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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 September 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, MICHIGAN 49509
(Address of principal executive offices) (Zip Code)
(616) 406-3777
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
At November 14, 2002, there were 5,148,342 shares of Common Stock outstanding.
1
MERCANTILE BANK CORPORATION
INDEX
- --------------------------------------------------------------------------------
PART 1. Financial Information Page No.
--------------------- --------
Item I. Financial Statements
Consolidated Balance Sheets -
September 30, 2002 (Unaudited) and December 31, 2001................................. 3
Consolidated Statements of Income and Comprehensive Income -
Three and Nine Months Ended September 30, 2002 (Unaudited)
and September 30, 2001 (Unaudited)................................................... 4
Consolidated Statements of Changes in Shareholders' Equity -
Nine Months Ended September 30, 2002 (Unaudited)
and September 30, 2001 (Unaudited)................................................... 5
Consolidated Statements of Cash Flows -
Three and Nine Months Ended September 30, 2002 (Unaudited)
and September 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.................... 22
Item 4. Controls and procedures....................................................... 24
PART II. Other Information
-----------------
Item 1. Legal Proceedings............................................................. 25
Item 2. Changes in Securities and Use of Proceeds..................................... 25
Item 3. Defaults upon Senior Securities............................................... 25
Item 4. Submission of Matters to a Vote of Security Holders........................... 25
Item 5. Other Information............................................................. 25
Item 6. Exhibits and Reports on Form 8-K.............................................. 25
Signatures............................................................................. 26
Certifications......................................................................... 27
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
September 30, December 31,
2002 2001
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 29,429,000 $ 14,467,000
Short-term investments 207,000 171,000
Federal funds sold 12,000,000 5,300,000
--------------- ----------------
Total cash and cash equivalents 41,636,000 19,938,000
Securities available for sale 55,119,000 52,054,000
Securities held to maturity (fair value of $33,272,000 at
September 30, 2002 and $26,183,000 at December 31, 2001) 31,140,000 25,979,000
Federal Home Loan Bank stock 786,000 785,000
Total loans 717,199,000 587,248,000
Allowance for loan and lease losses (10,193,000) (8,494,000)
---------------- -----------------
Total loans, net 707,006,000 578,754,000
Premises and equipment, net 11,328,000 9,557,000
Accrued interest receivable 3,444,000 2,811,000
Bank owned life insurance policies 14,673,000 3,991,000
Other assets 5,250,000 4,813,000
--------------- ----------------
Total assets $ 870,382,000 $ 698,682,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 67,831,000 $ 43,162,000
Interest-bearing 654,319,000 525,915,000
--------------- ----------------
Total 722,150,000 569,077,000
Securities sold under agreements to repurchase 48,135,000 36,485,000
Other borrowed money 516,000 239,000
Accrued expenses and other liabilities 6,001,000 5,418,000
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,000,000 16,000,000
--------------- ----------------
Total liabilities 792,802,000 627,219,000
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 September 30, 2002 and
5,147,791 shares outstanding at December 31, 2001 69,375,000 69,406,000
Retained earnings 7,125,000 1,649,000
Accumulated other comprehensive income 1,080,000 408,000
--------------- ----------------
Total shareholders' equity 77,580,000 71,463,000
--------------- ----------------
Total liabilities and shareholders' equity $ 870,382,000 $ 698,682,000
=============== ================
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
3
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest income
Loans, including fees $ 11,132,000 $ 10,341,000 $ 31,553,000 $ 29,767,000
Investment securities 1,144,000 1,048,000 3,344,000 3,127,000
Federal funds sold 41,000 140,000 98,000 500,000
Short-term investments 1,000 1,000 2,000 3,000
--------------- -------------- -------------- ---------------
Total interest income 12,318,000 11,530,000 34,997,000 33,397,000
Interest expense
Deposits 5,396,000 6,475,000 16,086,000 19,754,000
Short-term borrowings 242,000 307,000 668,000 949,000
Long-term borrowings 398,000 395,000 1,192,000 1,182,000
--------------- -------------- -------------- ---------------
Total interest expense 6,036,000 7,177,000 17,946,000 21,885,000
--------------- -------------- -------------- ---------------
NET INTEREST INCOME 6,282,000 4,353,000 17,051,000 11,512,000
Provision for loan and lease losses 880,000 455,000 2,022,000 1,635,000
--------------- -------------- -------------- ---------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 5,402,000 3,898,000 15,029,000 9,877,000
Noninterest income
Service charges on accounts 243,000 130,000 660,000 356,000
Net gain on sales of securities 121,000 0 270,000 100,000
Other income 555,000 308,000 1,119,000 757,000
--------------- -------------- -------------- ---------------
Total noninterest income 919,000 438,000 2,049,000 1,213,000
Noninterest expense
Salaries and benefits 2,020,000 1,467,000 5,648,000 4,113,000
Occupancy 265,000 144,000 796,000 396,000
Furniture and equipment 183,000 124,000 545,000 335,000
Other expense 803,000 658,000 2,328,000 1,884,000
--------------- -------------- -------------- ---------------
Total noninterest expenses 3,271,000 2,393,000 9,317,000 6,728,000
--------------- -------------- -------------- ---------------
INCOME BEFORE FEDERAL INCOME
TAX EXPENSE 3,050,000 1,943,000 7,761,000 4,362,000
Federal income tax expense 894,000 605,000 2,285,000 1,332,000
--------------- -------------- -------------- ---------------
NET INCOME $ 2,156,000 $ 1,338,000 $ 5,476,000 $ 3,030,000
=============== ============== ============== ===============
COMPREHENSIVE INCOME $ 2,556,000 $ 1,839,000 $ 6,148,000 $ 3,684,000
=============== ============== ============== ===============
Basic earnings per share $ 0.42 $ 0.32 $ 1.06 $ 0.88
============== ============== ============== ==============
Diluted earnings per share $ 0.41 $ 0.31 $ 1.04 $ 0.87
============== ============== ============== ==============
Average basic shares outstanding 5,148,342 4,243,810 5,148,271 3,445,922
=============== ============== ============== ===============
Average diluted shares outstanding 5,238,122 4,308,913 5,240,664 3,502,169
=============== ============== ============== ===============
- --------------------------------------------------------------------------------
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
September 30, 2001 3,030,000 3,030,000
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect 654,000 654,000
----------------
Total comprehensive income 3,684,000
----------------
Common stock sales, net proceeds 31,871,000 31,871,000
---------------- --------------- ----------- ----------------
BALANCE, SEPTEMBER 30, 2001 $ 61,807,000 $ 4,658,000 $ 944,000 $ 67,409,000
================ =============== =========== ================
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
September 30, 2002 5,476,000 5,476,000
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect 672,000 672,000
----------------
Total comprehensive income 6,148,000
----------------
Stock option exercise --- 551 shares 6,000 6,000
Issuance costs from December 2001
common stock sale (37,000) (37,000)
----------------- --------------- ----------- -----------------
BALANCE, SEPTEMBER 30, 2002 $ 69,375,000 $ 7,125,000 $ 1,080,000 $ 77,580,000
================ =============== =========== ================
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
5
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,156,000 $ 1,338,000 $ 5,476,000 $ 3,030,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 315,000 166,000 924,000 368,000
Provision for loan and lease losses 880,000 455,000 2,022,000 1,635,000
Net gain on sales of securities (121,000) 0 (270,000) (100,000)
Net change in:
Accrued interest receivable (479,000) (323,000) (633,000) (308,000)
Bank owned life insurance policies (10,591,000) (385,000) (10,683,000) (3,478,000)
Other assets 102,000 (196,000) (892,000) (808,000)
Accrued expenses and other liabilities 1,095,000 24,000 583,000 (602,000)
-------------- ------------- ------------- --------------
Net cash from (used in)
operating activities (6,643,000) 1,079,000 (3,473,000) (263,000)
CASH FLOWS FROM INVESTING ACTIVITIES
Loan originations and payments, net (49,586,000) (32,569,000) (130,274,000) (110,895,000)
Purchases of:
Securities available for sale (9,510,000) (3,009,000) (28,481,000) (20,179,000)
Securities held to maturity (1,392,000) (3,368,000) (6,173,000) (8,748,000)
Federal Home Loan Bank stock 0 0 (1,000) 0
Premises and equipment (616,000) (2,284,000) (2,428,000) (4,629,000)
Proceeds from:
Sales of available for sale securities 3,425,000 0 13,997,000 5,362,000
Maturities, calls and repayments of
available for sale securities 4,653,000 3,470,000 12,557,000 13,807,000
Maturities, calls and repayments of
held to maturity securities 0 0 1,005,000 102,000
-------------- ------------- ------------- --------------
Net cash used in investing activities (53,026,000) (37,760,000) (139,798,000) (125,180,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits 77,502,000 (1,486,000) 153,073,000 92,995,000
Net proceeds from the sale of common stock 0 25,123,000 (37,000) 31,872,000
Stock option exercise 0 0 6,000 0
Net increase (decrease) in other borrowed money (1,247,000) 93,000 277,000 148,000
Net increase in securities sold under agreements
to repurchase 8,499,000 3,153,000 11,650,000 5,789,000
-------------- ------------- ------------- --------------
Net cash from financing activities 84,754,000 26,883,000 164,969,000 130,804,000
-------------- ------------- ------------- --------------
Net change in cash and cash equivalents 25,085,000 (9,798,000) 21,698,000 5,361,000
Cash and cash equivalents at beginning of period 16,551,000 33,261,000 19,938,000 18,102,000
-------------- ------------- ------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 41,636,000 $ 23,463,000 $ 41,636,000 $ 23,463,000
============== ============= ============= ==============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 5,243,000 $ 7,317,000 $ 17,618,000 $ 22,334,000
Federal income tax 850,000 475,000 2,805,000 1,863,000
- --------------------------------------------------------------------------------
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 nine months ended
September 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 period ended September 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 September 30, 2002 were $717.2 million compared to
$587.2 million at December 31, 2001, an increase of $130.0 million or
22.1%. The components of our outstanding balances at September 30, 2002 and
December 31, 2001, and the percentage increase in loans from the end of
2001 to the end of the third quarter 2002 are as follows:
Percent
September 30, 2002 December 31, 2001 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Real Estate:
Construction and land
development $ 101,867,000 14.2% $ 62,710,000 10.6% 62.4%
Secured by 1-4 family
properties 48,760,000 6.8 41,028,000 7.0 18.8
Secured by multi-family
properties 11,957,000 1.7 7,394,000 1.3 61.7
Secured by nonfarm
nonresidential properties 312,696,000 43.5 263,568,000 44.9 18.6
Commercial 237,108,000 33.1 206,898,000 35.1 14.6
Consumer 4,811,000 0.7 5,650,000 1.1 (14.8)
------------- ------- ------------- ------- --------
$ 717,199,000 100.0% $ 587,248,000 100.0% 22.1%
============= ======= ============= ======= ========
- --------------------------------------------------------------------------------
(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 nine months ended September 30:
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Balance at beginning of
period $ 9,562,000 $ 7,462,000 $ 8,494,000 $ 6,302,000
Charge-offs (250,000) 0 (419,000) (65,000)
Recoveries 1,000 13,000 96,000 58,000
Provision for loan and
lease losses 880,000 455,000 2,022,000 1,635,000
------------- ------------- ------------- --------------
Balance at September 30 $ 10,193,000 $ 7,930,000 $ 10,193,000 $ 7,930,000
============= ============= ============= ==============
4. PREMISES AND EQUIPMENT, NET
Premises and equipment are comprised of the following:
September 30, December 31,
2002 2001
---- ----
Land and improvements $ 2,930,000 $ 1,970,000
Buildings and leasehold improvements 6,585,000 5,975,000
Furniture and equipment 3,956,000 3,119,000
-------------- ---------------
13,471,000 11,064,000
Less accumulated depreciation 2,143,000 1,507,000
-------------- ---------------
Premises and equipment, net $ 11,328,000 $ 9,557,000
============== ===============
Depreciation expense amounted to $221,000 during the third quarter of 2002,
compared to $122,000 in the third quarter of 2001. Depreciation expense
amounted to $657,000 during the first nine months of 2002, compared to
$338,000 during the first nine months of 2001.
- --------------------------------------------------------------------------------
(Continued)
8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
5. DEPOSITS
Our total deposits at September 30, 2002 were $722.2 million compared to
$569.1 million at December 31, 2001, an increase of $153.1 million, or
26.9%. The components of our outstanding balances at September 30, 2002 and
December 31, 2001, and percentage increase in deposits from the end of 2001
to the end of the third quarter 2002 are as follows:
Percent
September 30, 2002 December 31, 2001 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Noninterest-bearing demand $ 67,831,000 9.4% $ 43,162,000 7.6% 57.2%
Interest-bearing checking 22,731,000 3.1 22,188,000 3.9 2.4
Money market 6,759,000 0.9 5,578,000 1.0 21.2
Savings 63,197,000 8.8 47,157,000 8.3 34.0
Time, under $100,000 6,687,000 0.9 6,144,000 1.1 8.8
Time, $100,000 and over 61,252,000 8.5 52,601,000 9.2 16.4
------------- ------ --------------- ------ ------
228,457,000 31.6 176,830,000 31.1 29.2
Out-of-area time,
under $100,000 90,805,000 12.6 83,789,000 14.7 8.4
Out-of-area time,
$100,000 and over 402,888,000 55.8 308,458,000 54.2 30.6
------------- ------ --------------- ------ ------
493,693,000 68.4 392,247,000 68.9 25.9
------------- ------ --------------- ------ ------
Total deposits $ 722,150,000 100.0% $ 569,077,000 100.0% 26.9%
============== ====== ============== ====== ======
6. BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
September 30, December 31,
2002 2001
---- ----
Outstanding balance at end of period $ 48,135,000 $ 36,485,000
Average interest rate at end of period 2.03% 2.21%
Average balance during the period $ 40,829,000 $ 34,596,000
Average interest rate during the period 2.16% 3.42%
Maximum month end balance during the period $ 49,190,000 $ 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 September 30, 2002 and December
31, 2001 follows:
September 30, December 31,
2002 2001
---- ----
Commercial unused lines of credit $ 131,209,000 $ 110,787,000
Unused lines of credit secured by 1-4 family
residential properties 11,823,000 8,181,000
Credit card unused lines of credit 6,073,000 6,212,000
Other consumer unused lines of credit 4,813,000 3,965,000
Commitments to make loans 46,849,000 25,966,000
Standby letters of credit 40,311,000 36,377,000
-------------- ---------------
$ 241,078,000 $ 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
------ ----- ------ ----- ------ -----
September 30, 2002
------------------
Total capital (to risk
weighted assets)
Consolidated $102,693,000 12.5% $ 65,843,000 8.0% $ 82,303,000 10.0%
Bank 99,901,000 12.2 65,745,000 8.0 82,181,000 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 92,500,000 11.2 32,922,000 4.0 49,382,000 6.0
Bank 89,708,000 10.9 32,873,000 4.0 49,309,000 6.0
Tier 1 capital (to
average assets)
Consolidated 92,500,000 11.3 32,846,000 4.0 41,058,000 5.0
Bank 89,708,000 10.9 32,806,000 4.0 41,008,000 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 September 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 September 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 September 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.
- --------------------------------------------------------------------------------
(Continued)
12
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and about our company. Words such as
"anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is
likely", "plans", "projects", variations of such words and similar expressions
are intended to identify such forward-looking statements. These statements are
not guarantees of future performance and involve certain risks, uncertainties
and assumptions ("Future Factors") that are difficult to predict with regard to
timing, extent, likelihood and degree of occurrence. Therefore, actual results
and outcomes may materially differ from what may be expressed or forecasted in
such forward-looking statements. We undertake no obligation to update, amend, or
clarify forward looking statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; and changes in the national and local economy. These are representative
of the Future Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, Mercantile Bank of West Michigan
("our bank"), our bank's 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 September 30, 2002 to
December 31, 2001 and the results of operations for the three and nine months
ended September 30, 2002 and September 30, 2001. This discussion should be read
in conjunction with the interim consolidated condensed 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 third 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 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 nine months of 2002, our assets increased from $698.7 million
on December 31, 2001, to $870.4 million on September 30, 2002. This represents a
total increase in assets of $171.7 million, or 24.6%. The asset growth was
comprised primarily of a $128.2 million increase in net loans, a $21.7 million
increase in cash and cash equivalents, an $11.1 million increase in other assets
and an $8.2 million increase in securities. The increase in assets was primarily
funded by a $153.1 million increase in deposits and an increase of $11.6 million
in securities sold under agreements to repurchase.
- --------------------------------------------------------------------------------
13
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Commercial loans increased by $123.0 million during the first nine months of
2002, and at September 30, 2002 totaled $663.6 million, or 92.5% 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 $7.8 million during the first nine
months of 2002, while the balance of our consumer loan portfolio declined by
$0.9 million. As of September 30, 2002, residential mortgage and consumer loans
totaled a combined $53.6 million, or 7.5% of the total loan portfolio. Although
our non-commercial 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 nine months of 2002 totaled $323,000, or 0.07% of average total loans
on an annualized basis. Past due loans and nonacccrual loans at September 30,
2002 totaled $994,000, or 0.14% of 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 non-affiliated commercial banks
outside the immediate area, which are underwritten using the same loan criteria
as though our bank was the originating bank.
Securities increased by $8.2 million, or 10.4%, during the first nine months of
2002. Purchases during the first nine months of 2002 totaled $34.7 million,
maturities, calls and repayments totaled $13.6 million and sales totaled $14.0
million. The unrealized net gain on securities available for sale increased $1.0
million during the same time period. Holdings of securities remained confined to
U.S. Government Agency bonds, mortgage-backed securities issued or guaranteed by
U.S. Government Agencies, investment grade municipal securities and Federal Home
Loan Bank stock.
Cash and cash equivalents increased $21.7 million during the first nine months
of 2002, totaling $41.6 million on September 30, 2002. The increase was
primarily the result of a large outgoing cash letter on the last day of the
third quarter and an increase in our federal funds sold position. Our commercial
lending and wholesale funding focus results in relatively large day-to-day
fluctuations of our cash and cash equivalent balances. The average balance of
cash and cash equivalents during the first nine months of 2002 equaled $25.0
million, or approximately 10.0% below the balance at September 30, 2001.
Other assets increased $11.1 million during the first nine months of 2002,
totaling $19.9 million on September 30, 2002. The increase is primarily
attributable to our purchase of approximately $10.5 million in bank owned life
insurance policies for selected officers during the third quarter of 2002. These
single premium whole life insurance policies, that include term insurance
coverage of which our bank is the sole beneficiary, have a positive impact on
noninterest income due to the income recognition relating to the increase in
cash surrender value. The recognition of the increased cash surrender value in
part mitigates the rapidly increasing cost of employee medical and long term
disability insurance policies resulting from increased premiums charged by our
insurance carriers and the hiring of additional staff.
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14
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Deposits increased $153.1 million during the first nine months of 2002, totaling
$722.2 million at September 30, 2002. Local deposits increased $51.7 million, or
29.2%, while out-of-area deposits increased $101.5 million, or 25.9%. As a
percent of total deposits, local deposits increased from 31.1% on December 31,
2001, to 31.6% on September 30, 2002. Noninterest-bearing demand deposits,
comprising 9.4% of total deposits, increased $24.6 million during the first nine
months of 2002. Savings deposits (8.8% of total deposits) increased $16.0
million, money market deposit accounts (0.9% of total deposits) increased $1.2
million and interest-bearing checking deposits (3.1% of total deposits)
increased $0.5 million during the first nine months of 2002. Local certificates
of deposit, comprising 9.4% of total deposits, increased by $9.2 million during
the first nine months of 2002.
Out-of-area deposits totaled $493.7 million, or 68.4% of total deposits, as of
September 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 nine months of 2002 rates
paid on new out-of-area certificates of deposit were 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 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 $11.7 million during the first nine 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 the 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 the market area have
consistently increased, the growth has not been sufficient to meet the
substantial loan growth and provide monies for additional investing activities.
To assist in providing the additional needed funds, we have regularly obtained
certificates of deposit from customers outside of the market area and placed by
deposit brokers for a fee, as well as certificates of deposit obtained from the
deposit owners directly. As of September 30, 2002, out-of-area deposits totaled
$493.7 million, or 64.1% of combined deposits and repurchase agreements,
compared to $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 growth.
- --------------------------------------------------------------------------------
15
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established unsecured federal funds purchased lines, totaling $25.0
million as of September 30, 2002. However, we view federal funds purchased as
only a secondary and temporary source of funds and our bank was generally in a
federal funds sold position during the first nine months of 2002. The average
balance of federal funds purchased during the first nine months of 2002 equaled
$0.6 million, compared to a $7.6 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 available collateral at
September 30, 2002, our bank could borrow up to approximately $82.0 million. Our
bank has yet to use its established borrowing line at the FHLBI; however, we
expect our bank to begin to obtain advances from the FHLBI by December 31, 2002.
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 September 30, 2002, our bank had a total of $200.8 million in
unfunded loan commitments and $40.3 million in unfunded standby letters of
credit. Of the total unfunded loan commitments, $154.0 million were commitments
available as lines of credit to be drawn at any time as customers' cash needs
vary, and $46.8 million were for loan commitments expected to close and become
funded within the next three to six months. We monitor fluctuations in loan
balances and commitment levels, and include such data in managing overall
liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $6.1 million during
the first nine months of 2002, from $71.5 million on December 31, 2001, to $77.6
million at September 30, 2002. The increase is primarily attributable to net
income of $5.5 million during the first nine months of 2002. In addition,
shareholders' equity was positively impacted during the first nine months of
2002 by a $0.7 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 nine months of 2002.
In September 1999 we, through the trust, issued 1.6 million shares of trust
preferred securities at $10.00 per trust preferred security. Substantially all
of the net proceeds were 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
September 30, 2002, the entire $16.0 million of trust preferred securities was
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 September 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.
- --------------------------------------------------------------------------------
16
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Net income for the third quarter of 2002 was $2.2 million ($0.42 per basic share
and $0.41 per diluted share), which represents a 61.1% increase over net income
of $1.3 million ($0.32 per basic share and $0.31 per diluted share) recorded
during the third quarter of 2001. The 31.3% growth in basic earnings per share
and the 32.3% 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 third quarter of 2002 were up 21.3% and 21.6% over the levels during the
same time period in 2001, respectively. Net income for the first nine months of
2002 was $5.5 million ($1.06 per basic share and $1.04 per diluted share), which
represents an 80.7% increase over net income of $3.0 million ($0.88 per basic
share and $0.87 per diluted share) recorded during the first nine months of
2001. The 20.5% increase in basic earnings per share and the 19.5% 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 first nine months of
2002 were up 49.4% and 49.6% 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 third quarter of 2002 was $12.3 million, an increase
of 6.8% over the $11.5 million earned during the third quarter of 2001. Interest
income during the first nine months of 2002 was $35.0 million, an increase of
4.8% over the $33.4 million earned during the first nine months of 2001. The
growth in interest income during both time periods is primarily attributable to
an increase in earning assets, which more than offset the negative impact of a
declining interest rate environment. During the third quarter of 2002 earning
assets averaged $782.4 million, $175.4 million higher than the average earning
assets of $607.0 million during the third quarter of 2001. Average loans were up
$165.9 million and securities increased $15.3 million, while federal funds sold
were down $5.8 million. During the first nine months of 2002 earning assets
averaged $735.9 million, $173.8 million higher than the average earning assets
of $562.1 million during the same time period in 2001. Average loans were up
$166.0 million and securities increased $15.1 million, while federal funds sold
were down $7.3 million. Negatively impacting the growth in interest income
during the third quarter of 2002 and the first nine months of 2002, when
compared to the comparable periods in 2001, was the decline in yield on earning
assets. During the third quarter of 2002 and 2001, earning assets had a weighted
average yield of 6.33% and 7.61%, respectively. During the first nine months of
2002 and 2001 earning assets had a weighted average yield of 6.44% and 8.01%,
respectively. The decrease in weighted average yields during 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 during 2001.
- --------------------------------------------------------------------------------
17
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Interest expense during the third quarter of 2002 was $6.0 million, a decrease
of 15.9% from the $7.2 million expensed during the third quarter of 2001.
Interest expense during the first nine months of 2002 was $17.9 million, a
decrease of 18.0% from the $21.9 million expensed during the first nine 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 third
quarter of 2002, interest-bearing liabilities averaged $687.8 million, $152.8
million higher than average interest-bearing liabilities of $535.0 million
during the third quarter of 2001. During the first nine months of 2002
interest-bearing liabilities averaged $644.5 million, $143.2 million higher than
average interest-bearing liabilities of $501.3 million during the same time
period in 2001. Positively impacting interest expense during the third quarter
of 2002 and the first nine months of 2002 was the decline in the cost of
interest-bearing liabilities. During the third quarter of 2002 and 2001,
interest-bearing liabilities had a weighted average rate of 3.48% and 5.32%,
respectively. During the first nine months of 2002 and 2001 interest-bearing
liabilities had a weighted average rate of 3.72% and 5.84%, 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.
Net interest income during the third quarter of 2002 was $6.3 million, an
increase of 44.3% over the $4.4 million earned during the third quarter of 2001.
Net interest income during the first nine months of 2002 was $17.1 million, an
increase of 48.1% over the $11.5 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 2.92%
during the third quarter of 2001 to 3.27% in third quarter of 2002, and
increased from 2.81% during the first nine months of 2001 to 3.18% in the first
nine 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 third
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. Tax-exempt securities interest income and yield have
been computed on a tax equivalent basis using a marginal tax rate of 34%.
- --------------------------------------------------------------------------------
18
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
--------------------------Quarters ended September 30,--------------------------------
------------------2 0 0 2------------ ------------------2 0 0 1-----------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
ASSETS
Loans $ 688,550 $ 11,132 6.41% $ 522,615 $ 10,341 7.85%
Investment securities 84,163 1,303 6.19 68,902 1,162 6.75
Federal funds sold 9,527 41 1.68 15,376 140 3.56
Short term investments 195 1 1.25 143 1 2.79
----------- ----------- ---- ----------- ----------- ----
Total interest-earning
assets 782,435 12,477 6.33 607,036 11,644 7.61
Allowance for loan
and lease losses (9,927) (7,704)
Other assets 48,641 31,592
----------- -----------
Total assets $ 821,149 $ 630,924
=========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 624,792 5,396 3.43% $ 482,430 6,475 5.32%
Short-term borrowings 46,540 242 2.06 36,427 307 3.35
Long-term borrowings 16,485 398 9.66 16,161 395 9.70
----------- ----------- ---- ----------- ----------- ----
Total interest-bearing
liabilities 687,817 6,036 3.48 535,018 7,177 5.32
Noninterest-bearing
deposits 51,869 34,138
Other liabilities 5,113 5,935
Shareholders' equity 76,350 55,833
----------- ----------- ---- ----------- ----------- ----
Total liability and
shareholders' equity $ 821,149 $ 630,924
=========== ===========
Net interest income $ 6,441 $ 4,467
=========== ===========
Net interest rate spread 2.85% 2.29%
==== ====
Net interest rate spread
on average assets 3.11% 2.81%
==== ====
Net interest margin on
earning assets 3.27% 2.92%
==== ====
Provisions to the allowance for loan and lease losses during the third quarter
of 2002 were $0.9 million, compared to the $0.5 million expensed during the
third quarter of 2001. Provisions to the allowance for loan and lease losses
during the first nine months of 2002 were $2.0 million, compared to the $1.6
million that was expensed during the same time period in 2001. The increase
during both time periods primarily reflects the higher volume of loan growth.
Net loan charge-offs during the third quarter of 2002 were $249,000 compared to
a net recovery of $13,000 during the third quarter of 2001. During the first
nine months of 2002 net loan charge-offs totaled $323,000 compared to net loan
charge-offs of $7,000 during the same time period in 2001. The allowance for
loan and lease losses as a percentage of total loans outstanding as of September
30, 2002 was 1.42%, down from the 1.45% level at December 31, 2001.
- --------------------------------------------------------------------------------
19
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
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, excluding net gains on sales of securities, during the third
quarter of 2002 was $0.8 million, an increase of 82.2% over the $0.4 million
earned during the third quarter of 2001. Noninterest income, excluding net gains
on sales of securities, during the first nine months of 2002 was $1.8 million,
an increase of 59.8% over the $1.1 million earned during the same time period in
2001. Service charge income on deposits and repurchase agreements increased
$113,000 (86.9%) during the third quarter of 2002 over that earned in the third
quarter of 2001, and during the first nine months of 2002 increased $304,000
(85.4%) over that earned in the comparable time period in 2001. The increases
during both time periods primarily results from new accounts opened during the
last twelve months, decline in the earnings credit rate and modest increases in
our deposit fee structure. Fees earned on referring residential mortgage loan
applicants to various third parties totaled $147,000 during the third quarter of
2002 compared to $67,000 earned during the third quarter of 2001, and totaled
$318,000 during the first nine months of 2002 compared to $245,000 earned during
the first nine months of 2001. Letter of credit fees totaled $141,000 during the
third quarter of 2002 compared to $139,000 recorded during the third quarter of
2001, and totaled $247,000 during the first nine months of 2002 compared to
$290,000 recorded during the first nine months of 2001. Credit and debit card
usage fees totaled $76,000 during the third quarter of 2002 compared to $42,000
earned during the third quarter of 2001, and totaled $180,000 during the first
nine months of 2002 compared to $116,000 earned during the first nine months of
2001.
Noninterest income related to the cash surrender value of bank owned life
insurance policies ("BOLI") totaled $116,000 during the third quarter of 2002
compared to $46,000 recorded during the third quarter of 2001, and totaled
$208,000 during the first nine months of 2002 compared to $52,000 recorded
during the first nine months of 2001. During the third quarter of 2002 we
purchased BOLI totaling approximately $10.5 million, which are in addition to
the BOLI policies we purchased at various intervals during 2001 as part of our
non-qualified deferred compensation program.
- --------------------------------------------------------------------------------
20
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Noninterest expense during the third quarter of 2002 was $3.3 million, an
increase of 36.7% over the $2.4 million expensed during the same time period in
2001. Noninterest expense during the first nine months of 2002 was $9.3 million,
an increase of 38.5% over the $6.7 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 ($0.6 million in third quarter 2002
over third quarter 2001, and $1.5 million for the first nine months of 2002 over
the first nine 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 third quarter of 2002 over the level
expensed in the third quarter of 2001 and $0.6 million during the first nine
months of 2002 over the level expensed during the first nine months of 2001
primarily due to the opening of our new facilities in southwest Grand Rapids.
General overhead costs have also increased, reflecting the additional expenses
required to administer our significantly increased asset base.
Monitoring and controlling noninterest costs, while at the same time providing
high quality service to customers, is a key component to our business strategy.
While the dollar volume of noninterest costs has increased, the rate of growth
has been lower than the increase in net interest income and noninterest income.
The efficiency ratio, computed by dividing noninterest expenses by net interest
income plus noninterest income, was 45.4% during the third quarter of 2002, a
9.2% improvement over the 50.0% during the third quarter of 2001, and was 48.8%
during the first nine months of 2002, a 7.8% improvement over the 52.9% during
the first nine months of 2001. Although noninterest expenses increased by $0.9
million during the third quarter of 2002 over the amount expensed during the
third quarter of 2001, and increased $2.6 million during the first nine months
of 2002 over the amount expensed during the first nine months of 2001, net
revenues (net interest income plus noninterest income) increased at a
substantially higher level of $2.4 million and $6.4 million during the same time
periods, respectively.
Federal income tax expense was $0.9 million and $2.3 million during the third
quarter and first nine months of 2002, respectively. Federal income tax expense
was $0.6 million and $1.3 million during the third quarter and first nine months
of 2001, respectively. The increases during both time periods primarily result
from the increase in net income before federal income tax expense. During the
third quarter of 2002 net income before federal income tax expense was $3.1
million, an increase of $1.1 million over the amount recorded during the third
quarter of 2001. During the first nine months of 2002 net income before federal
income tax expense was $7.8 million, an increase of $3.4 million over the amount
recorded during the first nine months of 2001.
- --------------------------------------------------------------------------------
21
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
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 September 30,
2002 (dollars in thousands):
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22
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
Assets:
Commercial loans $ 278,095 $ 35,850 $ 335,157 $ 14,526 $ 663,628
Residential real estate loans 24,034 1,634 15,257 7,835 48,760
Consumer loans 1,040 52 3,561 158 4,811
Investment securities (1) 2,358 2,766 32,449 49,472 87,045
Federal funds sold 12,000 12,000
Short term investments 207 207
Allowance for loan and lease losses (10,193) (10,193)
Other assets 64,124 64,124
----------- ----------- ----------- ----------- -----------
Total assets 317,734 40,302 386,424 125,922 870,382
Liabilities:
Interest-bearing checking 22,731 22,731
Savings 63,197 63,197
Money market accounts 6,759 6,759
Time deposits < $100,000 21,809 49,416 26,267 97,492
Time deposits $100,000 and over 106,132 229,824 128,184 464,140
Short-term borrowings 48,135 48,135
Long-term borrowings 516 16,000 16,516
Noninterest-bearing checking 67,831 67,831
Other liabilities 6,001 6,001
----------- ----------- ----------- ----------- -----------
Total liabilities 269,279 279,240 154,451 89,832 792,802
Shareholders' equity 77,580 77,580
----------- ----------- ----------- ----------- -----------
Total sources of funds 269,279 279,240 154,451 167,412 870,382
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 48,455 $ (238,938) $ 231,973 $ (41,490)
=========== ============ =========== ============
Cumulative GAP $ 48,455 $ (190,483) $ 41,490
=========== ============ ===========
Percent of cumulative GAP to
total assets 5.6% (21.9)% 4.8%
=========== =========== ===========
(1) Mortgage-backed securities are categorized by average life calculations
based upon prepayment trends as of September 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 our strategies, among other factors.
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23
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
- --------------------------------------------------------------------------------
We conducted multiple simulations as of September 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 are well within our policy
parameters established to manage and monitor interest rate risk.
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
---------------------- ------------------- -------------------
Interest rates down 200 basis points $ 605,000 2.4%
Interest rates down 100 basis points 956,000 3.8
No change in interest rates 1,147,000 4.5
Interest rates up 100 basis points 1,658,000 6.6
Interest rates up 200 basis points 2,174,000 8.6
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 interest rates on 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 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.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2002, an evaluation was performed under the supervision of
and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures. Based on that evaluation,
our management, including our Chief Executive Officer and Chief Financial
Officer, concluded that our disclosure controls and procedures were effective as
of September 30, 2002. There have been no significant changes in our internal
controls or in other factors that could significantly affect internal controls
subsequent to September 30, 2002.
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24
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.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
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
(b) Reports on Form 8-K:
We have not filed any reports on Form 8-K during the quarter for which this
report is filed.
- --------------------------------------------------------------------------------
(Continued)
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 November 14, 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
CERTIFICATIONS
I, Gerald R. Johnson, Jr., Chairman and Chief Executive Officer of Mercantile
Bank Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Mercantile Bank
Corporation (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002 /s/ Gerald R. Johnson, Jr.
-----------------------------------------
Gerald R. Johnson, Jr.
Chairman and Chief Executive Officer
- --------------------------------------------------------------------------------
27
I, Charles E. Christmas, Senior Vice President, Chief Financial Officer and
Treasurer of Mercantile Bank Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Mercantile Bank
Corporation (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002 /s/ Charles E. Christmas
--------------------------------------------
Charles E. Christmas.
Senior Vice President, Chief Financial Officer
and Treasurer
- --------------------------------------------------------------------------------
28
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
- --------------------------------------------------------------------------------
29