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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________________ to _________________________
Commission File Number 000-26719
MERCANTILE BANK CORPORATION
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(Exact name of registrant as specified in its charter)
MICHIGAN 38-3360865
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(State or Other Jurisdiction of Incorporation or Organization) (IRS Employer Identification Number)
5650 BYRON CENTER AVENUE SW, WYOMING, MICHIGAN 49509
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(Address of Principal Executive Offices) (Zip Code)
(616) 406-3777
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(Registrant's Telephone Number including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
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Securities Registered Pursuant Section 12(g) of the Act:
COMMON STOCK
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(Title of Class)
9.60% CUMULATIVE PREFERRED SECURITIES, $10 LIQUIDATION AMOUNT
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act 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 requirements for the
past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ ]
As of February 1, 2002, there were issued and outstanding 5,147,791
shares of the Registrant's Common Stock. The aggregate value of the voting stock
held by non-affiliates (persons other than directors and executive officers) of
the Registrant, computed by reference to the average of the closing bid and
asked prices of the Common Stock as of February 1, 2002, $18.36, was
approximately $86.2 million.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2002 Annual Meeting of Shareholders
(Portions of Part III).
PART I
ITEM 1. BUSINESS
THE COMPANY
Mercantile Bank Corporation is a bank holding company under the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"). Unless
the text clearly suggests otherwise, references to "us," "we," "our," or "the
company" include Mercantile Bank Corporation and its wholly-owned subsidiaries.
As a bank holding company, we are subject to regulation by the Federal Reserve
Board. We were organized on July 15, 1997, under the laws of the State of
Michigan, primarily for the purpose of holding all of the stock of Mercantile
Bank of West Michigan ("our bank"), and of such other subsidiaries as we may
acquire or establish. Our bank commenced business on December 15, 1997. MBWM
Capital Trust I ("the trust"), a wholly-owned business trust subsidiary, was
formed in September 1999. Mercantile Bank Mortgage Company ("our mortgage
company"), a wholly-owned subsidiary of our bank, initiated business in October
2000. On February 7, 2002, Mercantile BIDCO, Inc. ("our BIDCO"), a wholly-owned
subsidiary of our bank, was granted a license by the Michigan Office of
Financial and Insurance Services to operate as a Michigan Business and
Industrial Development Company under the Michigan BIDCO Act of 1986.
To date we have raised capital from our initial public offering of
common stock in October 1997, a public offering of common stock in July 1998,
issuance of cumulative preferred securities in September 1999, three private
placements of common stock during 2001 and a public offering of common stock in
August 2001. Our expenses have generally been paid using the proceeds of the
capital sales and dividends from our bank. Our principal source of future
operating funds is expected to be dividends from our bank.
We filed an election to become a financial holding company pursuant to
Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board
regulations which became effective March 23, 2000.
OUR BANK
Our bank is a state banking company that operates under the laws of the
State of Michigan, pursuant to a charter issued by the Michigan Office of
Financial and Insurance Services. Our bank's deposits are insured to the maximum
extent provided by the Federal Deposit Insurance Corporation ("FDIC"). Our
bank's primary service area is the Kent and Ottawa County areas of West
Michigan, which includes the City of Grand Rapids, the second largest city in
the State of Michigan.
Our bank, through its main office located at 216 North Division Avenue,
Grand Rapids, Michigan, its combination branch and retail loan center located at
4613 Alpine Avenue, Comstock Park, Michigan, its combination branch and
operations center located at 5610 Byron Center Avenue SW, Wyoming, Michigan, and
its administration facility located at 5650 Byron Center Avenue SW, Wyoming,
Michigan, provides commercial and retail banking services primarily to small- to
medium-sized businesses based in and around Grand Rapids. Our bank makes secured
and unsecured commercial, construction, mortgage and consumer loans, and accepts
checking, savings and time deposits. Our bank owns three automated teller
machines ("ATM") that participate in the MAC and NYCE regional network systems,
as well as other ATM networks throughout the country. Our bank also enables
customers to conduct certain loan and deposit transactions by telephone and
personal computer. Courier service is provided to certain commercial customers,
and safe deposit facilities are available at all locations. Our bank does not
have trust powers. In December 2001, our bank entered into a joint brokerage
services and marketing agreement with Raymond James Financial Services, Inc. to
make available to its customers financial planning, retail brokerage, equity
research, insurance and annuities, retirement planning, trust services and
estate planning.
THE TRUST
In 1999 we formed the trust, a Delaware business trust. The trust's
business and affairs are conducted by its property trustee, a Delaware trustee,
and three individual administrative trustees who are employees and officers of
the company. The trust was established for the purpose of issuing and selling
its preferred securities and common securities, and used the proceeds from the
sales of those securities to acquire subordinated debentures issued by the
company. Substantially all of the net proceeds received by the company from the
transaction were contributed to our bank as capital. Additional information
regarding the trust is incorporated by reference to "Note 14 - Trust Preferred
Securities" and "Note 16 - Regulatory Matters" of the Consolidated Financial
Statements included in this Annual Report on pages F-41 and F-42.
2.
OUR MORTGAGE COMPANY
Our mortgage company commenced operations on October 24, 2000 when our
bank contributed most of its residential mortgage loan portfolio and
participation interests in certain commercial mortgage loans to our mortgage
company. On the same date our bank also transferred its residential mortgage
origination function to our mortgage company. Mortgage loans originated and held
by our mortgage company are serviced by our bank pursuant to a servicing
agreement.
OUR BIDCO
Our BIDCO was granted a license by the Michigan Office of Financial and
Insurance Services on February 7, 2002, to operate our BIDCO as a Michigan
Business and Industrial Development Company. Our BIDCO, a non-depository
Michigan financial institution, offers equipment lease financing, asset based
loans, junior debt facilities and other financing where equity features may be
part of the facility pricing.
EFFECT OF GOVERNMENT MONETARY POLICIES
Our earnings are affected by domestic economic conditions and the
monetary and fiscal policies of the United States government, its agencies, and
the Federal Reserve Board. The Federal Reserve Board's monetary policies have
had, and will likely continue to have, an important impact on the operating
results of commercial banks through its power to implement national monetary
policy in order to, among other things, curb inflation or avoid a recession. The
policies of the Federal Reserve Board have a major effect upon the levels of
bank loans, investments and deposits through its open market operations in
United States government securities, and through its regulation of, among other
things, the discount rate on borrowings of member banks and the reserve
requirements against member bank deposits. Our bank maintains reserves directly
with the Federal Reserve Bank of Chicago to the extent required by law. It is
not possible to predict the nature and impact of future changes in monetary and
fiscal policies.
REGULATION AND SUPERVISION
As a bank holding company under the Bank Holding Company Act, we are
required to file an annual report with the Federal Reserve Board and such
additional information as the Federal Reserve Board may require. We are also
subject to examination by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding
companies that have not qualified as financial holding companies to banking and
the management of banking organizations, and to certain non-banking activities.
These non-banking activities include those activities that the Federal Reserve
Board found, by order or regulation as of the day prior to enactment of the
Gramm-Leach-Bliley Act, to be so closely related to banking or managing or
controlling banks as to be a proper incident to those activities. These
non-banking activities include, among other things: operating a mortgage
company, finance company, credit card company or factoring company; performing
certain data processing operations; providing certain investment and financial
advice; acting as an insurance agent for certain types of credit-related
insurance; leasing property on a full-payout, nonoperating basis; and providing
discount securities brokerage services for customers. With the exception of the
respective activities of our mortgage company and our BIDCO discussed above,
neither we nor any of our subsidiaries engages in any of the foregoing
non-banking activities. Neither we nor any of our subsidiaries currently engage
in any other activity previously listed.
In March 2000, our election to become a financial holding company, as
permitted by the Gramm-Leach-Bliley Act, was accepted by the Federal Reserve
Board. In order to continue as a financial holding company, we and our bank must
satisfy certain statutory requirements regarding capitalization, management, and
compliance with the Community Reinvestment Act. As a financial holding company,
we are permitted to engage in a broader range of activities than are permitted
to bank holding companies.
3.
Those expanded activities include any activity which the Federal
Reserve Board (in certain instances in consultation with the Department of the
Treasury) determines, by order or regulation, to be financial in nature or
incidental to such financial activity, or to be complementary to a financial
activity and not to pose a substantial risk to the safety or soundness of
depository institutions or the financial system generally. Such expanded
activities include, among others: insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness disability or death, or issuing annuities,
and acting as principal, agent, or broker for such purposes; providing
financial, investment, or economic advisory services, including advising a
mutual fund; and underwriting, dealing in, or making a market in securities.
Neither we nor our subsidiaries has any plans to engage in any such expanded
activity.
Our bank is subject to certain restrictions imposed by federal law and
regulation. These restrictions apply to any extension of credit to us or to our
other subsidiaries, to investments in stock or other securities that we issue,
to the taking of such stock or securities as collateral for loans to any
borrower, and to acquisitions of assets or services from, and sales of certain
types of assets to, us or our other subsidiaries. Federal law prevents us from
borrowing from our bank unless the loans are secured in designated amounts with
specified forms of collateral.
With respect to the acquisition of banking organizations, we are
generally required to obtain the prior approval of the Federal Reserve Board
before we can acquire all or substantially all of the assets of any bank, or
acquire ownership or control of any voting shares of any bank, if, after such
acquisition, we would own or control more than 5% of the voting shares of the
bank. Acquisitions across state lines are subject to certain state and Federal
Reserve Board restrictions.
EMPLOYEES
As of December 31, 2001, we and our bank employed 81 full-time and 25
part-time persons. Management believes that relations with employees are good.
LOAN POLICY
As a routine part of our business, we make loans to businesses and
individuals located within our market area. Our loan policy states that the
function of the lending operation is twofold: to provide a means for the
investment of funds at a profitable rate of return with an acceptable degree of
risk, and to meet the credit needs of the creditworthy businesses and
individuals who are our customers. We recognize that in the normal business of
lending, some losses on loans will be inevitable and should be considered a part
of the normal cost of doing business.
Our loan policy anticipates that priorities in extending loans will be
modified from time to time as interest rates, market conditions and competitive
factors change. The policy sets forth guidelines on a nondiscriminatory basis
for lending in accordance with applicable laws and regulations. The policy
describes various criteria in granting loans, including the ability to pay; the
character of the customer; evidence of financial responsibility; purpose of the
loan; knowledge of collateral and its value; terms of repayment; source of
repayment; payment history; and economic conditions.
The loan policy further limits the amount of funds that may be loaned
against specified types of real estate collateral. For certain loans secured by
real estate, the policy requires an appraisal of the property offered as
collateral by a state certified independent appraiser. The policy also provides
general guidelines for loan to value limits for other types of collateral, such
as accounts receivable and machinery and equipment. In addition, the loan policy
provides general guidelines as to environmental analysis, loans to employees,
executive officers and directors, problem loan identification, maintenance of an
allowance for loan losses, loan review and grading, mortgage and consumer
lending, and other matters relating to our lending practices.
The Board of Directors has delegated significant lending authority to
officers of our bank. The Board of Directors believes this empowerment,
supported by our strong credit culture and the significant experience of our
commercial lending staff, makes us responsive to our customers. The loan policy
currently specifies lending authority for certain officers up to $1.0 million,
and $6.0 million for our bank's Chairman of the Board and its President and
Chief Executive Officer; however, the $6.0 million lending authority is used
only in rare circumstances where timing is of the essence. Generally, loan
requests exceeding $2.5 million require approval by the Officers Loan Committee,
and loan requests exceeding $3.0 million, up to the legal lending limit of
approximately $19.0 million, require approval by the Board of Directors. In most
circumstances we apply an in-house lending limit that is significantly less than
our bank's legal lending limit.
4.
LENDING ACTIVITY
Commercial Loans. Our commercial lending group originates commercial
loans primarily in our market area. Commercial loans are originated by eight
lenders, with over 110 years of combined commercial lending experience. Loans
are originated for general business purposes, including working capital,
accounts receivable financing, machinery and equipment acquisition, and
commercial real estate financing including new construction and land
development.
Working capital loans are often structured as a line of credit and are
reviewed periodically in connection with the borrower's year-end financial
reporting. These loans are generally secured by all of the assets of the
borrower, and have an interest rate tied to the national prime rate. Loans for
machinery and equipment purposes typically have a maturity of three to five
years and are fully amortizing, while commercial real estate loans are usually
written with a five-year maturity and amortized over a 15 year period. These
commercial loan types have an interest rate that is fixed to maturity or is tied
to the national prime rate.
We evaluate many aspects of a commercial loan transaction in order to
minimize credit and interest rate risk. Underwriting includes an assessment of
the management, products, markets, cash flow, capital, income and collateral.
This analysis includes a review of the borrower's historical and projected
financial results. Appraisals are generally required by certified independent
appraisers where real estate is the primary collateral, and in some cases, where
equipment is the primary collateral. In certain situations, for creditworthy
customers, we may accept title reports instead of requiring lenders' policies of
title insurance.
Commercial real estate lending involves more risk than residential
lending because loan balances are greater and repayment is dependent upon the
borrower's business operations. We attempt to minimize the risks associated with
these transactions by generally limiting our commercial real estate lending to
owner-operated properties of well-known customers or new customers whose
businesses have an established profitable history. In many cases, risk is
further reduced by limiting the amount of credit to any one borrower to an
amount considerably less than our legal lending limit and avoiding certain types
of commercial real estate financings.
We have no material foreign or agricultural loans, and no material
loans to energy producing customers.
Single-Family Residential Real Estate Loans. Our mortgage company
originates single-family residential real estate loans in our market area,
usually according to secondary market underwriting standards. Loans not
conforming to those standards are made in limited circumstances. Single-family
residential real estate loans provide borrowers with a fixed or adjustable
interest rate with terms up to 30 years.
Our bank has a home equity line of credit program. Home equity credit
is generally secured by either a first or second mortgage on the borrower's
primary residence. The program provides revolving credit at a rate tied to the
national prime rate.
Consumer Loans. We originate consumer loans for a variety of personal
financial needs, including new and used automobiles, boat loans, credit cards
and overdraft protection for our checking account customers. Consumer loans
generally have shorter terms and higher interest rates and usually involve more
credit risk than single-family residential real estate loans because of the type
and nature of the collateral.
While we do not utilize a formal credit scoring system, management
believes our consumer loans are underwritten carefully, with a strong emphasis
on the amount of the down payment, credit quality, employment stability and
monthly income of the borrower. These loans are generally repaid on a monthly
repayment schedule with the source of repayment tied to the borrower's periodic
income. In addition, consumer lending collections are dependent on the
borrower's continuing financial stability, and are thus likely to be adversely
affected by job loss, illness and personal bankruptcy. In many cases,
repossessed collateral for a defaulted consumer loan will not provide an
adequate source of repayment of the outstanding loan balance because of
depreciation of the underlying collateral.
Management believes that the generally higher yields earned on consumer
loans compensate for the increased credit risk associated with such loans and
that consumer loans are important to our efforts to serve the credit needs of
the communities and customers that we serve.
5.
LOAN PORTFOLIO QUALITY
We utilize a comprehensive loan grading system for our commercial loans
as well as residential mortgage and consumer loans. Administered as part of the
loan review program, all commercial loans are graded on an eight grade rating
system. The rating system utilizes a standardized grade paradigm that analyzes
several critical factors such as cash flow, management and collateral coverage.
All commercial loans are graded at inception and later at various intervals.
Residential mortgage and consumer loans are graded on a four grade rating system
using a separate standardized grade paradigm that analyzes several critical
factors such as debt-to-income and credit and employment histories. Residential
mortgage and consumer loans are generally only graded once after the loans are
made.
Our independent loan review program is primarily responsible for the
administration of the loan grading systems and ensuring adherence to established
loan policies and procedures. The loan review program is an integral part of
maintaining our strong asset quality culture. The loan review function works
closely with senior management, although it functionally reports to the Board of
Directors. All commercial loan relationships exceeding $1 million are formally
reviewed at least annually. Watch list credits are formally reviewed monthly.
Credits between $0.5 million and $1.0 million are formally reviewed every two
years, with a random sampling performed on credits under $0.5 million.
Loans are placed in a nonaccrual status when, in the opinion of
management, uncertainty exists as to the ultimate collection of principal and
interest. For the year ended December 31, 2001, loans placed in nonaccrual
status totaled $1.4 million, or 0.24% of total loans. At December 31, 2001,
there were no other significant loans where known information about credit
problems of borrowers causes management to have serious doubts as to the ability
of the borrower to comply with present loan repayment terms. Management is not
aware of any potential problem loans that could have a material adverse effect
on our operating results, liquidity, or capital resources.
Additional detail and information relative to the loan portfolio is
incorporated by reference to Management's Discussion and Analysis of Financial
Condition and Results of Operation ("Management's Discussion and Analysis")
beginning on Page F-4 and Note 3 of the Consolidated Financial Statements on
pages F-32 and F-33 included in this Annual Report.
ALLOWANCE FOR LOAN LOSSES
In each accounting period, the allowance for loan losses is adjusted by
management to the amount management believes is necessary to maintain the
allowance for loan losses at adequate levels. Through its loan review and credit
departments, management attempts to allocate specific portions of the allowance
for loan losses based on specifically identifiable problem loans. Management's
evaluation of the allowance for loan losses is further based on, but not limited
to, consideration of internally prepared calculations based upon the experience
of senior management and lending staff making similar loans in the same
community over the past 15 years, composition of the loan portfolio, third party
analysis of the loan administration processes and loan portfolio and general
economic conditions. In addition, our bank's status as a relatively new banking
organization, the rapid loan growth since inception and commercial loan emphasis
is taken into account. Management believes that the present allowance for loan
losses is adequate, based on the broad range of considerations listed above.
The primary risks associated with commercial loans are the financial
condition of the borrower, the sufficiency of collateral, and lack of timely
payment. Management has a policy of requesting and reviewing periodic financial
statements from its commercial loan customers, and periodically reviews
existence of collateral and its value. The primary risk element considered by
management with respect to each consumer and residential real estate loan is
lack of timely payment. Management has a reporting system that monitors past due
loans and has adopted policies to pursue its creditor's rights in order to
preserve our bank's collateral position.
Additional detail regarding the allowance for loan losses is
incorporated by reference to Management's Discussion and Analysis beginning on
Page F-4 and Note 3 of the Consolidated Financial Statements of the Company on
pages F-32 and F-33 included in this Annual Report.
Although management believes that the allowance for loan losses is
adequate to absorb losses as they arise, there can be no assurance that we will
not sustain losses in any given period which could be substantial in relation
to, or greater than, the size of the allowance for loan losses.
6.
INVESTMENTS
Our principal investments are our investment in the common stock of our
bank and the common securities of the trust. Our funds may be invested from time
to time in various debt instruments, including obligations of or guaranteed by
the United States, general obligations of a state or political subdivision or an
agency of a state or political subdivision, banker's acceptances or certificates
of deposit of United States commercial banks, or commercial paper of United
States issuers rated in the highest category by a nationally-recognized
investment rating service. We are permitted to make unlimited portfolio
investments in equity securities and to make equity investments in subsidiary
corporations engaged in certain non-banking activities which may include real
estate-related activities such as mortgage banking, community development, real
estate appraisals, arranging equity financing for commercial real estate, and
owning and operating real estate used substantially by our bank or acquired for
its future use. However, we have no present plans to make any of these equity
investments. Our Board of Directors may alter the investment policy at any time
without shareholder approval.
Our bank may invest its funds in a wide variety of debt instruments and
may participate in the federal funds market with other depository institutions.
Subject to certain exceptions, our bank is prohibited from investing in equity
securities. Under one such exception, in certain circumstances and with the
prior approval of the FDIC, our bank could invest up to 10% of its total assets
in the equity securities of a subsidiary corporation engaged in the acquisition
and development of real property for sale, or the improvement of real property
by construction or rehabilitation of residential or commercial units for sale or
lease. Our bank has no present plans to make such an investment. Real estate
acquired by our bank in satisfaction of or foreclosure upon loans may be held by
our bank. Our bank is also permitted to invest in such real estate as is
necessary for the convenient transaction of its business. Our bank's Board of
Directors may alter the investment policy without shareholder approval at any
time.
Additional detail and information relative to the securities portfolio
is incorporated by reference to Management's Discussion and Analysis beginning
at Page F-4 and Note 2 of the Consolidated Financial Statements on pages F-31
and F-32 included in this Annual Report.
COMPETITION
Our primary market area for loans and core deposits is the Kent and
Ottawa Counties of western Michigan, which includes the City of Grand Rapids,
the second largest city in the State of Michigan. We face substantial
competition in all phases of our operations from a variety of different
competitors. We compete for deposits, loans and other financial services from
numerous Michigan-based and out-of-state banks, savings banks, thrifts, credit
unions and other financial institutions as well as from other entities that
provide financial services. Some of the financial institutions and financial
service organizations with which we compete are not subject to the same degree
of regulation as we are. Many of our primary competitors have been in business
for many years, have established customer bases, are larger, have substantially
higher lending limits than we do, and offer branch networks and other services
which we do not. Most of these same entities have greater capital resources than
we do, which, among other things, may allow them to price their services at
levels more favorable to the customer and to provide larger credit facilities
than we do. Under the Gramm-Leach-Bliley Act, effective March 11, 2000,
securities firms and insurance companies that elect to become financial holding
companies may acquire banks and other financial institutions. The
Gramm-Leach-Bliley Act may significantly change the competitive environment in
which we conduct our business. The financial services industry is also likely to
become more competitive as further technological advances enable more companies
to provide financial services.
SELECTED STATISTICAL INFORMATION
Management's Discussion and Analysis beginning at Page F-4 in this
Annual Report includes selected statistical information.
RETURN ON EQUITY AND ASSETS
Return on Equity and Asset information is included in Management's
Discussion and Analysis beginning at Page F-4 in this Annual Report.
7.
ITEM 2. PROPERTIES
Our bank leases a one story building in downtown Grand Rapids, Michigan
for use as its main office. This building is of masonry construction and has
approximately 11,000 square feet of usable space with on-site parking. The lease
for this facility, which commenced in 1997, has an initial term of ten years and
our bank has four, five-year renewal options. The address of this facility is
216 North Division Avenue, and is located in downtown Grand Rapids.
Our bank designed and constructed a full service branch and retail loan
facility in Alpine Township, a northwest suburb of Grand Rapids, which opened in
July of 1999. The facility is one story, of masonry construction, and has
approximately 8,000 square feet of usable space. The land and building is owned
by our bank. The facility has multiple drive-through lanes and ample parking
space. The address of this facility is 4613 Alpine Avenue NW, Comstock Park,
Michigan.
During 2001 our bank designed and constructed two facilities on a
4-acre parcel of land located in the City of Wyoming, a southwest suburb of
Grand Rapids. The land had been purchased by our bank in 2000. The larger of the
two buildings is a full service branch and operations facility opened in
September of 2001. The facility is two-stories, of masonry construction, and has
approximately 25,000 square feet of usable space. The facility is owned by our
bank, and has multiple drive-through lanes and ample parking space. The address
of this facility is 5610 Byron Center Avenue SW, Wyoming, Michigan. The other
building, a single-story facility of masonry construction with approximately
7,000 square feet of usable space, accommodates the administration function.
This facility is also owned by the bank. The address is 5650 Byron Center Avenue
SW, Wyoming, Michigan.
During 2001 our bank purchased approximately two acres of land in the
City of Kentwood, a southeast suburb of Grand Rapids. Our bank is in the initial
process of designing and constructing a branch facility on this property. It is
expected that the branch facility will consist of approximately 7,000 square
feet of usable space and contain multiple drive-thru lanes. Anticipated opening
date is late 2002. The address is 4860 Broadmoor, Kentwood, Michigan.
During 2001 our bank signed an option to purchase approximately 1.5
acres of land in the northeast quadrant of the City of Grand Rapids. Subject to
pending due diligence and zoning changes, our bank plans to design and construct
a branch facility on this property. The branch facility would likely consist of
about 3,500 square feet of usable space and contain multiple drive-thru lanes.
Anticipated opening date would be in 2003. The property is located near the
intersection of Knapp Street and East Beltline.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that
are incidental to our business. In the opinion of management, we are not a party
to any current legal proceedings that are material to our financial condition,
either individually or in the aggregate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
8.
EXECUTIVE OFFICERS OF THE REGISTRANT
Name and Position Age
Gerald R. Johnson, Jr. 55
Chairman of the Board and Chief
Executive Officer
Michael H. Price 45
President and Chief Operating
Officer
Robert B. Kaminski 40
Senior Vice President and
Secretary
Charles E. Christmas 36
Senior Vice President, Chief Financial
Officer and Treasurer
Each of the persons named above has held the designated office with the company
since 1997, except for Mr. Christmas, who joined the company in 1998 and held
the position of Vice President of Finance, Treasurer and Compliance Officer
before being promoted to Chief Financial Officer and Treasurer and Compliance
Officer effective January 1, 1999. On October 12, 2000 Mr. Christmas was
promoted to Senior Vice President, Chief Financial Officer and Treasurer.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is quoted on the Nasdaq National Market under the
symbol MBWM. At February 1, 2002, there were 153 record holders of our common
stock. In addition, we estimate that there were approximately 3,000 beneficial
owners of our common stock who own their shares through brokers or banks.
The following table shows the high and low bid prices by quarter during
2001 and 2000 as reported by the Nasdaq National Market. The quotations do not
include retail mark-up, mark-down or commission, but have been adjusted for the
5% stock dividends paid on February 1, 2002 and 2001.
BID PRICES
HIGH LOW
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CALENDAR YEAR 2001
First Quarter.............................................................................$15.24 $10.95
Second Quarter............................................................................$16.71 $14.06
Third Quarter.............................................................................$18.38 $14.30
Fourth Quarter............................................................................$17.00 $15.25
CALENDAR YEAR 2000
First Quarter.............................................................................$11.79 $9.07
Second Quarter.............................................................................$9.98 $8.39
Third Quarter.............................................................................$11.22 $8.50
Fourth Quarter............................................................................$11.79 $10.09
9.
On January 7, 2002, we declared a 5% stock dividend on our common
stock, payable on February 1, 2002 to record holders as of January 18, 2002. The
stock dividend increased the number of common shares outstanding from 4,902,702
to 5,147,791. We have not paid cash dividends on our common stock since our
formation in 1997, and currently have no intention of doing so in the
foreseeable future. We are a holding company and substantially all of our assets
are held by our subsidiaries. Our ability to pay dividends to our shareholders,
if we determine in the future to do so, will depend primarily on our bank's
ability to pay dividends to us. Dividend payments and extensions of credit to us
from our bank are subject to legal and regulatory limitations, generally based
on capital levels and current and retained earnings imposed by law and
regulatory agencies with authority over our bank. The ability of our bank to pay
dividends is also subject to its profitability, financial condition, capital
expenditures and other cash flow requirements. In addition, under the terms of
our 9.60% junior subordinated debentures due 2029, we would be precluded from
paying dividends on our common stock if we were in default under the debentures
and did not take reasonable steps to sure the default, if we exercised our right
to defer payments of interest on the debentures, or if certain related defaults
occurred.
During 2001 we completed three unregistered sales of our common stock.
In February 2001, we completed a privately negotiated sale of 70,000 shares of
our common stock to a small number of individuals residing in the Grand Rapids,
Michigan area for cash. The sale generated approximately $1.0 million in
capital, net of transaction costs. In March 2001, we completed a private
placement of 446,600 shares of our common stock for cash through the investment
banking firm Stifel, Nicolaus & Company. The sale generated approximately $6.7
million, net of transaction costs which included a placement fee of about $0.3
million to Stifel, Nicolaus & Company. The 446,600 shares of common stock were
subsequently registered in April 2001. In December 2001, we completed a
privately negotiated sale of 180,000 shares of our common stock to a small
number of individuals residing in the Grand Rapids, Michigan area for cash. The
purchasers included a member of our Board of Directors and members of his
family, an organizer of our bank and several other local residents. The sale
generated approximately $3.1 million in capital, net of transaction costs. Each
of the purchasers in the offerings was believed to be an accredited investor
under Regulation D of the Securities Act of 1933. Each of the sales was made in
reliance upon an exemption from registration under Rule 506 of Regulation D or
Section 4(2) under the Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data on page F-3 in this Annual Report is
incorporated here by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
Management's Discussion and Analysis on pages F-4 through F-21 in this
Annual Report is incorporated here by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the heading "Market Risk Analysis" on pages F-19
through F-21 in this Annual Report is incorporated here by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements and the Report of Independent Public Accountants on pages F-22
through F-45 in this Annual Report are incorporated here by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
10.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information listed under the captions "Information about Directors,
Nominees and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the definitive Proxy Statement of Mercantile for its
April 18, 2002 Annual Meeting of Shareholders (the "Proxy Statement"), a copy of
which will be filed with the Securities and Exchange Commission before the
meeting date, is incorporated here by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information presented under the captions "Summary Compensation
Table," "Options Granted in 2001," "Aggregated Stock Option Exercises in 2001
and Year End Option Values" and "Employment Agreements" and in the last
paragraph under the caption "Board of Director Meetings and Committees", in the
Proxy Statement is incorporated here by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information presented under the caption "Stock Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is incorporated here by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information listed under the caption "Certain Transactions" in the
Proxy Statement is incorporated here by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements. The following financial statements and report of
independent public accountants of Mercantile Bank Corporation and its
subsidiaries are filed as part of this report:
Report of Independent Public Accountants dated January 18, 2002
Consolidated Balance Sheets --- December 31, 2001 and 2000
Consolidated Statements of Income for each of the three years in the
period ended December 31, 2001
Consolidated Statements of Changes in Shareholders' Equity for each of
the three years in the period ended December 31, 2001
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 2001
Notes to Consolidated Financial Statements
The financial statements, the notes to financial statements, and the
report of independent public accountants listed above are incorporated
by reference in Item 8 of this report.
(2) Financial Statement Schedules
Not applicable
11.
(b) Reports on Form 8-K
We have not filed any reports on Form 8-K during the last quarter of
the period covered by this Report.
(c) 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 Bylaws are incorporated by reference to exhibit 3.2
of our Registration Statement on Form SB-2 (Commission
File No. 333-33081) that became effective on October 23,
1997
10.1 Our 1997 Employee Stock Option Plan is incorporated by
reference to exhibit 10.1 of our Registration
Statement on Form SB-2 (Commission File No. 333-33081)
that became effective on October 23, 1997 (management
contract or compensatory plan)
10.2 Lease Agreement between our bank and Division Avenue
Partners, L.L.C. dated August 16, 1997, is incorporated
by reference to exhibit 10.2 of our Registration
Statement on Form SB-2 (Commission File No. 333-33081)
that became effective October 23, 1997
10.3 Agreement between Fiserve Solution, Inc. and our bank
dated September 10, 1997, is incorporated by reference
to exhibit 10.3 of our Registration Statement on
Form SB-2 (Commission File No. 333-33081) that became
effective on October 23, 1997.
10.4 Agreement between our bank and Visser Brothers
Construction Inc. dated November 16, 1998, on modified
Standard Form of Agreement Between Owner and
Construction Manager where the Construction Manager is
also the Constructor, is incorporated by reference to
exhibit 10.4 of our Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1998 (Commission File
No. 333-33081)
10.5 Employment Agreement among Gerald R. Johnson, Jr., the
company and our bank dated December 1, 1998, is
incorporated by reference to Exhibit 10.4 of our
Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1998 (Commission File No. 333-33081)
(management contract or compensatory plan)
10.6 Employment Agreement among Michael H. Price, the
company and our bank dated December 1, 1998, is
incorporated by reference to Exhibit 10.5 of our Annual
Report on Form 10-KSB for the fiscal year ended December
31, 1998 (Commission File No. 333-33081) (management
contract or compensatory plan)
10.7 Mercantile Bank of West Michigan Deferred Compensation
Plan for Members of the Board of Directors (1999) is
incorporated by reference to Exhibit 10.6 of the
Registration Statement of the company and our trust on
Form SB-2 (Commission File Nos. 333-84313 and
333-84313-01) that became effective on September 13,
1999.
10.8 Subordinated Indenture dated as of September 17, 1999
between the company and Wilmington Trust Company, as
Trustee, relating to 9.60% Junior Subordinated
Debentures due 2029 is incorporated by reference to
Exhibit 4.1 of the Registration Statement of the company
and our trust on Form SB-2 (Commission File Nos.
333-84313 and 333-84313-01) that become effective on
September 13, 1999)
12.
EXHIBIT NO. EXHIBIT DESCRIPTION
10.9 Amended and Restated Trust Agreement dated as of
September 17, 1999 among the company, as depositor,
Wilmington Trust Company, as Property Trustee,
Wilmington Trust Company, as Delaware Trustee, and the
Administrative Trustees is incorporated by reference to
Exhibit 4.5 of the Registration Statement of the company
and our trust on Form SB-2 (Commission File Nos.
333-84313 and 333-84313-01) that became effective on
September 13, 1999
10.10 Preferred Securities Guarantee Agreement between the
company and Wilmington Trust Company dated September 17,
1999, is incorporated by reference to Exhibit 4.7 of the
Registration Statement of the company and our trust on
Form SB-2 (Commission File Nos. 333-84313 and
333-84313-01) that became effective on September 13,
1999
10.11 Agreement as to Expenses and Liabilities dated as of
September 17, 1999, between the company and our trust
(included as Exhibit D to Exhibit 10.9)
10.12 Amended and Restated Employment Agreement dated as of
December 31, 1999, among the company, our bank and
Gerald R. Johnson, Jr., is incorporated by reference to
exhibit 10.12 of our Form 10-KSB for the fiscal year
ended December 31, 1999 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.13 Amended and Restated Employment Agreement dated as of
December 31, 1999, among the company, our bank and
Michael H. Price, is incorporated by reference to
exhibit 10.13 of our Form 10-KSB for the fiscal year
ended December 31, 1999 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.14 Mercantile Bank Corporation 2000 Employee Stock Option
Plan, approved by the shareholders at the annual meeting
on April 20, 2000, is incorporated by reference to
exhibit 10.14 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
10.15 Extension Agreement of Data Processing Contract between
Fiserve Solution, Inc. and our bank dated May 12, 2000
extending the agreement between Fiserve Solution, Inc.
and our bank dated September 10, 1997, is incorporated
by reference to exhibit 10.15 of our Form 10-K for the
fiscal year ended December 31, 2000 (Commission File No.
000-26719)
10.16 Amended and Restated Employment Agreement dated as of
October 12, 2000, among the company, our bank and Gerald
R. Johnson, Jr., is incorporated by reference to exhibit
10.16 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.17 Amended and Restated Employment Agreement dated as of
October 12, 2000, among the company, our bank and
Michael H. Price, is incorporated by reference to
exhibit 10.17 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.18 Employment Agreement dated as of October 12, 2000, among
the company, our bank and Robert B. Kaminski, is
incorporated by reference to exhibit 10.18 of our Form
10-K for the fiscal year ended December 31, 2000
(Commission File No. 000-26719) (management contract or
compensatory plan)
10.19 Employment Agreement dated as of October 12, 2000, among
the company, our bank and Charles E. Christmas, is
incorporated by reference to exhibit 10.19 of our Form
10-K for the fiscal year ended December 31, 2000
(Commission File No. 000-26719) (management contract or
compensatory plan)
13.
EXHIBIT NO. EXHIBIT DESCRIPTION
10.20 Agreement between our bank and C.D. Barnes dated October
28, 2000, on Amendment to Standard Form of Agreement
Between Owner and Construction Manager where the
Construction Manager is also the Constructor, is
incorporated by reference to exhibit 10.20 of our Form
10-K for the fiscal year ended December 31, 2000
(Commission File No. 000-26719)
10.21 Amended and Restated Employment Agreement dated as of
October 18, 2001, among the company, our bank and Gerald
R. Johnson, Jr. (management contract or compensatory
plan)
10.22 Amended and Restated Employment Agreement dated as of
October 18, 2001, among the company, our bank and
Michael H. Price (management contract or compensatory
plan)
10.23 Employment Agreement dated as of October 18, 2001, among
the company, our bank and Robert B. Kaminski (management
contract or compensatory plan)
10.24 Employment Agreement dated as of October 18, 2001, among
the company, our bank and Charles E. Christmas
(management contract or compensatory plan)
21 Subsidiaries of the company
23 Consent of Independent Accountants
(d) Financial Statements Not Included In Annual Report
Not applicable
14.
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
CONTENTS
SELECTED FINANCIAL DATA.................................................. F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS..................................... F-4
REPORT OF INDEPENDENT AUDITORS........................................... F-22
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS......................................... F-23
CONSOLIDATED STATEMENTS OF INCOME................................... F-24
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY.......... F-25
CONSOLIDATED STATEMENTS OF CASH FLOWS............................... F-26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.......................... F-27
F-2
SELECTED FINANCIAL DATA
2001 2000 1999 1998
---- ---- ---- ----
(In thousands except per share data)
CONSOLIDATED RESULTS OF OPERATIONS:
Interest income $ 44,619 $ 36,835 $ 22,767 $ 10,168
Interest expense 28,201 24,560 13,330 5,629
----------- ----------- ----------- -----------
Net interest income 16,418 12,275 9,437 4,539
Provision for loan losses 2,370 1,854 1,961 2,572
Noninterest income 1,879 1,192 847 488
Noninterest expense 9,454 7,515 5,888 3,564
----------- ----------- ----------- -----------
Income (loss) before income tax expense and cumulative
effect of change in accounting principle 6,473 4,098 2,435 (1,109)
Income tax expense 1,990 1,303 292 0
----------- ----------- ----------- -----------
Income (loss) before cumulative effect of change in
accounting principle 4,483 2,795 2,143 (1,109)
Cumulative effect of change in accounting principle 0 0 (42) 0
----------- ----------- ---------- -----------
Net income (loss) $ 4,483 $ 2,795 $ 2,101 $ (1,109)
=========== =========== =========== ==========
CONSOLIDATED BALANCE SHEET DATA:
Total assets $ 698,682 $ 512,746 $ 368,037 $ 216,237
Cash and cash equivalents 19,938 18,102 13,650 6,456
Securities 78,818 60,457 41,957 24,160
Loans, net of deferred loan fees 587,248 429,804 308,006 184,745
Allowance for loan losses 8,494 6,302 4,620 2,765
Deposits 569,077 425,740 294,829 171,998
Securities sold under agreements to repurchase 36,485 32,151 26,607 17,038
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,000 16,000 16,000 0
Shareholders' equity 71,463 31,854 27,968 26,701
CONSOLIDATED FINANCIAL RATIOS:
Return on average assets 0.74% 0.63% 0.71% (0.86)%
Return on average shareholders' equity 9.05% 9.48% 7.70% (6.40)%
Nonperforming loans to loans 0.24% 0.02% 0.00% 0.00%
Allowance for loan losses to loans 1.45% 1.47% 1.50% 1.50%
Tier 1 leverage capital 13.00% 8.59% 10.88% 13.83%
Tier 1 leverage risk-based capital 13.00% 8.59% 10.64% 11.79%
Total risk-based capital 14.25% 10.97% 13.67% 13.01%
PER SHARE DATA:
Net Income (Loss):
Basic before cumulative effect of change
in accounting principle $ 1.17 $ 1.03 $ 0.79 $ (0.52)
Diluted before cumulative effect of change
in accounting principle 1.15 1.02 0.78 (0.52)
Basic 1.17 1.03 0.77 (0.52)
Diluted 1.15 1.02 0.76 (0.52)
Book value at end of period 13.89 11.66 10.26 9.80
Dividends declared NA NA NA NA
NA - Not Applicable
Note: 1997 data not meaningful as operations commenced on December 15, 1997.
F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion 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
This Management's Discussion and Analysis should be read in conjunction with the
consolidated financial statements contained herein. This discussion provides
information about the consolidated financial condition and results of operations
of Mercantile Bank Corporation and its wholly-owned subsidiaries, Mercantile
Bank of West Michigan ("our bank") and MBWM Capital Trust I ("the trust"), and
of Mercantile Bank Mortgage Company ("our mortgage company"), a wholly-owned
subsidiary of our bank. Unless the text clearly suggests otherwise, references
to "us," "we," "our," or "the company" include Mercantile Bank Corporation and
its wholly-owned subsidiaries referred to above.
We were incorporated on July 15, 1997 as a bank holding company to establish and
own our bank. Our bank, after receiving all necessary regulatory approvals,
began operations on December 15, 1997. Our bank has a strong commitment to
community banking and offers a wide range of financial products and services,
primarily to small- to medium-sized businesses, as well as individuals. Our
bank's lending strategy focuses on commercial lending, and, to a lesser extent,
residential mortgage and consumer lending. Our bank also offers a broad array of
deposit products, including checking, savings, money market, and certificates of
deposit, as well as security repurchase agreements. Our bank's primary market
area is the Kent and Ottawa County areas of West Michigan, which includes the
City of Grand Rapids, the second largest city in the State of Michigan. Our bank
utilizes certificates of deposit from customers located outside of the primary
market area to assist in funding the rapid asset growth our bank has experienced
since inception.
The trust, a business trust subsidiary of the company, was incorporated in 1999
for the purpose of issuing 1.6 million shares of 9.60% Cumulative Preferred
Securities ("trust preferred securities") at $10.00 per trust preferred
security. The proceeds from the September 1999 sale were used by the trust to
purchase an equivalent amount of subordinated debentures of the company. The
company, in turn, used a majority of the proceeds from the issuance of the
subordinated debentures for a capital contribution to our bank. The only
significant asset of the trust is the subordinated debenture of the company and
the only significant liability of the trust is the trust preferred securities.
The trust preferred securities are carried on the company's consolidated balance
sheet as a liability and the interest expense is recorded on the company's
consolidated statement of income.
F-4
Our mortgage company, formed to increase the profitability and efficiency of the
company's mortgage loan operations, initiated business on October 24, 2000 from
our bank's contribution of most of its residential mortgage loan portfolio and
participation interests in certain commercial mortgage loans to our mortgage
company. On the same date our bank also transferred its residential mortgage
origination function to our mortgage company. Mortgage loans originated and held
by our mortgage company are serviced by our bank pursuant to a servicing
agreement.
On February 7, 2002 Mercantile BIDCO, Inc. ("our BIDCO"), a wholly-owned
subsidiary of our bank, was granted a license by the Michigan Office of
Financial and Insurance Services to operate as a Michigan Business and
Industrial Development Company. Our BIDCO, a non-depository Michigan financial
institution, offers equipment lease financing, asset based loans, junior debt
facilities and other financing where equity features may be part of the facility
pricing.
FINANCIAL CONDITION
We continued to experience significant asset growth during 2001. Assets
increased from $512.7 million on December 31, 2000 to $698.7 million on December
31, 2001. This represents an increase in total assets of $186.0 million, or
36.3%. The increase in total assets was primarily comprised of a $155.3 million
increase in net loans and an $18.4 million increase in securities. The increase
in assets was primarily funded by a $143.3 million increase in deposits and a
$39.6 million increase in shareholders' equity.
EARNING ASSETS
Average earning assets equaled over 96.4% of average total assets during 2001.
Although we experienced significant asset growth during 2001, the asset
composition remained relatively constant. The loan portfolio continued to
comprise a majority of earning assets, followed by securities, federal funds
sold, and short-term investments.
Our loan portfolio, which equaled 86.1% of average earnings assets during 2001,
is primarily comprised of commercial loans. Constituting 92.2% of average loans
and growing by $150.2 million during 2001, the commercial loan portfolio
represents loans to business interests generally located within our market area.
Approximately 62% of the commercial loan portfolio is primarily secured by real
estate properties, with the remaining generally secured by other business assets
such as accounts receivable, inventory, and equipment. The continued significant
concentration of the loan portfolio in commercial loans and the rapid growth of
this portion of our lending business is consistent with our strategy of focusing
a substantial amount of our efforts on "wholesale" banking. Corporate and
business lending continues to be an area of expertise for our senior management
team, and our eight commercial lenders have over 110 years of combined
commercial lending experience. Of each of the loan categories that we originate,
commercial loans are 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 and consumer lending, while averaging only 7.8% of average
loans during 2001, also experienced excellent growth; however, while we expect
the residential mortgage loan and consumer loan portfolios to increase in future
periods, given our wholesale banking strategy, the commercial sector of the
lending efforts and resultant assets are expected to remain the dominant loan
portfolio category.
F-5
The following tables present the maturity of total loans outstanding, as of
December 31, 2001, according to scheduled repayments of principal on fixed rate
loans and repricing frequency on variable rate loans.
0-1 1-5 After 5
Year Years Years Total
---- ----- ----- -----
Construction and land development $ 51,316,000 $ 11,194,000 $ 200,000 $ 62,710,000
Real estate - secured by 1-4 family
properties 16,532,000 15,748,000 8,748,000 41,028,000
Real estate - secured by multi-family
properties 737,000 370,000 0 1,107,000
Real estate - secured by nonfarm
nonresidential properties 80,958,000 185,463,000 3,434,000 269,855,000
Commercial 123,779,000 76,944,000 5,116,000 205,839,000
Consumer 2,773,000 3,865,000 71,000 6,709,000
--------------- ---------------- ------------- ----------------
$ 276,095,000 $ 293,584,000 $ 17,569,000 $ 587,248,000
=============== ================ ============= ================
Fixed rate loans $ 27,078,000 $ 293,376,000 $ 17,569,000 $ 338,023,000
Floating rate loans 249,017,000 208,000 0 249,225,000
--------------- ---------------- ------------- ----------------
$ 276,095,000 $ 293,584,000 $ 17,569,000 $ 587,248,000
=============== ================ ============= ================
Our credit policies establish guidelines to manage credit risk and asset
quality. These guidelines include loan review and early identification of
problem loans to provide effective loan portfolio administration. The credit
policies and procedures are meant to minimize the risk and uncertainties
inherent in lending. In following these policies and procedures, we must rely on
estimates, appraisals and evaluations of loans and the possibility that changes
in these could occur quickly because of changing economic conditions. Identified
problem loans, which exhibit characteristics (financial or otherwise) that could
cause the loans to become nonperforming or require restructuring in the future,
are included on the internal "Watch List." Senior management reviews this list
regularly.
The quality of our loan portfolio remains strong, with past due loans and net
loan charge-offs well below banking industry averages during 2001. As of
December 31, 2001, past due loans and nonaccrual loans totaled $1.4 million, or
0.24% of total loans. Net loan charge-offs during 2001 totaled $178,000, or
0.04% of average total loans. During 2000 net loan charge-offs equaled 0.05% of
average total loans. 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 delinquency and loan charge-off
ratios. Over 97% of the loan portfolio consists of loans extended directly to
companies and individuals doing business and residing within our market area.
The remaining portion is comprised of commercial loans participated with certain
non-affiliated commercial banks outside the immediate area, which are
underwritten using the same loan criteria as though our bank was the originating
bank.
F-6
The following table summarizes changes in the allowance for loan and lease
losses.
Years ended December 31,
2001 2000 1999
---- ---- ----
Loans outstanding at year-end $ 587,248,000 $ 429,804,000 $ 308,006,000
============== ============== ===============
Daily average balance of loans outstanding $ 500,965,000 $ 372,428,000 $ 246,921,000
============== ============== ===============
Balance of allowance at beginning of year $ 6,302,000 $ 4,620,000 $ 2,765,000
Loans charged-off:
Commercial, financial and agricultural (251,000) (147,000) (109,000)
Construction and land development 0 0 0
Residential real estate 0 0 0
Installment loans to individuals (1,000) (38,000) 0
-------------- -------------- ---------------
Total loans charged-off (252,000) (185,000) (109,000)
Recoveries of previously charged-off loans:
Commercial, financial and agricultural 73,000 13,000 3,000
Construction and land development 0 0 0
Residential real estate 0 0 0
Installment loans to individuals 1,000 0 0
-------------- -------------- ---------------
Total recoveries 74,000 13,000 3,000
-------------- -------------- ---------------
Net charge-offs (178,000) (172,000) (106,000)
Provision for loan losses 2,370,000 1,854,000 1,961,000
-------------- -------------- ---------------
Balance of the allowance at year-end $ 8,494,000 $ 6,302,000 $ 4,620,000
============== ============== ===============
Ratio of net charge-offs during period to average
loans outstanding during the period (0.04)% (0.05)% (0.04)%
=========== =========== ==============
Ratio of allowance to loans outstanding at
end of period 1.45% 1.47% 1.50%
=========== =========== ==============
In each accounting period the allowance for loan and lease losses ("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. The evaluation of the allowance is further based on, although not
limited to, consideration of the internally prepared Loan Loss Reserve Analysis
("Reserve Analysis"), composition of the loan portfolio, third party analysis of
the loan administration processes and loan portfolio and the general economic
conditions. In addition, our bank's status as a relatively new banking
organization and the rapid commercial loan growth since inception is taken into
account.
The Reserve Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan balances to
calculate an overall allowance dollar amount. For commercial loans, which
continue to comprise a vast majority of our total loans, reserve allocation
factors are based upon the loan ratings as determined by our 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 over
the past 15 years. The Reserve Analysis is reviewed regularly by senior
management and the Board of Directors and is adjusted periodically based upon
identifiable trends and experience.
F-7
The following table illustrates the breakdown of the allowance balance to loan
type (dollars in thousands).
2 0 0 1 2 0 0 0
------- -------
Balance at End Percent of Loans Percent of Loans
of Period in each Category in each Category
Applicable to Amount to Total Loans Amount to Total Loans
------------- ------ -------------- ------ --------------
Commercial, financial and agricultural $ 7,172 81.0% $ 5,259 81.6%
Construction and land development 785 10.7 580 9.0
Residential real estate 453 7.2 369 7.8
Installment loans to individuals 84 1.1 94 1.6
Unallocated 0 N/A 0 N/A
--------- ------ --------- ------
$ 8,494 100.0% $ 6,302 100.0%
========= ====== ========= ======
The primary risk elements with respect to commercial loans are the financial
condition of the borrower, the sufficiency of collateral, and lack of timely
payment. We have a policy of requesting and reviewing periodic financial
statements from commercial loan customers, and we periodically review existence
of collateral and its value. The primary risk element with respect to each
installment and residential real estate loan is lack of timely payment. We have
a reporting system that monitors past due loans and have adopted policies to
pursue creditor's rights in order to preserve our bank's position.
Although we believe that the allowance is adequate to sustain losses as they
arise, there can be no assurance that our bank will not sustain losses in any
given period that could be substantial in relation to, or greater than, the size
of the allowance.
The securities portfolio also experienced significant growth during 2001,
increasing from $60.5 million on December 31, 2000 to $78.8 million at December
31, 2001. During 2001, the securities portfolio equaled 11.6% of average earning
assets. We maintain the portfolio at levels to provide adequate pledging for the
repurchase agreement program and secondary liquidity for our daily operations.
In addition, the portfolio serves a primary interest rate risk management
function. At December 31, 2001, the portfolio was comprised of high credit
quality U.S. Government Agency issued and guaranteed mortgage-backed securities
(64%), municipal general obligation and revenue bonds (34%), U.S. Government
Agency issued bonds (1%) and Federal Home Loan Bank stock (1%).
All securities with the exception of tax-exempt municipal bonds have been
designated as "available for sale" as defined in Financial Accounting Standards
Board Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Securities designated as available for sale are stated at
fair value, with the unrealized gains and losses, net of income tax, reported as
a separate component of shareholders' equity in accumulated other comprehensive
income. The fair value of securities designated as available for sale at
December 31, 2001 and 2000 was $52.8 million and $45.9 million, respectively.
The net unrealized gain recorded at December 31, 2001 and 2000, was $408,000 and
$290,000, respectively. All tax-exempt municipal bonds have been designated as
"held to maturity" as defined in SFAS No. 115, and are stated at amortized cost.
As of December 31, 2001 and 2000, held to maturity securities had an amortized
cost of $26.0 million and $14.5 million and a fair value of $26.2 million and
$14.9 million, respectively.
F-8
The following table shows by class of maturities as of December 31, 2001, the
amounts and weighted average yields of investment securities (1):
Carrying Average
Value Yield
----- -----
(Dollars in thousands)
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations
One year or less $ 513,000 6.50%
Over one through five years 0 NA
Over five through ten years 0 NA
Over ten years 982,000 6.55
-------------- --------
1,495,000 6.53
Obligations of states and political subdivisions
One year or less 951,000 8.78
Over one through five years 3,269,000 6.60
Over five through ten years 6,530,000 6.70
Over ten years 15,229,000 6.98
-------------- --------
25,979,000 6.93
Mortgage-backed securities 50,559,000 6.41
-------------- --------
$ 78,033,000 6.59%
============== ========
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent
basis.
Federal funds sold, consisting of excess funds sold overnight to correspondent
banks, are used to manage daily liquidity needs and interest rate sensitivity.
During 2001, the average balance of these funds equaled 2.3% of average earning
assets. This level is well within our internal policy guidelines and is not
expected to change significantly in the future.
SOURCE OF FUNDS
Our major source of funds is from deposits. Total deposits increased from $425.7
million at December 31, 2000, to $569.1 million on December 31, 2001. Included
within these numbers is the success we achieved in generating deposit growth
from customers located within the market area during 2001. Local deposits
increased from $126.7 million at December 31, 2000, to $176.8 million on
December 31, 2001, an increase of 39.6%. In addition, our repurchase agreement
program, which exhibits the characteristics of an interest-bearing checking
account, increased by $4.3 million, or 13.5%, during the same time period.
Despite this success in obtaining funds from local customers, the substantial
asset growth has necessitated the continued acquisition of funds from depositors
outside of the market area. Out-of-area deposits increased from $299.0 million
at December 31, 2000, to $392.2 million on December 31, 2001, an increase of
31.2%. However, the strong growth in local deposits resulted in out-of-area
deposits declining as a percentage of total deposits from 70.2% at year-end 2000
to 68.9% at year-end 2001.
During 2001 we experienced significant growth in our check-writing deposit
accounts, which include noninterest-bearing demand accounts, interest-bearing
checking accounts and money market deposit accounts. In aggregate these deposit
types grew by 55.8%. Leading the growth were noninterest-bearing demand
accounts. Comprised primarily of business loan customers, noninterest-bearing
demand accounts grew $15.8 million, or 57.7%, and equaled 6.0% of average
funding liabilities during 2001. Interest-bearing checking accounts increased
$9.2 million, or 71.1%, and equaled 2.9% of average funding liabilities during
2001. Money market deposit accounts increased $0.4 million, or 7.4%, and equaled
1.0% of average funding liabilities during 2001. Business loan customers also
comprise the majority of interest-bearing checking and money market deposit
accounts, although to a lesser extent than noninterest-bearing checking
accounts. Pursuant to banking regulations, incorporated businesses may not own
interest-bearing checking accounts and transactions from money market accounts
are limited. We anticipate continued growth of our check-writing deposit
accounts as additional business loans are extended and through the efforts of
our branch network and business development activities.
F-9
Savings account balances recorded an increase of $10.8 million, or 29.8%, during
2001, and equaled 7.7% of average funding liabilities during 2001. Business loan
customers also comprise the majority of savings account holders, although to a
lesser extent than check-writing accounts. We anticipate an increase in savings
account balances as additional business loans are extended and through the
efforts of our branch network and business development activities.
Certificates of deposit purchased by customers located within the market area
increased significantly during 2001, growing from $44.8 million at December 31,
2000, to $58.7 million on December 31, 2001, a growth rate of 31.0%. These
deposits accounted for 9.5% of average funding sources during 2001. Leading the
growth were certificates of deposit issued to local municipalities, primarily
counties, cities and townships, increasing from $18.6 million at December 31,
2000, to $28.7 million at December 31, 2001. The increase in local municipality
certificates of deposit has been facilitated by our qualifying for additional
funds from existing customers through a combination of our asset growth and
increased profitability as measured by the municipalities' investment policy
guidelines, and is a trend that we expect to continue.
During 2001 certificates of deposit obtained from customers located outside of
the market area increased by $93.2 million, and represented 63.6% of average
funding liabilities during 2001. At December 31, 2001, out-of-area deposits
totaled $392.2 million. Out-of-area deposits consist primarily of certificates
of deposit placed by deposit brokers for a fee, but also include certificates of
deposit obtained from the deposit owners directly. The owners of the out-of-area
deposits include individuals, businesses and governmental units located
throughout the country. 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 most of 2001 rates paid on new out-of-area
deposits were very similar to rates paid on new certificates of deposit issued
to local customers. In addition, the overhead costs associated with the
out-of-area deposits are considerably less than the overhead costs that would be
incurred to administer a similar level of local deposits. While we anticipated
the reliance on out-of-area deposits in the early stages of our development, our
longer-term funding strategy is to increase local deposits and lower our
reliance on out-of-area deposits. Although local deposits have and are expected
to increase as new business, governmental and consumer deposit relationships are
established and as existing customers increase the balances in their deposit
accounts, the relatively high reliance on out-of-area deposits will likely
remain.
Securities sold under agreements to repurchase ("repurchase agreements")
increased $4.3 million and equaled 6.3% of average funding liabilities during
2001. As part of our sweep account program, collected funds from certain
business noninterest-bearing checking accounts are invested in overnight
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 an interest-bearing
checking deposit account.
Shareholders' equity increased $39.6 million and equaled 8.2% of average assets
during 2001. The increase was primarily attributable to the sale of common stock
and net income from operations. During 2001, we sold in aggregate approximately
2.3 million shares of common stock, raising $35.0 million net of issuance costs.
Substantially all of the net proceeds were contributed to our bank as capital to
provide support for asset growth, fund investments in loans and securities and
for general corporate purposes. Net income from operations totaled $4.5 million.
Shareholders' equity was also positively impacted by a $118,000 mark-to-market
adjustment for available for sale securities as defined in SFAS No. 115,
resulting from the changing interest rate environment during 2001.
F-10
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001 and 2000
SUMMARY
We recorded strong earnings performance during 2001. Net income was $4.5
million, or $1.17 per basic share and $1.15 per diluted share. This earnings
performance compares very favorably to net income of $2.8 million, or $1.03 per
basic share and $1.02 per diluted share, recorded in 2000. The $1.7 million
improvement in net income represents an increase of 60.7%, while diluted
earnings per share were up 12.7%, with the difference reflecting the impact of
our common stock sales during 2001 and resulting increases in average common
shares outstanding. The earnings improvement during 2001 over that of 2000 is
primarily attributable to increased net interest income and improved operating
efficiencies resulting from asset growth, strong credit culture, controlled
overhead expenses and increased fee income. We expect our percentage rate of
loan growth to exceed the banking industry average in 2002.
The following table shows some of the key performance and equity ratios for the
years ended December 31, 2001 and 2000.
2001 2000
---- ----
Return on average total assets 0.7% 0.6%
Return on average equity 9.1 9.5
Dividend payout ratio N/A N/A
Average equity to average assets 8.2 6.6
NET INTEREST INCOME
Net interest income, the difference between revenue generated from earning
assets and the interest cost of funding those assets, is our primary source of
earnings. Interest income (adjusted for tax-exempt income) and interest expense
totaled $45.0 million and $28.2 million during 2001, respectively, providing for
net interest income of $16.8 million. This performance compares very favorably
to that of 2000 when interest income and interest expense were $37.1 million and
$24.6 million, respectively, providing for net interest income of $12.5 million.
In comparing 2001 with 2000, interest income increased 21.4%, interest expense
was up 14.8% and net interest income increased 34.3%. The level of net interest
income is primarily a function of asset size, as the weighted average interest
rate received on earning assets is greater than the weighted average interest
cost of funding sources; however, factors such as types of assets and
liabilities, interest rate risk, common stock sales, liquidity, and customer
behavior also impact net interest income as well as the net interest margin. The
net interest margin remained virtually unchanged in 2001 at 2.89%, compared to
2.90% in 2000.
The following table depicts the average balance, interest earned and paid, and
weighted average rate of our assets, liabilities and shareholders' equity during
2001, 2000 and 1999 (dollars in thousands). The table also depicts the dollar
amount of change in interest income and interest expense of interest-earning
assets and interest-bearing liabilities, segregated between change due to volume
and change due to rate. For tax-exempt investment securities interest income and
yield have been computed on a tax equivalent basis using a marginal tax rate of
34%.
F-11
Years ended December 31,
---------------2 0 0 1---------- ---------------2 0 0 0---------- ---------------1 9 9 9----------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
Taxable securities $ 48,172 $ 3,245 6.74% $ 38,788 $ 2,662 6.86% $ 30,124 $ 1,869 6.20%
Tax-exempt
securities 19,566 1,362 6.96 10,972 782 7.12 1,251 84 6.74
--------- ---------- --------- ---------- --------- ----------
Total securities 67,738 4,607 6.80 49,760 3,444 6.92 31,375 1,953 6.22
Loans 500,965 39,852 7.95 372,428 33,057 8.88 246,921 20,410 8.27
Short-term
investments 134 4 2.89 115 6 4.74 551 26 4.68
Federal funds sold 13,289 546 4.11 8,986 567 6.31 8,099 406 5.01
--------- ---------- --------- ---------- --------- ----------
Total earning
assets 582,126 45,009 7.73 431,289 37,074 8.60 286,946 22,795 7.94
Allowance for
loan losses (7,383) (5,527) (3,681)
Cash and due
from banks 13,697 8,926 7,096
Other non-earning
assets 15,355 10,044 6,099
--------- --------- ---------
Total assets $ 603,795 $ 444,732 $ 296,460
========= ========== =========
Interest-bearing
demand
deposits $ 15,923 $ 491 3.08% $ 11,207 $ 501 4.47% $ 8,575 $ 351 4.09%
Savings deposits 42,334 1,614 3.81 36,040 1,875 5.20 38,886 1,871 4.81
Money market
accounts 5,518 177 3.20 5,405 251 4.64 4,411 189 4.29
Time deposits 400,180 23,155 5.79 288,791 18,992 6.58 173,158 9,629 5.56
--------- ---------- --------- ---------- --------- ----------
Total interest-
bearing
deposits 463,955 25,437 5.48 341,443 21,619 6.33 225,030 12,040 5.35
Short-term
borrowings 34,662 1,186 3.42 29,331 1,369 4.67 20,229 835 4.13
Long-term
borrowings 16,132 1,578 9.78 16,033 1,572 9.80 4,654 455 9.78
--------- ---------- --------- ---------- --------- ----------
Total interest-
bearing
liabilities 514,749 28,201 5.48 386,807 24,560 6.35 249,913 13,330 5.33
---------- ---------- ----------
Demand deposits 33,041 23,568 17,812
Other liabilities 6,450 4,893 1,447
--------- --------- ---------
Total liabilities 554,240 415,268 269,172
Average equity 49,555 29,464 27,288
--------- --------- ---------
Total liabilities
and equity $ 603,795 $ 444,732 $ 296,460
========= ========= =========
Net interest
income $ 16,808 $ 12,514 $ 9,465
========== ========== ==========
Rate spread 2.25 2.25 2.61
Net interest
margin 2.89 2.90 3.30
F-12
Years ended December 31,
-------------2001 over 2000------------- -------------2000 over 1999-------------
Total Volume Rate Total Volume Rate
----- ------ ---- ----- ------ ----
Increase (decrease) in interest income
Taxable securities $ 583,000 $ 633,000 $ (50,000) $ 793,000 $ 579,000 $ 214,000
Tax exempt securities 580,000 598,000 (18,000) 697,000 692,000 5,000
Loans 6,795,000 10,499,000 (3,704,000) 12,647,000 11,043,000 1,604,000
Short term investments (2,000) 1,000 (3,000) (20,000) (21,000) 1,000
Federal funds sold (21,000) 217,000 (238,000) 162,000 48,000 114,000
------------ ----------- ------------ ----------- ------------ -----------
Net change in tax-equivalent
income 7,935,000 11,948,000 (4,013,000) 14,279,000 12,341,000 1,938,000
Increase (decrease) in interest expense
Interest-bearing demand deposits (11,000) 173,000 (184,000) 150,000 115,000 35,000
Savings deposits (261,000) 293,000 (554,000) 4,000 (142,000) 146,000
Money market accounts (74,000) 5,000 (79,000) 62,000 45,000 17,000
Time deposits 4,163,000 6,654,000 (2,491,000) 9,363,000 7,352,000 2,011,000
Short term borrowings (183,000) 222,000 (405,000) 534,000 414,000 120,000
Long term borrowings 6,000 10,000 (4,000) 1,117,000 1,116,000 1,000
------------ ----------- ------------ ----------- ------------ -----------
Net change in interest
expense 3,640,000 7,357,000 (3,717,000) 11,230,000 8,900,000 2,330,000
------------ ----------- ------------ ----------- ------------ -----------
Net change in tax-equivalent
net interest income $ 4,295,000 $ 4,591,000 $ (296,000) $ 3,049,000 $ 3,441,000 $ (392,000)
============ =========== ============ =========== ============ ============
Interest income is primarily generated from the loan portfolio, and to a lesser
degree from securities, federal funds sold and short term investments. Interest
income increased $7.9 million during 2001 from that earned in 2000, totaling
$45.0 million in 2001 compared to $37.1 million in the previous year. The
increase is due to the growth in earning assets, which more than offset the
impact of the declining interest rate environment during 2001 during which time
the prime rate declined by 475 basis points. Reflecting the significantly lower
interest rates, the yield on average earning assets decreased from 8.60%
recorded in 2000 to 7.73% in 2001.
The growth in interest income is attributable to an increase in earning assets.
During 2001, earning assets averaged $582.1 million, a level substantially
higher than the average earning assets of $431.3 million during 2000. Growth in
average total loans, totaling $128.5 million, comprised 85.2% of the increase in
average earnings assets. Interest income generated from the loan portfolio
increased $6.8 million during 2001 over the level earned in 2000, comprised of
an increase of $10.5 million from the growth in the loan portfolio which was
partially offset by a decrease of $3.7 million due to the decline in the yield
earned on the loan portfolio of 7.95% from 8.88%. The decline in the loan
portfolio yield is primarily due to decreased market interest rates during 2001.
Growth in the securities portfolio also added to the increase in interest income
during 2001 over that of 2000. Average securities increased by $18.0 million in
2001, increasing from $49.7 million in 2000 to $67.7 million in 2001. The growth
equated to an increase in interest income of $1.2 million, which was slightly
offset by a decrease of $0.1 million due to the decline in the yield earned on
the securities portfolio of 6.80% from 6.92%. Although interest income earned on
federal funds sold increased by $0.2 million due to a $4.3 million increase in
the average balance during 2001, a lower yield earned on federal funds sold
offset the higher income resulting from the increased average balance. The lower
yield on securities and federal funds sold is the result of decreased market
interest rates during 2001.
Interest expense is primarily generated from interest-bearing deposits, and to a
lesser degree repurchase agreements and trust preferred securities. Interest
expense increased $3.6 million during 2001 from that paid in 2000, totaling
$28.2 million in 2001 compared to $24.6 million in the previous year. The growth
in interest expense is primarily attributable to an increase in interest-bearing
liabilities during 2001, which more than offset the impact of the declining
interest rate environment during 2001. Interest-bearing liabilities averaged
$514.7 million during 2001, a level substantially higher than the average
interest-bearing liabilities of $386.8 million during 2000. This growth resulted
in increased interest expense of $7.3 million; however, a decrease in interest
expense of $3.7 million was recorded during 2001 due to lower market interest
rates on all interest-bearing liability categories except trust preferred
securities that have a fixed interest rate. The cost of average interest-bearing
liabilities decreased from the 6.35% recorded in 2000 to 5.48% in 2001.
F-13
Growth in average certificates of deposits, totaling $111.4 million, comprised
87.1% of the increase in average interest-bearing liabilities between 2001 and
2000. The certificate of deposit growth during 2001 equated to an increase in
interest expense of $6.7 million, although a decrease in interest expense of
$2.5 million was recorded due to the decline in the average rate paid. Increases
in repurchase agreements and other interest-bearing deposits added to interest
expense; however, the decline in interest rates paid on these funding
liabilities more than offset the increased costs due to dollar volume growth.
Average repurchase agreements grew from $29.3 million in 2000 to $34.7 million
in 2001. The growth equated to an increase in interest expense of $0.2 million;
however, a decrease of $0.4 million in interest expense was recorded due to the
decline in the average rate paid. Lower interest rates paid on interest-bearing
checking accounts, savings deposits and money market accounts reduced, in
aggregate, $0.8 million in interest expense during 2001, while the increase in
dollar volume added $0.5 million in interest expense.
PROVISION FOR LOAN LOSSES
Reflecting continued significant loan growth, the provision for loan losses
totaled approximately $2.4 million during 2001, compared to the $1.9 million
expensed during 2000. The allowance as a percentage of total loans outstanding
as of December 31, 2001 was 1.45%, slightly lower than the 1.47% at year-end
2000. Net loan charge-offs during 2001 approximated $178,000, or 0.04% of
average total loans. Net loan charge-offs during 2000 totaled about $172,000, or
0.05% of average total loans. We maintain the allowance at a level we believe is
adequate to absorb losses contained within the loan portfolio.
NONINTEREST INCOME
Noninterest income, excluding net gains on sales of securities, totaled $1.7
million in 2001, an increase of 40.3% over the $1.2 million earned in 2000
(excluding the interest rate swap termination fee). Deposit and repurchase
agreement service charges totaled $529,000 in 2001, an increase of $183,000, or
52.9%, from the amount earned in 2000. The increase is primarily due to the
growth in the number of deposit accounts. Reflecting increased volume of
refinance activity resulting from the decreased interest rate environment, fees
earned on referring residential mortgage loan applicants to various third
parties totaled $401,000 in 2001, up significantly from the $175,000 earned in
2000. Letter of credit commitment fees were virtually unchanged at $379,000
during 2001 when compared to the $391,000 earned in 2000.
Noninterest income related to cash surrender value of bank owned life insurance
policies ("BOLI") totaled $99,000 during 2001. Purchased at various time
intervals during mid-2001, the cash surrender value of the BOLI policies totaled
$4.0 million at December 31, 2001. The BOLI policies represent a combination of
whole life and term insurance, and were purchased as part of our bank's
non-qualified deferred compensation program. Under this program, certain
officers have the ability to defer all or portions of their salary and/or bonus
payments. A BOLI policy was purchased for each of the participating officers,
with the whole life portion of the BOLI policy providing a funding source when
each of the specific officers reach retirement age and begin to receive payments
under the program. Any payments made under the term life insurance portion of
the BOLI policies would be shared between our bank and the officers' named
beneficiaries.
In addition to providing interest income and secondary liquidity, our securities
portfolio plays an integral role in managing our net interest margin. In
reaction to the declining interest rate environment during 2001 we completed two
separate bond swap transactions whereby selected securities were sold and the
sales proceeds were re-invested into securities containing differing interest
rate risk characteristics. The first bond swap transaction involved the sale of
two callable U.S. Government Agency bonds. During the relatively high interest
rate environment in 2000, our bank purchased four $1.0 million heavily
discounted callable U.S. Government Agency bonds. A major factor in purchasing
the bonds was our expectation that the bonds would likely be called by the
issuer in a declining interest rate environment, resulting in the remaining
discount being immediately accreted into interest income and at least partially
offsetting the short-term negative impact a declining interest rate environment
would have on our net interest margin. With interest rates declining during the
first quarter of 2001, two of the bonds were called by the issuer and the
combined unaccreted discount of $72,000 was immediately taken into interest
income. Of the remaining two bonds, one was not initially callable until June
2001, and the other bond, while immediately callable, was not called by the
issuer as interest rates had not declined to a level where it was likely to be
called. Given that net interest margin management was a major factor in
purchasing the bonds, we decided to sell the remaining two bonds, and a net gain
of $97,000 was recorded as noninterest income.
F-14
The second bond swap was completed during the fourth quarter of 2001. In an
effort to address the impact of a possible future increasing interest rate
environment, we decided to sell certain mortgage-backed pass-through securities
and re-invest the proceeds into mortgage-backed securities that exhibit
different principal repayment characteristics. We sold seven bonds with an
aggregate par value of $7.4 million, and recorded a net gain of $110,000. These
issues were generally the lowest yielding bonds and had the lowest coupons on
the underlying residential mortgages within the mortgage-backed pass-through
segment of our investment securities portfolio, and although comprising almost
24% of that portfolio segment these particular bonds comprised only about 13% of
the unrealized gain as of September 30, 2001. In an increasing interest rate
environment, we would expect these particular bonds to reflect extension, that
is the principal repayments would slow and therefore our total return would be
negatively impacted as we would have less money to re-invest in higher yielding
products. Proceeds from the sales were re-invested into mortgage-backed
pass-through securities that we believe would provide greater principal
repayment during an increasing interest rate environment, therefore giving us
the opportunity to invest more money into higher yielding products and improving
our total return.
NONINTEREST EXPENSE
Noninterest expense during 2001 totaled $9.5 million, an increase of 25.8% over
the $7.5 million expensed in 2000. Of the $2.0 million growth in overhead costs,
$1.4 million was in salaries and benefits, and primarily reflects the increase
in full-time equivalent employees from 65 at year-end 2000 to 96 at year-end
2001 and annual pay increases. The remaining growth in overhead costs were
generally due to general and administrative cost increases associated with an
increased asset base and the opening of the new administrative office and the
combined branch and operations center.
While the dollar volume of noninterest costs have increased, as a percent of
average assets the level has substantially declined as a result of our asset
growth and the realization of operating efficiencies. During 2001, noninterest
costs were 1.57% of average assets, a 7.1% decline from the 1.69% level during
2000. Monitoring and controlling our noninterest costs, while at the same time
providing high quality service to our customers, is one of our priorities. The
efficiency ratio, a banking industry standardized calculation that attempts to
reflect the utilization of overhead costs, also declined during 2001. Computed
by dividing noninterest expenses by net interest income plus noninterest income,
the efficiency ratio was 51.7% during 2001. This level compares favorably to the
efficiency ratio of 55.8% recorded during 2000, and reflects the improved
efficiencies resulting from increased earning asset growth and controlled costs.
Although noninterest expenses increased $2.0 million during 2001, our net
revenue increased $4.8 million during the same time period.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $2.0 million in 2001, an increase of 52.7% over
the $1.3 million expensed during 2000. The increase is due to the growth in our
profitability.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999
SUMMARY
We recorded strong earnings performance during 2000, only our third full year of
operation. Net income was $2.8 million, or $1.03 per basic share and $1.02 per
diluted share. This earnings performance compares very favorably to the net
income of $2.1 million, or $0.77 per basic share and $0.76 per diluted share,
recorded in 1999. The 1999 net income includes a one-time charge of $42,000
($0.02 per basic and diluted share), reflecting a change in accounting for
organization costs. In accordance with previous accounting guidelines, these
costs were being amortized over a five-year period; however, as required by
AICPA Statement of Position 98-5, the unamortized balance was written off
effective January 1, 1999, and is reflected in the Consolidated Financial
Statements as a change in accounting principle. The earnings improvement during
2000 over that of 1999 is primarily attributable to increased net interest
income and improved operating efficiencies resulting from asset growth, strong
credit culture, and controlled overhead expenses, and was achieved despite a
significant increase in federal income tax expense. As in 1999, significant loan
growth necessitated large provisions to the allowance during 2000, substantially
impacting our earnings performance.
F-15
NET INTEREST INCOME
Net interest income, the difference between revenue generated from earning
assets and the interest cost of funding those assets, is our primary source of
earnings. Interest income (adjusted for tax-exempt income) and interest expense
totaled $37.1 million and $24.6 million during 2000, respectively, providing for
net interest income of $12.5 million. This performance compares very favorably
to that of 1999 when interest income and interest expense were $22.8 million and
$13.3 million, respectively, providing for net interest income of $9.5 million.
The level of net interest income is primarily a function of asset size, as the
weighted average interest rate received on earning assets is greater than the
weighted average interest cost of funding sources; however, factors such as
types of assets and liabilities, interest rate risk, liquidity, and customer
behavior also impact net interest income as well as the net interest margin. The
net interest margin declined from 3.30% in 1999 to 2.90% in 2000, primarily
resulting from the full-year's impact of the September 1999 issuance of trust
preferred securities, increased reliance on out-of-area certificates of deposit
and lower level of shareholders' equity as a percent of average earning assets.
Interest income is primarily generated from the loan portfolio, and to a lesser
degree from investment securities, federal funds sold and short term
investments. Interest income increased $14.3 million during 2000 from that
earned in 1999, totaling $37.1 million in 2000 compared to $22.8 million in the
previous year. Approximately 86% of the increase is due to the growth in earning
assets, with the remaining amount due to the increased interest rate environment
during 2000. The yield on average earning assets increased from 7.94% recorded
in 1999 to 8.60% in 2000.
The growth in interest income is primarily attributable to an increase in
earning assets. During 2000, earning assets averaged $431.3 million, a level
substantially higher than the average earning assets of $286.9 million during
1999. Growth in average total loans, totaling $125.5 million, comprised 87% of
the increase in average earning assets. Interest income generated from the loan
portfolio increased $12.6 million during 2000 over the level earned in 1999,
comprised of an increase of $11.0 million due to growth in the loan portfolio
and an increase of $1.6 million due to an increase in the yield earned on the
loan portfolio. The improved loan portfolio yield is primarily due to increased
market interest rates during 2000.
Growth in the investment securities portfolio and a slightly larger federal
funds sold position also added to the increase in interest income during 2000
over that of 1999. Average investment securities increased by $18.4 million in
2000, increasing from $31.4 million in 1999 to $49.8 million in 2000. This
growth equated to an increase in interest income of $1.3 million. A higher
investment securities portfolio yield during 2000 also increased interest income
by $0.2 million. Average federal funds sold increased $0.9 million in 2000 that,
when combined with an increase in yield, added $0.2 million to interest income.
The improved yield on investment securities and federal funds sold is the result
of increased market interest rates during 2000.
Interest expense is primarily generated from interest-bearing deposits, and to a
lesser degree repurchase agreements and trust preferred securities. Interest
expense increased $11.2 million during 2000 from that paid in 1999, totaling
$24.5 million in 2000 compared to $13.3 million in the previous year. The growth
in interest expense is primarily attributable to an increase in interest-bearing
liabilities and increased market interest rates during 2000. Interest-bearing
liabilities averaged $386.8 million during 2000, a level substantially higher
than the average interest-bearing liabilities of $249.9 million during 1999.
This growth resulted in increased interest expense of $8.9 million. Increased
interest expense of $2.3 million was recorded during 2000 due to higher market
interest rates on all interest-bearing liability categories except trust
preferred securities that have a fixed interest rate. The cost of average
interest-bearing liabilities increased from the 5.33% recorded in 1999 to 6.35%
in 2000.
F-16
Growth in average certificates of deposit, totaling $115.6 million, comprised
84% of the increase in average interest-bearing liabilities between 2000 and
1999. The certificate of deposit growth during 2000 equated to an increase in
interest expense of $7.4 million. In addition, interest expense of $2.0 million
was recorded due to the increase in the average rate paid. Growth in repurchase
agreements also added to the increased interest expense during 2000 over that of
1999, as average repurchase agreements grew from $20.2 million in 1999 to $29.3
million in 2000. The growth equated to an increase in interest expense of $0.4
million, with an additional $0.1 million in interest expense recorded due to the
increase in the average rate paid. Higher interest rates paid on
interest-bearing checking accounts, savings deposits and money market accounts
added, in aggregate, $0.2 million in interest expense during 2000, while the
change in volume added less than $0.1 million in interest expense. The September
1999 issuance of $16.0 million trust preferred securities had a sizeable impact
on interest expense during 2000, adding $1.1 million in interest expense over
that recorded during 1999.
PROVISION FOR LOAN LOSSES
Reflecting continued significant loan growth the provision for loan losses
totaled $1.9 million during 2000, compared to the $2.0 million expensed during
1999. The allowance as a percentage of total loans outstanding as of December
31, 2000 was 1.47%, slightly lower than the 1.50% at year-end 1999. Net loan
charge-offs during 2000 totaled $173,000, or only 0.05% of average total loans.
Net loan charge-offs during 1999 totaled $106,000, or only 0.04% of average
total loans. We maintain the allowance at a level we feel is adequate to absorb
losses contained within the loan portfolio.
NONINTEREST INCOME
Other income totaled $1.2 million in 2000, an increase over the $0.8 million
earned in 1999. Deposit and repurchase agreement service charges totaled
$346,000 in 2000, an increase of $144,000, or 71.3%, from the amount earned in
1999. The increase is primarily due to the growth in the number of deposit and
repurchase agreement accounts. Reflecting additional letter of credit issuances,
letter of credit commitment fees increased to $391,000 in 2000, an increase of
$123,000, or 45.9%, from the fees earned in 1999. Credit card and debit card
interchange income, reflecting increased issuance and usage, increased $46,000
during 2000, totaling $144,000 for the year. Fees earned on referring
residential mortgage loan applicants to various third parties, reflecting a
decline in volume due to the increased interest rate environment, totaled
$175,000 in 2000, compared to the $208,000 earned in 1999.
To reduce the negative impact of rising interest rates on net interest income,
during the second quarter of 2000 we entered into a $50.0 million two-year
interest rate swap agreement with a correspondent bank. Due to market
expectations and the resulting impact on the value of the interest rate swap
agreement, we terminated the interest rate swap agreement to lock-in the earned
benefit shortly thereafter. A termination fee of $275,000 was received from the
correspondent bank. At the same time we elected to sell $7.0 million in
relatively low-yielding U.S. Government Agency callable bonds and reinvest the
sales proceeds in higher-yielding mortgage-backed securities. The loss on the
sale of the bonds totaled $275,000; however, the consummation of this
transaction was expected to generate a higher level of interest income than
would have otherwise been earned over at least the next three years on a present
value basis, while at the same time improving our interest rate risk position.
NONINTEREST EXPENSE
Noninterest expense during 2000 totaled $7.5 million, an increase over the $5.9
million expensed in 1999. An increase in all major overhead cost categories,
including salaries and benefits, occupancy, and furniture and equipment, was
recorded. The increases primarily result from the hiring of additional staff and
the construction of a new combined branch and operations center in mid-1999. All
other noninterest costs also increased, reflecting additional expenses required
to administer the significantly increased loan and deposit base.
While the dollar volume of noninterest costs have increased, as a percent of
average assets the level has substantially declined as a result of our growth
and realized operating efficiencies. During 2000, noninterest costs were 1.69%
of average assets, a significant decline from the 1.99% level in 1999. The
efficiency ratio, a banking industry standardized calculation that attempts to
reflect the utilization of overhead costs, also declined during 2000. Computed
by dividing noninterest expense by net interest income plus noninterest income,
the efficiency ratio was 55.8% in 2000. This level compares favorably to the
57.3% recorded in 1999, and reflects the improved efficiencies resulting from
increased asset growth and controlled costs.
F-17
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $1.3 million in 2000, compared to $0.3 million
expensed in 1999. The increase was due to the improvement in profitability and
the change in our federal income tax status. During 1999 we used tax-loss
carryforwards generated in 1997 and 1998 to reduce federal income tax expense.
These tax-loss carryforwards were fully utilized over the course of 1999;
therefore, we had to expense the full statutory federal income tax rate in 2000.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for our asset growth. Shareholders' equity was $71.5 million and $31.9
million at December 31, 2001 and 2000, respectively. The $39.6 million increase
during 2001 is primarily attributable to the sale of common stock and net income
from operations. During 2001, we sold in aggregate approximately 2.3 million
shares of common stock, raising $35.0 million net of issuance costs. Net income
from operations totaled $4.5 million. Shareholders' equity was also positively
impacted by an $118,000 mark-to-market adjustment for available for sale
securities as defined in SFAS No. 115, resulting from the changing interest rate
environment during 2001.
We conducted four common stock sales during 2001. In February, we sold 70,000
shares of common stock in a privately negotiated transaction, generating $1.0
million in capital, net of transaction costs. In March, we sold 446,600 common
shares in a private placement with an investment banking firm, raising $5.7
million in capital, net of transaction expenses. In August, we sold 1,610,000
shares of common stock in an underwritten public offering, raising $25.1 million
in capital, net of issuance costs. In December, we sold 180,000 in a privately
negotiated transaction, generating $3.2 million in capital, net of transaction
costs. Substantially all of the net proceeds from all four common stock sales
were contributed to our bank as capital to provide support for asset growth,
fund investments in loans and investment securities and for general corporate
purposes.
We and our bank are subject to regulatory capital requirements administered by
the State of Michigan and federal banking agencies. Failure to meet the various
capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements. Since our bank began operations,
both we and our bank have been categorized as "Well Capitalized," the highest
classification contained within the banking regulations. Our and our bank's
capital ratios as of December 31, 2001 and 2000 are disclosed under Note 16 on
pages F-41 and F-42 of the Notes to Consolidated Financial Statements.
Our ability to pay cash and stock dividends is subject to limitations under
various laws and regulations and to prudent and sound banking practices. On
January 7, 2002, we declared a 5% common stock dividend, payable on February 1,
2002 to record holders as of January 18, 2002. We also declared a 5% stock
dividend on January 10, 2001, payable on February 1, 2001 to record holders as
of January 19, 2001. We have not paid cash dividends on our common stock since
our formation in 1997, and currently have no intention of doing so in the
foreseeable future.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment of loans and investment
securities. These funds are used to meet deposit withdrawals, maintain reserve
requirements, fund loans and operate our company. Liquidity is primarily
achieved through the growth of deposits (both local and out-of-area) and liquid
assets such as securities available for sale, matured securities, and federal
funds sold. Asset and liability management is the process of managing the
balance sheet to achieve a mix of earning assets and liabilities that maximizes
profitability, while providing adequate liquidity.
F-18
Our liquidity strategy is to fund loan growth with deposits and repurchase
agreements and to maintain an adequate level of short- and medium-term
investments to meet typical daily loan and deposit activity. Although deposit
and repurchase agreement growth from depositors located in the market area
increased by $54.5 million, or 34.3%, during 2001, the growth was not sufficient
to meet the substantial loan growth of $157.4 million and provide monies for
additional investing activities. To assist in providing the additional needed
funds we regularly obtained certificates of deposit from customers outside of
the market area. As of December 31, 2001, out-of-area deposits totaled $392.2
million, or 64.8% of combined deposits and repurchase agreements, an increase in
dollar volume from the $299.0 million outstanding, but a decline from the 65.3%
level of combined deposits and repurchase agreements, as of December 31, 2000.
We have the ability to borrow money on a daily basis through correspondent banks
using established federal funds purchased lines; however, this is viewed as only
a secondary and temporary source of funds. The federal funds purchased lines
were utilized on several occasions during 2001. During 2001, our federal funds
sold position averaged $13.3 million and our federal funds purchased position
averaged less than $0.1 million. In addition, as a member of the Federal Home
Loan Bank of Indianapolis ("FHLBI"), our bank has access to the FHLBI's
borrowing programs. Based on ownership of FHLBI stock and available collateral
at December 31, 2001, our bank could borrow up to approximately $15 million. Our
bank has yet to use its established borrowing line at the FHLBI.
We have been extended a $5.0 million unsecured revolving line of credit from a
correspondent bank. The line of credit matures on February 28, 2003. Proceeds
from the line of credit may be used for working capital, investment in our bank
or acquisition of financial institutions.
In addition to normal loan funding and deposit flow, we also need to maintain
liquidity to meet the demands of certain unfunded loan commitments and standby
letters of credit. As of December 31, 2001, we had a total of $155.1 million in
unfunded loan commitments and $36.4 million in unfunded standby letters of
credit. Of the total unfunded loan commitments, $129.1 million were commitments
available as lines of credit to be drawn at any time as customers' cash needs
vary, and $26.0 million were for loan commitments scheduled to close and become
funded within the next three months. We monitor fluctuations in loan balances
and commitment levels, and include such data in our overall liquidity
management.
MARKET RISK ANALYSIS
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
interest-earning assets over the interest paid on 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.
F-19
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 the net interest margin during periods of changing market
interest rates.
The following table depicts our GAP position as of December 31, 2001 (dollars in
thousands).
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
Assets:
Commercial loans $ 239,515 $ 17,275 $ 273,971 $ 8,750 $ 539,511
Residential real estate loans 14,491 2,041 15,748 8,748 41,028
Consumer loans 2,584 189 3,865 71 6,709
Investment securities (1) 785 1,012 34,381 42,640 78,818
Federal funds sold 5,300 0 0 0 5,300
Short term investments 171 0 0 0 171
Allowance for loan losses 0 0 0 (8,494) (8,494)
Other assets 0 0 0 35,639 35,639
----------- ------------ ----------- ----------- -----------
Total assets 262,846 20,517 327,965 87,354 698,682
Liabilities:
Interest-bearing checking 22,188 0 0 0 22,188
Savings 47,157 0 0 0 47,157
Money market accounts 5,578 0 0 0 5,578
Time deposits under $100,000 23,735 36,357 29,841 0 89,933
Time deposits $100,000 and over 90,156 138,928 131,975 0 361,059
Short term borrowings 36,485 0 0 0 36,485
Long term borrowings 239 0 0 16,000 16,239
Noninterest-bearing checking 0 0 0 43,162 43,162
Other liabilities 0 0 0 5,418 5,418
----------- ------------ ----------- ----------- -----------
Total liabilities 225,538 175,285 161,816 64,580 627,219
Shareholders' equity 0 0 0 71,463 71,463
----------- ------------ ----------- ----------- -----------
Total sources of funds 225,538 175,285 161,816 136,043 698,682
----------- ------------ ----------- ----------- -----------
Net asset (liability) GAP $ 37,308 $ (154,768) $ 166,149 $ (48,689)
=========== ============ =========== ============
Cumulative GAP $ 37,308 $ (117,460) $ 48,689
=========== ============ ===========
Percent of cumulative GAP to
total assets 5.3% (16.8)% 7.0%
=========== ============ ===========
(1) Mortgage-backed securities are categorized by expected maturities based
upon prepayment trends as of December 31, 2001.
F-20
The second interest rate risk measurement used is commonly referred to as net
interest income simulation analysis. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, serves as our primary interest rate risk measurement technique. The
simulation model assesses the direction and magnitude of variations in net
interest income resulting from potential changes in market interest rates. Key
assumptions in the model include prepayment speeds on various loan and
investment assets; cash flows and maturities of interest-sensitive assets and
liabilities; and changes in market conditions impacting loan and deposit volume
and pricing. These assumptions are inherently uncertain, subject to fluctuation
and revision in a dynamic environment; therefore, the model cannot precisely
estimate net interest income or exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes and
changes in market conditions and our strategies, among other factors.
We conducted multiple simulations as of December 31, 2001, whereby it was
assumed that a simultaneous, instant and sustained change in market interest
rates occurred. The following table reflects the suggested impact on net
interest income over the next twelve months, which is 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 $2,014,000 10.8%
Interest rates down 100 basis points 2,055,000 11.0
No change in interest rates 1,983,000 10.7
Interest rates up 100 basis points 2,129,000 11.4
Interest rates up 200 basis points 2,278,000 12.2
The increase in net interest income under all interest rate scenarios reflects
the expected repricing of local and out-of-area certificates of deposit during
the next twelve months. Unlike our floating rate loans that declined throughout
2001 as the prime rate declined, our certificates of deposit have fixed interest
rates and only reprice at maturity. Throughout most of 2002 we have a large
volume of certificates of deposit that based upon the current interest rate
environment we expect will be refinanced at lower interest rates.
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of other variables, including: the growth,
composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; economic and competitive conditions; potential
changes in lending, investing, and deposit gathering strategies; client
preferences; and other factors.
F-21
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Mercantile Bank Corporation
Wyoming, Michigan
We have audited the accompanying consolidated balance sheets of Mercantile Bank
Corporation as of December 31, 2001 and 2000 and the related consolidated
statements of income, changes in shareholders' equity and cash flows for each of
the three years in the period ended December 31, 2001. These financial
statements are the responsibility of Mercantile's management. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Mercantile Bank
Corporation as of December 31, 2001 and 2000, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2001 in conformity with accounting principles generally accepted in the United
States of America.
As disclosed in Note 1, the Corporation changed its method of accounting for
start-up costs in 1999 to comply with new accounting guidance.
/s/ Crowe, Chizek and Company LLP
------------------------------------
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
January 18, 2002,
except for Note 1 as to which the date is February 1, 2002.
F-22
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
2001 2000
---- ----
ASSETS
Cash and due from banks $ 14,467,000 $ 11,693,000
Short term investments 171,000 109,000
Federal funds sold 5,300,000 6,300,000
--------------- --------------
Total cash and cash equivalents 19,938,000 18,102,000
Securities available for sale 52,054,000 45,148,000
Securities held to maturity (fair value of $26,183,000 at
December 31, 2001 and $14,942,000 at December 31, 2000) 25,979,000 14,524,000
Federal Home Loan Bank stock 785,000 785,000
Total loans 587,248,000 429,804,000
Allowance for loan losses (8,494,000) (6,302,000)
---------------- --------------
Total loans, net 578,754,000 423,502,000
Premises and equipment, net 9,557,000 4,119,000
Accrued interest receivable 2,811,000 2,758,000
Other assets 8,804,000 3,808,000
--------------- --------------
Total assets $ 698,682,000 $ 512,746,000
=============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 43,162,000 $ 27,368,000
Interest-bearing 525,915,000 398,372,000
--------------- --------------
Total 569,077,000 425,740,000
Securities sold under agreements to repurchase 36,485,000 32,151,000
Other borrowed money 239,000 57,000
Accrued expenses and other liabilities 5,418,000 6,944,000
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,000,000 16,000,000
--------------- --------------
Total liabilities 627,219,000 480,892,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value; 9,000,000 shares
authorized; 5,147,791 and 2,596,102 shares issued
and outstanding at December 31, 2001 and 2000 69,406,000 29,936,000
Retained earnings 1,649,000 1,628,000
Accumulated other comprehensive income 408,000 290,000
--------------- --------------
Total shareholders' equity 71,463,000 31,854,000
--------------- --------------
Total liabilities and shareholders' equity $ 698,682,000 $ 512,746,000
=============== ==============
See accompanying notes to consolidated financial statements.
F-23
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2001, 2000 and 1999
2001 2000 1999
---- ---- ----
Interest income
Loans, including fees $ 39,852,000 $ 33,057,000 $ 20,410,000
Investment securities 4,217,000 3,206,000 1,925,000
Federal funds sold 546,000 567,000 406,000
Short-term investments 4,000 5,000 26,000
-------------- ------------- --------------
Total interest income 44,619,000 36,835,000 22,767,000
Interest expense
Deposits 25,437,000 21,619,000 12,040,000
Short-term borrowings 1,186,000 1,369,000 835,000
Long-term borrowings 1,578,000 1,572,000 455,000
-------------- ------------- --------------
Total interest expense 28,201,000 24,560,000 13,330,000
-------------- ------------- --------------
NET INTEREST INCOME 16,418,000 12,275,000 9,437,000
Provision for loan losses 2,370,000 1,854,000 1,961,000
-------------- ------------- --------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 14,048,000 10,421,000 7,476,000
Noninterest income
Service charges on accounts 529,000 346,000 202,000
Letter of credit fees 379,000 391,000 267,000
Mortgage loan referral fees 401,000 175,000 208,000
Gain on sale of loans 0 50,000 13,000
Gain (loss) on sale of securities 207,000 (275,000) 0
Interest rate swap termination fee 0 275,000 0
Other income 363,000 230,000 157,000
-------------- ------------- --------------
Total noninterest income 1,879,000 1,192,000 847,000
Noninterest expense
Salaries and benefits 5,712,000 4,274,000 3,256,000
Occupancy 627,000 510,000 413,000
Furniture and equipment 514,000 440,000 350,000
Data processing 446,000 435,000 335,000
Advertising 248,000 197,000 158,000
Other expense 1,907,000 1,659,000 1,376,000
-------------- ------------- --------------
Total noninterest expenses 9,454,000 7,515,000 5,888,000
-------------- ------------- --------------
INCOME BEFORE FEDERAL INCOME TAX AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 6,473,000 4,098,000 2,435,000
Federal income tax expense 1,990,000 1,303,000 292,000
-------------- ------------- --------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE 4,483,000 2,795,000 2,143,000
Cumulative effect of change in accounting principle
(net of taxes) 0 0 (42,000)
-------------- ------------- --------------
NET INCOME $ 4,483,000 $ 2,795,000 $ 2,101,000
============== ============= ==============
Earnings per share before cumulative effect of change
in accounting principle:
Basic $ 1.17 $ 1.03 $ 0.79
======= ======= =======
Diluted $ 1.15 $ 1.02 $ 0.78
======= ======= =======
Per share cumulative effect of change in accounting principle $ 0.00 $ 0.00 $ 0.02
======= ======= =======
Earnings per share:
Basic $ 1.17 $ 1.03 $ 0.77
======= ======= =======
Diluted $ 1.15 $ 1.02 $ 0.76
======= ======= =======
See accompanying notes to consolidated financial statements.
F-24
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2001, 2000 and 1999
Accumulated
Retained Other Total
Common Earnings Comprehensive Shareholders'
Stock (Deficit) Income/(Loss) Equity
----- --------- ------------- ------
BALANCES, JANUARY 1, 1999 $ 28,182,000 $ (1,514,000) $ 32,000 $ 26,700,000
Comprehensive income:
Net income 2,101,000 2,101,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassification and tax effect (833,000) (833,000)
----------------
Total comprehensive income 1,268,000
--------------- -------------- ------------- ----------------
BALANCES, DECEMBER 31, 1999 28,182,000 587,000 (801,000) 27,968,000
Payment of 5% stock dividend 1,754,000 (1,754,000)
Comprehensive income:
Net income 2,795,000 2,795,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassification and tax effect 1,091,000 1,091,000
----------------
Total comprehensive income 3,886,000
--------------- -------------- ------------- ----------------
BALANCES, DECEMBER 31, 2000 29,936,000 1,628,000 290,000 31,854,000
Sale of 2,306,600 shares of common
stock, net of issuance costs 35,009,000 35,009,000
Payment of 5% stock dividend 4,461,000 (4,462,000) (1,000)
Comprehensive income:
Net income 4,483,000 4,483,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassification and tax effect 118,000 118,000
----------------
Total comprehensive income 4,601,000
--------------- -------------- ------------- ----------------
BALANCES, DECEMBER 31, 2001 $ 69,406,000 $ 1,649,000 $ 408,000 $ 71,463,000
=============== ============== ============= ================
See accompanying notes to consolidated financial statements.
F-25
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2001, 2000 and 1999
2001 2000 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,483,000 $ 2,795,000 $ 2,101,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 651,000 590,000 539,000
Provision for loan losses 2,370,000 1,854,000 1,961,000
Gain on sale of loans 0 (50,000) (13,000)
(Gain)/loss on sale of securities (207,000) 275,000 0
Net change in
Accrued interest receivable (53,000) (915,000) (695,000)
Other assets (5,215,000) (828,000) (2,870,000)
Accrued expenses and other liabilities (1,526,000) 4,325,000 2,118,000
---------------- -------------- ---------------
Net cash from operating activities 503,000 8,046,000 3,141,000
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of:
Securities available for sale (38,542,000) (19,817,000) (17,765,000)
Securities held to maturity (11,555,000) (7,473,000) (7,057,000)
Federal Home Loan Bank stock 0 0 (785,000)
Proceeds from:
Sales of securities available for sale 12,843,000 6,718,000 0
Maturities and repayments of securities
available for sale 19,240,000 3,498,000 6,526,000
Maturities and repayments of securities
held to maturity 102,000 0 0
Loan originations and payments, net (157,622,000) (121,920,000) (123,354,000)
Purchases of premises and equipment, net (5,994,000) (1,099,000) (1,926,000)
---------------- --------------- ----------------
Net cash from investing activities (181,528,000) (140,093,000) (144,361,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 143,337,000 130,912,000 122,831,000
Proceeds from the sale of trust preferred securities 0 0 16,000,000
Net proceeds from sale of common stock 35,009,000 0 0
Fractional shares (1,000) 0 0
Net increase in other borrowed money 182,000 43,000 14,000
Net increase in securities sold under agreements
to repurchase 4,334,000 5,544,000 9,569,000
--------------- -------------- ---------------
Net cash from financing activities 182,861,000 136,499,000 148,414,000
--------------- -------------- ---------------
Net change in cash and cash equivalents 1,836,000 4,452,000 7,194,000
Cash and cash equivalents at beginning of period 18,102,000 13,650,000 6,456,000
--------------- -------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,938,000 $ 18,102,000 $ 13,650,000
=============== ============== ===============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 29,717,000 $ 20,382,000 $ 11,797,000
Federal income tax 2,713,000 1,693,000 1,621,000
Cash received during the year for
Gain on termination of interest rate swap 0 275,000 0
See accompanying notes to consolidated financial statements.
F-26
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of Mercantile Bank Corporation ("Mercantile") and its two wholly-owned
subsidiaries, Mercantile Bank of West Michigan ("Bank"), and its wholly-owned
subsidiaries, Mercantile Bank Mortgage Company ("Mortgage Company") and
Mercantile BIDCO, Inc. ("Mercantile BIDCO"), and MBWM Capital Trust I ("Capital
Trust"), after elimination of significant intercompany transactions and
accounts.
Nature of Operations: Mercantile was incorporated on July 15, 1997 to establish
and own the Bank based in Grand Rapids, Michigan. The Bank is a community-based
financial institution. The Bank began operations on December 15, 1997, after
several months of work by incorporators and employees in preparing applications
with the various regulatory agencies and obtaining insurance and building space.
The Bank's primary deposit products are checking, savings, and term certificate
accounts, and its primary lending products are commercial, residential mortgage,
and installment loans. Substantially all loans are secured by specific items of
collateral including business assets, real estate and consumer assets.
Commercial loans are expected to be repaid from cash flow from operations of
businesses. Real estate loans are secured by both commercial and residential
real estate. The Bank's loan accounts are primarily with customers located in
western Michigan, within Kent County and western Ottawa County. The Bank's
retail deposits are also from customers located in western Michigan. As an
alternative source of funds, the Bank has also issued certificates to depositors
outside of the Bank's primary market area. Substantially all revenues are
derived from banking products and services.
Capital Trust was formed in September 1999. All of the common securities of this
special purpose trust are owned by Mercantile. Capital Trust exists solely to
issue capital securities. For financial reporting purposes, Capital Trust is
reported as a subsidiary and is consolidated into the financial statements of
Mercantile. The capital securities are presented as a separate line item on the
consolidated balance sheet as guaranteed preferred beneficial interests in
Mercantile's subordinated debentures.
Mortgage Company was formed during 2000. A wholly-owned subsidiary of the Bank,
the Mortgage Company was established to increase the profitability and
efficiency of the mortgage loan operations. The Mortgage Company initiated
business on October 24, 2000 via the Bank's contribution of most of its
residential mortgage loan portfolio and participation interests in certain
commercial mortgage loans. On the same date the Bank also transferred its
residential mortgage origination function to the Mortgage Company. Mortgage
loans originated and held by the Mortgage Company are serviced by the Bank
pursuant to a servicing agreement.
On February 7, 2002, Mercantile BIDCO, a wholly-owned subsidiary of the Bank,
was granted a license by the Michigan Office of Financial and Insurance Services
to operate as a Michigan Business and Industrial Development Company, a
non-depository Michigan financial institution. Mercantile BIDCO offers equipment
lease financing, asset based loans, junior debt facilities and other financing
where equity features may be part of the facility pricing.
Mercantile filed an election to become a financial holding company pursuant to
Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board
regulations effective March 23, 2000.
Use of Estimates: To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ. The allowance for loan
losses and the fair values of financial instruments are particularly subject to
change.
(Continued)
F-27
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Cash Flow Reporting: Cash and cash equivalents include cash on hand, demand
deposits with other financial institutions, short-term investments (securities
with daily put provisions) and federal funds sold. Cash flows are reported net
for customer loan and deposit transactions, interest-bearing time deposits with
other financial institutions and short-term borrowings with maturities of 90
days or less.
Securities: Securities classified as held to maturity are carried at amortized
cost when management has the positive intent and ability to hold them to
maturity. Securities available for sale consist of those securities which might
be sold prior to maturity due to changes in interest rates, prepayment risks,
yield and availability of alternative investments, liquidity needs or other
factors. Securities classified as available for sale are reported at fair value
with unrealized holding gains or losses reported in other comprehensive income.
Other securities such as Federal Home Loan Bank stock are carried at cost.
Premiums and discounts on securities are recognized in interest income using the
interest method over the estimated life of the security. Gains and losses on the
sale of securities available for sale are determined based upon amortized cost
of the specific security sold. Securities are written down to fair value when a
decline in fair value is not temporary.
Loans: Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at the principal
balance outstanding, net of deferred loan fees and costs and an allowance for
loan losses. Interest income is reported on the interest method and includes
amortization of net deferred loan fees and costs over the loan term. Interest
income is not reported when full loan repayment is in doubt, typically when the
loan is impaired or payments are past due over 90 days. Payments received on
such loans are reported as principal reductions.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision for
loan 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, but the entire allowance is available
for any loan that, in management's judgment, should be charged-off. Loan losses
are charged against the allowance when management believes the uncollectibility
of a loan balance is confirmed.
A loan is impaired when full payment under the loan 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 is impaired, a portion of the
allowance is allocated so that the loan is reported, net, at the present value
of estimated future cash flows using the loan's existing rate or at the fair
value of collateral if repayment is expected solely from the collateral. Loans
are evaluated for impairment when payments are delayed, typically 90 days or
more, or when the internal grading system indicates a doubtful classification.
Premises and Equipment: Premises and equipment are stated at cost less
accumulated depreciation. Depreciation is computed using both straight-line and
accelerated methods over the estimated useful lives of the respective assets.
Maintenance, repairs and minor alterations are charged to current operations as
expenditures occur and major improvements are capitalized.
(Continued)
F-28
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Cumulative Effect of Change in Accounting Principle: In 1998, the Accounting
Standards Executive Committee (AcSEC) of the American Institute of Certified
Public Accountants promulgated Statement of Position (SOP) 98-5. This SOP
provides guidance on the financial reporting of start-up costs and organization
costs. It requires cost of start-up activities and organization costs to be
expensed as incurred. Initial application of this SOP should be reported as a
cumulative effect of a change in accounting principle. Mercantile elected to
adopt the provisions of SOP 98-5 on January 1, 1999. Included in the December
31, 1999 Consolidated Statement of Income is a charge to operations of $42,000
reported as a cumulative effect of change in accounting principle.
Long-term Assets: Premises and equipment and other long-term assets are reviewed
for impairment when events indicate their carrying amount may not be recoverable
from future undiscounted cash flows. If impaired, the assets are recorded at
discounted amounts. Issuance costs of trust preferred securities are amortized
over the term of the securities.
Repurchase Agreements: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged to cover
these liabilities, which are not covered by federal deposit insurance.
Stock Compensation: Employee compensation expense under stock option plans is
reported if options are granted below market price at grant date. Pro forma
disclosures of net income and earnings per share are shown using the fair value
method of SFAS No. 123 to measure expense for options granted using an option
pricing model to estimate fair value.
Income Taxes: Income tax expense is the total of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax amounts for the temporary
differences between the carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.
Financial Instruments: Financial instruments include off-balance-sheet credit
instruments, such as commitments to make loans and standby letters of credit,
issued to meet customer financing needs. The face amount for these items
represents the exposure to loss, before considering customer collateral or
ability to repay. Such financials instruments are recorded when they are funded.
Interest Rate Hedge Agreements: Mercantile may enter into interest rate hedge
agreements which involve the exchange of fixed and floating rate interest
payments over the life of the agreement without the exchange of the underlying
principal amounts. The differential to be paid or received is accrued as
interest rates change and is recognized over the life of the agreements as an
adjustment to interest income.
Fair Values of Financial Instruments: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed separately. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments and
other factors, especially in the absence of broad markets for particular items.
Changes in assumptions or in market conditions could significantly affect the
estimates. The fair value estimates of existing on- and off-balance sheet
financial instruments does not include the value of anticipated future business
or the values of assets and liabilities not considered financial instruments.
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. Earnings per share are restated for all stock dividends, including the
5% stock dividend paid on February 1, 2002 and February 1, 2001. The fair value
of shares issued in stock dividends is transferred from retained earnings to
common stock.
(Continued)
F-29
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale which are also recognized as separate
components of equity.
New Accounting Pronouncements: A new accounting standard requires all business
combinations to be recorded using the purchase method of accounting for any
transaction initiated after June 30, 2001. Under the purchase method, all
identifiable tangible and intangible assets and liabilities of the acquired
company must be recorded at fair value at date of acquisition, and the excess of
cost over fair value of net assets acquired is recorded as goodwill.
Identifiable intangible assets must be separated from goodwill. Identifiable
intangible assets with finite useful lives will be amortized under the new
standard, whereas goodwill, both amounts previously recorded and future amounts
purchased, will cease being amortized starting in 2002. Annual impairment
testing will be required for goodwill with impairment being recorded if the
carrying amount of goodwill exceeds its implied fair value. Adoption of this
standard on January 1, 2002 did not have a material effect on Mercantile's
financial statements.
Reclassifications: Some items in the prior year financial statements were
reclassified to conform to the current presentation.
Derivatives: All derivative instruments are recorded at their fair values. If
derivative instruments are designated as hedges of fair values, both the change
in the fair value of the hedge and the hedged item are included in current
earnings. Fair value adjustments related to cash flow hedges are recorded in
other comprehensive income and reclassified to earnings when the hedged
transaction is reflected in earnings. Ineffective portions of hedges are
reflected in earnings as they occur.
Operating Segments: While Mercantile's chief decision-makers monitor the revenue
streams of the various products and services offered, the identifiable segments
are not material and operations are managed and financial performance is
evaluated on a company-wide basis. Accordingly, all of Mercantile's financial
service operations are considered by management to be aggregated in one
reportable operating segment.
(Continued)
F-30
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 2 - SECURITIES
The amortized cost and fair values of securities at year-end were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Values
---- ----- ------ ------
AVAILABLE FOR SALE
2001
- ----
U.S. Government agency
debt obligations $ 972,000 $ 10,000 $ 0 $ 982,000
Mortgage-backed securities 49,964,000 778,000 (183,000) 50,559,000
Municipal revenue bonds 500,000 13,000 0 513,000
--------------- ------------ ------------- ----------------
$ 51,436,000 $ 801,000 $ (183,000) $ 52,054,000
=============== ============ ============== ================
2000
- ----
U.S. Government agency
debt obligations $ 9,800,000 $ 137,000 $ (60,000) $ 9,877,000
Mortgage-backed securities 33,908,000 475,000 (117,000) 34,266,000
Municipal revenue bonds 1,000,000 5,000 0 1,005,000
--------------- ------------ ------------- ----------------
$ 44,708,000 $ 617,000 $ (177,000) $ 45,148,000
=============== ============ ============= ================
Gross Gross
Amortized Unrecognized Unrecognized Fair
Cost Gains Losses Values
---- ----- ------ ------
HELD TO MATURITY
2001
- ----
Municipal general obligation bonds $ 21,686,000 $ 471,000 $ (246,000) $ 21,911,000
Municipal revenue bonds 4,293,000 37,000 (58,000) 4,272,000
--------------- ------------ ------------- ----------------
$ 25,979,000 $ 508,000 $ (304,000) $ 26,183,000
=============== ============ ============= ================
2000
- ----
Municipal general obligation bonds $ 13,065,000 $ 394,000 $ (1,000) $ 13,458,000
Municipal revenue bonds 1,459,000 30,000 (5,000) 1,484,000
--------------- ------------ ------------ ----------------
$ 14,524,000 $ 424,000 $ (6,000) $ 14,942,000
=============== ============ ============ ================
The amortized cost and fair values of debt securities at year-end 2001, by
contractual maturity, are shown below. The contractual maturity is utilized
below for U.S. Government agency debt obligations and municipal bonds. Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties. Securities not due at a single maturity date, primarily mortgage
backed securities, are shown separately.
(Continued)
F-31
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 2 - SECURITIES (Continued)
--------------Held-to-Maturity-------------- -----------Available-for-Sale------------
Weighted Weighted
Average Amortized Fair Average Amortized Fair
Yield Cost Value Yield Cost Value
----- ---- ----- ----- ---- -----
Due in one year or less 8.78% $ 951,000 $ 960,000 6.50% $ 500,000 $ 513,000
Due from one to five years 6.60 3,269,000 3,391,000 NA 0 0
Due from five to ten years 6.70 6,530,000 6,660,000 NA 0 0
Due after ten years 6.98 15,229,000 15,172,000 6.55 972,000 982,000
Mortgage-backed NA 0 0 6.41 49,964,000 50,559,000
-------------- -------------- ------------- --------------
6.93 $ 25,979,000 $ 26,183,000 6.41 $ 51,436,000 $ 52,054,000
============== ============== ============= ==============
During 2001, securities with an aggregate amortized cost basis of $12.8 million
were sold, resulting in an aggregate realized gain of $234,000 and an aggregate
realized loss of $27,000. During 2000, securities with an aggregate amortized
cost basis of $6.7 million were sold, resulting in an aggregate realized loss of
$275,000. There were no sales of securities during 1999.
At year-end 2001 and 2000, the amortized cost of securities issued by the state
of Michigan and all its political subdivisions totaled $26.0 million and $14.5
million, with an estimated market value of $26.2 million and $14.9 million,
respectively. Total securities of any one specific issuer did not exceed 10% of
shareholders' equity.
The carrying value of securities that are pledged to secure securities sold
under agreements to repurchase and other deposits was $49.5 million and $40.0
million at December 31, 2001 and 2000, respectively.
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
Year-end loans are as follows:
Percent
December 31, 2001 December 31, 2000 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Real Estate:
Construction and land
development $ 62,710,000 10.6% $ 38,815,000 9.0% 61.6%
Secured by 1 - 4
family properties 41,028,000 7.0 33,709,000 7.8 21.7
Secured by multi-
family properties 1,107,000 0.2 2,127,000 0.5 (48.0)
Secured by nonfarm
nonresidential properties 269,855,000 46.0 197,018,000 45.9 37.0
Commercial 205,839,000 35.1 151,344,000 35.2 36.0
Consumer 6,709,000 1.1 6,791,000 1.6 (1.2)
--------------- ------ --------------- ------- -------
$ 587,248,000 100.0% $ 429,804,000 100.0% 100.0%
=============== ====== =============== ======= ======
(Continued)
F-32
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
Activity in the allowance for loan losses is as follows:
2001 2000 1999
---- ---- ----
Beginning balance $ 6,302,000 $ 4,620,000 $ 2,765,000
Provision for loan losses 2,370,000 1,854,000 1,961,000
Charge-offs (252,000) (185,000) (109,000)
Recoveries 74,000 13,000 3,000
--------------- --------------- ----------------
Ending balance $ 8,494,000 $ 6,302,000 $ 4,620,000
=============== =============== ================
Impaired loans were as follows:
2001 2000
---- ----
Year-end loans with no allocated allowance for loan losses $ 80,000 $ 0
Year-end loans with allocated allowance for loan losses 1,302,000 95,000
--------------- ----------------
$ 1,382,000 $ 95,000
=============== ================
Amount of the allowance for loan losses allocated $ 320,000 $ 20,000
Average of impaired loans during the year 364,000 139,000
The Bank did not recognize any interest income on impaired loans during 2001,
2000 or 1999.
Concentrations within the loan portfolio were as follows at year-end:
2 0 0 1 2 0 0 0
------- -------
Percentage of Percentage of
Balance Loan Portfolio Balance Loan Portfolio
------- -------------- ------- --------------
Commercial real estate loans to
lessors of non-residential
buildings $ 81,822,000 13.9% $ 62,089,000 14.4%
NOTE 4 - PREMISES AND EQUIPMENT - NET
Year-end premises and equipment are as follows:
2001 2000
---- ----
Land and improvements $ 1,970,000 $ 1,135,000
Buildings and leasehold improvements 5,975,000 2,349,000
Furniture and equipment 3,119,000 1,586,000
--------------- ----------------
11,064,000 5,070,000
Less: accumulated depreciation 1,507,000 951,000
--------------- ----------------
$ 9,557,000 $ 4,119,000
=============== ================
Depreciation expense in 2001, 2000 and 1999 totaled $556,000, $441,000 and
$323,000, respectively.
(Continued)
F-33
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 5 - DEPOSITS
Deposits at year-end are summarized as follows:
Percent
December 31, 2001 December 31, 2000 Increase/
----------------- -----------------
Balance % Balance % (Decrease)
------- - ------- - ----------
Noninterest-bearing
demand $ 43,162,000 7.6% $ 27,368,000 6.4% 57.7%
Interest-bearing
checking 22,188,000 3.9 12,968,000 3.1 71.1
Money market 5,578,000 1.0 5,196,000 1.2 7.4
Savings 47,157,000 8.3 36,331,000 8.6 29.8
Time, under $100,000 6,144,000 1.1 6,165,000 1.4 (0.3)
Time, $100,000 and
over 52,601,000 9.2 38,682,000 9.1 36.0
---------------- -------- ---------------- ------- --------
176,830,000 31.1 126,710,000 29.8 39.6
Out-of-area time,
under $100,000 83,789,000 14.7 55,260,000 13.0 51.6
Out-of-area time,
$100,000 and over 308,458,000 54.2 243,770,000 57.2 26.5
---------------- -------- ---------------- ------- --------
392,247,000 68.9 299,030,000 70.2 31.2
---------------- -------- ---------------- ------- --------
$ 569,077,000 100.0% $ 425,740,000 100.0% 33.7%
================ ======== ================ ======= ========
Out-of-area certificates of deposit consist of certificates obtained from
depositors outside of the primary market area. As of December 31, 2001,
out-of-area certificates of deposit totaling $375.5 million were obtained
through deposit brokers, with the remaining $16.7 million obtained directly from
the depositors.
The following table depicts the maturity distribution for time deposits at
year-end.
2001 2000
---- ----
In one year $ 289,176,000 $ 291,074,000
In two years 107,469,000 49,585,000
In three years 45,386,000 3,196,000
In four years 77,000 22,000
In five years 8,884,000 0
-------------- ---------------
$ 450,992,000 $ 343,877,000
============== ===============
The following table depicts the maturity distribution for certificates of
deposit with balances of $100,000 or more at year-end.
2001 2000
---- ----
Up to three months $ 90,156,000 $ 64,939,000
Three months to six months 69,947,000 65,613,000
Six months to twelve months 68,981,000 107,354,000
Over twelve months 131,975,000 44,546,000
-------------- ---------------
$ 361,059,000 $ 282,452,000
============== ===============
(Continued)
F-34
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 6 - SHORT-TERM BORROWINGS
Information relating to short-term borrowings, comprised entirely of securities
sold under agreements to repurchase, at year-end is summarized below:
2001 2000
---- ----
Outstanding balance at year-end $ 36,485,000 $ 32,151,000
Weighted average interest rate at year-end 2.21% 4.63%
Average daily balance during the year 34,596,000 29,191,000
Weighted average interest rate during the year 3.42% 4.66%
Maximum month end balance during the year 40,587,000 35,473,000
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 repurchase agreements are
recorded as assets of the Bank and are primarily held in safekeeping by
correspondent banks. Repurchase agreements are offered principally to certain
large deposit customers as uninsured deposit equivalent investments.
NOTE 7 - FEDERAL INCOME TAXES
The consolidated provision for income taxes is as follows:
2001 2000 1999
---- ---- ----
Current $ 2,838,000 $ 1,913,000 $ 1,821,000
Deferred benefit (848,000) (610,000) (637,000)
Change in valuation allowance 0 0 (892,000)
-------------- -------------- ---------------
Tax expense $ 1,990,000 $ 1,303,000 $ 292,000
============== ============== ===============
Income tax expense was less than the amount computed by applying the statutory
federal income tax rate to income before income taxes. The reasons for the
difference are as follows:
2001 2000 1999
---- ---- ----
Statutory rates $ 2,201,000 $ 1,393,000 $ 828,000
Increase (decrease) from
Tax-exempt interest (264,000) (110,000) (15,000)
Valuation allowance 0 0 (527,000)
Other expenses 53,000 20,000 6,000
-------------- -------------- ---------------
Tax expense $ 1,990,000 $ 1,303,000 $ 292,000
============== ============== ===============
(Continued)
F-35
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 7 - FEDERAL INCOME TAXES (Continued)
The net deferred tax asset recorded includes the following amounts of deferred
tax assets and liabilities:
2001 2000
---- ----
Deferred tax assets
Allowance for loan losses $ 2,780,000 $ 2,023,000
Start-up/pre-opening expenses 34,000 60,000
Deferred loan fees 171,000 91,000
Deferred compensation 82,000 19,000
Other 20,000 0
-------------- ---------------
3,087,000 2,193,000
Deferred tax liabilities
Unrealized gain on securities available for sale 210,000 154,000
Accretion 12,000 8,000
Depreciation 71,000 30,000
-------------- ---------------
293,000 192,000
-------------- ---------------
Net deferred tax asset $ 2,794,000 $ 2,001,000
============== ===============
A valuation allowance related to deferred tax assets is required when it is
considered more likely than not that all or part of the benefits related to such
assets will not be realized. Management has determined that no valuation
allowance was required at year-end 2001 or 2000.
NOTE 8 - STOCK OPTION PLANS
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. The stock options granted to
the non-employee directors are subject to approval of the Independent Director
Stock Option Plan by Mercantile shareholders at the April 18, 2002 annual
meeting. 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. At year-end 2001, there were 124,942 shares authorized for
future option grants. Information about option grants follows.
Weighted
Average
Number of Exercise
Options Price
------- -----
Outstanding, beginning of 1999 134,222 $ 10.43
Granted 0 0.00
--------- --------
Outstanding, end of 1999 134,222 10.43
Granted 40,613 10.68
--------- --------
Outstanding, end of 2000 174,835 10.49
Granted 44,098 16.50
--------- --------
Outstanding, end of 2001 218,933 $ 11.70
========= ========
Options exercisable are as follows:
Options exercisable at December 31, 1999 83,140 $ 9.76
Options exercisable at December 31, 2000 119,891 10.20
Options exercisable at December 31, 2001 168,553 10.47
(Continued)
F-36
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 8 - STOCK OPTION PLAN (Continued)
2001 2000 1999
---- ---- ----
Minimum exercise price $ 9.07 $ 9.07 $ 9.52
Maximum exercise price 19.86 12.36 12.98
Average remaining option term 7.3 Years 7.6 Years 8.0 Years
Estimated fair value of stock options granted: $ 363,000 $ 155,000
Assumptions used:
Risk-free interest rate 4.58% 5.99%
Expected option life 10 Years 10 Years
Expected stock volatility 32% 37%
Expected dividends 0% 0%
SFAS No. 123, Accounting for Stock Based Compensation, requires proforma
disclosures for companies that do not adopt its fair value accounting method for
stock-based employee compensation. The following proforma information presents
net income and basic and diluted earnings per share had the fair value been used
to measure compensation cost for stock option plans. No compensation cost was
actually recognized for stock options.
2001 2000 1999
---- ---- ----
Pro-forma income, assuming SFAS 123 fair
value method was used for stock options:
Income before cumulative effect of
change in accounting principle $ 4,221,000 $ 2,681,000 $ 2,020,000
Basic earnings per share before cumulative
effect of change in accounting principle 1.10 0.98 0.74
Diluted earnings per share before cumulative
effect of change in accounting principle 1.09 0.98 0.73
Net income $ 4,221,000 $ 2,681,000 $ 1,978,000
Basic earnings per share 1.10 0.98 0.73
Diluted earnings per share 1.09 0.98 0.72
NOTE 9 - RELATED PARTIES
Certain directors and executive officers of the Bank, including their immediate
families and companies in which they are principal owners, were loan customers
of the Bank. At year-end 2001 and 2000, the Bank had $7.9 million and $7.1
million in loan commitments to directors and executive officers, of which $3.3
million and $3.9 million were outstanding at year-end 2001 and 2000,
respectively, as reflected in the following table.
2001 2000
---- ----
Beginning balance $ 3,914,000 $ 5,063,000
New loans 1,215,000 2,035,000
Repayments (1,806,000) (3,184,000)
--------------- ---------------
Ending balance $ 3,323,000 $ 3,914,000
============== ===============
Related party deposits and repurchase agreements totaled $13.9 million at
year-end 2001 and $13.2 million at year-end 2000.
(Continued)
F-37
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 10 - COMMITMENTS AND OFF-BALANCE-SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. Loan commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized, if any, in the balance sheet. The Bank's maximum
exposure to loan loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual notional amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. Collateral, such as
accounts receivable, securities, inventory, property and equipment, is generally
obtained based on management's credit assessment of the borrower.
Fair value of the Bank's off-balance sheet instruments (commitments to extend
credit and standby letters of credit) is based on rates currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing. At year-end 2001 and 2000,
the rates on existing off-balance sheet instruments were substantially
equivalent to current market rates, considering the underlying credit standing
of the counterparties.
The Bank's maximum exposure to credit losses for loan commitments and standby
letters of credit outstanding at year-end was as follows:
2001 2000
---- ----
Commercial unused lines of credit $ 110,787,000 $ 87,121,000
Unused lines of credit secured by 1 - 4 family
residential properties 8,181,000 7,641,000
Credit card unused lines of credit 6,212,000 4,578,000
Other consumer unused lines of credit 3,965,000 2,062,000
Commitments to make loans 25,966,000 20,111,000
Standby letters of credit 36,377,000 36,889,000
----------------- -----------------
$ 191,488,000 $ 158,402,000
================= =================
Mercantile was required to have $1,137,000 and $689,000 of cash on hand or on
deposit with the Federal Reserve Bank of Chicago to meet regulatory reserve and
clearing requirements at year-end 2001 and 2000. These balances do not earn
interest.
The Bank leases its downtown Grand Rapids facility under an operating lease
agreement. Total rental expense for the lease for 2001, 2000 and 1999 was
$165,000, $161,000 and $156,000, respectively. Future minimum rentals under this
lease, which expires on August 31, 2007, as of year-end 2001 are as follows:
2002 $ 169,000
2003 169,000
2004 169,000
2005 169,000
2006 169,000
Thereafter 112,000
-----------------
$ 957,000
=================
(Continued)
F-38
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 11 - BENEFIT PLANS
Mercantile has a 401(k) benefit plan that covers substantially all of its
employees. Mercantile's 2001, 2000 and 1999 matching 401(k) contribution charged
to expense was $173,000, $136,000 and $85,000, respectively. The percent of
Mercantile's matching contributions to the 401(k) is determined annually by the
Board of Directors. During 1999, the 401(k) benefit plan allowed employee
contributions up to 15% of their compensation, which are matched at 100% of the
first 4% of the compensation contributed. Matching contributions are immediately
vested. The 401(k) benefit plan was amended, effective January 1, 2000, to
increase the employer match from 4% of compensation contributed to 5%.
Mercantile has a deferred compensation plan in which all persons serving on the
Board of Directors may defer all or portions of annual retainer and meeting
fees, with distributions to be paid only upon termination of service as a
director. The deferred amounts are categorized on Mercantile's financial
statements as long term borrowings. Up until September 30, 2001, the deferred
balances were paid interest at a rate equal to 75% of the prime rate, adjusted
at the beginning of each calendar quarter. The deferred compensation plan was
amended, effective October 1, 2001, to increase the interest rate from 75% of
the prime rate to 100% of the prime rate. Interest expense for the plan during
2001, 2000 and 1999 was $6,000, $2,000 and $1,000, respectively.
Mercantile has a non-qualified deferred compensation program in which selected
officers may defer all or portions of salary and bonus payments. The deferred
amounts are categorized on Mercantile's financial statements as long term
borrowings. The deferred balances are paid interest as a rate equal to the prime
rate, adjusted at the beginning of each calendar quarter. Interest expense for
the plan during 2001 was $2,000.
NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as
follows at year-end.
2 0 0 1 2 0 0 0
------- -------
Carrying Fair Carrying Fair
Values Values Values Values
------ ------ ------ ------
Financial assets
Cash and cash equivalents $ 19,938,000 $ 19,938,000 $ 18,102,000 $ 18,102,000
Securities available for sale 52,054,000 52,054,000 45,148,000 45,148,000
Securities held to maturity 25,979,000 26,183,000 14,524,000 14,942,000
Federal Home Loan Bank stock 785,000 785,000 785,000 785,000
Loans, net 578,754,000 602,442,000 423,502,000 424,690,000
Accrued interest receivable 2,811,000 2,811,000 2,758,000 2,758,000
Financial liabilities
Deposits 569,077,000 576,575,000 425,740,000 424,359,000
Securities sold under agreements
to repurchase 36,485,000 36,485,000 32,151,000 32,151,000
Accrued interest payable 4,618,000 4,618,000 6,134,000 6,134,000
Guaranteed preferred beneficial
interests in the Corporation's
subordinated debentures 16,000,000 18,874,000 16,000,000 11,528,000
(Continued)
F-39
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Carrying amount is the estimated fair value for cash and cash equivalents,
Federal Home Loan Bank stock, accrued interest receivable and payable, demand
deposits, securities sold under agreements to repurchase, and variable rate
loans or deposits that reprice frequently and fully. Security fair values are
based on market prices or dealer quotes, and if no such information is
available, on the rate and term of the security and information about the
issuer. For fixed rate loans or deposits and for variable rate loans or deposits
with infrequent repricing or repricing limits, fair value is based on discounted
cash flows using current market rates applied to the estimated life and credit
risk. Fair value of guaranteed preferred beneficial interests in the
Corporation's subordinated debentures is based on current rates for similar
financing. Fair value of off balance sheet items is estimated to be nominal.
NOTE 13 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow.
2001 2000 1999
---- ---- ----
Basic
Net income $ 4,483,000 $ 2,795,000 $ 2,101,000
============== ============= ==============
Weighted average common shares outstanding 3,831,402 2,725,907 2,725,907
-------------- ------------- --------------
Basic earnings per common share $ 1.17 $ 1.03 $ 0.77
============== ============= ==============
Diluted
Net income $ 4,483,000 $ 2,795,000 $ 2,101,000
============== ============= ==============
Weighted average common shares outstanding for
basic earnings per common share 3,831,402 2,725,907 2,725,907
Add: Dilutive effects of assumed exercises of
stock options 58,075 7,680 32,297
-------------- ------------- --------------
Average shares and dilutive potential
common shares 3,889,475 2,733,588 2,758,206
============== ============= ==============
Diluted earnings per common share $ 1.15 $ 1.02 $ 0.76
============== ============= ==============
Stock options for 44,098 and 102,071 shares of common stock were not considered
in computing diluted earnings per common share for 2001 and 2000, respectively,
because they were antidilutive. There were no antidilutive shares in 1999.
(Continued)
F-40
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 14 - TRUST PREFERRED SECURITIES
Capital Trust, a business trust subsidiary of Mercantile, sold 1.6 million
Cumulative Preferred Securities ("trust preferred securities") at $10.00 per
trust preferred security in a September 1999 offering. The proceeds from the
sale of the trust preferred securities were used by MBWM Capital Trust I to
purchase an equivalent amount of subordinated debentures from Mercantile. The
trust preferred securities carry a fixed rate of 9.60%, have a stated maturity
of 30 years, and, in effect, are guaranteed by Mercantile. The securities are
redeemable at par after 5 years. Distributions on the trust preferred securities
are payable quarterly on January 15, April 15, July 15 and October 15. The first
distribution was paid on October 15, 1999. Under certain circumstances,
distributions may be deferred for up to 20 calendar quarters. However, during
any such deferrals, interest accrues on any unpaid distributions at the rate of
9.60% per annum. The trust preferred securities are carried on Mercantile's
consolidated balance sheet as a liability, and the interest expense is recorded
on Mercantile's consolidated statement of income.
NOTE 15 - SALE OF COMMON STOCK
During 2001, Mercantile sold in aggregate approximately 2.3 million shares of
common stock, raising $35.0 million net of issuance costs. Substantially all of
the net proceeds were contributed to the Bank as capital to provide support for
asset growth, fund investments in loans and securities and for general corporate
purposes.
NOTE 16 - REGULATORY MATTERS
Mercantile and the Bank are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and other
factors, and the regulators can lower classifications in certain cases. Failure
to meet various capital requirements can initiate regulatory action that could
have a direct material effect on the financial statements.
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.
(Continued)
F-41
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 16 - REGULATORY MATTERS (Continued)
At year end, actual capital levels (in thousands) and minimum required levels
for Mercantile and the Bank 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
------ ----- ------ ----- ------ -----
2001
- ----
Total capital (to risk
weighted assets)
Consolidated $ 95,430 14.3% $ 53,584 8.0% $ 66,980 10.0%
Bank 92,683 13.9 53,404 8.0 66,754 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 87,057 13.0 26,797 4.0 40,195 6.0
Bank 84,337 12.6 26,708 4.0 40,062 6.0
Tier 1 capital (to average
assets)
Consolidated 87,057 13.0 26,786 4.0 33,482 5.0
Bank 84,337 12.6 26,722 4.0 33,403 5.0
2000
- ----
Total capital (to risk
weighted assets)
Consolidated $ 53,685 11.0% $ 39,163 8.0% $ 48,953 10.0%
Bank 51,596 10.6 39,017 8.0 48,771 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 42,085 8.6 19,589 4.0 29,383 6.0
Bank 45,497 9.3 19,517 4.0 29,275 6.0
Tier 1 capital (to average
assets)
Consolidated 42,085 8.6 19,601 4.0 24,502 5.0
Bank 45,497 9.3 19,528 4.0 24,410 5.0
The Bank was categorized as well capitalized at year-end 2001 and 2000.
Federal and state banking laws and regulations place certain restrictions on the
amount of dividends the Bank can transfer to Mercantile and on the capital
levels that must be maintained. At year-end 2001, under the most restrictive of
these regulations (to remain well capitalized), the Bank could distribute
approximately $5.9 million to Mercantile as dividends without prior regulatory
approval.
The capital levels as of year-end 2001 and year-end 2000 include an adjustment
for the 1.6 million trust preferred securities issued by Capital Trust in
September 1999 subject to certain limitations. Federal Reserve guidelines limit
the amount of trust preferred securities which can be included in Tier 1 capital
of Mercantile to 25% of total Tier 1 capital. At year-end 2001, all $16.0
million of the trust preferred securities were included at Tier 1 capital of
Mercantile. At year-end 2000, $10.5 million of the $16.0 million of the trust
preferred securities were included as Tier 1 capital of Mercantile, with the
remaining $5.5 million included as Tier 2 capital, a component of risk-based
capital.
(Continued)
F-42
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 17 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows.
2001 2000 1999
---- ---- ----
Unrealized holding gains and losses on $ 386,000 $ 1,379,000 $ (1,263,000)
available-for-sale securities
Reclassification adjustments for gains
and losses later recognized in income (207,000) 275,000 0
--------------- --------------- --------------
Net unrealized gains and losses 179,000 1,654,000 (1,263,000)
Tax effect (61,000) (563,000) 430,000
--------------- --------------- --------------
Other comprehensive income (loss) $ 118,000 $ 1,091,000 $ (833,000)
============== =============== ==============
NOTE 18 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Income Before Earnings per Share
Cumulative Effect of Before Cumulative Effect of
Interest Net Interest Change in Accounting Net Change in Accounting Principle
Income Income Principle Income Basic Diluted
------ ------ --------- ------ ----- -------
2001
- ----
First quarter $10,856,000 $ 3,462,000 $ 915,000 $ 915,000 $ 0.32 $ 0.32
Second quarter 11,011,000 3,698,000 777,000 777,000 0.24 0.24
Third quarter 11,530,000 4,352,000 1,338,000 1,338,000 0.31 0.30
Fourth quarter 11,222,000 4,906,000 1,453,000 1,453,000 0.30 0.29
2000
- ----
First quarter $ 7,864,000 $ 2,797,000 $ 500,000 $ 500,000 $ 0.18 $ 0.18
Second quarter 8,848,000 3,004,000 636,000 636,000 0.24 0.24
Third quarter 9,741,000 3,133,000 778,000 778,000 0.29 0.29
Fourth quarter 10,382,000 3,341,000 881,000 881,000 0.32 0.31
1999
- ----
First quarter $ 4,532,000 $ 1,930,000 $ 394,000 $ 352,000 $ 0.14 $ 0.14
Second quarter 5,212,000 2,265,000 504,000 504,000 0.18 0.18
Third quarter 6,111,000 2,591,000 562,000 562,000 0.21 0.21
Fourth quarter 6,912,000 2,651,000 683,000 683,000 0.26 0.25
(Continued)
F-43
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 19 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company only financial statements.
CONDENSED BALANCE SHEETS
2001 2000
---- ----
ASSETS
Cash and cash equivalents $ 626,000 $ 627,000
Investment in subsidiaries 85,250,000 46,292,000
Other assets 2,462,000 1,800,000
--------------- ----------------
Total assets $ 88,338,000 $ 48,719,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 380,000 $ 370,000
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,495,000 16,495,000
Shareholders' equity 71,463,000 31,854,000
--------------- ----------------
Total liabilities and shareholders' equity $ 88,338,000 $ 48,719,000
=============== ================
CONDENSED STATEMENTS OF INCOME
2001 2000 1999
---- ---- ----
Income
Dividends from subsidiaries $ 1,583,000 $ 1,583,000 $ 123,000
Other 22,000 30,000 33,000
-------------- ------------- --------------
Total income 1,605,000 1,613,000 156,000
Expenses
Interest expense 1,617,000 1,617,000 468,000
Other operating expenses 543,000 433,000 415,000
-------------- ------------- --------------
Total expenses 2,160,000 2,050,000 883,000
-------------- ------------- --------------
INCOME (LOSS) BEFORE INCOME TAX AND EQUITY IN
UNDISTRIBUTED NET INCOME (LOSS) OF SUBSIDIARIES (555,000) (437,000) (727,000)
Federal income tax expense (benefit) (698,000) (649,000) (420,000)
Equity in undistributed net income of subsidiary 4,340,000 2,583,000 2,408,000
-------------- ------------- --------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE 4,483,000 2,795,000 2,143,000
Cumulative effect of change in accounting principle
(net of applicable taxes) 0 0 (42,000)
-------------- ------------- --------------
NET INCOME $ 4,483,000 $ 2,795,000 $ 2,101,000
============== ============= ==============
(Continued)
F-44
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
NOTE 19 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL
STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
2001 2000 1999
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,483,000 $ 2,795,000 $ 2,101,000
Adjustments to reconcile net income to net
cash from operating activities
Equity in undistributed (income) loss of subsidiary (4,340,000) (2,583,000) (2,408,000)
Capital investment into Mercantile Bank of
West Michigan (34,500,000) 0 (14,828,000)
Change in other assets (662,000) (267,000) (1,451,000)
Change in other liabilities 10,000 12,000 347,000
-------------- ------------- --------------
Net cash from operating activities (35,009,000) (44,000) (16,239,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from sale of common stock 35,009,000 0 0
Fraction shares paid (1,000) 0 0
Proceeds from the sale of trust preferred securities
and issuance of debentures 0 0 16,495,000
Investment in common stock of MBWM Capital Trust I 0 0 (495,000)
-------------- ------------- ---------------
Net cash from financing activities 35,008,000 0 16,000,000
-------------- ------------- --------------
Net change in cash and cash equivalents (1,000) (44,000) (239,000)
Cash and cash equivalents at beginning of period 626,000 671,000 910,000
-------------- ------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 626,000 $ 627,000 $ 671,000
============== ============= ==============
F-45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 February 21, 2002.
MERCANTILE BANK CORPORATION
/s/ Gerald R. Johnson, Jr.
--------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on February 21, 2002.
/s/ Betty S. Burton /s/ Susan K. Jones
- ------------------- ------------------
Betty S. Burton, Director Susan K. Jones, Director
/s/ David M. Cassard /s/ Lawrence W. Larsen
- -------------------- ----------------------
David M. Cassard, Director Lawrence W. Larsen, Director
/s/ Edward J. Clark /s/ Calvin D. Murdock
- ------------------- ---------------------
Edward J. Clark, Director Calvin D. Murdock, Director
/s/ Peter A. Cordes /s/ Michael H. Price
- ------------------- --------------------
Peter A. Cordes, Director Michael H. Price, Director, President and Chief
Operating Officer
/s/ C. John Gill /s/ Dale J. Visser
- ---------------- ------------------
C. John Gill, Director Dale J. Visser, Director
/s/ Doyle A. Hayes /s/ Donald Williams
- ------------------ -------------------
Doyle A. Hayes, Director Donald Williams, Director
/s/ David M. Hecht /s/ Robert M. Wynalda
- ------------------ ---------------------
David M. Hecht, Director Robert M. Wynalda, Director
/s/ Gerald R. Johnson, Jr. /s/ Charles E. Christmas
- -------------------------- ------------------------
Gerald R. Johnson, Jr., Chairman of the Board and Charles E. Christmas, Senior Vice President, Chief
Chief Executive Officer (principal executive officer) 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 Bylaws are incorporated by reference to exhibit 3.2
of our Registration Statement on Form SB-2 (Commission
File No. 333-33081) that became effective on October 23,
1997
10.1 Our 1997 Employee Stock Option Plan is incorporated by
reference to exhibit 10.1 of our Registration Statement
on Form SB-2 (Commission File No. 333-33081) that became
effective on October 23, 1997 (management contract or
compensatory plan)
10.2 Lease Agreement between our bank and Division Avenue
Partners, L.L.C. dated August 16, 1997, is incorporated
by reference to exhibit 10.2 of our Registration
Statement on Form SB-2 (Commission File No. 333-33081)
that became effective October 23, 1997
10.3 Agreement between Fiserve Solution, Inc. and our bank
dated September 10, 1997, is incorporated by reference
to exhibit 10.3 of our Registration Statement on Form
SB-2 (Commission File No. 333-33081) that became
effective on October 23, 1997.
10.4 Agreement between our bank and Visser Brothers
Construction Inc. dated November 16,1998, on modified
Standard Form of Agreement Between Owner and
Construction Manager where the Construction Manager is
also the Constructor, is incorporated by reference to
exhibit 10.4 of our Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1998 (Commission File No.
333-33081)
10.5 Employment Agreement among Gerald R. Johnson, Jr., the
company and our bank dated December 1, 1998, is
incorporated by reference to Exhibit 10.4 of our Annual
Report on Form 10-KSB for the fiscal year ended December
31, 1998 (Commission File No. 333-33081) (management
contract or compensatory plan)
10.6 Employment Agreement among Michael H. Price, the company
and our bank dated December 1, 1998, is incorporated by
reference to Exhibit 10.5 of our Annual Report on Form
10-KSB for the fiscal year ended December 31, 1998
(Commission File No. 333-33081) (management contract or
compensatory plan)
10.7 Mercantile Bank of West Michigan Deferred Compensation
Plan for Members of the Board of Directors (1999) is
incorporated by reference to Exhibit 10.6 of the
Registration Statement of the company and our trust on
Form SB-2 (Commission File Nos. 333-84313 and
333-84313-01) that became effective on September 13,
1999.
10.8 Subordinated Indenture dated as of September 17, 1999
between the company and Wilmington Trust Company, as
Trustee, relating to 9.60% Junior Subordinated
Debentures due 2029 is incorporated by reference to
Exhibit 4.1 of the Registration Statement of the company
and our trust on Form SB-2 (Commission File Nos.
333-84313 and 333-84313-01) that become effective on
September 13, 1999)
10.9 Amended and Restated Trust Agreement dated as of
September 17, 1999 among the company, as depositor,
Wilmington Trust Company, as Property Trustee,
Wilmington Trust Company, as Delaware Trustee, and the
Administrative Trustees is incorporated by reference to
Exhibit 4.5 of the Registration Statement of the company
and our trust on Form SB-2 (Commission File Nos.
333-84313 and 333-84313-01) that became effective on
September 13, 1999
EXHIBIT NO. EXHIBIT DESCRIPTION
10.10 Preferred Securities Guarantee Agreement between the
company and Wilmington Trust Company dated September 17,
1999, is incorporated by reference to Exhibit 4.7 of the
Registration Statement of the company and our trust on
Form SB-2 (Commission File Nos. 333-84313 and
333-84313-01) that became effective on September 13,
1999
10.11 Agreement as to Expenses and Liabilities dated as of
September 17, 1999, between the company and our trust
(included as Exhibit D to Exhibit 10.9)
10.12 Amended and Restated Employment Agreement dated as of
December 31, 1999, among the company, our bank and
Gerald R. Johnson, Jr., is incorporated by reference to
exhibit 10.12 of our Form 10-KSB for the fiscal year
ended December 31, 1999 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.13 Amended and Restated Employment Agreement dated as of
December 31, 1999, among the company, our bank and
Michael H. Price, is incorporated by reference to
exhibit 10.13 of our Form 10-KSB for the fiscal year
ended December 31, 1999 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.14 Mercantile Bank Corporation 2000 Employee Stock Option
Plan, approved by the shareholders at the annual meeting
on April 20, 2000, is incorporated by reference to
exhibit 10.14 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
10.15 Extension Agreement of Data Processing Contract between
Fiserve Solution, Inc. and our bank dated May 12, 2000
extending the agreement between Fiserve Solution, Inc.
and our bank dated September 10, 1997, is incorporated
by reference to exhibit 10.15 of our Form 10-K for the
fiscal year ended December 31, 2000 (Commission File No.
000-26719)
10.16 Amended and Restated Employment Agreement dated as of
October 12, 2000, among the company, our bank and Gerald
R. Johnson, Jr., is incorporated by reference to exhibit
10.16 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.17 Amended and Restated Employment Agreement dated as of
October 12, 2000, among the company, our bank and
Michael H. Price, is incorporated by reference to
exhibit 10.17 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.18 Employment Agreement dated as of October 12, 2000, among
the company, our bank and Robert B. Kaminski, is
incorporated by reference to exhibit 10.18 of our Form
10-K for the fiscal year ended December 31, 2000
(Commission File No. 000-26719) (management contract or
compensatory plan)
10.19 Employment Agreement dated as of October 12, 2000, among
the company, our bank and Charles E. Christmas, is
incorporated by reference to exhibit 10.19 of our Form
10-K for the fiscal year ended December 31, 2000
(Commission File No. 000-26719) (management contract or
compensatory plan)
10.20 Agreement between our bank and C.D. Barnes dated October
28, 2000, on Amendment to Standard Form of Agreement
Between Owner and Construction Manager where the
Construction Manager is also the Constructor, is
incorporated by reference to exhibit 10.20 of our Form
10-K for the fiscal year ended December 31, 2000
(Commission File No. 000-26719)
10.21 Amended and Restated Employment Agreement dated as of
October 18, 2001, among the company, our bank and Gerald
R. Johnson, Jr. (management contract or compensatory
plan)
EXHIBIT NO. EXHIBIT DESCRIPTION
10.22 Amended and Restated Employment Agreement dated as of
October 18, 2001, among the company, our bank and
Michael H. Price (management contract or compensatory
plan)
10.23 Employment Agreement dated as of October 18, 2001, among
the company, our bank and Robert B. Kaminski (management
contract or compensatory plan)
10.24 Employment Agreement dated as of October 18, 2001, among
the company, our bank and Charles E. Christmas
(management contract or compensatory plan)
21 Subsidiaries of the company
23 Consent of Independent Accountants