
Federal Home Loan Bank advances 1,315,000 857,000
Long-term borrowings 599,000 415,000
----------- -----------
Total interest expense 16,000,000 9,050,000
----------- -----------
NET INTEREST INCOME 15,099,000 12,655,000
Provision for loan and lease losses 1,225,000 725,000
----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 13,874,000 11,930,000
Noninterest income
Service charges on accounts 316,000 338,000
Net gain on sales of securities 0 0
Net gain on sales of commercial loans 29,000 0
Other income 898,000 872,000
----------- -----------
Total noninterest income 1,243,000 1,210,000
Noninterest expense
Salaries and benefits 4,765,000 4,159,000
Occupancy 830,000 518,000
Furniture and equipment 522,000 288,000
Other expense 1,889,000 1,885,000
----------- -----------
Total noninterest expenses 8,006,000 6,850,000
----------- -----------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 7,111,000 6,290,000
Federal income tax expense 2,182,000 1,928,000
----------- -----------
NET INCOME $ 4,929,000 $ 4,362,000
=========== ===========
COMPREHENSIVE INCOME $ 4,599,000 $ 3,502,000
=========== ===========
Basic earnings per share $ 0.62 $ 0.55
=========== ===========
Diluted earnings per share $ 0.61 $ 0.54
=========== ===========
Cash dividends per share $ 0.12 $ 0.10
=========== ===========
Average basic shares outstanding 7,974,180 7,944,969
=========== ===========
Average diluted shares outstanding 8,101,081 8,098,461
=========== ===========
See accompanying notes to consolidated financial statements.
2.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Retained Comprehensive Shareholders'
Common Stock Earnings Income (Loss) Equity
------------ ------------ ------------- -------------
BALANCE, JANUARY 1, 2005 $131,010,000 $ 10,475,000 $ 132,000 $141,617,000
Employee stock purchase plan, 436 shares 17,000 17,000
Dividend reinvestment plan, 864 shares 33,000 33,000
Stock option exercises, 23,621 shares 225,000 225,000
Stock tendered for stock option
exercises, 4,125 shares (172,000) (172,000)
Cash dividends ($0.10 per share) (721,000) (721,000)
Comprehensive income:
Net income for the period from
January 1, 2005 through
March 31, 2005 4,362,000 4,362,000
Change in net unrealized gain (loss)
on securities available for sale, net
of reclassifications and tax effect (860,000) (860,000)
------------
Total comprehensive income 3,502,000
------------ ------------ ----------- ------------
BALANCE, MARCH 31, 2005 $131,113,000 $ 14,116,000 $ (728,000) $144,501,000
============ ============ =========== ============
BALANCE, JANUARY 1, 2006 $148,533,000 $ 8,000,000 $(1,408,000) $155,125,000
Payment of 5% stock dividend 12,014,000 (12,018,000) (4,000)
Employee stock purchase plan, 794 shares 29,000 29,000
Dividend reinvestment plan, 565 shares 21,000 21,000
Stock option exercises, 7,974 shares 95,000 95,000
Stock tendered for stock option
exercises, 2,558 shares (95,000) (95,000)
Stock option expense 51,000 51,000
Cash dividends ($0.12 per share) (911,000) (911,000)
Comprehensive income:
Net income for the period from
January 1, 2006 through
March 31,2006 4,929,000 4,929,000
Change in net unrealized gain (loss)
on securities
available for sale, net of
reclassifications and tax effect (330,000) (330,000)
------------
Total comprehensive income 4,599,000
------------ ------------ ----------- ------------
BALANCE, MARCH 31, 2006 $160,648,000 $ 0 $(1,738,000) $158,910,000
============ ============ =========== ============
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, March 31,
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,929,000 $ 4,362,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 785,000 490,000
Provision for loan and lease losses 1,225,000 725,000
Net gain on sales of commercial loans (29,000) 0
Stock option expense 51,000 0
Net change in:
Accrued interest receivable (1,100,000) (1,239,000)
Bank owned life insurance policies (289,000) (236,000)
Other assets 867,000 (1,129,000)
Accrued expenses and other liabilities (1,087,000) 839,000
------------ ------------
Net cash from operating activities 5,352,000 3,812,000
CASH FLOWS FROM INVESTING ACTIVITIES
Loan and lease originations and payments, net (51,267,000) (57,900,000)
Purchases of:
Securities available for sale (8,133,000) (15,756,000)
Securities held to maturity (1,428,000) (4,895,000)
Federal Home Loan Bank stock 0 (224,000)
Proceeds from:
Maturities, calls and repayments of
available for sale securities 2,488,000 5,510,000
Maturities, calls and repayments of
held to maturity securities 0 201,000
Purchases of premises and equipment, net (330,000) (2,378,000)
------------ ------------
Net cash from investing activities (58,670,000) (75,442,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 62,867,000 130,836,000
Net increase (decrease) in securities sold under
agreements to repurchase (4,245,000) 3,891,000
Net increase (decrease) in federal funds purchased (3,000,000) (15,000,000)
Proceeds from new Federal Home Loan Bank advances 15,000,000 20,000,000
Maturities of Federal Home Loan Bank advances (15,000,000) (15,000,000)
Net increase in other borrowed money 444,000 307,000
Employee stock purchase plan 29,000 17,000
Dividend reinvestment plan 21,000 33,000
Stock option exercises, net 0 53,000
Cash paid in lieu of fractional shares on stock dividend (4,000) 0
Payment of cash dividend (911,000) (721,000)
------------ ------------
Net cash from financing activities 55,201,000 124,416,000
------------ ------------
Net change in cash and cash equivalents 1,883,000 52,786,000
Cash and cash equivalents at beginning of period 36,753,000 20,811,000
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 38,636,000 $ 73,597,000
============ ============
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 14,302,000 $ 7,726,000
Federal income tax 1,000,000 325,000
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, 2006 include the consolidated results of operations
of Mercantile Bank Corporation and its consolidated subsidiaries. These
subsidiaries include Mercantile Bank of Michigan ("our bank"), our bank's
three subsidiaries, Mercantile Bank Mortgage Company, LLC ("our mortgage
company"), 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, 2006 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, 2005.
Mercantile Bank Capital Trust I ("the trust"), a business trust formed by
Mercantile Bank Corporation, sold 16,000 trust preferred securities at
$1,000.00 per trust preferred security in a September 2004 offering. The
trust sold an additional 16,000 trust preferred securities at $1,000.00 per
trust preferred security in a December 2004 offering. Mercantile Bank
Corporation issued subordinated debentures to the trust in exchange for the
proceeds of the offerings. The debentures and related debt issuance costs
represent the sole assets of the trust. Under current accounting guidance,
FASB Interpretation No. 46, as revised in December 2003, the trust is not
consolidated. Accordingly, Mercantile Bank Corporation does not report the
securities issued by the trust as liabilities, but instead reports as
liabilities the subordinated debentures issued by Mercantile Bank
Corporation and held by the trust, as these are not eliminated in
consolidation. The effect of not consolidating the trust does not
significantly change the amounts reported as Mercantile Bank Corporation's
assets, liabilities, equity or interest expense.
Earnings Per Share: Basic earnings per share is based on weighted average
common shares outstanding during the period. Diluted earnings per share
include the dilutive effect of additional potential common shares issuable
under stock options. Options for 55,203 shares were antidilutive and were
not included in determining diluted earnings per share for the three month
period ended March 31,2006.
Stock Dividend: All per share amounts and average shares outstanding have
been adjusted for all periods presented to reflect the 5% stock dividend
that will be distributed on May 16, 2006. The Statement of Changes in
Shareholders' Equity reflects a transfer from retained earnings to common
stock for the fair value of the shares distributed to the extent of
available retained earnings.
(Continued)
5.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan and Lease Losses: The allowance for loan and lease
losses ("allowance") 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 30
days or more, or when serious deficiencies are identified within the credit
relationship.
Stock Options: Stock option plans are used to reward directors and
employees and provide them with additional equity interest. Stock options
granted to non-employee directors are at 125% of the market price on the
date of grant, fully vest after five years and expire ten years from the
date of grant. Stock options granted to employees are granted at the market
price on the date of grant, generally fully vest after one year and expire
ten years from the date of grant. Stock options granted to non-executive
employees during 2005 vested about three weeks after being granted. At
March 31, 2006, there were 243,380 shares authorized for future option
grants.
Prior to January 1, 2006, the Company accounted for stock-based
compensation expense using the intrinsic value method as required by APB
Opinion No. 25 "Accounting for Stock Issued to Employees" and as permitted
by SFAS No. 123 "Accounting for Stock-Based Compensation." No compensation
cost for stock options was reflected in net income for 2005, as all options
granted had an exercise price equal to the market price of the underlying
common stock at date of grant.
On January 1, 2006, the Company adopted SFAS No. 123(R), which requires
measurement of compensation cost for all stock-based awards be based on the
grant-date fair value and recognition of compensation cost over the service
period of stock-based awards, which is usually the same as the vesting
period. The fair value of stock options is determined using the
Black-Scholes valuation model, which is consistent with the Company's
valuation methodology previously utilized for options in the footnote
disclosures required under SFAS No. 123. The fair value of stock option
grants will also be determined using the Black-Scholes valuation model. The
Company has adopted SFAS No. 123(R) using the modified prospective method,
which provides for no retroactive application to prior periods and no
cumulative adjustment to equity accounts. It also provides for expense
recognition, for both new and existing stock-based awards, as the required
services are rendered. SFAS No. 123(R) also amends SFAS No. 95 "Statement
of Cash Flows," and requires tax benefits relating to excess stock-based
compensation deductions be presented in the consolidated statements of cash
flows as financing cash inflows.
(Continued)
6.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
On March 29, 2005, the Securities and Exchange Commission ("SEC") published
Staff Accounting Bulletin ("SAB") No. 107, which expressed the views of the
Staff regarding interaction between SFAS No. 123(R) and certain SEC rules
and regulations and provided the Staff's views regarding the valuation of
stock-based payment arrangements for public companies. SAB No. 107 requires
that stock-based compensation be classified in the same expense category as
cash compensation. Accordingly, the Company has included stock-based
compensation expense in salaries and employee benefits in the consolidated
statements of income and comprehensive income.
The adoption of SFAS No. 123(R) had the following impact on reported
amounts compared with amounts that would have been reported using the
intrinsic value method under previous accounting.
Three Months Ended March 31, 2006
-------------------------------------
Using SFAS
Previous 123(R) As
Accounting Adjustments Reported
---------- ----------- ----------
Income before taxes $7,162,000 $(51,000) $7,111,000
Income taxes 2,182,000 0 2,182,000
---------- -------- ----------
Net income $4,980,000 $(51,000) $4,929,000
========== ======== ==========
Basic earnings per share $ 0.62 $ -- $ 0.62
Diluted earnings per share $ 0.61 $ -- $ 0.61
The following table illustrates the effect on net income and earnings per
share if expense had been measured using the fair value expense had been
recognition provisions of SFAS No. 123(R).
Three Months Ended March 31, 2005
---------------------------------------
Pro Forma As
As Pro Forma If Under
Reported Adjustments SFAS 123(R)
---------- ----------- ------------
Income before taxes $6,290,000 $(94,000) $6,196,000
Income taxes 1,928,000 0 1,928,000
---------- -------- ----------
Net income $4,362,000 $(94,000) $4,268,000
========== ======== ==========
Basic earnings per share $ 0.55 $ (0.01) $ 0.54
Diluted earnings per share $ 0.54 $ (0.01) $ 0.53
(Continued)
7.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
The following is activity under the stock option plans:
Three Months Ended March 31, 2006
---------------------------------
Weighted
Average
Exercise
Shares Price
-------- --------
Outstanding at beginning of period $315,465 $21.84
Granted 0 NA
Exercised 7,974 11.93
Forfeited 0 NA
-------- ------
Outstanding at end of period $307,491 $22.09
======== ======
Exercisable at end of period $264,813 $20.60
======== ======
The aggregate intrinsic value of all options outstanding at March 31, 2006
was $4.7 million.
The aggregate intrinsic value of all options that were exercisable at March
31, 2006 was $4.4 million.
The aggregate intrinsic value of stock options exercised during the first
three months of 2006 was $0.2 million.
The weighted average fair value of the 2,479 stock options that vested
during the first three months of 2006 was $10.90.
Stock options outstanding as of March 31,2006:
Outstanding Exercisable
-------------------------------- ------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Shares Life Price Shares Price
------- ----------- -------- ------- --------
$4.00 - $9.00 17,253 1.5 Years $ 7.62 17,253 $ 7.62
$9.01 - $13.00 69,178 3.5 Years 9.38 69,178 9.38
$13.01 - $17.00 42,053 5.5 Years 13.66 34,416 13.07
$17.01 - $21.00 37,643 6.5 Years 16.94 37,643 16.94
$21.01 - $25.00 7,283 6.5 Years 21.19 0 NA
$25.01 - $29.00 34,079 7.6 Years 27.94 34,079 27.94
$33.00 - $38.00 92,836 9.0 Years 36.53 72,244 36.46
$38.01 - $42.00 7,166 8.5 Years 42.29 0 NA
------- -------
Outstanding at end of period 307,491 6.3 Years $22.09 264,813 $20.60
======= =======
(Continued)
8.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
The compensation cost yet to be recognized for stock option grants that
have been awarded but not vested is $149,000 for the remainder of 2006, and
$27,000, $17,000 and $8,000 for 2007, 2008 and 2009, respectively.
2. LOANS
Our total loans at March 31, 2006 were $1,612.4 million compared to
$1,561.8 million at December 31, 2005, an increase of $50.6 million, or
3.2%. The components of our outstanding balances at March 31, 2006 and
December 31, 2005, and percentage increase in loans from the end of 2005 to
the end of the first quarter 2006 are as follows:
March 31, 2006 December 31, 2005 Percent
---------------------- ---------------------- Increase/
Balance % Balance % (Decrease)
-------------- ----- -------------- ----- ----------
Real Estate:
Construction and land
development $ 242,411,000 15.0% $ 226,544,000 14.5% 7.0%
Secured by 1-4 family
properties 129,784,000 8.0 128,111,000 8.2 1.3
Secured by multi-family
properties 36,475,000 2.3 30,114,000 2.0 21.1
Secured by nonresidential
properties 742,003,000 46.0 714,963,000 45.8 3.8
Commercial 452,612,000 28.1 454,911,000 29.1 (0.5)
Leases 1,475,000 0.1 1,786,000 0.1 (17.4)
Consumer 7,591,000 0.5 5,383,000 0.3 41.0
-------------- ----- -------------- ----- -----
Total loans and leases $1,612,351,000 100.0% $1,561,812,000 100.0% 3.2%
============== ===== ============== ===== =====
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:
2006 2005
----------- -----------
Balance at January 1 $20,527,000 $17,819,000
Charge-offs (780,000) (493,000)
Recoveries 23,000 46,000
Provision for loan and lease losses 1,225,000 725,000
----------- -----------
Balance at March 31 $20,995,000 $18,097,000
=========== ===========
(Continued)
9.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. PREMISES AND EQUIPMENT, NET
Premises and equipment are comprised of the following:
March 31, December 31,
2006 2005
----------- ------------
Land and improvements $ 7,202,000 $ 7,135,000
Buildings and leasehold improvements 18,638,000 18,450,000
Furniture and equipment 10,426,000 10,351,000
----------- -----------
36,266,000 35,936,000
Less: accumulated depreciation 6,381,000 5,730,000
----------- -----------
Premises and equipment, net $29,885,000 $30,206,000
=========== ===========
Depreciation expense amounted to $651,000 during the first quarter of 2006,
compared to $374,000 in the first quarter of 2005.
5. DEPOSITS
Our total deposits at March 31, 2006 were $1,482.2 million compared to
$1,419.4 million at December 31, 2005, an increase of $62.9 million, or
4.4%. The components of our outstanding balances at March 31, 2006 and
December 31, 2005, and percentage increase in deposits from the end of 2005
to the end of the first quarter 2006 are as follows:
March 31, 2006 December 31, 2005 Percent
---------------------- ---------------------- Increase/
Balance % Balance % (Decrease)
-------------- ----- -------------- ----- ----------
Noninterest-bearing demand $ 114,880,000 7.8 $ 120,828,000 8.5% (4.9)%
Interest-bearing checking 35,971,000 2.4 39,792,000 2.8 (9.6)
Money market 10,840,000 0.7 10,344,000 0.7 4.8
Savings 95,422,000 6.5 106,247,000 7.5 (10.2)
Time, under $100,000 27,988,000 1.9 23,906,000 1.7 17.1
Time, $100,000 and over 236,035,000 15.9 155,401.000 11.0 51.9
-------------- ----- -------------- ----- ----
521,136,000 35.2 456,518,000 32.2 14.2
Out-of-area time,
under $100,000 79,756,000 5.3 80,048,000 5.6 (0.4)
Out-of-area time,
$100,000 and over 881,327,000 59.5 882,786,000 62.2 (0.2)
-------------- ----- -------------- ----- ----
961,083,000 64.8 962,834,000 67.8 (0.2)
-------------- ----- -------------- ----- ----
Total deposits $1,482,219,000 100.0% $1,419,352,000 100.0% 4.4%
============== ===== ============== ===== ====
(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:
March 31, December 31,
2006 2005
----------- ------------
Outstanding balance at end of period $67,956,000 $72,201,000
Average interest rate at end of period 3.64% 3.31%
Average balance during the period $69,397,000 $60,743,000
Average interest rate during the period 3.37% 2.63%
Maximum month end balance during the period $74,218,000 $74,639,000
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 uninsured deposit
equivalent investments.
7. FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at March 31, 2006 and December 31, 2005 were as
follows.
March 31, December 31,
2006 2005
------------ ------------
Maturities April 2006 through May 2008,
fixed rates from 2.64% to 4.99%, averaging 3.96% $120,000,000 $
Maturities in May 2006, floating rates tied
to Libor indices, averaging 4.84% 10,000,000
Maturities January 2006 through May 2008,
fixed rates from 2.13% to 4.92%, averaging 3.68% 120,000,000
Maturities in May 2006, floating rates tied to
Libor indices, averaging 4.42% 10,000,000
------------ ------------
$130,000,000 $130,000,000
============ ============
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, 2006 totaled $203.4 million, with availability approximating $61.7
million.
(Continued)
11.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. FEDERAL HOME LOAN BANK ADVANCES (Continued)
Maturities of currently outstanding FHLB advances during the next five
years are:
2006 $85,000,000
2007 30,000,000
2008 15,000,000
2009 0
2010 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 its customers.
These financial instruments include commitments to extend credit and
standby letters of credit. Loan commitments to extend credit are agreements
to lend to a customer as long as there is no violation of any condition
established in the contract. Standby letters of credit are conditional
commitments issued by 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. If required, estimated loss
exposure resulting from these instruments is expensed and recorded as a
liability. The balance of the liability account was $0.5 million as of
March 31, 2006 and December 31, 2005.
A summary of the contractual amounts of our financial instruments with
off-balance sheet risk at March 31,2006 and December 31, 2005 follows:
March 31, December 31,
2006 2005
------------ ------------
Commercial unused lines of credit $316,334,000 $303,115,000
Unused lines of credit secured by 1 - 4 family
residential properties 30,053,000 27,830,000
Credit card unused lines of credit 7,931,000 7,971,000
Other consumer unused lines of credit 8,188,000 10,791,000
Commitments to extend credit 90,539,000 83,280,000
Standby letters of credit 57,060,000 59,058,000
------------ ------------
$510,105,000 $492,045,000
============ ============
(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
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, 2006
Total capital (to risk
weighted assets)
Consolidated $213,647 11.9% $143,486 8.0% $ NA NA
Bank 210,218 11.7 143,400 8.0 179,250 10.0%
Tier 1 capital (to risk
weighted assets)
Consolidated 192,652 10.7 71,743 4.0 NA NA
Bank 189,223 10.6 71,700 4.0 107,550 6.0
Tier 1 capital (to
average assets)
Consolidated 192,652 10.3 74,878 4.0 NA NA
Bank 189,223 10.1 74,826 4.0 93,533 5.0
(Continued)
13.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS (Continued)
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
---------------- ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ----- -------- -----
December 31,2005
Total capital (to risk
weighted assets)
Consolidated $209,060 12.0% $139,337 8.0% $ NA NA
Bank 205,642 11.8 139,158 8.0 173,947 10.0%
Tier 1 capital (to risk
weighted assets)
Consolidated 188,533 10.8 69,669 4.0 NA NA
Bank 185,115 10.6 69,579 4.0 104,368 6.0
Tier 1 capital (to
average assets)
Consolidated 188,533 10.5 72,163 4.0 NA NA
Bank 185,115 10.3 72,100 4.0 90,124 5.0
Our consolidated capital levels as of March 31, 2006 and December 31, 2005
include the $32.0 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, 2006 and December 31, 2005,
all $32.0 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 s 5% stock dividend on April 11, 2006, that
will be distributed on May 16, 2006 to record holders as of April 24, 2006.
All earnings per share and dividend per share information have been
adjusted for the 5% stock dividend. On January 10, 2006, we declared a
$0.12 per share cash dividend on our common stock, which was paid on March
10, 2006 to record holders as of February 10, 2006. On April 11, 2006, we
declared a $0.13 per share cash dividend on our common stock, which is
payable on June 9, 2006 to record holders as of May 17, 2006.
10. BENEFIT PLANS
We sponsor an employee stock purchase plan which allows employees to defer
after-tax payroll dollars and purchase our stock, at market value, on a
quarterly basis. We have registered 30,387 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, 2006, we issued 794 shares under the plan.
(Continued)
14.
MERCANTILE BANK CORPORATION
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," and 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; changes in the national and local economies; and risk factors described
in our annual report on Form 10-K for the year ended December 31, 2005. 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 Michigan ("our
bank"), our bank's three subsidiaries Mercantile Bank Mortgage Company ("our
mortgage company"), Mercantile Bank Real Estate Co., LLC ("our real estate
company") and Mercantile Insurance Center, Inc. ("our insurance company"), at
March 31, 2006 to December 31, 2005 and the results of operations for the three
months ended March 31, 2006 and March 31, 2005. This discussion should be read
in conjunction with the interim consolidated financial statements and footnotes
included therein. 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. 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-35 through F-40 in our
Form 10-K for the fiscal year ended December 31, 2005 (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.
15.
MERCANTILE BANK CORPORATION
Allowance for Loan and Lease Losses: The allowance for loan and lease losses
("allowance") 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 30 days or more, or when serious
deficiencies are identified within the credit relationship.
FINANCIAL CONDITION
During the first three months of 2006, our assets increased from $1,838.2
million on December 31, 2005, to $1,897.0 million on March 31, 2006. This
represents an increase in total assets of $58.8 million, or 3.2%. The asset
growth was comprised primarily of a $50.1 million increase in net loans and a
$6.6 million increase in securities. The growth in total assets was primarily
funded by a $62.9 million increase in deposits, partially offset by a $4.2
million decrease in securities sold under agreements to repurchase ("repurchase
agreements") and a $3.0 million decrease in federal funds purchased.
Commercial loans and leases increased by $46.7 million during the first three
months of 2006, and at March 31, 2006 totaled $1,475.0 million, or 91.5% 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 our efforts on "wholesale" banking. Corporate
and business lending continues to be an area of expertise of our senior
management team, and our commercial lenders have extensive commercial lending
experience, with most having at least 10 years 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 our primary source of
demand deposits.
Residential mortgage loans and consumer loans increased an aggregate $3.9
million during the first three months of 2006. As of March 31, 2006, residential
mortgage and consumer loans totaled a combined $137.4 million, or 8.5% of the
total loan and lease portfolio. Although we plan to increase our noncommercial
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.
16.
MERCANTILE BANK CORPORATION
Management believes the quality of our loan and lease portfolio remains strong.
Net loan and lease charge-offs during the first three months of 2006 totaled
$757,000, or 0.19% of average total loans and leases on an annualized basis.
During the first quarter of 2005, net loan and lease charge-offs totaled
$447,000, or 0.13% of average total loans and leases on an annualized basis.
Nonperforming assets at March 31, 2006 totaled $8.8 million, or 0.46% of
period-ending total assets. At March 31, 2005, nonperforming assets totaled $5.2
million, or 0.31% of period-ending total assets, while nonperforming assets at
December 31, 2005 totaled $4.0 million, or 0.22% of period-ending total assets.
Of the $4.8 million increase in nonperforming assets during the first quarter of
2006, approximately $2.6 million is attributable to eleven related loans that
had been requested to finance the purchase of vacant residential real estate,
where the purpose, collateral, and structure of the loans does not appear to
coincide with what was portrayed to us in the loan application process. These
loans have been placed on non-accrual. We are currently pursuing various legal
remedies against the multiple parties to these transactions and expect the real
estate collateral received in connection with the loans to eventually be
liquidated as part of the collection process. While it is still early in the
litigation and evaluation process, a portion of the allowance has been allocated
to these specific credits based on the current assessment of the value of the
collateral and the other collection avenues being pursued.
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 historical 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 increased by $6.6 million during the first three months of 2006.
Purchases during the first three months of 2006 totaled $9.6 million, while
proceeds from maturities, calls and repayments of securities totaled $2.5
million. Our securities portfolio primarily 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 $1.9 million during the first three months
of 2006, totaling $38.6 million on March 31, 2006. Cash and due from bank
balances were up $2.0 million and short term investments were down $0.1 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 2006 equaled $49.1
million.
Premises and equipment at March 31, 2006 equaled $29.9 million, a decrease of
$0.3 million over the past three months. Purchases of premises and equipment
during the first three months of 2006 totaled $0.3 million, while depreciation
expense equaled $0.6 million.
17.
MERCANTILE BANK CORPORATION
Deposits increased $62.9 million during the first three months of 2006, totaling
$1,482.2 million at March 31, 2006. Local deposits increased $64.6 million,
while out-of-area deposits decreased $1.7 million. As a percent of total
deposits, local deposits increased from 32.2% on December 31, 2005, to 35.2% at
March 31, 2006. Noninterest-bearing demand deposits, comprising 7.8% of total
deposits, decreased $5.9 million during the first three months of 2006. Savings
deposits (6.5% of total deposits) decreased $10.8 million, interest-bearing
checking accounts (2.4% of total deposits) decreased $3.8 million and money
market deposit accounts (0.7% of total deposits) increased $0.5 million during
the first three months of 2006. Local certificates of deposit, comprising 17.8%
of total deposits, increased by $84.7 million during the first three months of
2006. The increase in local certificates of deposit is primarily attributable to
increases in balances from municipalities and transfers of monies by consumer
and commercial customers from savings accounts to certificate of deposit
products, the latter of which reflecting that rates offered on certificates of
deposit have risen at a faster pace than the rates offered on savings accounts.
Out-of-area deposits decreased $1.7 million during the first three months of
2006, totaling $961.1 million at March 31, 2006. 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 three months of 2006, rates paid on new out-of-area
certificates of deposit were generally only slightly higher than rates paid on
new certificates of deposit issued to local customers. Overhead costs associated
with 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 generally 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.
Repurchase agreements decreased by $4.2 million during the first three months of
2006, totaling $68.0 million as of March 31, 2006. 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 funds purchased declined by $3.0 million during the first three months
of 2006, totaling $6.6 million as of March 31, 2006. Advances obtained from the
FHLBI totaled $130.0 million as of March 31, 2006, unchanged from December 31,
2005, as $15.0 million in new advances replaced the $15.0 million from maturing
advances during the first quarter. The FHLBI 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, 2006 totaled $203.4
million, with availability approximating $61.7 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.
18.
MERCANTILE BANK CORPORATION
Our liquidity strategy is to fund earning asset growth with deposits, repurchase
agreements and FHLBI advances 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 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 $1,091.1 million, or 64.9% of combined deposits
and borrowed funds as of March 31, 2006. As of December 31, 2005, wholesale
funds totaled $1,092.8 million, or 67.4% 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, 2006, advances from the FHLBI totaled $130.0 million, unchanged
from the amount outstanding at December 31, 2005. Based on available collateral
at March 31, 2006, our bank could borrow an additional $61.7 million.
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established unsecured federal funds purchased lines, totaling $62.0
million as of March 31,2006. The average balance of federal funds purchased
during the first three months of 2006 equaled $2.2 million, compared to a $12.0
million average federal funds sold position during the same time period.
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, 2006, our bank had a total of $453.0 million in unfunded
loan commitments and $57.1 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $362.5 million were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $90.5
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 $3.7 million during
the first three months of 2006, from $155.1 million on December 31, 2005, to
$158.8 million at March 31, 2006. The increase is primarily attributable to net
income of $4.9 million recorded during the first quarter of 2006. Shareholders'
equity was negatively impacted during the first quarter of 2006 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.
Shareholders' equity also increased $0.1 million from the issuance of 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, 2006 and December 31, 2005 are disclosed under Note 9 of
the Notes to Consolidated Financial Statements.
19.
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 April 11, 2006, that will be
distributed on May 16, 2006 to record holders as of April 24, 2006. All earnings
per share and dividend per share information have been adjusted for the 5% stock
dividend. On January 10, 2006, we declared a $0.12 per share cash dividend on
our common stock, which was paid on March 10, 2006 to record holders as of
February 10, 2006. On April 11, 2006, we declared a $0.13 per share cash
dividend on our common stock, which is payable on June 9, 2006 to record holders
as of May 17,2006.
RESULTS OF OPERATIONS
Net income for the first quarter of 2006 was $4.9 million ($0.62 per basic share
and $0.61 per diluted share), which represents a 13.0% increase over net income
of $4.4 million ($0.55 per basic share and $0.54 per diluted share) recorded
during the first quarter of 2005. The improvement in net income is primarily the
result of higher net interest income and greater operating efficiency, which
more than offset a higher provision expense.
Interest income during the first quarter of 2006 was $31.1 million, an increase
of 43.3% over the $21.7 million earned during the first quarter of 2005. The
growth in interest income is primarily attributable to the growth in earning
assets and an increasing interest rate environment. During the first three
months of 2006, earning assets averaged $1,778.7 million, $266.8 million higher
than the average earning assets of $1,511.9 million during the same time period
in 2005. Average loans were up $236.3 million and securities increased $25.9
million. Also positively impacting the growth in interest income was the
increased yield on earning assets. During the first three months of 2006 and
2005, earning assets had a weighted average rate (tax equivalent-adjusted basis)
of 7.16% and 5.89%, respectively. With approximately 70% of our total loans and
leases tied to the prime rate, our asset yield has benefited from recent
increases in the prime rate. Between June 30, 2004 and March 31, 2006, the
Federal Open Market Committee raised the target federal funds rate by a total of
375 basis points, with the prime rate increasing by the same magnitude.
Interest expense during the first quarter of 2006 was $16.0 million, an increase
of 76.8% over the $9.1 million expensed during the first quarter of 2005. The
growth in interest expense is primarily attributable to an increase in
interest-bearing liabilities necessitated by asset growth and a higher interest
rate environment. During the first three months of 2006, interest-bearing
liabilities averaged $1,588.4 million, $252.6 million higher than the average
interest-bearing liabilities of $1,335.8 million during the same time period in
2005. Average interest-bearing deposits were up $237.4 million, FHLBI advances
increased $8.0 million and short-term borrowings increased $6.4 million. Adding
to the increased interest expense was the rise in the cost of interest-bearing
liabilities. During the first three months of 2006 and 2005, interest-bearing
liabilities had a weighted average rate of 4.09% and 2.75%, respectively. The
higher weighted average cost of interest-bearing liabilities is primarily due to
the increase in market interest rates.
Net interest income during the first quarter of 2006 was $15.1 million, an
increase of 19.3% over the $12.7 million earned during the first quarter of
2005. 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
3.46% during the first three months of 2005 to 3.51% during the first three
months of 2006, primarily reflecting the overall positive impact of the recent
increasing interest rate environment. Our earning assets, led by the relatively
high level of floating rate loans tied to the prime rate, have generally
repriced faster than our interest-bearing liabilities, led by our relatively
high level of fixed rate certificates of deposit.
20.
MERCANTILE BANK CORPORATION
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 2006 and 2005. 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 35%.
Securities interest income was increased by $296,000 and $261,000 in the first
quarter of 2006 and 2005, respectively, for this adjustment.
Quarters ended March 31,
-----------------------------------------------------------------
2006 2005
------------------------------- -------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- -------
(dollars in thousands)
ASSETS
Loans and leases $1,581,618 $28,727 7.37% $1,345,336 $19,772 5.96%
Investment securities 184,736 2,533 5.48 158,860 2,148 5.41
Federal funds sold 11,953 132 4.42 7,036 44 2.51
Short-term investments 387 3 3.52 659 2 1.31
---------- ------- ---------- -------
Total interest - earning
assets 1,778,694 31,395 7.16 1,511,891 21,966 5.89
Allowance for loan
and lease losses (20,894) (18,150)
Other assets 114,145 98,023
---------- ----------
Total assets $1,871.945 $1.591.764
========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
deposits $1,348,407 $13,485 4.06% $1,111,026 $ 7,440 2.72%
Short-term borrowings 71,627 601 3.40 65,274 338 2.10
Federal Home Loan
Bank advances 132,778 1,315 4.02 124,778 857 2.75
Long-term borrowings 35,549 599 6.83 34,732 415 4.78
---------- ------- ---------- -------
Total interest-bearing
liabilities 1,588,361 16,000 4.09 1,335,810 9,050 2.75
Noninterest-bearing
deposits 110,859 103,864
Other liabilities 15,824 8,921
Shareholders' equity 156,901 143,169
---------- ------- ---------- -------
Total liabilities and
shareholders' equity $1.871.945 $1.591.764
========== ==========
Net interest income $15.395 $12.916
======= =======
Net interest rate spread 3.07% 3.14%
==== ====
Net interest rate spread
on average assets 3.34 3.29
==== ====
Net interest margin on
earning assets 3.51 3.46
==== ====
21.
MERCANTILE BANK CORPORATION
Provisions to the allowance during the first quarter of 2006 were $1.2 million,
compared to the $0.7 million that was expensed during the first quarter of 2005.
The increase primarily reflects the higher volume of net loan charge-offs, which
was partially offset by a lower volume of loan and lease growth. Net loan and
lease charge-offs of $757,000 were recorded during the first three months of
2006, compared to net loan and lease charge-offs of $447,000 during the same
time period in 2005. Loan and lease growth during the first quarter of 2006 was
$50.5 million, compared to loan and lease growth of $57.5 million during the
same time period in 2005. The allowance, as a percentage of total loans and
leases outstanding, was 1.30% as of March 31, 2006, compared to 1.32% at March
31, 2005.
In each accounting period, the allowance is adjusted to the amount believed
necessary to maintain the allowance at adequate levels. Through the loan review
and credit departments, we attempt to allocate specific portions of the
allowance based on specifically identifiable problem loans and leases. The
evaluation of the allowance 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 loan rating paradigm that is administered by our loan review
function. For retail loans, reserve allocation factors are based upon the type
of credit. Adjustments for specific loan relationships, including impaired
loans, are made on a case-by-case basis. The reserve allocation factors are
primarily based on the experience of senior management making similar loans in
the same community for almost 20 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 2006 was $1.24 million, an
increase of 2.7% over the $1.21 million earned during the first quarter of 2005.
Service charge income on deposits and repurchase agreements decreased $22,000
(6.5%) during the first quarter of 2006, primarily reflecting an increase in the
earnings credit rate which was only partially offset by an increase in new
accounts opened during the last twelve months. There were no major changes in
the other fee income categories when comparing the first quarter of 2006 with
the first quarter of 2005.
Noninterest expense during the first quarter of 2006 was $8.0 million, an
increase of 16.9% over the $6.9 million expensed during the first quarter of
2005. Employee salary and benefit expenses were $0.6 million higher during the
first quarter of 2006 than the level expensed during the same time period in
2005, primarily reflecting the hiring of additional staff and merit annual pay
raises. The level of full-time equivalent employees increased from 212 at the
end of the first quarter in 2005 to 275 at the end of the first quarter in 2006,
an increase of 29.7%. During the first quarter of 2005, we expensed $0.6 million
for the non-lender bonus program; during the first quarter of 2006, no expense
was recorded for the non-lender bonus program, the latter reflecting
management's assessment of the likelihood of achieving a 15% growth in net
income for all of 2006. Occupancy and furniture and equipment costs increased
$0.5 million during the first quarter of 2006 over the level expensed during the
same time period of 2005, primarily reflecting the opening of our new main
office during the second quarter of 2005 and the opening of our new leased
facilities in Lansing and Ann Arbor during the third quarter of 2005. General
overhead costs remained relatively unchanged from the first quarter of 2005 to
the first quarter of 2006. While additional expenses were required to administer
the significantly increased asset base, these increases were offset by the
absence of a $0.3 million expense that was incurred during the first quarter of
2005 relating to an accrual for the estimated exposure for an unfunded
commercial letter of credit.
22.
MERCANTILE BANK CORPORATION
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 first quarter
of 2006 over the amount expensed during the first quarter of 2005; however, net
revenues (net interest income plus noninterest income) increased at a
substantially higher level of $2.5 million during the same time period. The
efficiency ratio, a banking industry standardized calculation that attempts to
reflect the utilization of overhead costs, improved from 49.4% during the first
quarter of 2005 to 49.0% during the first quarter of 2006.
Federal income tax expense was $2.2 million during the first three months of
2006, an increase of 13.2% over the $1.9 million expensed during the same time
period in 2005. The increase is primarily due to the higher level of net income
before federal income tax. Our effective tax rate was 30.6% in both periods.
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 is assumed to be insignificant. Interest rate risk
is the exposure of our financial condition to adverse movements in interest
rates. We derive our income primarily from the excess of interest collected on
our interest-earning assets over the interest paid on our interest-bearing
liabilities. The rates of interest we earn on our assets and owe on our
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, we are exposed to lower profitability if
we cannot adapt to interest rate changes. Accepting interest rate risk can be an
important source of profitability and shareholder value; however, excessive
levels of interest rate risk could pose a significant threat to our earnings and
capital base. Accordingly, effective risk management that maintains interest
rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. Our interest rate risk management process seeks to ensure
that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk, we assess the existing and potential future effects of
changes in interest rates on our financial condition, including capital
adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is
commonly referred to as GAP analysis, measures the difference between the dollar
amounts of interest sensitive assets and liabilities that will be refinanced or
repriced during a given time period. A significant repricing gap could result in
a negative impact to our net interest margin during periods of changing market
interest rates. The following table depicts our GAP position as of March 31,2006
(dollars in thousands):
23.
MERCANTILE BANK CORPORATION
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
-------- --------- --------- -------- ----------
Assets:
Commercial loans and leases (1) $845,082 $ 57,969 $ 527,100 $ 44,825 $1,474,976
Residential real estate loans 60,663 3,548 51,762 13,811 129,784
Consumer loans 1,206 596 3,204 2,585 7,591
Investment securities (2) 9,620 415 32,943 145,191 188,169
Short-term investments 389 0 0 0 389
Allowance for loan and lease losses 0 0 0 (20,995) (20,995)
Other assets 0 0 0 117,060 117,060
-------- --------- --------- -------- ----------
Total assets 916,960 62,528 615,009 302,477 1,896,974
Liabilities:
Interest-bearing checking 35,971 0 0 0 35,971
Savings 95,422 0 0 0 95,422
Money market accounts 10,840 0 0 0 10,840
Time deposits less than $100,000 32,365 36,970 38,409 0 107,744
Time deposits $100,000 and over 304,399 507,727 305,236 0 1,117,362
Short-term borrowings 74,556 0 0 0 74,556
FHLB advances 35,000 70,000 25,000 0 130,000
Long-term borrowings 35,781 0 0 0 35,781
Noninterest-bearing checking 0 0 0 114,880 114,880
Other liabilities 0 0 0 15,508 15,508
-------- --------- --------- -------- ----------
Total liabilities 624,334 614,697 368,645 130,388 1,738,064
Shareholders' equity 158,910 158,910
-------- --------- --------- -------- ----------
Total sources of funds 624,334 614,697 368,645 289,298 1,896,974
-------- --------- --------- -------- ----------
Net asset (liability) GAP $292,626 $(552,169) $ 246,364 $ 13,179
======== ========= ========= ========
Cumulative GAP $292,626 $(259,543) $ (13,179)
======== ========= =========
Percent of cumulative GAP to
total assets 15.4% (l3.7)% (0.7)%
======== ========= =========
(1) Floating rate loans that are currently at interest rate ceilings 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, 2006.
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.
24.
MERCANTILE BANK CORPORATION
We conducted multiple simulations as of March 31, 2006, whereby it was assumed
that changes in market interest rates occurred ranging from up 200 basis points
to down 200 basis points in equal quarterly instalments over the next twelve
months. The following table reflects the suggested impact on our net interest
income over the next twelve months, which are well within our 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 $(4,755,000) (7.6)%
Interest rates down 100 basis points (3,591,000) (5.8)
No change in interest rates (2,422,000) (3.9)
Interest rates up 100 basis points (481,000) (0.8)
Interest rates up 200 basis points 1,435,000 2.3
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 31,2006, 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, 2006. There have been no significant changes in our controls over financial
reporting during the quarter ended March 31, 2006 that has materially affected,
or is reasonably likely to materially affect, our internal controls over
financial reporting.
25.
MERCANTILE BANK CORPORATION
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 1A. RISK FACTORS.
There have been no material changes in our risk factors from those previously
disclosed in our annual report on Form 10-K for the year ended December 31,
2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
On January 12, 2006, we issued 1,846 shares of our common stock to one of our
employees upon his exercise of employee stock options issued under our 1997
Employee Stock Option Plan. We received a weighted average exercise price of
$9,658 per share aggregating $17,829 for these shares. The exercise price for
these shares was substantially paid by the employee delivering to us common
stock of the company that he already owned having an aggregate value of $17,797,
with the difference paid in cash. On February 8, 2006, we issued 2,364 shares of
our common stock to one of our employees upon his exercise of employee stock
options issued under our 1997 Employee Stock Option Plan. We received a weighted
average exercise price of $10,174 per share aggregating $24,051 for these
shares. The exercise price for these shares was substantially paid by the
employee delivering to us common stock of the company that he already owned
having an aggregate value of $24,031, 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 of
Number of (b) Average Part of Publicly Shares that May Yet
Shares Price Paid Announced Plans or Be Purchased Under
Period Purchased Per Share Programs the Plans or Programs
- ------------- --------- ----------- ------------------- ---------------------
January 1-31 1,465 $37.93 0 0
February 1-28 668 35.98 0 0
March 1 - 31 424 36.36 0 0
Total 2,558 37.16 0 0
The shares shown in column (a) above as having been purchased were acquired from
three 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.
26.
MERCANTILE BANK CORPORATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Our Articles of Incorporation are incorporated by reference to
Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2004
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
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
27.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on May 8,2006.
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 Form 10-Q for the quarter ended June 30, 2004
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
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification