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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-3360865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5650 BYRON CENTER AVENUE SW, WYOMING, MI 49509
(Address of principal executive offices) (Zip Code)
(616) 406-3777
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
At August 12, 2002, there were 5,148,342 shares of Common Stock outstanding.
1
PART 1. Financial Information Page No.
--------
Item I. Financial Statements
Consolidated Balance Sheets -
June 30, 2002 (Unaudited) and December 31, 2001...................................... 3
Consolidated Statements of Income and Comprehensive Income -
Three and Six Months Ended June 30, 2002 (Unaudited) and
June 30, 2001 (Unaudited)............................................................ 4
Consolidated Statements of Changes in Shareholders Equity -
Six Months Ended June 30, 2002 (Unaudited) and
June 30, 2001 (Unaudited)............................................................ 5
Consolidated Statements of Cash Flows --
Three and Six Months Ended June 30, 2002 (Unaudited) and
June 30, 2001 (Unaudited)............................................................ 6
Notes to Consolidated Financial Statements (Unaudited)................................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 21
PART II. Other Information
Item 1. Legal Proceedings............................................................. 24
Item 2. Changes in Securities and Use of Proceeds..................................... 24
Item 3. Defaults upon Senior Securities............................................... 24
Item 4. Submission of Matters to a Vote of Security Holders........................... 24
Item 5. Other Information............................................................. 24
Item 6. Exhibits and Reports on Form 8-K.............................................. 25
Signatures............................................................................. 26
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 16,357,000 $ 14,467,000
Short-term investments 194,000 171,000
Federal funds sold 0 5,300,000
--------------- ----------------
Total cash and cash equivalents 16,551,000 19,938,000
Securities available for sale 53,006,000 52,054,000
Securities held to maturity (fair value of $30,754,000
at June 30, 2002 and $26,183,000 at December 31, 2001) 29,751,000 25,979,000
Federal Home Loan Bank stock 786,000 785,000
Total loans 667,862,000 587,248,000
Allowance for loan and lease losses (9,562,000) (8,494,000)
---------------- ----------------
Total loans, net 658,300,000 578,754,000
Premises and equipment, net 10,933,000 9,557,000
Accrued interest receivable 2,965,000 2,811,000
Other assets 9,685,000 8,804,000
--------------- ----------------
Total assets $ 781,977,000 $ 698,682,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 43,649,000 $ 43,162,000
Interest-bearing 600,999,000 525,915,000
--------------- ----------------
Total deposits 644,648,000 569,077,000
Securities sold under agreements to repurchase 39,636,000 36,485,000
Federal funds purchased 1,300,000 0
Other borrowed money 463,000 239,000
Accrued expenses and other liabilities 4,906,000 5,418,000
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,000,000 16,000,000
--------------- ----------------
Total liabilities 706,953,000 627,219,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value: 9,000,000 shares authorized;
5,148,342 shares outstanding at June 30, 2002 and
5,147,791 shares outstanding at December 31, 2001 69,375,000 69,406,000
Retained earnings 4,969,000 1,649,000
Accumulated other comprehensive income 680,000 408,000
--------------- ----------------
Total shareholders' equity 75,024,000 71,463,000
--------------- ----------------
Total liabilities and shareholders' equity $ 781,977,000 $ 698,682,000
=============== ================
See accompanying notes to consolidated financial statements.
3
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Interest income
Loans, including fees $ 10,514,000 $ 9,850,000 $ 20,421,000 $ 19,426,000
Investment securities 1,103,000 1,018,000 2,200,000 2,078,000
Federal funds sold 22,000 142,000 57,000 360,000
Short-term investments 0 1,000 1,000 2,000
--------------- -------------- -------------- ---------------
Total interest income 11,639,000 11,011,000 22,679,000 21,866,000
Interest expense
Deposits 5,281,000 6,614,000 10,690,000 13,279,000
Short-term borrowings 225,000 305,000 426,000 641,000
Long-term borrowings 398,000 394,000 794,000 787,000
--------------- -------------- -------------- ---------------
Total interest expense 5,904,000 7,313,000 11,910,000 14,707,000
--------------- -------------- -------------- ---------------
NET INTEREST INCOME 5,735,000 3,698,000 10,769,000 7,159,000
Provision for loan and lease losses 682,000 730,000 1,142,000 1,180,000
--------------- -------------- -------------- ---------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 5,053,000 2,968,000 9,627,000 5,979,000
Noninterest income
Services charges on accounts 223,000 124,000 417,000 226,000
Net gain on sales of securities 0 0 149,000 100,000
Other income 338,000 242,000 564,000 449,000
--------------- -------------- -------------- ---------------
Total noninterest income 561,000 366,000 1,130,000 775,000
Noninterest expense
Salaries and benefits 1,950,000 1,402,000 3,628,000 2,646,000
Occupancy 266,000 124,000 531,000 252,000
Furniture and equipment 189,000 105,000 362,000 211,000
Other expense 776,000 632,000 1,525,000 1,226,000
--------------- -------------- -------------- ---------------
Total noninterest expenses 3,181,000 2,263,000 6,046,000 4,335,000
--------------- -------------- -------------- ---------------
INCOME BEFORE FEDERAL INCOME
TAX EXPENSE 2,433,000 1,071,000 4,711,000 2,419,000
Federal income tax expense 717,000 294,000 1,391,000 727,000
--------------- -------------- -------------- ---------------
NET INCOME $ 1,716,000 $ 777,000 $ 3,320,000 $ 1,692,000
=============== ============== ============== ===============
COMPREHENSIVE INCOME $ 2,275,000 $ 708,000 $ 3,592,000 $ 1,845,000
=============== ============== ============== ===============
Basic earnings per share $ 0.33 $ 0.24 $ 0.64 $ 0.56
=============== ============== ============== ===============
Diluted earnings per share $ 0.33 $ 0.23 $ 0.63 $ 0.55
=============== ============== ============== ===============
Average basic shares outstanding 5,148,342 3,268,337 5,148,235 3,040,365
=============== ============== ============== ===============
Average diluted shares outstanding 5,247,622 3,328,083 5,241,670 3,091,583
=============== ============== ============== ===============
See accompanying notes to consolidated financial statements.
4
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income Equity
----- -------- ------ ------
BALANCE, JANUARY 1, 2001 $ 29,936,000 $ 1,628,000 $ 290,000 $ 31,854,000
Comprehensive income:
Net income for the period from
January 1, 2001 through
June 30, 2001 1,692,000 1,692,000
Change in net unrealized gain
(loss) on securities available for
sale, net of reclassifications
and tax effect 153,000 153,000
----------------
Total comprehensive income 1,845,000
Common stock sales, net proceeds 6,748,000 6,748,000
---------------- --------------- ----------- ----------------
BALANCE, JUNE 30, 2001 $ 36,684,000 $ 3,320,000 $ 443,000 $ 40,447,000
================ =============== =========== ================
BALANCE, JANUARY 1, 2002 $ 69,406,000 $ 1,649,000 $ 408,000 $ 71,463,000
Comprehensive income:
Net income for the period from
January 1, 2002 through
June 30, 2002 3,320,000 3,320,000
Change in net unrealized gain
(loss) on securities available for
sale, net of reclassifications
and tax effect 272,000 272,000
----------------
Total comprehensive income 3,592,000
Stock option exercise --- 551 shares 6,000 6,000
Issuance costs from December 2001
common stock sale (37,000) (37,000)
---------------- --------------- ----------- ----------------
BALANCE, JUNE 30, 2002 $ 69,375,000 $ 4,969,000 $ 680,000 $ 75,024,000
================ =============== =========== ================
See accompanying notes to consolidated financial statements.
5
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,716,000 $ 777,000 $ 3,320,000 $ 1,692,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 308,000 140,000 609,000 201,000
Provision for loan and lease losses 682,000 730,000 1,142,000 1,180,000
Net gain on sales of securities 0 0 (149,000) (100,000)
Net change in:
Accrued interest receivable 206,000 186,000 (154,000) 15,000
Other assets (1,348,000) (3,485,000) (1,086,000) (3,705,000)
Accrued expenses and other liabilities (724,000) (1,013,000) (512,000) (625,000)
------------- ------------ ------------ ------------
Net cash used in operating activities 840,000 (2,665,000) 3,170,000 (1,342,000)
CASH FLOWS FROM INVESTING ACTIVITIES
Loan originations and payments, net (46,606,000) (48,415,000) (80,688,000) (78,326,000)
Purchases of:
Securities available for sale (7,094,000) (6,807,000) (18,971,000) (17,170,000)
Securities held to maturity (2,710,000) (4,282,000) (4,781,000) (5,380,000)
Federal Home Loan Bank stock (1,000) 0 (1,000) 0
Premises and equipment (1,185,000) (1,597,000) (1,812,000) (2,345,000)
Proceeds from:
Maturities, calls and repayments of
available for sale securities 2,944,000 5,741,000 7,904,000 10,337,000
Maturities, calls and repayments of
held to maturity securities 1,005,000 102,000 1,005,000 102,000
Sales of available for sale securities 0 0 10,572,000 5,362,000
------------- ------------ ------------ ------------
Net cash used in investing activities (53,647,000) (55,258,000) (86,772,000) (87,420,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 48,672,000 53,129,000 75,571,000 94,482,000
Net proceeds from sale of common stock (22,000) (91,000) (37,000) 6,748,000
Stock option exercise 0 0 6,000 0
Net increase in other borrowed money 1,357,000 17,000 1,524,000 55,000
Net increase in securities sold under agreements
to repurchase 2,363,000 4,735,000 3,151,000 2,637,000
------------- ------------ ------------ ------------
Net cash from financing activities 52,370,000 57,790,000 80,215,000 103,922,000
------------- ------------ ------------ ------------
Net change in cash and cash equivalents (437,000) (133,000) (3,387,000) 15,160,000
Cash and cash equivalents at beginning of period 16,988,000 33,395,000 19,938,000 18,102,000
------------- ------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 16,551,000 $ 33,262,000 $ 16,551,000 $ 33,262,000
============= ============ ============ ============
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 6,913,000 $ 7,841,000 $ 12,375,000 $ 15,017,000
Federal income tax 1,955,000 1,192,000 1,955,000 1,388,000
See accompanying notes to consolidated financial statements.
6
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION:
The unaudited financial statements for the three and six months ended June
30, 2002 include the consolidated results of operations of Mercantile Bank
Corporation and its consolidated subsidiaries. The subsidiaries include
Mercantile Bank of West Michigan ("our bank"), our bank's two wholly-owned
subsidiaries, Mercantile Bank Mortgage Company ("our mortgage company") and
Mercantile BIDCO, Inc. ("our BIDCO"), and our subsidiary MBWM Capital Trust
I ("the trust"). These consolidated financial statements have been prepared
in accordance with the instructions for Form 10-Q and Item 303(b) of
Regulation S-K and do not include all disclosures required by accounting
principles generally accepted in the United States of America for a
complete presentation of our financial condition and results of operations.
In the opinion of management, the information reflects all adjustments
(consisting only of normal recurring adjustments) which are necessary in
order to make the financial statements not misleading and for a fair
presentation of the results of operations for such periods. The results for
the periods ended June 30, 2002 should not be considered as indicative of
results for a full year. For further information, refer to the consolidated
financial statements and footnotes included in our annual report on Form
10-K for the year ended December 31, 2001.
2. LOANS
Our total loans at June 30, 2002 were $667.9 million compared to $587.2
million at December 31, 2001, an increase of $80.7 million, or 13.7%. The
components of our outstanding balances at June 30, 2002 and December 31,
2001, and the percentage increase in loans from the end of 2001 to the end
of the second quarter 2002 are as follows:
Percent
June 30, 2002 December 31, 2001 Increase/
Balance % Balance % (Decrease)
------------- ------- ------------- -------- ----------
Real Estate:
Construction and land
development $ 88,993,000 13.3% $ 62,710,000 10.6% 41.9%
Secured by 1-4 family
properties 42,846,000 6.4 41,028,000 7.0 4.4
Secured by multi-family
properties 1,565,000 0.2 1,107,000 0.2 41.4
Secured by nonfarm
nonresidential properties 301,493,000 45.1 269,855,000 46.0 11.7
Commercial 226,224,000 33.9 205,839,000 35.1 9.9
Consumer 6,741,000 1.1 6,709,000 1.1 0.5
--------------- ------- ------------- -------- --------
$ 667,862,000 100.0% $ 587,248,000 100.0% 13.7%
=============== ======= ============= ======== ========
(Continued)
7
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. ALLOWANCE FOR LOAN AND LEASE LOSSES
The following is a summary of the activity in our allowance for loan and
lease losses account for the three and six months ended June 30:
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Balance at beginning of
period $ 8,925,000 $ 6,765,000 $ 8,494,000 $ 6,302,000
Charge-offs (76,000) (45,000) (169,000) (65,000)
Recoveries 31,000 12,000 95,000 45,000
Provision for loan and
lease losses 682,000 730,000 1,142,000 1,180,000
------------- ------------- ------------- --------------
Balance at June 30 $ 9,562,000 $ 7,462,000 $ 9,562,000 $ 7,462,000
============= ============= ============= ==============
4. PREMISES AND EQUIPMENT - NET
Premises and equipment are comprised of the following:
June 30, December 31,
2002 2001
---- ----
Land and improvements $ 2,914,000 $ 1,970,000
Buildings and leasehold improvements 6,180,000 5,975,000
Furniture and equipment 3,781,000 3,119,000
-------------- ---------------
12,875,000 11,064,000
Less accumulated depreciation 1,942,000 1,507,000
-------------- ---------------
Premises and equipment, net $ 10,933,000 $ 9,557,000
============== ===============
Depreciation expense amounted to $219,000 during the second quarter of
2002, compared to $106,000 in the second quarter of 2001. Depreciation
expense amounted to $436,000 during the first six months of 2002, compared
to $216,000 during the first six months of 2001.
(Continued)
8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. DEPOSITS
Our total deposits at June 30, 2002 were $644.6 million compared to $569.1
million at December 31, 2001, an increase of $75.5 million or 13.3%. The
components of our outstanding balances at June 30, 2002 and December 31,
2001, and percentage increase in deposits from the end of 2001 to the end
of the second quarter 2002 are as follows:
Percent
June 30, 2002 December 31, 2001 Increase/
Balance % Balance % (Decrease)
------------ ------------ ------------ ------------ ------------
Noninterest-bearing demand $ 43,649,000 6.8% $ 43,162,000 7.6% 1.1%
Interest-bearing checking 21,877,000 3.4 22,188,000 3.9 (1.4)
Money market 6,898,000 1.1 5,578,000 1.0 23.7
Savings 55,088,000 8.5 47,157,000 8.3 16.8
Time, under $100,000 6,836,000 1.1 6,144,000 1.1 11.3
Time, $100,000 and over 51,092,000 7.9 52,601,000 9.2 (2.9)
------------ ------------ ------------ ------------ ------------
185,440,000 28.8 176,830,000 31.1 4.9
Out-of-area time,
under $100,000 86,279,000 13.4 83,789,000 14.7 3.0
Out-of-area time,
$100,000 and over 372,929,000 57.8 308,458,000 54.2 20.9
------------ ------------ ------------ ------------ ------------
459,208,000 71.2 392,247,000 68.9 17.1
------------ ------------ ------------ ------------ ------------
Total deposits $644,648,000 100.0% $569,077,000 100.0% 13.3%
============ ============ ============ ============ ============
6. BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
June 30, December 31,
2002 2001
---- ----
Outstanding balance at end of period $ 39,636,000 $ 36,485,000
Average interest rate at end of period 2.22% 2.21%
Average balance during the period $ 38,309,000 $ 34,596,000
Average interest rate during the period 2.21% 3.42%
Maximum month end balance during the period $ 40,202,000 $ 40,587,000
Securities sold under agreements to repurchase ("repurchase agreements")
generally have original maturities of less than one year. Repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as liabilities. Securities involved with the
agreements are recorded as assets of our bank and are primarily held in
safekeeping by correspondent banks. Repurchase agreements are offered
principally to certain large deposit customers as deposit equivalent
investments.
(Continued)
9
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. COMMITMENTS AND OFF-BALANCE-SHEET RISK
Our bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of our customers.
These financial instruments include commitments to extend credit and
standby letters of credit. Loan commitments to extend credit are agreements
to lend to a customer as long as there is no violation of any condition
established in the contract. Standby letters of credit are conditional
commitments issued by our bank to guarantee the performance of a customer
to a third party. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in
excess of the amount recognized, if any, in the balance sheet. Our bank's
maximum exposure to loan loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount
of those instruments. Our bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. Collateral, such as accounts receivable, securities,
inventory, property and equipment, is generally obtained based on
management's credit assessment of the borrower.
A summary of the notional or contractual amounts of our financial
instruments with off-balance-sheet risk at June 30, 2002 and December 31,
2001 follows:
June 30, December 31,
2002 2001
---- ----
Commercial unused lines of credit $ 129,533,000 $ 110,787,000
Unused lines of credit secured by 1-4 family
residential properties 11,234,000 8,181,000
Credit card unused lines of credit 5,564,000 6,212,000
Other consumer unused lines of credit 4,864,000 3,965,000
Commitments to make loans 47,599,000 25,966,000
Standby letters of credit 41,459,000 36,377,000
-------------- ---------------
$ 240,253,000 $ 191,488,000
============== ===============
8. REGULATORY MATTERS
We are subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain
cases. Failure to meet various capital requirements can initiate regulatory
action that could have a direct material effect on our financial
statements.
(Continued)
10
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. REGULATORY MATTERS (Continued)
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent overall financial condition. If
adequately capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are required.
Our actual capital levels and minimum required levels were:
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
June 30, 2002
-------------
Total capital (to risk
weighted assets)
Consolidated $ 99,829,000 13.2% $ 60,699,000 8.0% $ 75,873,000 10.0%
Bank 97,064,000 12.8 60,596,000 8.0 75,744,000 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 90,344,000 11.9 30,353,000 4.0 45,529,000 6.0
Bank 87,595,000 11.6 30,302,000 4.0 45,452,000 6.0
Tier 1 capital (to
average assets)
Consolidated 90,344,000 11.9 30,457,000 4.0 38,071,000 5.0
Bank 87,595,000 11.5 30,406,000 4.0 38,008,000 5.0
December 31, 2001
-----------------
Total capital (to risk
weighted assets)
Consolidated $ 95,430,000 14.3% $ 53,584,000 8.0% $ 66,980,000 10.0%
Bank 92,683,000 13.9 53,404,000 8.0 66,754,000 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 87,057,000 13.0 26,797,000 4.0 40,195,000 6.0
Bank 84,337,000 12.6 26,708,000 4.0 40,062,000 6.0
Tier 1 capital (to
average assets)
Consolidated 87,057,000 13.0 26,786,000 4.0 33,482,000 5.0
Bank 84,337,000 12.6 26,722,000 4.0 33,403,000 5.0
We were categorized as well capitalized at June 30, 2002 and year-end 2001.
(Continued)
11
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. REGULATORY MATTERS (Continued)
The trust sold 1.6 million Cumulative Preferred Securities ("trust
preferred securities") at $10.00 per trust preferred security in a
September 1999 offering. The proceeds from the sale were used by the trust
to purchase an equivalent amount of subordinated debentures from the
company. The trust preferred securities carry a fixed rate of 9.60%, have a
stated maturity of 30 years, and, in effect, are guaranteed by the company.
The securities are redeemable at par after 5 years. Distributions on the
trust preferred securities are payable quarterly on January 15, April 15,
July 15, and October 15. The first distribution was paid on October 15,
1999. Under certain circumstances, distributions may be deferred for up to
20 calendar quarters. However, during any such deferrals, interest accrues
on any unpaid distributions at the rate of 9.60% per annum.
The company's capital levels as of June 30, 2002 include an adjustment for
the 1.6 million trust preferred securities issued by the trust subject to
certain limitations. Federal Reserve guidelines limit the amount of trust
preferred securities which can be included in Tier 1 capital of the company
to 25% of total Tier 1 capital. As of June 30, 2002, the entire $16.0
million of the trust preferred securities were included as Tier 1 capital.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound
banking practices. We declared a 5% stock dividend on January 7, 2002, that
was paid on February 1, 2002 to record holders as of January 18, 2002. We
have not paid cash dividends on our common stock since our formation in
1997, and we currently have no intention of doing so in the foreseeable
future.
9. NEW ACCOUNTING PRONOUNCEMENTS
A new accounting standard dealing with asset retirement obligations will
apply for 2003. We do not believe this standard will have a material effect
on our financial position or results of operations. Effective January 1,
2002, we adopted a new standard issued by the FASB on impairment and
disposal of long-lived assets. This standard did not have a material effect
on our financial position or results of operations.
12
MERCANTILE BANK CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and about our company. Words such as
"anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is
likely", "plans", "projects", variations of such words and similar expressions
are intended to identify such forward-looking statements. These statements are
not guarantees of future performance and involve certain risks, uncertainties
and assumptions ("Future Factors") that are difficult to predict with regard to
timing, extent, likelihood and degree of occurrence. Therefore, actual results
and outcomes may materially differ from what may be expressed or forecasted in
such forward-looking statements. We undertake no obligation to update, amend, or
clarify forward looking statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; and changes in the national and local economy. These are representative
of the Future Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, Mercantile Bank of West Michigan
("our bank"), our bank's two wholly-owned subsidiaries Mercantile Bank Mortgage
Company ("our mortgage company") and Mercantile BIDCO, Inc. ("our BIDCO"), and
our subsidiary MBWM Capital Trust I ("the trust"), at June 30, 2002 to December
31, 2001 and the results of operations for the three and six months ended June
30, 2002 and June 30, 2001. This discussion should be read in conjunction with
the interim consolidated financial statements and footnotes included herein.
Unless the text clearly suggests otherwise, references in this report to "us,"
"we," "our," or "the company" include Mercantile Bank Corporation and its
consolidated subsidiaries referred to above.
During the second quarter of 2002, we were engaged in preliminary discussions
with a few unaffiliated financial institutions to explore the possibility of an
acquisition by us. To date the discussions have been exploratory in nature and
no likely acquisition candidate has been identified. We expect that such
discussions may occur from time-to-time with these or other financial
institutions in future periods.
FINANCIAL CONDITION
During the first six months of 2002, our assets increased from $698.7 million on
December 31, 2001, to $782.0 million on June 30, 2002. This represents a total
increase in assets of $83.3 million, or 11.9%. The asset growth was comprised
primarily of a $79.5 million increase in net loans and an increase of $4.7
million in investment securities. The increase in assets was primarily funded by
a $75.5 million growth in deposits and an increase of $3.1 million in securities
sold under agreements to repurchase. In addition, federal funds purchased
totaled $1.3 million at June 30, 2002, compared to a federal funds sold position
of $5.3 million at December 31, 2001.
(Continued)
13
MERCANTILE BANK CORPORATION
Commercial loans increased by $78.9 million, or 14.6%, during the first six
months of 2002, and at June 30, 2002 totaled $618.4 million, or 92.6% of the
total loan portfolio. 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 stated strategy of focusing a
substantial amount of efforts on "wholesale" banking. Corporate and business
lending continues to be an area of expertise of our senior management team, and
our ten commercial lenders have an average commercial lending experience of
approximately 16 years. Of each of the loan categories that we originate,
commercial loans are most efficiently originated and managed, thus reducing
overhead costs by necessitating the attention of fewer employees. Our commercial
lending business generates the greatest amount of local deposits, and is
virtually the only source of significant demand deposits.
Residential mortgage loans increased by $1.8 million during the first six months
of 2002, while the balance of our consumer loan portfolio remained virtually
unchanged during the same time period. As of June 30, 2002, residential mortgage
and consumer loans totaled a combined $49.5 million, or 7.5% of the total loan
portfolio. Although the residential mortgage loan and consumer loan portfolios
are expected to increase in future periods, given our wholesale banking
strategy, the commercial sector of the lending efforts and resultant assets are
expected to remain the dominant loan portfolio category.
The quality of our loan portfolio remains strong. Net loan charge-offs during
the first six months of 2002 totaled $74,000, or only 0.02% of average total
loans on an annualized basis. Past due loans and nonaccrual loans at June 30,
2002 totaled $451,000, or only 0.07% of period-ending total loans. We believe we
have instilled a very strong credit culture within our lending departments as it
pertains to the underwriting and administration processes, which in part is
reflected in our loan charge-off and delinquency ratios. Over 98% of the loan
portfolio consists of loans extended directly to companies and individuals doing
business and residing within our market area. The remaining portion is comprised
of commercial loans participated with certain unaffiliated commercial banks
outside of the immediate area, which are underwritten using the same loan
underwriting criteria as though our bank was the originating bank.
Deposits increased $75.5 million during the first six months of 2002, totaling
$644.6 million at June 30, 2002. Local deposits increased $8.6 million, or 4.9%,
while out-of-area deposits increased $67.0 million, or 17.1%. As a percent of
total deposits, local deposits declined from 31.1% on December 31, 2001, to
28.8% on June 30, 2002. Noninterest-bearing demand deposits, comprising 6.8% of
total deposits, increased $0.5 million during the first six months of 2002.
Savings deposits (8.5% of total deposits) increased $7.9 million,
interest-bearing checking deposits (3.4% of total deposits) decreased $0.3
million and money market deposit accounts (1.1% of total deposits) increased
$1.3 million during the first six months of 2002. Local certificates of deposit,
comprising 9.0% of total deposits, decreased by $0.8 million during the first
six months of 2002.
Out-of-area deposits totaled $459.2 million, or 71.2% of total deposits, as of
June 30, 2002. Out-of-area deposits consist primarily of certificates of deposit
obtained from depositors located outside our market area and placed by deposit
brokers for a fee, but also include certificates of deposit obtained from the
deposit owners directly. Out-of-area deposits are utilized to support our asset
growth, and are generally a lower cost source of funds when compared to the
interest rates that would have to be offered in the local market to generate a
sufficient level of funds. During the first six months of 2002 rates paid on new
out-of-area certificates of deposit were very similar to rates paid on new
certificates of deposit issued to local customers. In addition, the overhead
costs associated with the out-of-area deposits are considerably less than the
overhead costs that would be incurred to administer a similar level of local
deposits. Although local deposits have and are expected to increase as new
business, governmental and consumer deposit
(Continued)
14
MERCANTILE BANK CORPORATION
relationships are established and as existing customers increase their deposit
accounts, the relatively high reliance on out-of-area deposits will likely
remain.
Securities sold under agreements to repurchase ("repurchase agreements")
increased by $3.2 million during the first six months of 2002. As part of our
sweep account program, collected funds from certain business noninterest-bearing
checking accounts are invested into over-night interest-bearing repurchase
agreements. Although not considered a deposit account and therefore not afforded
federal deposit insurance, the repurchase agreements have characteristics very
similar to that of our business checking deposit accounts.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment of loans and securities. These
funds are used to meet deposit withdrawals, maintain reserve requirements, fund
loans and support our operations. Liquidity is primarily achieved through the
growth of deposits (both local and out-of-area) and liquid assets such as
securities available for sale, matured securities, and federal funds sold. Asset
and liability management is the process of managing our balance sheet to achieve
a mix of earning assets and liabilities that maximizes profitability, while
providing adequate liquidity.
Our liquidity strategy is to fund loan growth with deposits and repurchase
agreements and to maintain an adequate level of short- and medium-term
investments to meet typical daily loan and deposit activity. Although deposit
and repurchase agreement growth from depositors located in our market area have
consistently increased, the growth has not been sufficient to meet our
substantial loan growth and provide monies for additional investing activities.
To assist in providing the additional needed funds, we have regularly obtained
certificates of deposit from customers outside of our market area and placed by
deposit brokers for a fee, as well as certificates of deposit obtained from the
deposit owners directly. As of June 30, 2002, out-of-area deposits totaled
$459.2 million, or 67.1% of combined deposits and repurchase agreements, an
increase from the $392.2 million, or 64.8% of combined deposits and repurchase
agreements, as of December 31, 2001. Reliance on out-of-area deposits is
expected to be ongoing due to our planned future asset growth.
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established federal funds purchased lines; however, we view these
funds as only a secondary and temporary source of funds and our bank was
generally in a federal funds sold position during the first six months of 2002.
The average balance of federal funds purchased during the first six months of
2002 equaled $0.6 million, compared to a $6.7 million average federal funds sold
position.
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 June 30, 2002, our bank could borrow up to
approximately $20.0 million. Our bank has yet to use its established borrowing
line at the FHLBI. During the second quarter of 2002, the FHLBI announced a new
borrowing program that allows its members to pledge commercial real estate loans
for advances. Subject to meeting certain financial condition and capital
requirements, members will be permitted to borrow up to $1 for every $3 of
eligible commercial real estate loans. Using commercial real estate loan
balances as of June 30, 2002, under this new program our bank would be able to
borrow an additional $100.0 million. It is expected that our bank will begin to
obtain advances under this new borrowing program by September 30, 2002.
(Continued)
15
MERCANTILE BANK CORPORATION
In addition to typical loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of June 30, 2002, our bank had a total of $198.8 million in unfunded
loan commitments and $41.5 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $151.2 million were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $47.6
million were for loan commitments expected to close and become funded within the
next three to six months. We monitor fluctuations in loan balances and
commitment levels, and include such data in managing our overall liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $3.5 million during
the first six months of 2002, from $71.5 million on December 31, 2001, to $75.0
million at June 30, 2002. The increase is primarily attributable to net income
of $3.3 million recorded during the first six months of 2002. In addition,
shareholders' equity was also positively impacted during the first six months of
2002 by a $0.2 million mark-to-market adjustment for available for sale
securities as defined in SFAS No. 115. The adjustment was due to the decline in
the interest rate environment during the first six months of 2002.
In September 1999 the company, through the trust, issued 1.6 million shares of
trust preferred securities at $10.00 per trust preferred security. Substantially
all of the net proceeds were ultimately contributed to our bank as capital and
were used to support growth in assets, fund investments in loans and securities,
and for general corporate purposes. Although not part of shareholder's equity,
subject to certain limitations the trust preferred securities are considered a
component of capital for purposes of calculating regulatory capital ratios. At
June 30, 2002, the entire $16.0 million of trust preferred securities were
included as Tier 1 capital.
We are subject to regulatory capital requirements primarily administered by
federal banking regulatory agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. Since our bank commenced operations, both
the company and our bank have been categorized as "Well Capitalized," the
highest classification contained within the banking regulations. The capital
ratios of the company and our bank as of June 30, 2002 and December 31, 2001 are
disclosed under Note 8 of the Notes to Consolidated Financial Statements.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. We declared a 5% stock dividend on January 7, 2002, which was paid on
February 1, 2002 to record holders as of January 18, 2002. We have not paid cash
dividends on our common stock since our formation in 1997, and we currently have
no intention of doing so in the foreseeable future.
(Continued)
16
MERCANTILE BANK CORPORATION
RESULTS OF OPERATIONS
Net income for the second quarter of 2002 was $1.7 million ($0.33 per basic and
diluted share), which represents a 120.8% increase over net income of $0.8
million ($0.24 per basic share and $0.23 per diluted share) recorded during the
second quarter of 2001. The 37.5% increase in basic earnings per share and the
43.5% increase in diluted earnings per share were lower than the percentage
growth in net income due to the dilution impact of the common stock sales
completed during 2001. Average basic and diluted shares outstanding during the
second quarter of 2002 were up 57.5% and 57.7% over the levels during the same
time period in 2001, respectively. Net income for the first six months of 2002
was $3.3 million ($0.64 per basic share and $0.63 per diluted share), which
represents a 96.2% increase over net income of $1.7 million ($0.56 per basic
share and $0.55 per diluted share) recorded during the first six months of 2001.
The 14.3% increase in basic earnings per share and the 14.5% increase in diluted
earnings per share were lower than the percentage growth in net income due to
the dilution impact of the common stock sales completed during 2002. Average
basic and diluted shares outstanding during the first six months of 2002 were up
69.3% and 69.5% over the levels during the same time period in 2001,
respectively. The improvement in net income during both time periods is
primarily the result of an increase in net interest income, higher noninterest
income and greater employee efficiency.
Interest income during the second quarter of 2002 was $11.6 million, an increase
of 5.7% over the $11.0 million earned during the second quarter of 2001.
Interest income during the first six months of 2002 was $22.7 million, an
increase of 3.7% over the $21.9 million earned during the first six months of
2001. The growth in interest income during both time periods is primarily
attributable to an increase in earning assets. During the second quarter of 2002
earning assets averaged $732.1 million, $175.2 million higher than the average
earning assets of $556.9 million during the second quarter of 2001. Average
loans were up $168.6 million and securities increased $15.0 million, while
federal funds sold were down $8.4 million. During the first six months of 2002,
earning assets averaged $712.3 million, $173.0 million higher than the average
earning assets of $539.3 million during the same time period in 2001. Average
loans were up $166.0 million and securities increased $14.9 million, while
federal funds sold were down $8.1 million. Negatively impacting the growth in
interest income during the second quarter of 2002 and the first six months of
2002 was the decline in yield on earning assets. During the second quarter of
2002 and 2001, earning assets had a weighted average yield of 6.46% and 8.10%,
respectively. During the first six months of 2002 and 2001 earning assets had a
weighted average yield of 6.50% and 8.24%, respectively. The decrease in
weighted average yields in 2002 is primarily due to the overall decline of
market interest rates, in part evidenced by the 475 basis point drop in the
prime rate since January 3, 2001.
Interest expense during the second quarter of 2002 was $5.9 million, a decrease
of 19.3% from the $7.3 million expensed during the second quarter of 2001.
Interest expense during the first six months of 2002 was $11.9 million, a
decrease of 19.0% from the $14.7 million expensed during the first six months of
2001. The decrease in interest expense is primarily attributable to the overall
decline of market interest rates, which more than offset the increase in funding
liabilities necessitated by the growth in assets. During the second quarter of
2002, interest-bearing liabilities averaged $640.7 million, $142.3 million
higher than average interest-bearing liabilities of $498.4 million during the
second quarter of 2001. During the first six months of 2002, interest-bearing
liabilities averaged $622.5 million, $138.4 million higher than average
interest-bearing liabilities of $484.1 million during the same time period in
2001. Positively impacting interest expense during the second quarter of 2002
and the first six months of 2002 was the decline in the cost of interest-bearing
funds. During the second quarter of 2002 and 2001, interest-bearing liabilities
had a weighted average rate of 3.70% and 5.89%, respectively. During the first
six months of 2002 and 2001, interest-bearing liabilities had a weighted average
rate of 3.86% and 6.13%, respectively. The decrease in the weighted average cost
of interest-bearing liabilities in 2002 is primarily due to the decline in
market interest rates since the beginning of 2001.
(Continued)
17
MERCANTILE BANK CORPORATION
Net interest income during the second quarter of 2002 was $5.7 million, an
increase of 55.1% over the $3.7 million earned during the second quarter of
2001. Net interest income during the first six months of 2002 was $10.8 million,
an increase of 50.4% over the $7.2 million earned during the same time period in
2001. The increase in net interest income was due to growth in earning assets
and an improved net interest margin. The net interest margin improved from 2.73%
during the second quarter of 2001 to 3.22% in the second quarter of 2002, and
increased from 2.75% during the first six months of 2001 to 3.13% in the first
six months of 2002. The improved net interest margin is primarily the result of
the positive impact of the decreasing interest rate environment since the
beginning of 2001 and the common stock sales completed during 2001.
The following table sets forth certain information relating to our consolidated
average interest earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the second
quarter of 2002 and 2001. Such yields and costs are derived by dividing income
or expense by the average daily balance of assets or liabilities, respectively,
for the period presented. For tax-exempt securities interest income and yield
have been computed on a tax equivalent basis using a marginal tax rate of 34%.
-----------------------------Quarters ended June 30,----------------------------------
------------------2 0 0 2------------ ------------------2 0 0 1-----------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
ASSETS
Loans $ 646,844 $ 10,514 6.52% $ 478,259 $ 9,850 8.26%
Investment securities 80,096 1,251 6.25 65,120 1,108 6.81
Federal funds sold 4,957 22 1.69 13,391 142 4.18
Short term investments 182 < 1 1.25 126 1 3.28
----------- ----------- ---- ----------- ----------- ----
Total interest-earning
assets 732,079 11,787 6.46 556,896 11,101 8.10
Allowance for loan losses (9,305) (7,052)
Other assets 38,634 26,040
----------- -----------
Total assets $ 761,408 $ 575,884
=========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 583,415 $ 5,281 3.63% $ 449,761 $ 6,614 5.90%
Short-term borrowings 40,886 225 2.21 32,521 305 3.77
Long-term borrowings 16,428 398 9.72 16,095 394 9.81
----------- ----------- ---- ----------- ----------- ----
Total interest-bearing
liabilities 640,729 5,904 3.70 498,377 7,313 5.89
Noninterest-bearing
deposits 40,588 30,410
Other liabilities 6,265 6,978
Shareholders' equity 73,826 40,119
----------- -----------
Total liabilities and
shareholders' equity $ 761,408 $ 575,884
=========== ----------- ---- =========== ----------- ----
Net interest income $ 5,883 $ 3,788
=========== ===========
Net interest rate spread 2.76% 2.21%
===== =====
Net interest rate spread
on average assets 3.10% 2.64%
===== =====
Net interest margin on
earning assets 3.22% 2.73%
===== =====
(Continued)
18
MERCANTILE BANK CORPORATION
Provisions to the allowance for loan and lease losses during the second quarter
of 2002 were $682,000, compared to the $730,000 that was expensed during the
first quarter of 2001. Provisions to the allowance for loan and leases losses
during the first six months of 2002 were $1.1 million, compared to the $1.2
million that was expensed during the same time period in 2001. Net loan
charge-offs during the second quarter of 2002 were $45,000 compared to net loan
charge-offs of $33,000 during the second quarter of 2001. During the first six
months of 2002 net loan charge-offs totaled $74,000 compared to net loan
charge-offs of $20,000 during the same time period in 2001. The allowance for
loan and lease losses as a percentage of total loans outstanding as of June 30,
2002 was 1.43%, down slightly from the 1.45% level at December 31, 2001.
In each accounting period, the allowance for loan and lease losses is adjusted
to the amount believed necessary to maintain the allowance for loan and lease
losses at adequate levels. Through the loan review and credit departments, we
attempt to allocate specific portions of the allowance for loan and lease losses
based on specifically identifiable problem loans. The evaluation of the
allowance for loan and lease losses is further based on, although not limited
to, consideration of the internally prepared Loan Loss Reserve Analysis
("Reserve Analysis"), composition of the loan portfolio, third party analysis of
the loan administration processes and loan portfolio and general economic
conditions. In addition, the rapid loan growth since inception is taken into
account.
The Reserve Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan balances to
calculate an overall allowance dollar amount. For commercial loans, which
continue to comprise a vast majority of our total loans, reserve allocation
factors are based upon the loan ratings as determined by our comprehensive loan
rating paradigm that is administered by our loan review function. For retail
loans, reserve allocation factors are based upon the type of credit. The reserve
allocation factors are based on the experience of senior management making
similar loans in the same community over the past 15 years. The Reserve Analysis
is reviewed regularly by senior management and the Board of Directors and is
adjusted periodically based upon identifiable trends and experience.
Noninterest income during the second quarter of 2002 was $0.6 million, an
increase of 53.3% over the $0.4 million earned during the second quarter of
2001. Noninterest income, excluding the net gains on sales of securities, during
the first six months of 2002 was $1.0 million, an increase of 45.3% over the
$0.7 million earned during the same time period in 2001. Service charge income
on deposits and repurchase agreements increased $99,000 (79.8%) during the
second quarter of 2002 over that earned in the second quarter of 2001, and
during the first six months of 2002 increased $191,000 (84.5%) over that earned
in the comparable time period in 2001. The strong increases during both time
periods primarily results from new accounts opened during the last 12 months,
decline in the earnings credit rate and modest increases in our deposit account
fee structure. Fees earned on referring residential mortgage loan applicants to
various third parties totaled $75,000 during the second quarter of 2002 compared
to $97,000 earned during the second quarter of 2001, and totaled $171,000 during
the first six months of 2002 compared to $178,000 earned during the first six
months of 2001. Letter of credit fees totaled $104,000 during the second quarter
of 2002 compared to $77,000 recorded during the second quarter of 2001, and
totaled $106,000 during the first six months of 2002 compared to $151,000
recorded the first six months of 2001. Noninterest income related to the cash
surrender value of bank owned life insurance policies ("BOLI") totaled $47,000
during the second quarter of 2002, and $92,000 for the first six months of 2002.
Purchased at various intervals during 2001 starting in late second quarter of
2001, the BOLI policies represent a combination of whole life and term life
insurance and were purchased as part of our non-qualified deferred compensation
program.
(Continued)
19
MERCANTILE BANK CORPORATION
Noninterest expense during the second quarter of 2002 was $3.2 million, an
increase of 40.6% over the $2.3 million expensed during the second quarter of
2001. Noninterest expense during the first six months of 2002 was $6.0 million,
an increase of 39.5% over the $4.3 million expensed during the same time period
in 2001. An increase in all major overhead cost categories was recorded, but was
primarily related to employee salaries and benefits and the opening of our new
administration and combination branch/operations center in the latter part of
2001. Increases in salaries and benefits ($0.5 million in second quarter 2002
over second quarter 2001, and $1.0 million for the first six months of 2002 over
the first six months of 2001) primarily resulted from the hiring of additional
staff and merit annual pay increases. Occupancy and furniture and equipment
costs increased $0.2 million in the second quarter of 2002 over the level
expensed in the second quarter of 2001 and $0.4 million during the first six
months of 2002 over the level expensed during the first six months of 2001
primarily due to the opening of our new facilities in southwest Grand Rapids.
General overhead costs also increased, reflecting the additional expenses
required to administer our significantly increased asset base.
While the dollar volume of noninterest costs has increased, as a percent of
average assets the level has substantially declined as a result of our growth
and the realization of operating efficiencies. Monitoring and controlling
noninterest costs, while at the same time providing high quality service to
customers, is a key component to our business strategy. The efficiency ratio,
computed by dividing noninterest expenses by net interest income plus
noninterest income, was 50.5% during the second quarter of 2002, a 9.3%
improvement over the 55.7% during the second quarter of 2001, and was 50.8%
during the first six months of 2002, a 7.0% improvement over the 54.6% during
the first six months of 2001. Although noninterest expenses increased by $0.9
million during the second quarter of 2002 over the amount expensed during the
second quarter of 2001, and increased $1.7 million during the first six months
of 2002 over the amount expensed during the first six months of 2001, net
revenues (net interest income plus noninterest income) increased at a
substantially higher level of $2.2 million and $4.0 million during the same time
periods, respectively.
Federal income tax expense was $0.7 million and $1.4 million during the second
quarter and first six months of 2002, respectively. Federal income tax expense
was $0.3 million and $0.7 million during the second quarter and first six months
of 2001, respectively. The increases during both time periods primarily results
from the increase in net income before federal income tax. During the second
quarter of 2002, net income before federal income tax was $2.4 million, an
increase of $1.3 million over the amount recorded during the second quarter of
2001. During the first six months of 2002, net income before federal income tax
was $4.7 million, an increase of $2.3 million over the amount recorded during
the first six months of 2001.
(Continued)
20
MERCANTILE BANK CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity risk. All of our transactions are denominated in U.S. dollars with no
specific foreign exchange exposure. We have only limited agricultural-related
loan assets and therefore have no significant exposure to changes in commodity
prices. Any impact that changes in foreign exchange rates and commodity prices
would have on interest rates are assumed to be insignificant. Interest rate risk
is the exposure of our financial condition to adverse movements in interest
rates. We derive our income primarily from the excess of interest collected on
our interest-earning assets over the interest paid on our interest-bearing
liabilities. The rates of interest we earn on our assets and owe on our
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, we are exposed to lower profitability if
we cannot adapt to interest rate changes. Accepting interest rate risk can be an
important source of profitability and shareholder value; however, excessive
levels of interest rate risk could pose a significant threat to our earnings and
capital base. Accordingly, effective risk management that maintains interest
rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. Our interest rate risk management process seeks to ensure
that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk we assess the existing and potential future effects of
changes in interest rates on our financial condition, including capital
adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is
commonly referred to as GAP analysis, measures the difference between the dollar
amounts of interest sensitive assets and liabilities that will be refinanced or
repriced during a given time period. A significant repricing gap could result in
a negative impact to our net interest margin during periods of changing market
interest rates. The following table depicts our GAP position as of June 30, 2002
(dollars in thousands):
(Continued)
21
MERCANTILE BANK CORPORATION
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
Assets:
Commercial loans $ 262,136 $ 33,264 $ 315,726 $ 7,149 $ 618,275
Residential real estate loans 19,269 892 13,672 9,013 42,846
Consumer loans 1,306 1,313 4,014 108 6,741
Investment securities (1) 786 3,387 34,352 45,018 83,543
Short-term investments 194 194
Allowance for loan losses (9,562) (9,562)
Other assets 39,940 39,940
----------- ----------- ----------- ----------- -----------
Total assets 283,691 38,856 367,764 91,666 781,977
Liabilities:
Interest-bearing checking 21,877 21,877
Savings 55,088 55,088
Money market accounts 6,898 6,898
Time deposits < $100,000 18,406 42,728 31,981 93,115
Time deposits $100,000 and over 101,450 179,785 142,786 424,021
Short-term borrowings 40,936 40,936
Long-term borrowings 463 16,000 16,463
Noninterest-bearing checking 43,649 43,649
Other liabilities 4,906 4,906
----------- ----------- ----------- ----------- -----------
Total liabilities 245,118 222,513 174,767 64,555 706,953
Shareholders' equity 75,024 75,024
----------- ----------- ----------- ----------- -----------
Total sources of funds 245,118 222,513 174,767 139,579 781,977
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 38,573 $ (183,657) $ 192,997 $ (47,913)
=========== ============ =========== ===========
Cumulative GAP $ 38,573 $ (145,084) $ 47,913
=========== ============ ===========
Percent of cumulative GAP to
total assets 4.9% (18.6)% 6.1%
=========== =========== ===========
(1) Mortgage-backed securities are categorized by expected final maturities
based upon prepayment trends as of June 30, 2002
The second interest rate risk measurement we use is commonly referred to as net
interest income simulation analysis. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, serves as our primary interest rate risk measurement technique. The
simulation model assesses the direction and magnitude of variations in net
interest income resulting from potential changes in market interest rates. Key
assumptions in the model include prepayment speeds on various loan and
investment assets; cash flows and maturities of interest-sensitive assets and
liabilities; and changes in market conditions impacting loan and deposit volume
and pricing. These assumptions are inherently uncertain, subject to fluctuation
and revision in a dynamic environment; therefore, the model cannot precisely
estimate net interest income or exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes and
changes in market conditions and the company's strategies, among other factors.
(Continued)
22
MERCANTILE BANK CORPORATION
We conducted multiple simulations as of June 30, 2002, whereby it was assumed
that a simultaneous, instant and sustained change in market interest rates
occurred. The following table reflects the suggested impact on our net interest
income over the next twelve months, which is well within our policy parameters
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 $ 68,000 0.3%
Interest rates down 100 basis points 282,000 1.2
No change in interest rates 377,000 1.6
Interest rates up 100 basis points 753,000 3.1
Interest rates up 200 basis points 1,137,000 4.7
The increase in our net interest income under all interest rate scenarios
reflects the expected repricing of local and out-of-area certificates of deposit
during the next twelve months. Unlike 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 the
remainder of 2002 and into 2003 we have a large volume of certificates of
deposit that will mature and are expected to be refinanced at lower interest
rates.
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of other variables, including: the growth,
composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; economic and competitive conditions; potential
changes in lending, investing and deposit gathering strategies; client
preferences; and other factors.
23
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that are
incidental to our business. In our opinion, we are not a party to any current
legal proceedings that are material to our financial condition, either
individually or in the aggregate.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At our Annual Meeting held on April 18, 2002, our shareholders voted to elect
five directors, Betty S. Burton, David M. Cassard, Peter A. Cordes, David M.
Hecht and Robert M. Wynalda, each for a three year term expiring at the Annual
Meeting of the shareholders of the company in 2005. The results of the election
were as follows:
Votes Votes Votes Broker
Nominee For Against Abstained Non-Votes
------- --- ------- --------- ---------
Betty S. Burton 4,266,533 0 43,985 0
David M. Cassard 4,277,521 0 32,997 0
Peter A. Cordes 4,281,243 0 29,275 0
David M. Hecht 4,278,430 0 32,088 0
Robert M. Wynalda 3,819,684 0 490,834 0
The terms of office of the following directors (who were not up for election)
continued after the Annual Meeting: Edward J. Clark, C. John Gill, Doyle A.
Hayes, Gerald R. Johnson, Jr., Susan K. Jones, Lawrence W. Larsen, Calvin D.
Murdock, Michael H. Price, Dale J. Visser and Donald Williams, Sr.
Also at our Annual Meeting held on April 18, 2002, our shareholders voted to
approve the Independent Director Stock Option Plan (the "Plan"). The plan
provides for the grant of options to acquire shares of our common stock, not to
exceed 68,250 shares, to members of the Board of Directors of the company and of
its subsidiaries who qualify as independent directors. The results of the vote
were as follows:
Votes Votes Votes Broker
For Against Abstained Non-Votes
--- ------- --------- ---------
4,166,981 105,251 38,286 0
ITEM 5. OTHER INFORMATION.
Not applicable.
24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
3.1 Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our
Registration Statement on Form SB-2 (Commission File no. 333-33081) that became
effective on October 23, 1997
3.2 Our Bylaws are incorporated by reference to Exhibit 3.2 of our Registration Statement
on Form SB-2 (Commission File No. 333-33081) that became effective on October 23, 1997
11 Statement re Computation of Per Share Earnings
99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 12, 2002.
MERCANTILE BANK CORPORATION
By: /s/ Gerald R. Johnson, Jr.
---------------------------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Charles E. Christmas
---------------------------------------------
Charles E. Christmas
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
26
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Articles of Incorporation are incorporated by reference to Exhibit 3.1 of our
Registration Statement on Form SB-2 (Commission File no. 333-33081) that became
effective on October 23, 1997
3.2 Our Bylaws are incorporated by reference to Exhibit 3.2 of our Registration Statement
on Form SB-2 (Commission File No. 333-33081) that became effective on October 23, 1997
11 Statement re Computation of Per Share Earnings
99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002
27