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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to _______________
Commission File Number 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-3360865
(State or Other Jurisdiction of Incorporation or Organization) (IRS Employer Identification Number)
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)
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant Section 12(g) of the Act:
COMMON STOCK
(Title of Class)
9.60% CUMULATIVE PREFERRED SECURITIES, $10 LIQUIDATION AMOUNT
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such requirements for the
past 90 days. YES X NO
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). YES X NO
----- -----
The aggregate value of the common equity held by non-affiliates
(persons other than directors and executive officers) of the Registrant,
computed by reference to the average of the closing bid and asked prices of the
common stock as of the last business day of the Registrant's most recently
completed second quarter, adjusted for the 5% stock dividend paid on February 3,
2003, was approximately $96.6 million.
As of February 3, 2003, there were issued and outstanding 5,405,706
shares of the Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of Shareholders
(Portions of Part III).
PART I
ITEM 1. BUSINESS
THE COMPANY
Mercantile Bank Corporation is a registered bank holding company under
the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company
Act"). Unless the text clearly suggests otherwise, references to "us," "we,"
"our," or "the company" include Mercantile Bank Corporation and its wholly-owned
subsidiaries. As a bank holding company, we are subject to regulation by the
Board of Governors of the Federal Reserve System (the "Federal Reserve Board").
We were organized on July 15, 1997, under the laws of the State of Michigan,
primarily for the purpose of holding all of the stock of Mercantile Bank of West
Michigan ("our bank"), and of such other subsidiaries as we may acquire or
establish. Our bank commenced business on December 15, 1997. MBWM Capital Trust
I ("the trust"), a wholly-owned business trust subsidiary, was formed in
September 1999. Mercantile Bank Mortgage Company ("our mortgage company"), a
wholly-owned subsidiary of our bank, initiated business in October 2000. On
February 7, 2002, Mercantile BIDCO, Inc. ("our BIDCO"), a wholly-owned
subsidiary of our bank, was granted a license by the Michigan Office of
Financial and Insurance Services to operate as a Michigan Business and
Industrial Development Company under the Michigan BIDCO Act of 1986. Mercantile
Insurance Center, Inc. ("our insurance company"), a wholly-owned subsidiary of
our bank, commenced operations during 2002 to offer insurance products.
To date we have raised capital from our initial public offering of
common stock in October 1997, a public offering of common stock in July 1998,
issuance of cumulative preferred securities in September 1999, three private
placements of common stock during 2001 and a public offering of common stock in
August 2001. Our expenses have generally been paid using the proceeds of the
capital sales and dividends from our bank. Our principal source of future
operating funds is expected to be dividends from our bank.
We filed an election to become a financial holding company, pursuant to
the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley
Act and implementing Federal Reserve Board regulations, which election became
effective March 23, 2000.
OUR BANK
Our bank is a state banking company that operates under the laws of the
State of Michigan, pursuant to a charter issued by the Michigan Office of
Financial and Insurance Services. Our bank's deposits are insured to the maximum
extent provided by law by the Federal Deposit Insurance Corporation ("FDIC").
Our bank's primary service area is the Kent and Ottawa County areas of West
Michigan, which includes the City of Grand Rapids, the second largest city in
the State of Michigan.
Our bank, through its main office located at 216 North Division Avenue,
Grand Rapids, Michigan, its combination branch and retail loan center located at
4613 Alpine Avenue, Comstock Park, Michigan, its combination branch and
operations center located at 5610 Byron Center Avenue SW, Wyoming, Michigan, its
branch located at 4860 Broadmoor, Kentwood, Michigan and its administration
facility located at 5650 Byron Center Avenue SW, Wyoming, Michigan, provides
commercial and retail banking services primarily to small- to medium-sized
businesses based in and around Grand Rapids. Our bank makes secured and
unsecured commercial, construction, mortgage and consumer loans, and accepts
checking, savings and time deposits. Our bank owns four automated teller
machines ("ATM") that participate in the MAC, NYCE and PLUS regional network
systems, as well as other ATM networks throughout the country. Our bank also
enables customers to conduct certain loan and deposit transactions by telephone
and personal computer. Courier service is provided to certain commercial
customers, and safe deposit facilities are available at all locations. Our bank
does not have trust powers. In December 2001, our bank entered into a joint
brokerage services and marketing agreement with Raymond James Financial
Services, Inc. to make available to our bank's customers financial planning,
retail brokerage, equity research, insurance and annuities, retirement planning,
trust services and estate planning.
2.
THE TRUST
In 1999 we formed the trust, a Delaware business trust. The trust's
business and affairs are conducted by its property trustee, a Delaware trustee,
and three individual administrative trustees who are employees and officers of
the company. The trust was established for the purpose of issuing and selling
its preferred securities and common securities, and used the proceeds from the
sales of those securities to acquire subordinated debentures issued by the
company. Substantially all of the net proceeds received by the company from the
transaction were contributed to our bank as capital. Additional information
regarding the trust is incorporated by reference to "Note 15 -- Trust Preferred
Securities" and "Note 17 -- Regulatory Matters" of the Consolidated Financial
Statements included in this Annual Report on pages F-44 and F-45.
OUR MORTGAGE COMPANY
Our mortgage company commenced operations on October 24, 2000 when our
bank contributed most of its residential mortgage loan portfolio and
participation interests in certain commercial mortgage loans to our mortgage
company. On the same date our bank also transferred its residential mortgage
origination function to our mortgage company. Mortgage loans originated and held
by our mortgage company are serviced by our bank pursuant to a servicing
agreement.
OUR BIDCO
Our BIDCO was granted a license by the Michigan Office of Financial and
Insurance Services on February 7, 2002, to operate our BIDCO as a Michigan
Business and Industrial Development Company. Our BIDCO, a non-depository
Michigan financial institution, offers equipment lease financing, asset based
loans, junior debt facilities and other financing where equity features may be
part of the facility pricing.
OUR INSURANCE COMPANY
Our insurance company acquired an existing shelf insurance agency
effective April 15, 2002. An Agency and Institution Agreement was entered into
among our insurance company, our bank and Burnham Insurance Group for the
purpose of providing programs of mass marketed personal lines of insurance.
Insurance product offerings include private passenger automobile, homeowners,
personal inland marine, boat owners, recreational vehicle, dwelling fire,
umbrella policies, small business and life insurance products, all of which are
provided by and written through companies that have appointed Burnham Insurance
Group as their agent. The insurance products are marketed through a central
facility operated by the Michigan Bankers Insurance Association, members of
which include the insurance subsidiaries of various Michigan-based financial
institutions and Burnham Insurance Group. Our insurance company receives
commissions based upon written premiums produced under the Agency and
Institution Agreement.
EFFECT OF GOVERNMENT MONETARY POLICIES
Our earnings are affected by domestic economic conditions and the
monetary and fiscal policies of the United States government, its agencies, and
the Federal Reserve Board. The Federal Reserve Board's monetary policies have
had, and will likely continue to have, an important impact on the operating
results of commercial banks through its power to implement national monetary
policy in order to, among other things, curb inflation or avoid a recession. The
policies of the Federal Reserve Board have a major effect upon the levels of
bank loans, investments and deposits through its open market operations in
United States government securities, and through its regulation of, among other
things, the discount rate on borrowings of member banks and the reserve
requirements against member bank deposits. Our bank maintains reserves directly
with the Federal Reserve Bank of Chicago to the extent required by law. It is
not possible to predict the nature and impact of future changes in monetary and
fiscal policies.
3.
REGULATION AND SUPERVISION
As a bank holding company under the Bank Holding Company Act, we are
required to file an annual report with the Federal Reserve Board and such
additional information as the Federal Reserve Board may require. We are also
subject to examination by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding
companies that have not qualified as financial holding companies to banking and
the management of banking organizations, and to certain non-banking activities.
These non-banking activities include those activities that the Federal Reserve
Board found, by order or regulation as of the day prior to enactment of the
Gramm-Leach-Bliley Act, to be so closely related to banking or managing or
controlling banks as to be a proper incident to those activities. These
non-banking activities include, among other things: operating a mortgage
company, finance company, credit card company or factoring company; performing
certain data processing operations; providing certain investment and financial
advice; acting as an insurance agent for certain types of credit-related
insurance; leasing property on a full-payout, nonoperating basis; and providing
discount securities brokerage services for customers. With the exception of the
respective activities of our mortgage company and our BIDCO discussed above,
neither we nor any of our subsidiaries engages in any of the foregoing
non-banking activities.
In March 2000, our election to become a financial holding company, as
permitted by the Bank Holding Company Act, as amended by Title I of the
Gramm-Leach-Bliley Act, was accepted by the Federal Reserve Board. In order to
continue as a financial holding company, we and our bank must satisfy certain
statutory requirements regarding capitalization, management, and compliance with
the Community Reinvestment Act. As a financial holding company, we are permitted
to engage in a broader range of activities than are permitted to bank holding
companies.
Those expanded activities include any activity which the Federal
Reserve Board (in certain instances in consultation with the Department of the
Treasury) determines, by order or regulation, to be financial in nature or
incidental to such financial activity, or to be complementary to a financial
activity and not to pose a substantial risk to the safety or soundness of
depository institutions or the financial system generally. Such expanded
activities include, among others: insuring, guaranteeing, or indemnifying
against loss, harm, damage, illness disability or death, or issuing annuities,
and acting as principal, agent, or broker for such purposes; providing
financial, investment, or economic advisory services, including advising a
mutual fund; and underwriting, dealing in, or making a market in securities.
Other than the insurance agency activities of our insurance company, neither we
nor our subsidiaries presently engage in any such expanded activity.
Our bank is subject to certain restrictions imposed by federal law and
regulation. These restrictions apply to any extension of credit to us or to our
other subsidiaries, to investments in stock or other securities that we issue,
to the taking of such stock or securities as collateral for loans to any
borrower, and to acquisitions of assets or services from, and sales of certain
types of assets to, us or our other subsidiaries. Federal law prevents us from
borrowing from our bank unless the loans are secured in designated amounts with
specified forms of collateral.
With respect to the acquisition of banking organizations, we are
generally required to obtain the prior approval of the Federal Reserve Board
before we can acquire all or substantially all of the assets of any bank, or
acquire ownership or control of any voting shares of any bank, if, after such
acquisition, we would own or control more than 5% of the voting shares of the
bank. Acquisitions across state lines are subject to certain state and Federal
Reserve Board restrictions.
EMPLOYEES
As of December 31, 2002, we and our bank employed 103 full-time and 31
part-time persons. Management believes that relations with employees are good.
4.
LENDING POLICY
As a routine part of our business, we make loans and leases to
businesses and individuals located within our market area. Our lending policy
states that the function of the lending operation is twofold: to provide a means
for the investment of funds at a profitable rate of return with an acceptable
degree of risk, and to meet the credit needs of the creditworthy businesses and
individuals who are our customers. We recognize that in the normal business of
lending, some losses on loans and leases will be inevitable and should be
considered a part of the normal cost of doing business.
Our lending policy anticipates that priorities in extending loans and
leases will be modified from time to time as interest rates, market conditions
and competitive factors change. The policy sets forth guidelines on a
nondiscriminatory basis for lending in accordance with applicable laws and
regulations. The policy describes various criteria in granting loans and leases,
including the ability to pay; the character of the customer; evidence of
financial responsibility; purpose of the loan or lease; knowledge of collateral
and its value; terms of repayment; source of repayment; payment history; and
economic conditions.
The lending policy further limits the amount of funds that may be
loaned or leased against specified types of real estate collateral. For certain
loans secured by real estate, the policy requires an appraisal of the property
offered as collateral by a state certified independent appraiser. The policy
also provides general guidelines for loan to value and lease to value limits for
other types of collateral, such as accounts receivable and machinery and
equipment. In addition, the policy provides general guidelines as to
environmental analysis, loans to employees, executive officers and directors,
problem loan and lease identification, maintenance of an allowance for loan and
lease losses, loan and lease review and grading, mortgage and consumer lending,
and other matters relating to our lending practices.
The Board of Directors has delegated significant lending authority to
officers of our bank. The Board of Directors believes this empowerment,
supported by our strong credit culture and the significant experience of our
commercial lending staff, makes us responsive to our customers. The loan policy
currently specifies lending authority for certain officers up to $1.0 million,
and $6.0 million for our bank's Chairman of the Board and its President and
Chief Executive Officer; however, the $6.0 million lending authority is used
only in rare circumstances where timing is of the essence. Generally, loan
requests exceeding $2.5 million require approval by the Officers Loan Committee,
and loan requests exceeding $3.0 million, up to the legal lending limit of
approximately $19.0 million, require approval by the Board of Directors. In most
circumstances we apply an in-house lending limit that is significantly less than
our bank's legal lending limit.
LENDING ACTIVITY
Commercial Loans. Our commercial lending group originates commercial
loans and leases primarily in our market area. Commercial loans and leases are
originated by ten lenders, with over 165 years of combined commercial lending
experience. Loans and leases are originated for general business purposes,
including working capital, accounts receivable financing, machinery and
equipment acquisition, and commercial real estate financing including new
construction and land development.
Working capital loans are often structured as a line of credit and are
reviewed periodically in connection with the borrower's year-end financial
reporting. These loans are generally secured by substantially all of the assets
of the borrower, and have an interest rate tied to the national prime rate.
Loans and leases for machinery and equipment purposes typically have a maturity
of three to five years and are fully amortizing, while commercial real estate
loans are usually written with a five-year maturity and amortized over a 15 year
period. These commercial loan and lease types have an interest rate that is
fixed to maturity or is tied to the national prime rate.
5.
We evaluate many aspects of a commercial loan or lease transaction in
order to minimize credit and interest rate risk. Underwriting includes an
assessment of the management, products, markets, cash flow, capital, income and
collateral. This analysis includes a review of the borrower's historical and
projected financial results. Appraisals are generally required by certified
independent appraisers where real estate is the primary collateral, and in some
cases, where equipment is the primary collateral. In certain situations, for
creditworthy customers, we may accept title reports instead of requiring
lenders' policies of title insurance.
Commercial real estate lending involves more risk than residential
lending because loan balances are greater and repayment is dependent upon the
borrower's business operations. We attempt to minimize the risks associated with
these transactions by generally limiting our commercial real estate lending to
owner-operated properties of well-known customers or new customers whose
businesses have an established profitable history. In many cases, risk is
further reduced by limiting the amount of credit to any one borrower to an
amount considerably less than our legal lending limit and avoiding certain types
of commercial real estate financings.
We have no material foreign or agricultural loans, and no material
loans to energy producing customers.
Single-Family Residential Real Estate Loans. Our mortgage company
originates single-family residential real estate loans in our market area,
usually according to secondary market underwriting standards. Loans not
conforming to those standards are made in limited circumstances. Single-family
residential real estate loans provide borrowers with a fixed or adjustable
interest rate with terms up to 30 years.
Our bank has a home equity line of credit program. Home equity credit
is generally secured by either a first or second mortgage on the borrower's
primary residence. The program provides revolving credit at a rate tied to the
national prime rate.
Consumer Loans. We originate consumer loans for a variety of personal
financial needs, including new and used automobiles, boat loans, credit cards
and overdraft protection for our checking account customers. Consumer loans
generally have shorter terms and higher interest rates and usually involve more
credit risk than single-family residential real estate loans because of the type
and nature of the collateral.
While we do not utilize a formal credit scoring system, management
believes our consumer loans are underwritten carefully, with a strong emphasis
on the amount of the down payment, credit quality, employment stability and
monthly income of the borrower. These loans are generally repaid on a monthly
repayment schedule with the source of repayment tied to the borrower's periodic
income. In addition, consumer lending collections are dependent on the
borrower's continuing financial stability, and are thus likely to be adversely
affected by job loss, illness and personal bankruptcy. In many cases,
repossessed collateral for a defaulted consumer loan will not provide an
adequate source of repayment of the outstanding loan balance because of
depreciation of the underlying collateral.
Management believes that the generally higher yields earned on consumer
loans compensate for the increased credit risk associated with such loans and
that consumer loans are important to our efforts to serve the credit needs of
the communities and customers that we serve.
LOAN AND LEASE PORTFOLIO QUALITY
We utilize a comprehensive grading system for our commercial loans and
leases as well as residential mortgage and consumer loans. Administered as part
of the loan and lease review program, all commercial loans and leases are graded
on an eight grade rating system. The rating system utilizes a standardized grade
paradigm that analyzes several critical factors such as cash flow, management
and collateral coverage. All commercial loans and leases are graded at inception
and later at various intervals. Residential mortgage and consumer loans are
graded on a four grade rating system using a separate standardized grade
paradigm that analyzes several critical factors such as debt-to-income and
credit and employment histories. Residential mortgage and consumer loans are
generally only graded once after the loans are made.
6.
Our independent loan and leases review program is primarily responsible
for the administration of the grading system and ensuring adherence to
established lending policies and procedures. The loan and lease review program
is an integral part of maintaining our strong asset quality culture. The loan
and lease review function works closely with senior management, although it
functionally reports to the Board of Directors. All commercial loan and lease
relationships exceeding $1.0 million are formally reviewed every twelve to
eighteen months. Watch list credits are formally reviewed monthly. Credits
between $0.5 million and $1.0 million are formally reviewed every two years,
with a random sampling performed on credits under $0.5 million.
Loans and leases are placed in a nonaccrual status when, in the opinion
of management, uncertainty exists as to the ultimate collection of principal and
interest. For the year ended December 31, 2002, loans and leases placed in
nonaccrual status totaled $0.8 million, or 0.11% of total loans. At December 31,
2002, there were no other significant loans where known information about credit
problems of borrowers causes management to have serious doubts as to the ability
of the borrower to comply with present repayment terms. Management is not aware
of any potential problem credits that could have a material adverse effect on
our operating results, liquidity, or capital resources.
Additional detail and information relative to the loan and lease
portfolio is incorporated by reference to Management's Discussion and Analysis
of Financial Condition and Results of Operation ("Management's Discussion and
Analysis") beginning on Page F-4 and Note 3 of the Consolidated Financial
Statements on pages F-34 and F-35 included in this Annual Report.
ALLOWANCE FOR LOAN AND LEASE LOSSES
In each accounting period, the allowance for loan and lease losses
("allowance") is adjusted by management to the amount management believes is
necessary to maintain the allowance at adequate levels. Through its loan and
lease review and credit departments, management attempts to allocate specific
portions of the allowance based on specifically identifiable problem loans and
leases. Management's evaluation of the allowance is further based on, but not
limited to, consideration of internally prepared calculations based upon the
experience of senior management and lending staff making similar loans and
leases in the same community over the past 15 years, composition of the loan and
lease portfolio, third party analysis of the loan and lease administration
processes and portfolio and general economic conditions. In addition, our bank's
status as a relatively new banking organization, the rapid loan growth since
inception and commercial lending emphasis is taken into account. Management
believes that the present allowance is adequate, based on the broad range of
considerations listed above.
The primary risks associated with commercial loans and leases are the
financial condition of the borrower, the sufficiency of collateral, and lack of
timely payment. Management has a policy of requesting and reviewing periodic
financial statements from its commercial loan and lease customers, and
periodically reviews existence of collateral and its value. The primary risk
element considered by management with respect to each consumer and residential
real estate loan is lack of timely payment. Management has a reporting system
that monitors past due loans and has adopted policies to pursue its creditor's
rights in order to preserve our bank's collateral position.
Additional detail regarding the allowance is incorporated by reference
to Management's Discussion and Analysis beginning on Page F-4 and Note 3 of the
Consolidated Financial Statements of the Company on pages F-34 and F-35 included
in this Annual Report.
Although management believes the allowance is adequate to absorb losses
as they arise, there can be no assurance that we will not sustain losses in any
given period which could be substantial in relation to, or greater than, the
size of the allowance.
7.
INVESTMENTS
Our principal investments are our investment in the common stock of our
bank and the common securities of the trust. Our funds may be invested from time
to time in various debt instruments, including obligations of or guaranteed by
the United States, general obligations of a state or political subdivision or an
agency of a state or political subdivision, banker's acceptances or certificates
of deposit of United States commercial banks, or commercial paper of United
States issuers rated in the highest category by a nationally-recognized
investment rating service. We are permitted to make portfolio investments in
equity securities and to make equity investments in subsidiary corporations
engaged in certain non-banking activities which may include real estate-related
activities such as mortgage banking, community development, real estate
appraisals, arranging equity financing for commercial real estate, and owning
and operating real estate used substantially by our bank or acquired for its
future use. However, we have no present plans to make any of these equity
investments. Our Board of Directors may alter the investment policy at any time
without shareholder approval.
Our bank may invest its funds in a wide variety of debt instruments and
may participate in the federal funds market with other depository institutions.
Subject to certain exceptions, our bank is prohibited from investing in equity
securities. Among such permitted equity investments are shares of a subsidiary
insurance agency, mortgage company, or Michigan business and industrial
development company, such as our insurance company, our mortgage company, or our
BIDCO. Under another such exception, in certain circumstances and with the prior
approval of the FDIC, our bank could invest up to 10% of its total assets in the
equity securities of a subsidiary corporation engaged in the acquisition and
development of real property for sale, or the improvement of real property by
construction or rehabilitation of residential or commercial units for sale or
lease. Our bank has no present plans to make such an investment. Real estate
acquired by our bank in satisfaction of or foreclosure upon loans may be held by
our bank. Our bank is also permitted to invest in such real estate as is
necessary for the convenient transaction of its business. Our bank's Board of
Directors may alter the investment policy without shareholder approval at any
time.
Additional detail and information relative to the securities portfolio
is incorporated by reference to Management's Discussion and Analysis beginning
at Page F-4 and Note 2 of the Consolidated Financial Statements on pages F-33
and F-34 included in this Annual Report.
COMPETITION
Our primary market area for loans and core deposits is the Kent and
Ottawa Counties of western Michigan, which includes the City of Grand Rapids,
the second largest city in the State of Michigan. We face substantial
competition in all phases of our operations from a variety of different
competitors. We compete for deposits, loans and other financial services from
numerous Michigan-based and out-of-state banks, savings banks, thrifts, credit
unions and other financial institutions as well as from other entities that
provide financial services. Some of the financial institutions and financial
service organizations with which we compete are not subject to the same degree
of regulation as we are. Many of our primary competitors have been in business
for many years, have established customer bases, are larger, have substantially
higher lending limits than we do, and offer branch networks and other services
which we do not. Most of these same entities have greater capital resources than
we do, which, among other things, may allow them to price their services at
levels more favorable to the customer and to provide larger credit facilities
than we do. Under the Gramm-Leach-Bliley Act, effective March 11, 2000,
securities firms and insurance companies that elect to become financial holding
companies may acquire banks and other financial institutions. The
Gramm-Leach-Bliley Act may significantly change the competitive environment in
which we conduct our business. The financial services industry is also likely to
become more competitive as further technological advances enable more companies
to provide financial services.
SELECTED STATISTICAL INFORMATION
Management's Discussion and Analysis beginning at Page F-4 in this
Annual Report includes selected statistical information.
8.
RETURN ON EQUITY AND ASSETS
Return on Equity and Asset information is included in Management's
Discussion and Analysis beginning at Page F-4 in this Annual Report.
AVAILABLE INFORMATION
We maintain an internet website at www.mercbank.com. We make available
on or through our website, free of charge, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practical after we
electronically file such material with, or furnish it to, the Securities and
Exchange Commission.
ITEM 2. PROPERTIES
Our bank leases a one story building in downtown Grand Rapids, Michigan
for use as its main office. This building is of masonry construction and has
approximately 11,000 square feet of usable space with on-site parking. The lease
for this facility, which commenced in 1997, has an initial term of ten years and
our bank has four, five-year renewal options. The address of this facility is
216 North Division Avenue, and is located in downtown Grand Rapids.
Our bank designed and constructed a full service branch and retail loan
facility in Alpine Township, a northwest suburb of Grand Rapids, which opened in
July of 1999. The facility is one story, of masonry construction, and has
approximately 8,000 square feet of usable space. The land and building is owned
by our bank. The facility has multiple drive-through lanes and ample parking
space. The address of this facility is 4613 Alpine Avenue NW, Comstock Park,
Michigan.
During 2001 our bank designed and constructed two facilities on a
4-acre parcel of land located in the City of Wyoming, a southwest suburb of
Grand Rapids. The land had been purchased by our bank in 2000. The larger of the
two buildings is a full service branch and operations facility opened in
September of 2001. The facility is two stories, of masonry construction, and has
approximately 25,000 square feet of usable space. The facility is owned by our
bank, and has multiple drive-through lanes and ample parking space. The address
of this facility is 5610 Byron Center Avenue SW, Wyoming, Michigan. The other
building, a single story facility of masonry construction with approximately
7,000 square feet of usable space, accommodates the administration function.
This facility is also owned by the bank. The address of this facility is 5650
Byron Center Avenue SW, Wyoming, Michigan.
During 2002 our bank designed and constructed a full service branch in
the City of Kentwood, a southeast suburb of Grand Rapids, which opened in
December of 2002. The land had been purchased by our bank in 2001. The facility
is one story, of masonry construction, and has approximately 10,000 square feet
of usable space. The facility is owned by our bank, and has multiple
drive-through lanes and ample parking space. The address of this facility is
4860 Broadmoor, Kentwood, Michigan.
During 2002 our bank designed and started construction of a full
service branch in the northeast quadrant of the City of Grand Rapids. The land
had been purchased by our bank in 2002. The facility will be one story, of
masonry construction, and will have approximately 3,500 square feet of usable
space. The facility will be owned by our bank, and will have multiple
drive-through lanes and ample parking space. The anticipated opening date is
during the second quarter of 2003. The address of this facility is 3156 Knapp
Street NE, Grand Rapids, Michigan.
9.
In January of 2003 our bank signed an option to purchase an existing
building situated on 2.75 acres of land located approximately two miles north
from the center of downtown Grand Rapids. Subject to pending due diligence and
various regulatory changes and approvals, our bank plans to demolish the
existing building and design and construct a four story facility on this
property. This facility will serve as the new location for our bank's current
downtown facility located on North Division Avenue, with all existing functions
and employees at that location ultimately transferring to this new facility upon
completion. Currently, the North Division Avenue facility serves as our bank's
main office, and houses our bank's entire commercial lending and review
function, a full service branch, portions of our bank's retail lending and
business development function and our bank's brokerage operation. The new
facility will also house our bank's loan operations function, which is currently
located at our facility on Alpine Avenue NW. The contemplated four story
facility would likely consist of approximately 55,000 square feet of usable
space and contain multiple drive-through lanes with ample parking. Anticipated
opening date would be late 2004 or the first part of 2005. The address is 1155
Front Street NW, Grand Rapids, Michigan.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that
are incidental to our business. In the opinion of management, we are not a party
to any current legal proceedings that are material to our financial condition,
either individually or in the aggregate.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
EXECUTIVE OFFICERS OF THE REGISTRANT
Name and Position Age
----------------- ---
Gerald R. Johnson, Jr. 56
Chairman of the Board and Chief
Executive Officer
Michael H. Price 46
President and Chief Operating
Officer
Robert B. Kaminski 41
Senior Vice President and
Secretary
Charles E. Christmas 37
Senior Vice President, Chief Financial
Officer and Treasurer
Each of the persons named above has held the designated office with the company
since 1997, except for Mr. Christmas, who joined the company in 1998 and held
the position of Vice President of Finance, Treasurer and Compliance Officer
before being promoted to Chief Financial Officer and Treasurer and Compliance
Officer effective January 1, 1999. On October 12, 2000 Mr. Christmas was
promoted to Senior Vice President, Chief Financial Officer and Treasurer.
10.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is quoted on the Nasdaq National Market under the
symbol MBWM. At February 3, 2003, there were 148 record holders of our common
stock. In addition, we estimate that there were approximately 3,000 beneficial
owners of our common stock who own their shares through brokers or banks.
The following table shows the high and low bid prices by quarter during
2002 and 2001 as reported by the Nasdaq National Market. The quotations do not
include retail mark-up, mark-down or commission, but have been adjusted for the
5% stock dividends paid on February 3, 2003 and February 1, 2002.
BID PRICES
HIGH LOW
---- ---
CALENDAR YEAR 2002
First Quarter.............................................................................$19.52 $16.86
Second Quarter............................................................................$22.02 $18.57
Third Quarter.............................................................................$21.14 $16.10
Fourth Quarter............................................................................$22.76 $17.86
CALENDAR YEAR 2001
First Quarter.............................................................................$14.51 $10.43
Second Quarter............................................................................$15.92 $13.39
Third Quarter.............................................................................$17.51 $13.62
Fourth Quarter............................................................................$16.19 $14.52
On January 6, 2003, we declared a 5% stock dividend on our common
stock, payable on February 3, 2003 to record holders as of January 17, 2003. The
stock dividend increased the number of common shares outstanding from 5,148,342
to 5,405,706. Also on January 6, 2003, we declared a $0.08 per share cash
dividend on our common stock, payable on March 10, 2003 to record holders as of
February 10, 2003. This represents the first cash dividend on our common stock
since our formation in 1997.
We are a holding company and substantially all of our assets are held
by our subsidiaries. Our ability to pay dividends to our shareholders depends
primarily on our bank's ability to pay dividends to us. Dividend payments and
extensions of credit to us from our bank are subject to legal and regulatory
limitations, generally based on capital levels and current and retained earnings
imposed by law and regulatory agencies with authority over our bank. The ability
of our bank to pay dividends is also subject to its profitability, financial
condition, capital expenditures and other cash flow requirements. In addition,
under the terms of our 9.60% junior subordinated debentures due 2029, we would
be precluded from paying dividends on our common stock if we were in default
under the debentures and did not take reasonable steps to cure the default, if
we exercised our right to defer payments of interest on the debentures, or if
certain related defaults occurred.
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data on page F-3 in this Annual Report is
incorporated here by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
Management's Discussion and Analysis on pages F-4 through F-22 in this
Annual Report is incorporated here by reference.
11.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the heading "Market Risk Analysis" on pages F-20
through F-22 in this Annual Report is incorporated here by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements and the Report of Independent Public Accountants on pages F-23
through F-48 in this Annual Report are incorporated here by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information listed under the captions "Information about Directors,
Nominees and Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the definitive Proxy Statement of Mercantile for its
April 17, 2003 Annual Meeting of Shareholders (the "Proxy Statement"), a copy of
which will be filed with the Securities and Exchange Commission before the
meeting date, is incorporated here by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information presented under the captions "Summary Compensation
Table," "Options Granted in 2002," "Aggregated Stock Option Exercises in 2002
and Year End Option Values," "Employment Agreements," and "Compensation
Committee Interlocks and Insider Participation" and in the last two paragraphs
under the caption "Board of Directors Meetings and Committees", in the Proxy
Statement is incorporated here by reference.
12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information presented under the caption "Stock Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is incorporated here by
reference.
EQUITY PLAN COMPENSATION INFORMATION
The following table summarizes information, as of December 31, 2002,
relating to our compensations plans under which our equity securities are
authorized for issuance.
PLAN CATEGORY NUMBER OF SECURITIES WEIGHTED AVERAGE NUMBER OF SECURITIES
TO BE ISSUED UPON EXERCISE PRICE OF REMAINING AVAILABLE FOR
EXERCISE OF OUTSTANDING OPTIONS, FUTURE ISSUANCE UNDER
OUTSTANDING OPTIONS, WARRANTS AND RIGHTS EQUITY COMPENSATION PLANS
WARRANTS AND RIGHTS (EXCLUDING SECURITIES
REFLECTED IN COLUMN (a))
(a) (b) (c)
Equity compensation 271,935 $12.63 88,555
plans approved by
security holders (1)
Equity compensation 0 0 0
Plans not approved by
Security holders
Total 271,935 $12.63 88,555
(1) These plans are our 1997 Employee Stock Option Plan, 2000 Employee Stock
Option Plan and Independent Director Stock Option Plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information listed under the caption "Certain Transactions" in the
Proxy Statement is incorporated here by reference.
PART IV
ITEM 14. CONTROLS AND PROCEDURES
As of December 31, 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 December 31, 2002. There have been no significant changes in our
internal controls or in other factors that could significantly affect internal
controls subsequent to December 31, 2002.
13.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements. The following financial statements and report of
independent public accountants of Mercantile Bank Corporation and its
subsidiaries are filed as part of this report:
Report of Independent Public Accountants dated January 17, 2003
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Income for each of the three years in the
period ended December 31, 2002
Consolidated Statements of Changes in Shareholders' Equity for each of
the three years in the period ended December 31, 2002
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 2002
Notes to Consolidated Financial Statements
The financial statements, the notes to financial statements, and the
report of independent public accountants listed above are incorporated
by reference in Item 8 of this report.
(2) Financial Statement Schedules
Not applicable
(b) Reports on Form 8-K
We have not filed any reports on Form 8-K during the last quarter of
the period covered by this Report.
(c) Exhibits:
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
3.1 Our Articles of Incorporation are incorporated by
reference to exhibit 3.1 of our Registration
Statement on Form SB-2 (Commission File no.
333-33081) that became effective on October 23,
1997
3.2 Our Amended and Restated Bylaws dated as of January
16, 2003 are incorporated by reference to exhibit
3.2 of our Registration Statement on Form S-3
(Commission File No. 333-103376) that became
effective on February 21, 2003
10.1 Our 1997 Employee Stock Option Plan is incorporated
by reference to exhibit 10.1 of our Registration
Statement on Form SB-2 (Commission File No.
333-33081) that became effective on October 23,
1997 (management contract or compensatory plan)
10.2 Lease Agreement between our bank and Division
Avenue Partners, L.L.C. dated August 16, 1997, is
incorporated by reference to exhibit 10.2 of our
Registration Statement on Form SB-2 (Commission
File No. 333-33081) that became effective October
23, 1997
14.
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
10.3 Agreement between Fiserve Solutions, Inc. and our
bank dated September 10, 1997, is incorporated by
reference to exhibit 10.3 of our Registration
Statement on Form SB-2 (Commission File No.
333-33081) that became effective on October 23,
1997.
10.4 Extension Agreement of Data Processing Contract
between Fiserve Solutions, Inc. and our bank dated
May 12, 2000 extending the agreement between
Fiserve Solutions, Inc. and our bank dated
September 10, 1997, is incorporated by reference to
exhibit 10.15 of our Form 10-K for the fiscal year
ended December 31, 2000 (Commission File No.
000-26719)
10.5 Extension Agreement of Data Processing Contract
between Fiserve Solutions, Inc. and our bank dated
November 22, 2002 extending the agreement between
Fiserve Solutions, Inc. and our bank dated
September 10, 1997
10.6 Mercantile Bank of West Michigan Deferred
Compensation Plan for Members of the Board of
Directors (1999) is incorporated by reference to
Exhibit 10.6 of the Registration Statement of the
company and our trust on Form SB-2 (Commission File
Nos. 333-84313 and 333-84313-01) that became
effective on September 13, 1999.
10.7 Subordinated Indenture dated as of September 17,
1999 between the company and Wilmington Trust
Company, as Trustee, relating to 9.60% Junior
Subordinated Debentures due 2029 is incorporated by
reference to Exhibit 4.1 of the Registration
Statement of the company and our trust on Form SB-2
(Commission File Nos. 333-84313 and 333-84313-01)
that become effective on September 13, 1999)
10.8 Amended and Restated Trust Agreement dated as of
September 17, 1999 among the company, as depositor,
Wilmington Trust Company, as Property Trustee,
Wilmington Trust Company, as Delaware Trustee, and
the Administrative Trustees is incorporated by
reference to Exhibit 4.5 of the Registration
Statement of the company and our trust on Form SB-2
(Commission File Nos. 333-84313 and 333-84313-01)
that became effective on September 13, 1999
10.9 Preferred Securities Guarantee Agreement between
the company and Wilmington Trust Company dated
September 17, 1999, is incorporated by reference to
Exhibit 4.7 of the Registration Statement of the
company and our trust on Form SB-2 (Commission File
Nos. 333-84313 and 333-84313-01) that became
effective on September 13, 1999
10.10 Agreement as to Expenses and Liabilities dated as
of September 17, 1999, between the company and our
trust (included as Exhibit D to Exhibit 10.8)
10.11 Mercantile Bank Corporation 2000 Employee Stock
Option Plan, approved by the shareholders at the
annual meeting on April 20, 2000, is incorporated
by reference to exhibit 10.14 of our Form 10-K for
the fiscal year ended December 31, 2000 (Commission
File No. 000-26719)
10.12 Amended and Restated Employment Agreement dated as
of October 12, 2000, among the company, our bank
and Gerald R. Johnson, Jr., is incorporated by
reference to exhibit 10.16 of our Form 10-K for the
fiscal year ended December 31, 2000 (Commission
File No. 000-26719) (management contract or
compensatory plan)
15.
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
10.13 Amended and Restated Employment Agreement dated as
of October 12, 2000, among the company, our bank
and Michael H. Price, is incorporated by reference
to exhibit 10.17 of our Form 10-K for the fiscal
year ended December 31, 2000 (Commission File No.
000-26719) (management contract or compensatory
plan)
10.14 Employment Agreement dated as of October 12, 2000,
among the company, our bank and Robert B. Kaminski,
is incorporated by reference to exhibit 10.18 of
our Form 10-K for the fiscal year ended December
31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.15 Employment Agreement dated as of October 12, 2000,
among the company, our bank and Charles E.
Christmas, is incorporated by reference to exhibit
10.19 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.16 Agreement between our bank and C.D. Barnes dated
October 28, 2000, on Amendment to Standard Form of
Agreement Between Owner and Construction Manager
where the Construction Manager is also the
Constructor, is incorporated by reference to
exhibit 10.20 of our Form 10-K for the fiscal year
ended December 31, 2000 (Commission File No.
000-26719)
10.17 Amended and Restated Employment Agreement dated as
of October 18, 2001, among the company, our bank
and Gerald R. Johnson, Jr., is incorporated by
reference to exhibit 10.21 of our Form 10-K for the
fiscal year ended December 31, 2001 (Commission
File No. 000-26719) (management contract or
compensatory plan)
10.18 Amended and Restated Employment Agreement dated as
of October 18, 2001, among the company, our bank
and Michael H. Price, is incorporated by reference
to exhibit 10.22 of our Form 10-K for the fiscal
year ended December 31, 2001 (Commission File No.
000-26719) (management contract or compensatory
plan)
10.19 Employment Agreement dated as of October 18, 2001,
among the company, our bank and Robert B. Kaminski,
is incorporated by reference to exhibit 10.23 of
our Form 10-K for the fiscal year ended December
31, 2001 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.20 Employment Agreement dated as of October 18, 2001,
among the company, our bank and Charles E.
Christmas, is incorporated by reference to exhibit
10.23 of our Form 10-K for the fiscal year ended
December 31, 2001 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.21 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Gerald R. Johnson, Jr. (management contract or
compensatory plan)
10.22 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Michael H. Price (management contract or
compensatory plan)
10.23 Amendment to Employment Agreement dated as of
company, our bank and Robert B. Kaminski
(management contract or compensatory plan)
16.
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
10.24 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Charles E. Christmas (management contract or
compensatory plan)
10.25 Agreement between our bank and Visser Brothers
Construction Inc. dated May 8, 2002, on Standard
Form of Agreement Between Owner and Contractor
where the basis of payment is a stipulated sum
10.26 Mercantile Bank Corporation Independent Director
Stock Option Plan, approved by the shareholders at
the annual meeting on April 18, 2002
21 Subsidiaries of the company
23 Consent of Independent Accountants
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
(d) Financial Statements Not Included In Annual Report
Not applicable
17.
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
F-1
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
CONTENTS
SELECTED FINANCIAL DATA..................................................................................... F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS........................................................................ F-4
REPORT OF INDEPENDENT AUDITORS.............................................................................. F-23
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS............................................................................ F-24
CONSOLIDATED STATEMENTS OF INCOME...................................................................... F-25
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY............................................. F-26
CONSOLIDATED STATEMENTS OF CASH FLOWS.................................................................. F-27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............................................................. F-28
F-2
SELECTED FINANCIAL DATA
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands except per share data)
CONSOLIDATED RESULTS OF OPERATIONS:
Interest income $ 47,632 $ 44,619 $ 36,835 $ 22,767 $ 10,168
Interest expense 23,978 28,201 24,560 13,330 5,629
--------- --------- --------- --------- ---------
Net interest income 23,654 16,418 12,275 9,437 4,539
Provision for loan and lease losses 3,002 2,370 1,854 1,961 2,572
Noninterest income 3,053 1,879 1,192 847 488
Noninterest expense 12,781 9,454 7,515 5,888 3,564
--------- --------- --------- --------- ---------
Income (loss) before income tax expense and cumulative
effect of change in accounting principle 10,924 6,473 4,098 2,435 (1,109)
Income tax expense 3,167 1,990 1,303 292 0
--------- --------- --------- --------- ---------
Income (loss) before cumulative effect of change in
accounting principle 7,757 4,483 2,795 2,143 (1,109)
Cumulative effect of change in accounting principle 0 0 0 (42) 0
--------- --------- --------- -------- ---------
Net income (loss) $ 7,757 $ 4,483 $ 2,795 $ 2,101 $ (1,109)
========= ========= ========= ========= =========
CONSOLIDATED BALANCE SHEET DATA:
Total assets $ 921,855 $ 698,682 $ 512,746 $ 368,037 $ 216,237
Cash and cash equivalents 28,117 19,938 18,102 13,650 6,456
Securities 96,893 78,818 60,457 41,957 24,160
Loans, net of deferred loan fees 771,554 587,248 429,804 308,006 184,745
Allowance for loan and lease losses 10,890 8,494 6,302 4,620 2,765
Bank owned life insurance policies 14,876 3,991 0 0 0
Deposits 754,113 569,077 425,740 294,829 171,998
Securities sold under agreements to repurchase 50,335 36,485 32,151 26,607 17,038
Federal Home Loan Bank advances 15,000 0 0 0 0
Trust preferred securities 16,000 16,000 16,000 16,000 0
Shareholders' equity 79,834 71,463 31,854 27,968 26,701
CONSOLIDATED FINANCIAL RATIOS:
Return on average assets 0.97% 0.74% 0.63% 0.71% (0.86)%
Return on average shareholders' equity 10.30% 9.05% 9.48% 7.70% (6.40)%
Nonperforming loans to loans 0.10% 0.24% 0.02% 0.00% 0.00%
Allowance for loan and lease losses to loans 1.41% 1.45% 1.47% 1.50% 1.50%
Tier 1 leverage capital 10.72% 13.00% 8.59% 10.88% 13.83%
Tier 1 leverage risk-based capital 10.85% 13.00% 8.59% 10.64% 11.79%
Total risk-based capital 12.10% 14.25% 10.97% 13.67% 13.01%
PER SHARE DATA:
Net Income (Loss):
Basic before cumulative effect of change
in accounting principle $ 1.43 $ 1.11 $ 0.98 $ 0.75 $ (0.50)
Diluted before cumulative effect of change
in accounting principle 1.41 1.10 0.97 0.74 (0.50)
Basic 1.43 1.11 0.98 0.73 (0.50)
Diluted 1.41 1.10 0.97 0.72 (0.50)
Book value at end of period 14.77 13.22 11.10 9.77 9.33
Dividends declared NA NA NA NA NA
NA -- Not Applicable
Note: Per share data reflects the impact of the 5% stock dividend paid on
February 3, 2003.
F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion contains forward-looking statements that are based on
management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about our
company. Words such as "anticipates," "believes," "estimates," "expects,"
"forecasts," "intends," "is likely," "plans," "projects," variations of such
words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions ("Future Factors") that are
difficult to predict with regard to timing, extent, likelihood and degree of
occurrence. Therefore, actual results and outcomes may materially differ from
what may be expressed or forecasted in such forward-looking statements. We
undertake no obligation to update, amend, or clarify forward-looking statements,
whether as a result of new information, future events (whether anticipated or
unanticipated), or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; and changes in the national and local economy. These are representative
of the Future Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement.
INTRODUCTION
This Management's Discussion and Analysis should be read in conjunction with the
consolidated financial statements contained herein. This discussion provides
information about the consolidated financial condition and results of operations
of Mercantile Bank Corporation and its wholly-owned subsidiaries, Mercantile
Bank of West Michigan ("our bank") and MBWM Capital Trust I ("the trust"), and
of Mercantile Bank Mortgage Company ("our mortgage company"), Mercantile BIDCO,
Inc. ("our BIDCO") and Mercantile Insurance Center, Inc. (our insurance
company"), wholly-owned subsidiaries of our bank. Unless the text clearly
suggests otherwise, references to "us," "we," "our," or "the company" include
Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.
We were incorporated on July 15, 1997 as a bank holding company to establish and
own our bank. Our bank, after receiving all necessary regulatory approvals,
began operations on December 15, 1997. Our bank has a strong commitment to
community banking and offers a wide range of financial products and services,
primarily to small- to medium-sized businesses, as well as individuals. Our
bank's lending strategy focuses on commercial lending, and, to a lesser extent,
residential mortgage and consumer lending. Our bank also offers a broad array of
deposit products, including checking, savings, money market, and certificates of
deposit, as well as security repurchase agreements. Our bank's primary market
area is the Kent and Ottawa County areas of West Michigan, which includes the
City of Grand Rapids, the second largest city in the State of Michigan. Our bank
utilizes certificates of deposit from customers located outside of the primary
market area to assist in funding the rapid asset growth our bank has experienced
since inception.
The trust, a business trust subsidiary of the company, was incorporated in 1999
for the purpose of issuing 1.6 million shares of 9.60% Cumulative Preferred
Securities ("trust preferred securities") at $10.00 per trust preferred
security. The proceeds from the September 1999 sale were used by the trust to
purchase an equivalent amount of subordinated debentures of the company. The
company, in turn, used a majority of the proceeds from the issuance of the
subordinated debentures for a capital contribution to our bank. The only
significant asset of the trust is the subordinated debenture of the company and
the only significant obligations of the trust are the trust preferred
securities. The trust preferred securities are carried on the company's
consolidated balance sheet as a liability and the interest expense is recorded
on the company's consolidated statement of income.
F-4
Our mortgage company, formed to increase the profitability and efficiency of the
company's mortgage loan operations, initiated business on October 24, 2000 from
our bank's contribution of most of its residential mortgage loan portfolio and
participation interests in certain commercial mortgage loans to our mortgage
company. On the same date our bank also transferred its residential mortgage
origination function to our mortgage company. Mortgage loans originated and held
by our mortgage company are serviced by our bank pursuant to a servicing
agreement.
On February 7, 2002 our BIDCO was granted a license by the Michigan Office of
Financial and Insurance Services to operate as a Michigan Business and
Industrial Development Company. Our BIDCO, a non-depository Michigan financial
institution, offers equipment lease financing, asset based loans, junior debt
facilities and other financing where equity features may be part of the facility
pricing.
Our insurance company acquired, at nominal cost, an existing shelf insurance
agency effective April 15, 2002. An Agency and Institution Agreement was entered
into among our insurance company, our bank and Burnham Insurance Group for the
purpose of providing programs of mass marketed personal lines of insurance.
Insurance product offerings include private passenger automobile, homeowners,
personal inland marine, boat owners, recreational vehicle, dwelling fire,
umbrella policies, small business and life insurance products, all of which are
provided by and written through companies that have appointed Burnham Insurance
Group as their agent. The insurance products are marketed through a central
facility operated by the Michigan Bankers Insurance Association, members of
which include the insurance subsidiaries of various Michigan-based financial
institutions and Burnham Insurance Group. Our insurance company receives
commissions based upon written premiums produced under the Agency and
Institution Agreement.
FINANCIAL CONDITION
We continued to experience significant asset growth during 2002. Assets
increased from $698.7 million on December 31, 2001 to $921.9 million on December
31, 2002. This represents an increase in total assets of $223.2 million, or
31.9%. The increase in total assets was primarily comprised of a $181.9 million
increase in net loans, an $18.1 million increase in securities, a $10.9 million
increase in bank owned life insurance policies and a net $8.2 million increase
in cash and cash equivalents. The increase in assets was primarily funded by a
$185.0 million increase in deposits, a $15.0 million increase in Federal Home
Loan Bank advances, a $13.8 million increase in security repurchase agreements
and an $8.4 million increase in shareholder's equity.
EARNING ASSETS
Average earning assets equaled 95.5% of average total assets during 2002,
compared to 96.4% during 2001. Although we experienced significant asset growth
during 2002, the asset composition remained relatively constant. The loan
portfolio continued to comprise a majority of earning assets, followed by
securities, federal funds sold, and short-term investments.
Our loan portfolio, which equaled 88.0% of average earnings assets during 2002,
is primarily comprised of commercial loans. Constituting 93.2% of average loans
and growing by $178.1 million during 2002, the commercial loan portfolio
represents loans to business interests generally located within our market area.
Approximately 67% of the commercial loan portfolio is primarily secured by real
estate properties, with the remaining generally secured by other business assets
such as accounts receivable, inventory, and equipment. The continued significant
concentration of the loan portfolio in commercial loans and the rapid growth of
this portion of our lending business is consistent with our strategy of focusing
a substantial amount of our efforts on "wholesale" banking. Corporate and
business lending continues to be an area of expertise for our senior management
team, and our ten commercial lenders have over 165 years of combined commercial
lending experience. Of each of the loan categories that we originate, commercial
loans are most efficiently originated and managed, thus limiting overhead costs
by necessitating the attention of fewer full-time employees. Our commercial
lending business generates the greatest amount of local deposits and is
virtually our only source of significant demand deposits.
F-5
Residential mortgage and consumer lending, while averaging only 6.8% of average
loans during 2002, also experienced excellent growth; however, while we expect
the residential mortgage loan and consumer loan portfolios to increase in future
periods, given our wholesale banking strategy, the commercial sector of the
lending efforts and resultant assets are expected to remain the dominant loan
portfolio category.
The following tables present the maturity of total loans outstanding, as of
December 31, 2002, according to scheduled repayments of principal on fixed rate
loans and repricing frequency on variable rate loans. Floating rate loans that
have reached interest rate floors are treated as fixed rate loans.
0-1 1-5 After 5
Year Years Years Total
---- ----- ----- -----
Construction and land development $ 56,866,000 $ 35,203,000 $ 11,831,000 $ 103,900,000
Real estate -- secured by 1-4 family
properties 32,813,000 20,780,000 7,235,000 60,828,000
Real estate -- secured by multi-family
properties 2,251,000 10,774,000 0 13,025,000
Real estate -- secured by
nonresidential properties 113,532,000 241,567,000 2,332,000 357,431,000
Commercial 161,934,000 66,723,000 2,005,000 230,662,000
Leases 0 850,000 0 850,000
Consumer 1,408,000 3,321,000 129,000 4,858,000
--------------- ---------------- ------------- ----------------
$ 368,804,000 $ 379,218,000 $ 23,532,000 $ 771,554,000
=============== ================ ============= ================
Fixed rate loans $ 59,265,000 $ 379,146,000 $ 23,532,000 $ 461,943,000
Floating rate loans 309,539,000 72,000 0 309,611,000
--------------- ---------------- ------------- ----------------
$ 368,804,000 $ 379,218,000 $ 23,532,000 $ 771,554,000
=============== ================ ============= ================
Our credit policies establish guidelines to manage credit risk and asset
quality. These guidelines include loan review and early identification of
problem loans to provide effective loan portfolio administration. The credit
policies and procedures are meant to minimize the risk and uncertainties
inherent in lending. In following these policies and procedures, we must rely on
estimates, appraisals and evaluations of loans and the possibility that changes
in these could occur quickly because of changing economic conditions. Identified
problem loans, which exhibit characteristics (financial or otherwise) that could
cause the loans to become nonperforming or require restructuring in the future,
are included on the internal "Watch List." Senior management reviews this list
regularly.
The quality of our loan portfolio remains strong, with past due loans and net
loan charge-offs well below banking industry averages during 2002. As of
December 31, 2002, past due loans and nonaccrual loans totaled $796,000, or
0.10% of total loans. At December 31, 2001, past due and nonaccrual loans
equaled 0.24% of total loans. Net loan charge-offs during 2002 totaled $606,000,
or 0.09% of average total loans. During 2001 net loan charge-offs equaled 0.04%
of average total loans. 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.
F-6
The following table summarizes changes in the allowance for loan and lease
losses.
Years ended December 31,
2002 2001 2000
---- ---- ----
Loans and leases outstanding at year-end $ 771,554,000 $ 587,248,000 $ 429,804,000
============== ============== ===============
Daily average balance of loans and leases outstanding $ 669,781,000 $ 500,965,000 $ 372,428,000
============== ============== ===============
Balance of allowance at beginning of year $ 8,494,000 $ 6,302,000 $ 4,620,000
Loans and leases charged-off:
Commercial, financial and agricultural (696,000) (247,000) (147,000)
Construction and land development 0 0 0
Leases 0 0 0
Residential real estate 0 (4,000) 0
Installment loans to individuals (10,000) (1,000) (38,000)
--------------- -------------- ---------------
Total loans charged-off (706,000) (252,000) (185,000)
Recoveries of previously charged-off loans and leases:
Commercial, financial and agricultural 78,000 73,000 13,000
Construction and land development 0 0 0
Leases 0 0 0
Residential real estate 4,000 0 0
Installment loans to individuals 18,000 1,000 0
-------------- -------------- ---------------
Total recoveries 100,000 74,000 13,000
-------------- -------------- ---------------
Net charge-offs (606,000) (178,000) (172,000)
Provision for loan and leases losses 3,002,000 2,370,000 1,854,000
-------------- -------------- ---------------
Balance of the allowance at year-end $ 10,890,000 $ 8,494,000 $ 6,302,000
============== ============== ===============
Ratio of net charge-offs during period to average
loans and leases outstanding during the period (0.09)% (0.04)% (0.05)%
============ =========== ==============
Ratio of allowance to loans and leases outstanding
at end of period 1.41% 1.45% 1.47%
=========== =========== ==============
In each accounting period the allowance for loan and lease losses ("allowance")
is adjusted to the amount believed necessary to maintain the allowance at
adequate levels. Through the loan review and credit departments, we attempt to
allocate specific portions of the allowance based on specifically identifiable
problem loans and leases. The evaluation of the allowance is further based on,
although not limited to, consideration of the internally prepared Loan Loss
Reserve Analysis ("Reserve Analysis"), composition of the loan portfolio, third
party analysis of the loan and lease administration processes and portfolio and
general economic conditions. In addition, our bank's status as a relatively new
banking organization and the rapid commercial loan and lease 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 and leases,
which continue to comprise a vast majority of our total loans, reserve
allocation factors are based upon the loan ratings as determined by our loan
rating paradigm that is administered by our loan review function. For retail
loans, reserve allocation factors are based upon the type of credit. Adjustments
for specific loan relationships, including impaired loans, are made on a
case-by-case basis. The reserve allocation factors are primarily based on the
experience of senior management making similar loans in the same community for
over 15 years. The Reserve Analysis is reviewed regularly by senior management
and the Board of Directors and is adjusted periodically based upon identifiable
trends and experience.
F-7
The following table illustrates the breakdown of the allowance balance to loan
type (dollars in thousands).
2 0 0 2 2 0 0 1
------- -------
Balance at End Percent of Loans Percent of Loans
of Period in each Category in each Category
Applicable to Amount to Total Loans Amount to Total Loans
------------- ------ -------------- ------ --------------
Commercial, financial and agricultural $ 9,188 77.9% $ 7,172 81.0%
Construction and land development 1,143 13.5 785 10.7
Leases 11 0.1 0 NA
Residential real estate 443 7.9 453 7.2
Installment loans to individuals 105 0.6 84 1.1
Unallocated 0 NA 0 NA
--------- ------ --------- ------
$ 10,890 100.0% $ 8,494 100.0%
========= ====== ========= ======
The primary risk elements with respect to commercial loans and leases are the
financial condition of the borrower, the sufficiency of collateral, and lack of
timely payment. We have a policy of requesting and reviewing periodic financial
statements from commercial loan and lease customers, and we periodically review
the existence of collateral and its value. The primary risk element with respect
to each installment and residential real estate loan is lack of timely payment.
We have a reporting system that monitors past due loans and have adopted
policies to pursue creditor's rights in order to preserve our bank's position.
Although we believe that the allowance is adequate to sustain losses as they
arise, there can be no assurance that our bank will not sustain losses in any
given period that could be substantial in relation to, or greater than, the size
of the allowance.
The securities portfolio also experienced significant growth during 2002,
increasing from $78.8 million on December 31, 2001 to $96.9 million at December
31, 2002. During 2002, the securities portfolio equaled 11.0% of average earning
assets. We maintain the portfolio at levels to provide adequate pledging for the
repurchase agreement program and secondary liquidity for our daily operations.
In addition, the portfolio serves a primary interest rate risk management
function. At December 31, 2002, the portfolio was comprised of high credit
quality U.S. Government Agency issued and guaranteed mortgage-backed securities
(45%), municipal general obligation and revenue bonds (38%), U.S. Government
Agency issued bonds (16%) and Federal Home Loan Bank stock (1%).
All securities, with the exception of tax-exempt municipal bonds, have been
designated as "available for sale" as defined in Statement of Financial
Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in
Debt and Equity Securities. Securities designated as available for sale are
stated at fair value, with the unrealized gains and losses, net of income tax,
reported as a separate component of shareholders' equity in accumulated other
comprehensive income. The fair value of securities designated as available for
sale at December 31, 2002 and 2001 was $59.6 million and $52.1 million,
respectively. The net unrealized gain recorded at December 31, 2002 and 2001,
was $1.6 million and $0.6 million, respectively. All tax-exempt municipal bonds
have been designated as "held to maturity" as defined in SFAS No. 115, and are
stated at amortized cost. As of December 31, 2002 and 2001, held to maturity
securities had an amortized cost of $36.5 million and $26.0 million and a fair
value of $38.0 million and $26.2 million, respectively.
F-8
The following table shows by class of maturities as of December 31, 2002, the
amounts and weighted average yields of investment securities (1):
Carrying Average
Value Yield
----- -----
(Dollars in thousands)
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations
One year or less $ 0 NA
Over one through five years 0 NA
Over five through ten years 14,321,000 4.76%
Over ten years 2,017,000 4.88
-------------- ------
16,338,000 4.77
Obligations of states and political subdivisions
One year or less 226,000 5.95
Over one through five years 4,515,000 6.87
Over five through ten years 7,824,000 6.61
Over ten years 23,928,000 6.95
-------------- ------
36,493,000 6.86
Mortgage-backed securities 43,276,000 5.67
-------------- ------
$ 96,107,000 5.97%
============== ======
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent
basis. (See Note 2 to the consolidated financial statements.)
Federal funds sold, consisting of excess funds sold overnight to correspondent
banks, are used to manage daily liquidity needs and interest rate sensitivity.
During 2002, the average balance of these funds equaled 1.0% of average earning
assets. This level is well within our internal policy guidelines and is not
expected to change significantly in the future.
Bank owned life insurance ("BOLI") policies increased from $4.0 million at
December 31, 2001, to $14.9 million on December 31, 2002, an increase of $10.9
million. Approximately $10.5 million of the increase is due to the purchase of
bank owned life insurance policies for selected officers during 2002, with the
remainder of the increase associated with the increased value in cash surrender
value of the policies during the year. These single premium whole life insurance
policies have a positive impact on noninterest income due to the income
recognition relating to the increase in cash surrender value. The policies
purchased in 2002 were in large part acquired to mitigate 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, through the recognition of noninterest income. The policies
purchased in 2002 also include term life insurance of which our bank is sole
beneficiary.
Cash and cash equivalents increased from $19.9 million at December 31, 2001, to
$28.1 million on December 31, 2002, an increase of $8.2 million. The increase
was primarily the result of an increase in our average daily outgoing cash
letter due to the growth in our local deposit base throughout 2002 and a larger
than average outgoing cash letter on the last day of 2002. In general, 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 2002 equaled $18.6 million.
F-9
SOURCE OF FUNDS
Our major source of funds is from deposits. Total deposits increased from $569.1
million at December 31, 2001, to $754.1 million on December 31, 2002, an
increase of $185.0 million, or 32.5%. Included within these numbers is the
success we achieved in generating deposit growth from customers located within
the market area during 2002. Local deposits increased from $176.8 million at
December 31, 2001, to $241.6 million on December 31, 2002, an increase of $64.8
million, or 36.6%. In addition, our repurchase agreement program, which exhibits
the characteristics of an interest-bearing checking account, increased by $13.8
million, or 38.0%, during the same time period. Despite this success in
obtaining funds from local customers, the substantial asset growth has
necessitated the continued acquisition of funds from depositors outside of the
market area. Out-of-area deposits increased from $392.2 million at December 31,
2001, to $512.5 million on December 31, 2002, an increase of $120.3 million, or
30.7%. However, the strong growth in local deposits resulted in out-of-area
deposits declining as a percentage of total deposits from 68.9% at year-end 2001
to 68.0% at year-end 2002. In late 2002 we accessed the Federal Home Loan Bank
of Indianapolis' ("FHLBI") advance program for the first time ever, with
borrowings totaling $15.0 million at year-end 2002.
During 2002 we experienced significant growth in our check-writing deposit
accounts, which include noninterest-bearing demand accounts, interest-bearing
checking accounts and money market deposit accounts. In aggregate these deposit
types grew $28.2 million, or 39.8%. Leading the growth were noninterest-bearing
demand accounts. Comprised primarily of business loan customers,
noninterest-bearing demand accounts grew $19.2 million, or 44.6%, and equaled
6.7% of average total liabilities during 2002. Interest-bearing checking
accounts increased $5.9 million, or 26.8%, and equaled 3.1% of average total
liabilities during 2002. Money market deposit accounts increased $3.0 million,
or 54.1%, and equaled 1.0% of average total liabilities during 2002. Business
loan customers also comprise the majority of interest-bearing checking and money
market deposit accounts, although to a lesser extent than noninterest-bearing
checking accounts. Pursuant to banking regulations, incorporated businesses may
not own interest-bearing checking accounts and transactions from money market
accounts are limited. We anticipate continued growth of our check-writing
deposit accounts as additional business loans are extended and through the
efforts of our branch network and business development activities.
During 2002, savings account balances recorded an increase of $22.3 million, or
47.3%, and equaled 8.1% of average total liabilities. Business loan customers
also comprise the majority of savings account holders, although to a lesser
extent than check-writing accounts. We anticipate an increase in savings account
balances as additional business loans are extended and through the efforts of
our branch network and business development activities.
Certificates of deposit purchased by customers located within the market area
increased significantly during 2002, growing from $58.7 million at December 31,
2001, to $73.0 million on December 31, 2002, a growth rate of 24.4%. These
deposits accounted for 8.8% of average total liabilities during 2002. Leading
the growth were certificates of deposit issued to local municipalities,
primarily counties, cities and townships, increasing from $28.7 million at
December 31, 2001, to $43.0 million at December 31, 2002. The increase in local
municipality certificates of deposit has been facilitated by our qualifying for
funds from new municipal customers and additional funds from existing customers
through a combination of our asset growth and increased profitability as
measured by the municipalities' investment policy guidelines, and is a trend
that we expect to continue.
During 2002 certificates of deposit obtained from customers located outside of
the market area increased by $120.3 million, and represented 63.0% of average
total liabilities during 2002. At December 31, 2002, out-of-area deposits
totaled $512.5 million. Out-of-area deposits consist primarily of certificates
of deposit placed by deposit brokers for a fee, but also include certificates of
deposit obtained from the deposit owners directly. The owners of the out-of-area
deposits include individuals, businesses and governmental units located
throughout the country. Out-of-area deposits are utilized to support our asset
growth, and are generally a lower cost source of funds when compared to the
interest rates that would have to be offered in the local market to generate a
sufficient level of funds. During most of 2002 rates paid on new out-of-area
deposits were very similar to rates paid on new certificates of deposit issued
to local customers. In addition, the overhead costs associated with the
out-of-area deposits are considerably less than the overhead costs that would be
incurred to administer a similar level of local deposits. Although local
deposits have and are expected to increase as new business, governmental and
consumer deposit relationships are established and as existing customers
increase the balances in their deposit accounts, the relatively high reliance on
out-of-area deposits will likely remain.
Securities sold under agreements to repurchase ("repurchase agreements")
increased $13.8 million and equaled 6.0% of average total liabilities during
2002. As part of our sweep account program, collected funds from certain
F-10
business noninterest-bearing checking accounts are invested in overnight
interest-bearing repurchase agreements. Although not considered a deposit
account and therefore not afforded federal deposit insurance, the repurchase
agreements have characteristics very similar to that of an interest-bearing
checking deposit account.
Shareholders' equity increased $8.4 million and equaled 9.4% of average assets
during 2002. The increase was primarily attributable to net income from
operations, which totaled $7.8 million. Shareholders' equity was also positively
impacted by a $0.6 million mark-to-market adjustment for available for sale
securities as defined in SFAS No. 115, resulting from the changing interest rate
environment during 2002.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
SUMMARY
We recorded strong earnings performance during 2002. Net income was $7.8
million, or $1.43 per basic share and $1.41 per diluted share. This earnings
performance compares very favorably to net income of $4.5 million, or $1.11 per
basic share and $1.10 per diluted share, recorded in 2001. The $3.3 million
improvement in net income represents an increase of 73.0%, while diluted
earnings per share were up 28.2%, with the difference reflecting the impact of
our common stock sales during 2001 and resulting increases in average common
shares outstanding. The earnings improvement during 2002 over that of 2001 is
primarily attributable to increased net interest income and improved operating
efficiencies resulting from asset growth, strong credit culture, controlled
overhead expenses and increased fee income. We expect our percentage rate of
loan growth to exceed the banking industry average in 2003.
The following table shows some of the key performance and equity ratios for the
years ended December 31, 2002 and 2001.
2002 2001
---- ----
Return on average total assets 0.97% 0.74%
Return on average equity 10.30 9.05
Dividend payout ratio NA NA
Average equity to average assets 9.44 8.21
NET INTEREST INCOME
Net interest income, the difference between revenue generated from earning
assets and the interest cost of funding those assets, is our primary source of
earnings. Interest income (adjusted for tax-exempt income) and interest expense
totaled $48.2 million and $24.0 million during 2002, respectively, providing for
net interest income of $24.3 million. This performance compares favorably to
that of 2001 when interest income and interest expense were $45.0 million and
$28.2 million, respectively, providing for net interest income of $16.8 million.
In comparing 2002 with 2001, interest income increased 7.1%, interest expense
was down 14.9% and net interest income increased 44.6%. The level of net
interest income is primarily a function of asset size, as the weighted average
interest rate received on earning assets is greater than the weighted average
interest cost of funding sources; however, factors such as types of assets and
liabilities, interest rate risk, common stock sales, liquidity, and customer
behavior also impact net interest income as well as the net interest margin. The
net interest margin improved from 2.89% in 2001 to 3.19% in 2002, an increase of
10.4%.
The following table depicts the average balance, interest earned and paid, and
weighted average rate of our assets, liabilities and shareholders' equity during
2002, 2001 and 2000 (dollars in thousands). The table also depicts the dollar
amount of change in interest income and interest expense of interest-earning
assets and interest-bearing liabilities, segregated between change due to volume
and change due to rate. For tax-exempt investment securities interest income and
yield have been computed on a tax equivalent basis using a marginal tax rate of
34%.
F-11
Years ended December 31,
---------------2 0 0 2---------- ---------------2 0 0 1---------- ---------------2 0 0 0----------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ---- ------- -------- ----
Taxable securities $ 53,509 $ 3,023 5.65% $ 48,172 $ 3,245 6.74% $ 38,788 $ 2,662 6.86%
Tax-exempt
securities 29,956 2,056 6.86 19,566 1,362 6.96 10,972 782 7.12
---------- -------- ---------- -------- -------- ---------
Total securities 83,465 5,079 6.09 67,738 4,607 6.80 49,760 3,444 6.92
Loans 669,781 43,032 6.42 500,965 39,852 7.95 372,428 33,057 8.88
Short-term
investments 194 2 1.03 134 4 2.89 115 6 4.74
Federal funds sold 7,901 130 1.65 13,289 546 4.11 8,986 567 6.31
-------- -------- ------ -------- -------- ---------
Total earning
assets 761,341 48,243 6.34 582,126 45,009 7.73 431,289 37,074 8.60
Allowance for loan
and lease losses (9,620) (7,383) (5,527)
Cash and due
from banks 18,568 13,697 8,926
Other non-earning
assets 26,872 15,355 10,044
---------- ---------- --------
Total assets $ 797,161 $ 603,795 $444,732
========== ========== ========
Interest-bearing
demand
deposits $ 22,354 $ 399 1.78% $ 15,923 $ 491 3.08% $ 11,207 $ 501 4.47%
Savings deposits 58,679 1,381 2.35 42,334 1,614 3.81 36,040 1,875 5.20
Money market
accounts 6,870 127 1.85 5,518 177 3.20 5,405 251 4.64
Time deposits 518,271 19,561 3.77 400,180 23,155 5.79 288,791 18,992 6.58
---------- -------- ---------- -------- -------- ---------
Total interest-
bearing
deposits 606,174 21,468 3.54 463,955 25,437 5.48 341,443 21,619 6.33
Short-term
borrowings 44,395 899 2.03 34,662 1,186 3.42 29,331 1,369 4.67
Federal Home Loan
Bank advances 1,014 20 1.97 0 0 0.00 0 0 0.00
Long-term
borrowings 16,441 1,591 9.68 16,132 1,578 9.78 16,033 1,572 9.80
---------- -------- ---------- -------- -------- ---------
Total interest-
bearing
liabilities 668,024 23,978 3.59 514,749 28,201 5.48 386,807 24,560 6.35
-------- -------- ---------
Demand deposits 48,140 33,041 23,568
Other liabilities 5,692 6,450 4,893
---------- ------- -------
Total liabilities 721,856 554,240 415,268
Average equity 75,305 49,555 29,464
---------- ---------- --------
Total liabilities
and equity $ 797,161 $ 603,795 $444,732
========== ========== ========
Net interest
income $ 24,265 $ 16,808 $ 12,514
======== ======== =========
Rate spread 2.75% 2.25% 2.25%
===== ===== =====
Net interest
margin 3.19% 2.89% 2.90%
===== ===== =====
F-12
Years ended December 31,
--------------2002 over 2001--------------- --------------2001 over 2000---------------
Total Volume Rate Total Volume Rate
----- ------ ---- ----- ------ ----
Increase (decrease) in interest income
Taxable securities $ (222,000) $ 336,000 $ (558,000) $ 583,000 $ 633,000 $ (50,000)
Tax exempt securities 694,000 713,000 (19,000) 580,000 598,000 (18,000)
Loans 3,180,000 11,785,000 (8,605,000) 6,795,000 10,499,000 (3,704,000)
Short term investments (2,000) 1,000 (3,000) (2,000) 1,000 (3,000)
Federal funds sold (416,000) (169,000) (247,000) (21,000) 217,000 (238,000)
------------ ------------ ------------ ------------ ------------ ------------
Net change in tax-equivalent
income 3,234,000 12,666,000 (9,432,000) 7,935,000 11,948,000 (4,013,000)
Increase (decrease) in interest expense
Interest-bearing demand deposits (92,000) 157,000 (249,000) (11,000) 173,000 (184,000)
Savings deposits (233,000) 503,000 (736,000) (261,000) 293,000 (554,000)
Money market accounts (50,000) 37,000 (87,000) (74,000) 5,000 (79,000)
Time deposits (3,594,000) 5,742,000 (9,336,000) 4,163,000 6,654,000 (2,491,000)
Short term borrowings (287,000) 278,000 (565,000) (183,000) 222,000 (405,000)
Federal Home Loan Bank advances 20,000 20,000 0
Long term borrowings 13,000 30,000 (17,000) 6,000 10,000 (4,000)
------------ ------------ ------------ ------------ ------------ ------------
Net change in interest
expense 4,223,000 6,767,000 (10,990,000) 3,640,000 7,357,000 (3,717,000)
------------ ------------ ------------ ------------ ------------ ------------
Net change in tax-equivalent
net interest income $ 7,457,000 $ 5,899,000 $ 1,558,000 $ 4,295,000 $ 4,591,000 $ (296,000)
============ ============ ============ ============ ============ ============
Interest income is primarily generated from the loan portfolio, and to a lesser
degree from securities, federal funds sold and short term investments. Interest
income increased $3.2 million during 2002 from that earned in 2001, totaling
$48.2 million in 2002 compared to $45.0 million in the previous year. The
increase is due to the growth in earning assets, which more than offset the
impact of the declining interest rate environment in 2002. Reflecting the lower
interest rates, the yield on average earning assets decreased from 7.73%
recorded in 2001 to 6.34% in 2002.
The growth in interest income is attributable to an increase in earning assets.
During 2002, earning assets averaged $761.3 million, a level substantially
higher than the average earning assets of $582.1 million during 2001. Growth in
average total loans, totaling $168.8 million, comprised 94.2% of the increase in
average earnings assets. Interest income generated from the loan portfolio
increased $3.2 million during 2002 over the level earned in 2001, comprised of
an increase of $11.8 million from the growth in the loan portfolio which was
partially offset by a decrease of $8.6 million due to the decline in the yield
earned on the loan portfolio of 6.42% from 7.95%. The decline in the loan
portfolio yield is primarily due to decreased market interest rates during 2002.
Growth in the securities portfolio also added to the increase in interest income
during 2002 over that of 2001. Average securities increased by $15.8 million in
2002, increasing from $67.7 million in 2001 to $83.4 million in 2002. The growth
equated to an increase in interest income of $1.0 million, which was partially
offset by a decrease of $0.6 million due to the decline in the yield earned on
the securities portfolio of 6.09% from 6.80%. Interest income earned on federal
funds sold decreased by $0.4 million due to a $5.4 million decrease in the
average balance and a lower yield during 2002. The lower yield on securities and
federal funds sold is the result of decreased market interest rates during 2002.
Interest expense is primarily generated from interest-bearing deposits, and to a
lesser degree repurchase agreements, trust preferred securities and Federal Home
Loan Bank advances. Interest expense decreased $4.2 million during 2002 from
that paid in 2001, totaling $24.0 million in 2002 compared to $28.2 million in
the previous year. The decline in interest expense is primarily attributable to
the impact of the declining interest rate environment during 2002, which more
than offset the impact of the increase in interest-bearing liabilities during
2002. Interest-bearing liabilities averaged $668.0 million during 2002, a level
substantially higher than the average interest-bearing liabilities of $514.7
million during 2001. This growth resulted in increased interest expense of $6.8
million; however, a decrease in interest expense of $11.0 million was recorded
during 2002 due to lower market interest rates on all interest-bearing liability
categories except trust preferred securities that have a fixed interest rate.
The cost of average interest-bearing liabilities decreased from the 5.48%
recorded in 2001 to 3.59% in 2002.
F-13
Growth in average certificates of deposits, totaling $118.1 million, comprised
77.0% of the increase in average interest-bearing liabilities between 2002 and
2001. The certificate of deposit growth during 2002 equated to an increase in
interest expense of $5.7 million; however, a decrease in interest expense of
$9.3 million was recorded due to the decline in the average rate paid as
higher-rate certificates of deposit matured and were either renewed or replaced
with lower-costing certificates of deposit. Increases in repurchase agreements
and other interest-bearing deposits added to interest expense; however, the
decline in interest rates paid on these funding liabilities more than offset the
increased costs due to dollar volume growth. Average repurchase agreements grew
from $34.7 million in 2001 to $44.4 million in 2002. The growth equated to an
increase in interest expense of $0.3 million; however, a decrease of $0.6
million in interest expense was recorded due to the decline in the average rate
paid. Lower interest rates paid on interest-bearing checking accounts, savings
deposits and money market accounts reduced, in aggregate, $1.1 million in
interest expense during 2002, while the increase in dollar volume added $0.7
million in interest expense.
PROVISION FOR LOAN AND LEASE LOSSES
Primarily reflecting continued significant loan and lease growth, the provision
for loan and lease losses totaled $3.0 million during 2002, compared to the $2.4
million expensed during 2001. The allowance as a percentage of total loans
outstanding as of December 31, 2002 was 1.41%, compared to 1.45% at year-end
2001. Net loan and lease charge-offs during 2002 totaled $606,000, or 0.09% of
average total loans and leases. Net loan and lease charge-offs during 2001
totaled $178,000, or 0.04% of average total loans and leases. We maintain the
allowance at a level we believe is adequate to absorb losses contained within
the loan and lease portfolio.
NONINTEREST INCOME
Noninterest income, excluding net gains on sales of securities, totaled $2.8
million in 2002, an increase of 66.4% over the $1.7 million earned in 2001.
Deposit and repurchase agreement service charges totaled $915,000 in 2002, an
increase of $386,000, or 73.0%, from the amount earned in 2001. The increase is
primarily due to the growth in the number of deposit accounts, reduction of the
deposit earnings credit rate and modest increases in the deposit fee structure.
Reflecting increased volume of refinance activity resulting from the decreased
interest rate environment, fees earned on referring residential mortgage loan
applicants to various third parties totaled $534,000 in 2002, up from the
$401,000 earned in 2001. Usage fees on credit and debit cards totaled $262,000
in 2002, up from the $166,000 earned in 2001. Letter of credit commitment fees
totaled $307,000 during 2002, down from the $379,000 earned in 2001.
Noninterest income related to cash surrender value of BOLI totaled $409,000 in
2002, up from the $99,000 recorded in 2001. The increase is primarily due to the
additional $10.5 million BOLI purchase in August 2002 and the impact of having a
full twelve month accrual of the $3.9 million in BOLI that were purchased at
various time intervals during mid-2001. The BOLI policies represent a
combination of whole life and term insurance. The purchase made in 2002 was done
primarily to mitigate the impact of 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,
while the 2001 purchases were done primarily to mitigate the interest cost of
and provide a funding mechanism for our bank's non-qualified deferred
compensation program. Our bank is the sole beneficiary of the term life
insurance policies that are part of the BOLI purchased in 2002, while any
payments made under the term life insurance policies that are part of the BOLI
purchased in 2001 may be shared between our bank and the officers' named
beneficiaries.
F-14
In addition to providing interest income and secondary liquidity, our securities
portfolio plays an integral role in managing our net interest margin. During
2002 we consummated two bond swap transactions, resulting in a net gain on the
sales of securities of $270,000. We also consummated two bond swap transactions
during 2001, resulting in a net gain on the sales of securities of $207,000. All
four bond swap transactions were consummated in reaction to the declining
interest rate environment occurring at the respective time periods of the sales,
and against the backdrop of an expected increasing interest rate environment
over the next one to four years. During the first quarter of 2002, we sold ten
mortgage-backed securities with an aggregate par value of $10.2 million,
resulting in a net gain of $149,000. The underlying mortgage loans of the
mortgage-backed securities generally had 25 to 30 years to final maturity and
exhibited a relatively high level of extension risk in an increasing interest
rate environment. The proceeds of the sold bonds were re-invested into five
mortgage-backed securities, the underlying mortgage loans of which had 10 to 15
years to final maturity and would expect to have a lower level of extension risk
in a rising interest rate environment when compared to the mortgage-backed
securities that were sold.
The second bond swap was completed during the third quarter of 2002. We sold
eight mortgage-backed securities with an aggregate par value of $3.3 million,
resulting in a net gain of $121,000. Due to the declining interest rate
environment, these mortgage-backed securities had received recent significant
principal reductions as the underlying mortgage loans were being paid-off
presumably due to refinancing activity on the part of the borrowers. As it was
likely that the remaining principal balance of the mortgage-backed securities
would be paid-off in the near term, and at a time of low interest rates, these
bonds were sold and the proceeds re-invested into one mortgage-backed security,
the underlying mortgages of which were expected to pay-off over the next two to
four years.
NONINTEREST EXPENSE
Noninterest expense during 2002 totaled $12.8 million, an increase of 35.2% over
the $9.5 million expensed in 2001. Of the $3.3 million growth in overhead costs,
$2.1 million (63.6%) was in salaries and benefits, and primarily reflects the
increase in full-time equivalent employees from 96 at year-end 2001 to 117 at
year-end 2002, annual pay increases and an increase in the maximum dollar amount
paid in the company-wide non-lender bonus program. Occupancy, furniture and
equipment costs increased $0.7 million (59.3%) in 2002 over that expensed in
2001, primarily reflecting the opening of our new administrative office and the
combined branch and operations center in the latter part of 2001. The remaining
growth in overhead costs were generally due to general and administrative cost
increases associated with an increased asset base.
While the dollar volume of noninterest costs have increased, the growth of net
interest income and fee income have increased by a much higher degree.
Noninterest costs during 2002 were $3.3 million higher than the level of
overhead costs expensed during 2001; however, net interest income and fee income
increased a combined $8.4 million during the same time period. Monitoring and
controlling our noninterest costs, while at the same time providing high quality
service to our customers, is one of our priorities. The efficiency ratio, a
banking industry standardized calculation that attempts to reflect the
utilization of overhead costs, continued to show improvement during 2002.
Computed by dividing noninterest expenses by net interest income plus
noninterest income, the efficiency ratio was 47.9% during 2002. This level
compares favorably to the efficiency ratio of 51.7% recorded during 2001, and
reflects the improved efficiencies resulting from increased net interest income
and fee income, and controlled overhead costs.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $3.2 million in 2002, an increase of $1.2
million, or 59.1% over the $2.0 million expensed during 2001. The increase is
primarily due to the growth in our pre-federal income tax profitability, which
was only partially offset by a decline in our effective federal income tax rate
from 30.7% in 2001 to 29.0% in 2002.
F-15
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
SUMMARY
We recorded strong earnings performance during 2001. Net income was $4.5
million, or $1.11 per basic share and $1.10 per diluted share. This earnings
performance compares very favorably to net income of $2.8 million, or $0.98 per
basic share and $0.97 per diluted share, recorded in 2000. The $1.7 million
improvement in net income represents an increase of 60.7%, while diluted
earnings per share were up 13.4%, with the difference reflecting the impact of
our common stock sales during 2001 and resulting increases in average common
shares outstanding. The earnings improvement during 2001 over that of 2000 is
primarily attributable to increased net interest income and improved operating
efficiencies resulting from asset growth, strong credit culture, controlled
overhead expenses and increased fee income.
NET INTEREST INCOME
Net interest income, the difference between revenue generated from earning
assets and the interest cost of funding those assets, is our primary source of
earnings. Interest income (adjusted for tax-exempt income) and interest expense
totaled $45.0 million and $28.2 million during 2001, respectively, providing for
net interest income of $16.8 million. This performance compares very favorably
to that of 2000 when interest income and interest expense were $37.1 million and
$24.6 million, respectively, providing for net interest income of $12.5 million.
In comparing 2001 with 2000, interest income increased 21.4%, interest expense
was up 14.8% and net interest income increased 34.3%. The level of net interest
income is primarily a function of asset size, as the weighted average interest
rate received on earning assets is greater than the weighted average interest
cost of funding sources; however, factors such as types of assets and
liabilities, interest rate risk, common stock sales, liquidity, and customer
behavior also impact net interest income as well as the net interest margin. The
net interest margin remained virtually unchanged in 2001 at 2.89%, compared to
2.90% in 2000.
Interest income is primarily generated from the loan portfolio, and to a lesser
degree from securities, federal funds sold and short term investments. Interest
income increased $7.9 million during 2001 from that earned in 2000, totaling
$45.0 million in 2001 compared to $37.1 million in the previous year. The
increase is due to the growth in earning assets, which more than offset the
impact of the declining interest rate environment during 2001 during which time
the prime rate declined by 475 basis points. Reflecting the significantly lower
interest rates, the yield on average earning assets decreased from 8.60%
recorded in 2000 to 7.73% in 2001.
The growth in interest income is attributable to an increase in earning assets.
During 2001, earning assets averaged $582.1 million, a level substantially
higher than the average earning assets of $431.3 million during 2000. Growth in
average total loans, totaling $128.5 million, comprised 85.2% of the increase in
average earnings assets. Interest income generated from the loan portfolio
increased $6.8 million during 2001 over the level earned in 2000, comprised of
an increase of $10.5 million from the growth in the loan portfolio which was
partially offset by a decrease of $3.7 million due to the decline in the yield
earned on the loan portfolio of 7.95% from 8.88%. The decline in the loan
portfolio yield is primarily due to decreased market interest rates during 2001.
Growth in the securities portfolio also added to the increase in interest income
during 2001 over that of 2000. Average securities increased by $18.0 million in
2001, increasing from $49.7 million in 2000 to $67.7 million in 2001. The growth
equated to an increase in interest income of $1.2 million, which was slightly
offset by a decrease of $0.1 million due to the decline in the yield earned on
the securities portfolio of 6.80% from 6.92%. Although interest income earned on
federal funds sold increased by $0.2 million due to a $4.3 million increase in
the average balance during 2001, a lower yield earned on federal funds sold
offset the higher income resulting from the increased average balance. The lower
yield on securities and federal funds sold is the result of decreased market
interest rates during 2001.
F-16
Interest expense is primarily generated from interest-bearing deposits, and to a
lesser degree repurchase agreements and trust preferred securities. Interest
expense increased $3.6 million during 2001 from that paid in 2000, totaling
$28.2 million in 2001 compared to $24.6 million in the previous year. The growth
in interest expense is primarily attributable to an increase in interest-bearing
liabilities during 2001, which more than offset the impact of the declining
interest rate environment during 2001. Interest-bearing liabilities averaged
$514.7 million during 2001, a level substantially higher than the average
interest-bearing liabilities of $386.8 million during 2000. This growth resulted
in increased interest expense of $7.3 million; however, a decrease in interest
expense of $3.7 million was recorded during 2001 due to lower market interest
rates on all interest-bearing liability categories except trust preferred
securities that have a fixed interest rate. The cost of average interest-bearing
liabilities decreased from the 6.35% recorded in 2000 to 5.48% in 2001.
Growth in average certificates of deposits, totaling $111.4 million, comprised
87.1% of the increase in average interest-bearing liabilities between 2001 and
2000. The certificate of deposit growth during 2001 equated to an increase in
interest expense of $6.7 million, although a decrease in interest expense of
$2.5 million was recorded due to the decline in the average rate paid. Increases
in repurchase agreements and other interest-bearing deposits added to interest
expense; however, the decline in interest rates paid on these funding
liabilities more than offset the increased costs due to dollar volume growth.
Average repurchase agreements grew from $29.3 million in 2000 to $34.7 million
in 2001. The growth equated to an increase in interest expense of $0.2 million;
however, a decrease of $0.4 million in interest expense was recorded due to the
decline in the average rate paid. Lower interest rates paid on interest-bearing
checking accounts, savings deposits and money market accounts reduced, in
aggregate, $0.8 million in interest expense during 2001, while the increase in
dollar volume added $0.5 million in interest expense.
PROVISION FOR LOAN LOSSES
Reflecting continued significant loan growth, the provision for loan losses
totaled approximately $2.4 million during 2001, compared to the $1.9 million
expensed during 2000. The allowance as a percentage of total loans outstanding
as of December 31, 2001 was 1.45%, slightly lower than the 1.47% at year-end
2000. Net loan charge-offs during 2001 approximated $178,000, or 0.04% of
average total loans. Net loan charge-offs during 2000 totaled about $172,000, or
0.05% of average total loans. We maintain the allowance at a level we believe is
adequate to absorb losses contained within the loan portfolio.
NONINTEREST INCOME
Noninterest income, excluding net gains on sales of securities, totaled $1.7
million in 2001, an increase of 40.3% over the $1.2 million earned in 2000
(excluding the interest rate swap termination fee). Deposit and repurchase
agreement service charges totaled $529,000 in 2001, an increase of $183,000, or
52.9%, from the amount earned in 2000. The increase is primarily due to the
growth in the number of deposit accounts. Reflecting increased volume of
refinance activity resulting from the decreased interest rate environment, fees
earned on referring residential mortgage loan applicants to various third
parties totaled $401,000 in 2001, up significantly from the $175,000 earned in
2000. Letter of credit commitment fees were virtually unchanged at $379,000
during 2001 when compared to the $391,000 earned in 2000.
Noninterest income related to cash surrender value of BOLI totaled $99,000
during 2001. Purchased at various time intervals during mid-2001, the cash
surrender value of the BOLI policies totaled $4.0 million at December 31, 2001.
The BOLI policies represent a combination of whole life and term insurance, and
were purchased as part of our bank's non-qualified deferred compensation
program. Under this program, certain officers have the ability to defer all or
portions of their salary and/or bonus payments. A BOLI policy was purchased for
each of the participating officers, with the whole life portion of the BOLI
policy providing a funding source when each of the specific officers reach
retirement age and begin to receive payments under the program. Any payments
made under the term life insurance portion of the BOLI policies may be shared
between our bank and the officers' named beneficiaries.
F-17
In addition to providing interest income and secondary liquidity, our securities
portfolio plays an integral role in managing our net interest margin. In
reaction to the declining interest rate environment during 2001 we completed two
separate bond swap transactions whereby selected securities were sold and the
sales proceeds were re-invested into securities containing differing interest
rate risk characteristics. The first bond swap transaction involved the sale of
two callable U.S. Government Agency bonds. During the relatively high interest
rate environment in 2000, our bank purchased four $1.0 million heavily
discounted callable U.S. Government Agency bonds. A major factor in purchasing
the bonds was our expectation that the bonds would likely be called by the
issuer in a declining interest rate environment, resulting in the remaining
discount being immediately accreted into interest income and at least partially
offsetting the short-term negative impact a declining interest rate environment
would have on our net interest margin. With interest rates declining during the
first quarter of 2001, two of the bonds were called by the issuer and the
combined unaccreted discount of $72,000 was immediately taken into interest
income. Of the remaining two bonds, one was not initially callable until June
2001, and the other bond, while immediately callable, was not called by the
issuer as interest rates had not declined to a level where it was likely to be
called by the issuer. Given that net interest margin management was a major
factor in purchasing the bonds, we decided to sell the remaining two bonds, and
a net gain of $97,000 was recorded as noninterest income.
The second bond swap was completed during the fourth quarter of 2001. In an
effort to address the impact of a possible future increasing interest rate
environment, we decided to sell certain mortgage-backed pass-through securities
and re-invest the proceeds into mortgage-backed securities that exhibit
different principal repayment characteristics. We sold seven bonds with an
aggregate par value of $7.4 million, and recorded a net gain of $110,000. These
issues were generally the lowest yielding bonds and had the lowest coupons on
the underlying residential mortgages within the mortgage-backed pass-through
segment of our investment securities portfolio, and although comprising almost
24% of that portfolio segment these particular bonds comprised only about 13% of
the unrealized gain as of September 30, 2001. In an increasing interest rate
environment, we would expect these particular bonds to reflect extension, that
is the principal repayments would slow and therefore our total return would be
negatively impacted as we would have less money to re-invest in higher yielding
products. Proceeds from the sales were re-invested into mortgage-backed
pass-through securities that we believe would provide greater principal
repayment during an increasing interest rate environment, therefore giving us
the opportunity to invest more money into higher yielding products and improving
our total return.
NONINTEREST EXPENSE
Noninterest expense during 2001 totaled $9.5 million, an increase of 25.8% over
the $7.5 million expensed in 2000. Of the $2.0 million growth in overhead costs,
$1.4 million was in salaries and benefits, and primarily reflects the increase
in full-time equivalent employees from 65 at year-end 2000 to 96 at year-end
2001 and annual pay increases. The remaining growth in overhead costs were
generally due to general and administrative cost increases associated with an
increased asset base and the opening of the new administrative office and the
combined branch and operations center.
While the dollar volume of noninterest costs have increased, as a percent of
average assets the level has substantially declined as a result of our asset
growth and the realization of operating efficiencies. During 2001, noninterest
costs were 1.57% of average assets, a 7.1% decline from the 1.69% level during
2000. Monitoring and controlling our noninterest costs, while at the same time
providing high quality service to our customers, is one of our priorities. The
efficiency ratio, a banking industry standardized calculation that attempts to
reflect the utilization of overhead costs, also declined during 2001. Computed
by dividing noninterest expenses by net interest income plus noninterest income,
the efficiency ratio was 51.7% during 2001. This level compares favorably to the
efficiency ratio of 55.8% recorded during 2000, and reflects the improved
efficiencies resulting from increased earning asset growth and controlled costs.
Although noninterest expenses increased $2.0 million during 2001, our net
revenue increased $4.8 million during the same time period.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $2.0 million in 2001, an increase of 52.7% over
the $1.3 million expensed during 2000. The increase is due to the growth in our
profitability.
F-18
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for our asset growth. Shareholders' equity was $79.8 million and $71.5
million at December 31, 2002 and 2001, respectively. The $8.4 million increase
during 2002 is primarily attributable to net income from operations, which
totaled $7.8 million. Shareholders' equity was also positively impacted by a
$0.6 million mark-to-market adjustment for available for sale securities as
defined in SFAS No. 115, resulting primarily from the declining interest rate
environment during 2002.
We and our bank are subject to regulatory capital requirements administered by
the State of Michigan and federal banking agencies. Failure to meet the various
capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements. Since our bank began operations,
both we and our bank have been categorized as "Well Capitalized," the highest
classification contained within the banking regulations. Our and our bank's
capital ratios as of December 31, 2002 and 2001 are disclosed under Note 17 on
pages F-44 and F-45 of the Notes to Consolidated Financial Statements.
Our ability to pay cash and stock dividends is subject to limitations under
various laws and regulations and to prudent and sound banking practices. On
January 6, 2003, we declared a 5% common stock dividend, payable on February 3,
2003 to record holders as of January 17, 2003. This represents the third
straight year we have declared and paid a 5% stock dividend. Also on January 6,
2003, we declared our first quarterly common stock cash dividend. The $0.08 per
common share cash dividend will be paid on March 10, 2003 to record holders as
of February 10, 2003.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment of loans and investment
securities. These funds are used to meet deposit withdrawals, maintain reserve
requirements, fund loans and operate our company. Liquidity is primarily
achieved through the growth of deposits (both local and out-of-area) and liquid
assets such as securities available for sale, matured securities, and federal
funds sold. Asset and liability management is the process of managing the
balance sheet to achieve a mix of earning assets and liabilities that maximizes
profitability, while providing adequate liquidity.
Our liquidity strategy is to fund loan growth with deposits, repurchase
agreements and other borrowed funds and to maintain an adequate level of short-
and medium-term investments to meet typical daily loan and deposit activity.
Although deposit and repurchase agreement growth from depositors located in the
market area increased by $78.6 million, or 36.8%, during 2002, the growth was
not sufficient to meet the substantial loan growth of $184.4 million
and provide monies for additional investing activities. To assist in providing
the additional needed funds we regularly obtained certificates of deposit from
customers outside of the market area. As of December 31, 2002, out-of-area
deposits totaled $512.5 million, or 63.7% of combined deposits and repurchase
agreements, an increase in dollar volume from the $392.2 million outstanding,
but a decline from the 64.8% level of combined deposits and repurchase
agreements, as of December 31, 2001.
We have the ability to borrow money on a daily basis through correspondent banks
using established federal funds purchased lines; however, this is generally
viewed as only a secondary and temporary source of funds. During 2002, our
federal funds sold position averaged $7.9 million and our federal funds
purchased position averaged $0.9 million. At December 31, 2002, our established
unsecured federal funds purchased lines totaled $22.0 million. In addition, as a
member of the Federal Home Loan Bank of Indianapolis ("FHLBI"), our bank has
access to the FHLBI's borrowing programs. Based on available collateral at
December 31, 2002, our bank could borrow up to $99.0 million. At December 31,
2002, FHLBI advances totaled $15.0 million.
F-19
In addition to normal loan funding and deposit flow, we also need to maintain
liquidity to meet the demands of certain unfunded loan commitments and standby
letters of credit. At December 31, 2002, we had a total of $178.1 million in
unfunded loan commitments and $39.3 million in unfunded standby letters of
credit. Of the total unfunded loan commitments, $153.8 million were commitments
available as lines of credit to be drawn at any time as customers' cash needs
vary, and $24.3 million were for loan commitments scheduled to close and become
funded within the next three months. We monitor fluctuations in loan balances
and commitment levels, and include such data in our overall liquidity
management.
MARKET RISK ANALYSIS
Our primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity risk. All of our transactions are denominated in U.S. dollars with no
specific foreign exchange exposure. We have only limited agricultural-related
loan assets and therefore have no significant exposure to changes in commodity
prices. Any impact that changes in foreign exchange rates and commodity prices
would have on interest rates are assumed to be insignificant. Interest rate risk
is the exposure of our financial condition to adverse movements in interest
rates. We derive our income primarily from the excess of interest collected on
interest-earning assets over the interest paid on interest-bearing liabilities.
The rates of interest we earn on our assets and owe on our liabilities generally
are established contractually for a period of time. Since market interest rates
change over time, we are exposed to lower profitability if we cannot adapt to
interest rate changes. Accepting interest rate risk can be an important source
of profitability and shareholder value; however, excessive levels of interest
rate risk could pose a significant threat to our earnings and capital base.
Accordingly, effective risk management that maintains interest rate risk at
prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. Our interest rate risk management process seeks to ensure
that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk we assess the existing and potential future effects of
changes in interest rates on our financial condition, including capital
adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is
commonly referred to as GAP analysis, measures the difference between the dollar
amounts of interest-sensitive assets and liabilities that will be refinanced or
repriced during a given time period. A significant repricing gap could result in
a negative impact to the net interest margin during periods of changing market
interest rates.
F-20
The following table depicts our GAP position as of December 31, 2002 (dollars in
thousands).
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
Assets:
Commercial loans $ 293,409 $ 41,174 $ 354,266 $ 16,168 $ 705,017
Leases 850 850
Residential real estate loans 30,470 2,343 20,781 7,235 60,829
Consumer loans 1,276 132 3,321 129 4,858
Securities (1) 1,642 579 36,784 57,888 96,893
Federal funds sold 4,500 4,500
Short term investments 213 213
Allowance for loan and lease losses (10,890) (10,890)
Other assets 59,585 59,585
----------- ----------- ----------- ----------- -----------
Total assets 331,510 44,228 416,002 130,115 921,855
Liabilities:
Interest-bearing checking 28,130 28,130
Savings 69,461 69,461
Money market accounts 8,592 8,592
Time deposits under $100,000 23,278 41,620 27,661 92,559
Time deposits $100,000 and over 115,615 256,557 120,794 492,966
Short term borrowings 50,335 50,335
Federal Home Loan Bank advances 10,000 5,000 15,000
Long term borrowings 576 16,000 16,576
Noninterest-bearing checking 62,405 62,405
Other liabilities 5,997 5,997
----------- ----------- ----------- ----------- -----------
Total liabilities 295,987 308,177 153,455 84,402 842,021
Shareholders' equity 79,834 79,834
----------- ----------- ----------- ----------- -----------
Total sources of funds 295,987 308,177 153,455 164,236 921,855
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 35,523 $ (263,949) $ 262,547 $ (34,121)
=========== =========== =========== ============
Cumulative GAP $ 35,523 $ (228,426) $ 34,121
=========== =========== ===========
Percent of cumulative GAP to
total assets 3.9% (24.8)% 3.7%
=========== =========== ===========
(1) Mortgage-backed securities are categorized by expected maturities based
upon prepayment trends as of December 31, 2002.
The second interest rate risk measurement used is commonly referred to as net
interest income simulation analysis. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, serves as our primary interest rate risk measurement technique. The
simulation model assesses the direction and magnitude of variations in net
interest income resulting from potential changes in market interest rates. Key
assumptions in the model include prepayment speeds on various loan and
investment assets; cash flows and maturities of interest-sensitive assets and
liabilities; and changes in market conditions impacting loan and deposit volume
and pricing. These assumptions are inherently uncertain, subject to fluctuation
and revision in a dynamic environment; therefore, the model cannot precisely
estimate net interest income or exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes and
changes in market conditions and our strategies, among other factors.
F-21
We conducted multiple simulations as of December 31, 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 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 $ 15,000 0.1%
Interest rates down 100 basis points 536,000 2.1
No change in interest rates 851,000 3.3
Interest rates up 100 basis points 1,435,000 5.5
Interest rates up 200 basis points 2,031,000 7.8
The increase in net interest income under all interest rate scenarios reflects
the expected repricing of local and out-of-area certificates of deposit during
the next twelve months. Throughout all of 2003, we have a large volume of
certificates of deposit set to mature that were issued during higher interest
rate environments. Based upon the current interest rate environment these
certificates of deposit will either be renewed at lower interest rates or
replaced with new certificates of deposit with lower interest rates.
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of other variables, including: the growth,
composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; economic and competitive conditions; potential
changes in lending, investing, and deposit gathering strategies; client
preferences; and other factors.
F-22
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Mercantile Bank Corporation
Wyoming, Michigan
We have audited the accompanying consolidated balance sheets of Mercantile Bank
Corporation as of December 31, 2002 and 2001 and the related consolidated
statements of income, changes in shareholders' equity and cash flows for each of
the three years in the period ended December 31, 2002. These financial
statements are the responsibility of Mercantile's management. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Mercantile Bank
Corporation as of December 31, 2002 and 2001, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2002 in conformity with accounting principles generally accepted in the United
States of America.
/s/ Crowe, Chizek and Company LLP
---------------------------------
Crowe, Chizek and Company LLP
Grand Rapids, Michigan
January 17, 2003
Except Note 1 as to which the date is February 3, 2003
F-23
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
- --------------------------------------------------------------------------------
2002 2001
---- ----
ASSETS
Cash and due from banks $ 23,404,000 $ 14,467,000
Short term investments 213,000 171,000
Federal funds sold 4,500,000 5,300,000
------------- -------------
Total cash and cash equivalents 28,117,000 19,938,000
Securities available for sale 59,614,000 52,054,000
Securities held to maturity (fair value of $37,985,000 at
December 31, 2002 and $26,183,000 at December 31, 2001) 36,493,000 25,979,000
Federal Home Loan Bank stock 786,000 785,000
Total loans 771,554,000 587,248,000
Allowance for loan and lease losses (10,890,000) (8,494,000)
------------- -------------
Total loans, net 760,664,000 578,754,000
Premises and equipment, net 12,174,000 9,557,000
Accrued interest receivable 3,336,000 2,811,000
Bank owned life insurance policies 14,876,000 3,991,000
Other assets 5,795,000 4,813,000
------------- -------------
Total assets $ 921,855,000 $ 698,682,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 62,405,000 $ 43,162,000
Interest-bearing 691,708,000 525,915,000
------------- -------------
Total 754,113,000 569,077,000
Securities sold under agreements to repurchase 50,335,000 36,485,000
Federal Home Loan Bank advances 15,000,000 0
Other borrowed money 576,000 239,000
Accrued expenses and other liabilities 5,997,000 5,418,000
Trust preferred securities 16,000,000 16,000,000
------------- -------------
Total liabilities 842,021,000 627,219,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value; 9,000,000 shares
authorized; 5,405,706 and 5,405,155 shares issued
and outstanding at December 31, 2002 and 2001 75,530,000 69,406,000
Retained earnings 3,250,000 1,649,000
Accumulated other comprehensive income 1,054,000 408,000
------------- -------------
Total shareholders' equity 79,834,000 71,463,000
------------- -------------
Total liabilities and shareholders' equity $ 921,855,000 $ 698,682,000
============= =============
See accompanying notes to consolidated financial statements.
F-24
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2002, 2001 and 2000
- --------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
Interest income
Loans, including fees $ 43,032,000 $ 39,852,000 $ 33,057,000
Securities, taxable 3,023,000 3,245,000 2,662,000
Securities, tax-exempt 1,445,000 972,000 544,000
Federal funds sold 130,000 546,000 567,000
Short-term investments 2,000 4,000 5,000
-------------- ------------- --------------
Total interest income 47,632,000 44,619,000 36,835,000
Interest expense
Deposits 21,468,000 25,437,000 21,619,000
Federal Home Loan Bank advances 20,000 0 0
Short-term borrowings 899,000 1,186,000 1,369,000
Long-term borrowings 1,591,000 1,578,000 1,572,000
-------------- ------------- --------------
Total interest expense 23,978,000 28,201,000 24,560,000
-------------- ------------- --------------
NET INTEREST INCOME 23,654,000 16,418,000 12,275,000
Provision for loan and lease losses 3,002,000 2,370,000 1,854,000
-------------- ------------- --------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES 20,652,000 14,048,000 10,421,000
Noninterest income
Service charges on accounts 915,000 529,000 346,000
Letter of credit fees 307,000 379,000 391,000
Mortgage loan referral fees 534,000 401,000 175,000
Gain on sale of loans 0 0 50,000
Gain (loss) on sale of securities 270,000 207,000 (275,000)
Interest rate swap termination fee 0 0 275,000
Increase in cash surrender value of bank owned life
insurance policies 409,000 99,000 0
Other income 618,000 264,000 230,000
-------------- ------------- --------------
Total noninterest income 3,053,000 1,879,000 1,192,000
Noninterest expense
Salaries and benefits 7,771,000 5,712,000 4,274,000
Occupancy 1,069,000 627,000 510,000
Furniture and equipment 749,000 514,000 440,000
Data processing 571,000 446,000 435,000
Advertising 300,000 248,000 197,000
Other expense 2,321,000 1,907,000 1,659,000
-------------- ------------- --------------
Total noninterest expenses 12,781,000 9,454,000 7,515,000
-------------- ------------- --------------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 10,924,000 6,473,000 4,098,000
Federal income tax expense 3,167,000 1,990,000 1,303,000
-------------- ------------- --------------
NET INCOME $ 7,757,000 $ 4,483,000 $ 2,795,000
============== ============= ==============
Earnings per share:
Basic $ 1.43 $ 1.11 $ 0.98
======= ======= =======
Diluted $ 1.41 $ 1.10 $ 0.97
======= ======= =======
See accompanying notes to consolidated financial statements.
F-25
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2002, 2001 and 2000
- --------------------------------------------------------------------------------
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income/(Loss) Equity
----- -------- ------------- ------
BALANCES, JANUARY 1, 2000 $ 28,182,000 $ 587,000 $ (801,000) $ 27,968,000
Payment of 5% stock dividend 1,754,000 (1,754,000)
Comprehensive income:
Net income 2,795,000 2,795,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassification and tax effect 1,091,000 1,091,000
----------------
Total comprehensive income 3,886,000
--------------- -------------- ------------- ----------------
BALANCES, DECEMBER 31, 2000 29,936,000 1,628,000 290,000 31,854,000
Sale of 2,306,600 shares of common
stock, net of issuance costs 35,009,000 35,009,000
Payment of 5% stock dividend 4,461,000 (4,462,000) (1,000)
Comprehensive income:
Net income 4,483,000 4,483,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassification and tax effect 118,000 118,000
----------------
Total comprehensive income 4,601,000
--------------- -------------- ------------- ----------------
BALANCES, DECEMBER 31, 2001 69,406,000 1,649,000 408,000 71,463,000
Payment of 5% stock dividend 6,155,000 (6,156,000) (1,000)
Issuance costs associated with 2001
stock sale (37,000) (37,000)
Stock option exercises, 578 shares 6,000 6,000
Comprehensive income:
Net income 7,757,000 7,757,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassification and tax effect 646,000 646,000
----------------
Total comprehensive income 8,403,000
--------------- -------------- ------------- ----------------
BALANCES, DECEMBER 31, 2002 $ 75,530,000 $ 3,250,000 $ 1,054,000 $ 79,834,000
=============== ============== ============= ================
See accompanying notes to consolidated financial statements.
F-26
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002, 2001 and 2000
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,757,000 $ 4,483,000 $ 2,795,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 1,366,000 651,000 590,000
Provision for loan and leases losses 3,002,000 2,370,000 1,854,000
Gain on sale of loans 0 0 (50,000)
(Gain)/loss on sale of securities (270,000) (207,000) 275,000
Net change in
Accrued interest receivable (525,000) (53,000) (915,000)
Bank owned life insurance policies (409,000) (99,000) 0
Other assets (1,484,000) (1,224,000) (828,000)
Accrued expenses and other liabilities 579,000 (1,526,000) 4,325,000
------------- ------------- -------------
Net cash from operating activities 10,016,000 4,395,000 8,046,000
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of:
Securities available for sale (41,074,000) (38,542,000) (19,817,000)
Securities held to maturity (11,783,000) (11,555,000) (7,473,000)
Federal Home Loan Bank stock (1,000) 0 0
Proceeds from:
Sales of securities available for sale 13,997,000 12,843,000 6,718,000
Maturities, calls and repayments of
securities available for sale 20,493,000 19,240,000 3,498,000
Maturities, calls and repayments of
securities held to maturity 1,255,000 102,000 0
Loan originations and payments, net (184,912,000) (157,622,000) (121,920,000)
Purchases of premises and equipment, net (3,527,000) (5,994,000) (1,099,000)
Purchases of bank owned life insurance policies (10,476,000) (3,892,000) 0
------------- ------------- -------------
Net cash from investing activities (216,028,000) (185,420,000) (140,093,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 185,036,000 143,337,000 130,912,000
Net proceeds from sale of common stock (37,000) 35,009,000 0
Stock option exercises 6,000 0 0
Cash paid in lieu of fractional shares on stock dividend (1,000) (1,000) 0
Proceeds from Federal Home Loan Bank advances 15,000,000 0 0
Net increase in other borrowed money 337,000 182,000 43,000
Net increase in securities sold under agreements
to repurchase 13,850,000 4,334,000 5,544,000
------------- ------------- -------------
Net cash from financing activities 214,191,000 182,861,000 136,499,000
------------- ------------- -------------
Net change in cash and cash equivalents 8,179,000 1,836,000 4,452,000
Cash and cash equivalents at beginning of period 19,938,000 18,102,000 13,650,000
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 28,117,000 $ 19,938,000 $ 18,102,000
============= ============= =============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 23,883,000 $ 29,717,000 $ 20,382,000
Federal income tax 4,165,000 2,713,000 1,693,000
Cash received during the year for
Gain on termination of interest rate swap 0 0 275,000
See accompanying notes to consolidated financial statements.
F-27
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of Mercantile Bank Corporation ("Mercantile") and its wholly-owned
subsidiaries, Mercantile Bank of West Michigan ("Bank") and MBWM Capital Trust I
("Capital Trust"), and of Mercantile Bank Mortgage Company ("Mortgage Company"),
Mercantile BIDCO, Inc. ("Mercantile BIDCO"), and Mercantile Insurance Center,
Inc. ("Mercantile Insurance"), wholly-owned subsidiaries of our bank, after
elimination of significant intercompany transactions and accounts.
Nature of Operations: Mercantile was incorporated on July 15, 1997 to establish
and own the Bank based in Grand Rapids, Michigan. The Bank is a community-based
financial institution. The Bank began operations on December 15, 1997, after
several months of work by incorporators and employees in preparing applications
with the various regulatory agencies and obtaining insurance and building space.
The Bank's primary deposit products are checking, savings, and term certificate
accounts, and its primary lending products are commercial loans, commercial
leases, residential mortgage loans, and installment loans. Substantially all
loans and leases are secured by specific items of collateral including business
assets, real estate and consumer assets. Commercial loans and leases are
expected to be repaid from cash flow from operations of businesses. Real estate
loans are secured by both commercial and residential real estate. The Bank's
loan accounts are primarily with customers located in western Michigan, within
Kent County and western Ottawa County. The Bank's retail deposits are also from
customers located in western Michigan. As an alternative source of funds, the
Bank has also issued certificates to depositors outside of the Bank's primary
market area. Substantially all revenues are derived from banking products and
services.
Capital Trust was formed in September 1999. All of the common securities of this
special purpose trust are owned by Mercantile. Capital Trust exists solely to
issue capital securities. For financial reporting purposes, Capital Trust is
reported as a subsidiary and is consolidated into the financial statements of
Mercantile. The capital securities are presented as a separate line item on the
consolidated balance sheet as trust preferred securities.
Mortgage Company was formed during 2000. A wholly owned subsidiary of the Bank,
the Mortgage Company was established to increase the profitability and
efficiency of the mortgage loan operations. The Mortgage Company initiated
business on October 24, 2000 via the Bank's contribution of most of its
residential mortgage loan portfolio and participation interests in certain
commercial mortgage loans. On the same date the Bank also transferred its
residential mortgage origination function to the Mortgage Company. Mortgage
loans originated and held by the Mortgage Company are serviced by the Bank
pursuant to a servicing agreement.
On February 7, 2002, Mercantile BIDCO, a wholly-owned subsidiary of the Bank,
was granted a license by the Michigan Office of Financial and Insurance Services
to operate as a Michigan Business and Industrial Development Company, a
non-depository Michigan financial institution. Mercantile BIDCO offers equipment
lease financing, asset based loans, junior debt facilities and other financing
where equity features may be part of the facility pricing.
Mercantile Insurance was formed during 2002 through the acquisition of an
existing shelf insurance agency. Insurance products are offered through an
Agency and Institutions Agreement among Mercantile Insurance, the Bank and
Burnham Insurance Group. The insurance products are marketed through a central
facility operated by the Michigan Bankers Insurance Association, members of
which include the insurance subsidiaries of various Michigan-based financial
institutions and Burnham Insurance Group. Mercantile Insurance receives
commissions based upon written premiums produced under the Agency and
Institutions Agreement.
Mercantile filed an election to become a financial holding company, pursuant to
the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley
Act and implementing Federal Reserve Board regulations, effective March 23,
2000.
(Continued)
F-28
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Use of Estimates: To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ. The allowance for loan
and lease losses and the fair values of financial instruments are particularly
subject to change.
Cash Flow Reporting: Cash and cash equivalents include cash on hand, demand
deposits with other financial institutions, short-term investments (securities
with daily put provisions) and federal funds sold. Cash flows are reported net
for customer loan and deposit transactions, interest-bearing time deposits with
other financial institutions and short-term borrowings with maturities of 90
days or less.
Securities: Securities classified as held to maturity are carried at amortized
cost when management has the positive intent and ability to hold them to
maturity. Securities available for sale consist of those securities which might
be sold prior to maturity due to changes in interest rates, prepayment risks,
yield and availability of alternative investments, liquidity needs or other
factors. Securities classified as available for sale are reported at fair value
with unrealized holding gains or losses reported in other comprehensive income.
Other securities such as Federal Home Loan Bank stock are carried at cost.
Premiums and discounts on securities are recognized in interest income using the
interest method over the estimated life of the security. Gains and losses on the
sale of securities available for sale are determined based upon amortized cost
of the specific security sold. Securities are written down to fair value when a
decline in fair value is not temporary.
Loans and Leases: Loans and leases that management has the intent and ability to
hold for the foreseeable future or until maturity or payoff are reported at the
principal balance outstanding, net of deferred loan fees and costs and an
allowance for loan and lease losses. Interest income is reported on the interest
method and includes amortization of net deferred loan fees and costs over the
loan term. Interest income is not reported when full loan repayment is in doubt,
typically when the loan or lease is impaired or payments are past due over 90
days. Payments received on such loans and leases are reported as principal
reductions. In all cases, loans and leases are placed on nonaccrual or
charged-off at an earlier date if collection of principal or interest is
considered doubtful.
All interest accrued but not received for loans placed on nonaccrual is reversed
against interest income. Interest received on such loans and leases is accounted
for on the cash-basis or cost-recovery method, until qualifying for return to
accrual. Loans and leases are returned to accrual status when all the principal
and interest amounts contractually due are brought current and future payments
are reasonably assured.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is
a valuation allowance for probable incurred credit losses, increased by the
provision for loan and lease losses and recoveries, and decreased by
charge-offs. Management estimates the allowance balance required based on past
loan loss experience, the nature and volume of the portfolio, information about
specific borrower situations and estimated collateral values, and economic
conditions. Allocations of the allowance may be made for specific loans and
leases, but the entire allowance is available for any loan or lease that, in
management's judgment, should be charged-off. Loan and lease losses are charged
against the allowance when management believes the uncollectibility of a loan or
lease balance is confirmed.
(Continued)
F-29
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
A loan or lease is impaired when full payment under the loan or lease terms is
not expected. Impairment is evaluated in aggregate for smaller-balance loans of
similar nature such as residential mortgage, consumer and credit card loans, and
on an individual loan basis for other loans. If a loan or lease is impaired, a
portion of the allowance is allocated so that the loan or lease is reported,
net, at the present value of estimated future cash flows using the loan's or
leases' existing rate or at the fair value of collateral if repayment is
expected solely from the collateral. Loans and leases are evaluated for
impairment when payments are delayed, typically 90 days or more, or when the
internal grading system indicates a doubtful classification.
Premises and Equipment: Land is carried at cost. Premises and equipment are
stated at cost less accumulated depreciation. Depreciation is computed using
both straight-line and accelerated methods over the estimated useful lives of
the respective assets. Maintenance, repairs and minor alterations are charged to
current operations as expenditures occur and major improvements are capitalized.
Long-term Assets: Premises and equipment and other long-term assets are reviewed
for impairment when events indicate their carrying amount may not be recoverable
from future undiscounted cash flows. If impaired, the assets are recorded at
discounted amounts. Issuance costs of trust preferred securities are amortized
over the term of the securities.
Foreclosed Assets: Assets acquired through or instead of foreclosure are
initially recorded at fair value when acquired, establishing a new cost basis.
If fair value declines, a valuation allowance is recorded through expense. Costs
after acquisition are expensed.
Bank Owned Life Insurance: The Company has purchased life insurance policies on
certain key officers. Company owned life insurance is recorded at its cash
surrender value, or the amount that can be realized.
Repurchase Agreements: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged to cover
these liabilities, which are not covered by federal deposit insurance.
Stock Compensation: Employee compensation expense under stock option plans is
reported using the intrinsic value method. No stock-based compensation cost is
reflected in net income, as all options granted had an exercise price equal to
or greater than the market price of the underlying common stock at date of
grant. The following table illustrates the effect on net income and earnings per
share if expense was measured using the fair value recognition provisions of
SFAS No. 123, Accounting for Stock-Based Compensation.
2002 2001 2000
---- ---- ----
Net income as reported $ 7,757,000 $ 4,483,000 $ 2,795,000
Deduct: Stock-based compensation expense
determined under fair value based method 337,000 262,000 114,000
Pro forma net income 7,420,000 4,221,000 2,681,000
Basic earnings per share as reported $ 1.43 $ 1.11 $ 0.98
Pro forma basic earnings per share 1.37 1.05 0.94
Diluted earnings per share as reported $ 1.41 $ 1.10 $ 0.97
Pro forma diluted earnings per share 1.35 1.03 0.93
(Continued)
F-30
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
2002 2001 2000
---- ---- ----
Risk-free interest rate 4.78% 4.58% 5.99%
Expected option life 10 Years 10 Years 10 Years
Expected stock price volatility 30% 32% 37%
Dividend yield 0% 0% 0%
Income Taxes: Income tax expense is the total of the current year income tax due
or refundable and the change in deferred tax assets and liabilities. Deferred
tax assets and liabilities are the expected future tax amounts for the temporary
differences between the carrying amounts and tax bases of assets and
liabilities, computed using enacted tax rates. A valuation allowance, if needed,
reduces deferred tax assets to the amount expected to be realized.
Financial Instruments: Financial instruments include off-balance-sheet credit
instruments, such as commitments to make loans and standby letters of credit,
issued to meet customer financing needs. The face amount for these items
represents the exposure to loss, before considering customer collateral or
ability to repay. Such financials instruments are recorded when they are funded.
Fair Values of Financial Instruments: Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed separately. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments and
other factors, especially in the absence of broad markets for particular items.
Changes in assumptions or in market conditions could significantly affect the
estimates. The fair value estimates of existing on- and off-balance sheet
financial instruments does not include the value of anticipated future business
or the values of assets and liabilities not considered financial instruments.
Earnings Per Share: Basic earnings per share is based on weighted average common
shares outstanding during the period. Diluted earnings per share include the
dilutive effect of additional potential common shares issuable under stock
options. Earnings per share are restated for all stock dividends, including the
5% stock dividend paid on February 3, 2003, February 1, 2002 and February 1,
2001. The fair value of shares issued in stock dividends is transferred from
retained earnings to common stock.
Comprehensive Income: Comprehensive income consists of net income and other
comprehensive income. Other comprehensive income includes unrealized gains and
losses on securities available for sale which are also recognized as separate
components of equity, net of tax.
Newly Issued But Not Yet Effective Accounting Standards: New accounting
standards on asset retirement obligations, restructuring activities and exit
costs, operating leases, and early extinguishment of debt were issued in 2002.
Management determined that when the new accounting standards are adopted in 2003
they will not have a material impact on Mercantile's financial condition or
results of operations.
Contingencies: Loss contingencies, including claims and legal actions arising in
the ordinary course of business, are recorded as liabilities when the likelihood
of loss is probable and an amount or range of loss can be reasonably estimated.
Management does not believe there now are such matters that will have a material
effect on the financial statements.
(Continued)
F-31
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Reclassifications: Some items in the prior year financial statements were
reclassified to conform to the current presentation.
Operating Segments: While management monitors the revenue streams of the various
products and services offered, the identifiable segments are not material and
operations are managed and financial performance is evaluated on a company-wide
basis. Accordingly, all of Mercantile's financial service operations are
considered by management to be aggregated in one reportable operating segment.
(Continued)
F-32
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 2 - SECURITIES
The fair value of available for sale securities and the related gross unrealized
gains and losses recognized in accumulated other comprehensive income (loss)
were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
2002
- ----
U.S. Government agency
debt obligations $ 16,121,000 $ 217,000 $ 0 $ 16,338,000
Mortgage-backed securities 41,895,000 1,381,000 0 43,276,000
--------------- ------------ ------------- ----------------
$ 58,016,000 $ 1,598,000 $ 0 $ 59,614,000
=============== ============ ============= ================
2001
- ----
U.S. Government agency
debt obligations $ 972,000 $ 10,000 $ 0 $ 982,000
Mortgage-backed securities 49,964,000 778,000 (183,000) 50,559,000
Municipal revenue bonds 500,000 13,000 0 513,000
--------------- ------------ ------------- ----------------
$ 51,436,000 $ 801,000 $ (183,000) $ 52,054,000
=============== ============ ============= ================
The carrying amount, unrecognized gains and losses, and fair value of securities
held to maturity were as follows:
Gross Gross
Carrying Unrecognized Unrecognized Fair
Amount Gains Losses Value
------ ----- ------ -----
2002
- ----
Municipal general obligation bonds $ 29,578,000 $ 1,371,000 $ (90,000) $ 30,859,000
Municipal revenue bonds 6,915,000 211,000 0 7,126,000
--------------- ------------ ------------ ----------------
$ 36,493,000 $ 1,582,000 $ (90,000) $ 37,985,000
=============== ============ ============= ================
2001
- ----
Municipal general obligation bonds $ 21,686,000 $ 471,000 $ (246,000) $ 21,911,000
Municipal revenue bonds 4,293,000 37,000 (58,000) 4,272,000
--------------- ------------ ------------ ----------------
$ 25,979,000 $ 508,000 $ (304,000) $ 26,183,000
=============== ============ ============ ================
The amortized cost and fair values of debt securities at year-end 2002, by
contractual maturity, are shown below. The contractual maturity is utilized
below for U.S. Government agency debt obligations and municipal bonds. Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties. Securities not due at a single maturity date, primarily mortgage
backed securities, are shown separately.
(Continued)
F-33
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 2 - SECURITIES (Continued)
------------Held-to-Maturity-------------- -----------Available-for-Sale------------
Weighted Weighted
Average Carrying Fair Average Amortized Fair
Yield Amount Value Yield Cost Value
----- ------ ----- ----- ---- -----
Due in one year or less 5.95% $ 226,000 $ 228,000 NA $ 0 $ 0
Due from one to five years 6.87 4,515,000 4,830,000 NA 0 0
Due from five to ten years 6.61 7,824,000 8,344,000 4.76% 14,116,000 14,321,000
Due after ten years 6.95 23,928,000 24,583,000 4.88 2,005,000 2,017,000
Mortgage-backed NA 0 0 5.67 41,895,000 43,276,000
------------- ------------- ------------- --------------
6.86 $ 36,493,000 $ 37,985,000 5.42 $ 58,016,000 $ 59,614,000
============= ============= ============= ==============
During 2002, securities with an aggregate amortized cost basis of $13.7 million
were sold, resulting in an aggregate realized gain of $270,000. During 2001,
securities with an aggregate amortized cost basis of $12.8 million were sold,
resulting in an aggregate realized gain of $234,000 and an aggregate realized
loss of $27,000. During 2000, securities with an aggregate amortized cost basis
of $6.7 million were sold, resulting in an aggregate realized loss of $275,000.
At year-end 2002 and 2001, the amortized cost of securities issued by the state
of Michigan and all its political subdivisions totaled $36.5 million and $26.0
million, with an estimated market value of $38.0 million and $26.2 million,
respectively. Total securities of any one specific issuer, other than the U.S.
Government and its agencies, did not exceed 10% of shareholders' equity.
The carrying value of securities that are pledged to repurchase agreements and
other deposits was $58.2 million and $49.5 million at December 31, 2002 and
2001, respectively.
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Year-end loans and leases are as follows:
Percent
December 31, 2002 December 31, 2001 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Real Estate:
Construction and land
development $ 103,900,000 13.5% $ 62,710,000 10.6% 65.7%
Secured by 1 -- 4
family properties 60,828,000 7.9 41,028,000 7.0 48.3
Secured by multi-
family properties 13,025,000 1.7 7,394,000 1.3 76.2
Secured by
nonresidential properties 357,431,000 46.3 263,568,000 44.9 35.6
Commercial 230,662,000 29.9 206,898,000 35.1 11.5
Leases 850,000 0.1 0 0.0 NA
Consumer 4,858,000 0.6 5,650,000 1.1 (14.0)
--------------- ------ --------------- ------- -------
$ 771,554,000 100.0% $ 587,248,000 100.0% 31.4%
=============== ====== =============== ======= ======
(Continued)
F-34
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Activity in the allowance for loan and lease losses is as follows:
2002 2001 2000
---- ---- ----
Beginning balance $ 8,494,000 $ 6,302,000 $ 4,620,000
Provision for loan and lease losses 3,002,000 2,370,000 1,854,000
Charge-offs (706,000) (252,000) (185,000)
Recoveries 100,000 74,000 13,000
--------------- --------------- ----------------
Ending balance $ 10,890,000 $ 8,494,000 $ 6,302,000
=============== =============== ================
2002 2001
---- ----
Impaired loans and leases were as follows:
Year-end loans with no allocated allowance for loan and lease losses $ 402,000 $ 80,000
Year-end loans with allocated allowance for loan and lease losses 394,000 1,302,000
--------------- ----------------
$ 796,000 $ 1,382,000
=============== ================
Amount of the allowance for loan and lease losses allocated $ 80,000 $ 320,000
Average of impaired loans during the year 782,000 364,000
Nonperforming loans and leases were as follows:
Loans and leases past due over 90 days still accruing interest $ 0 $ 0
Nonaccrual loans and leases 796,000 1,382,000
--------------- ----------------
$ 796,000 $ 1,382,000
=============== ================
The Bank did not recognize any interest income on impaired loans during 2002,
2001 or 2000.
Concentrations within the loan portfolio were as follows at year-end:
2 0 0 2 2 0 0 1
------- -------
Percentage of Percentage of
Balance Loan Portfolio Balance Loan Portfolio
------- -------------- ------- --------------
Commercial real estate loans to
lessors of non-residential
buildings $ 179,688,000 23.3% $81,822,000 13.9%
(Continued)
F-35
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment are as follows:
2002 2001
---- ----
Land and improvements $ 3,234,000 $ 1,970,000
Buildings and leasehold improvements 7,009,000 5,975,000
Furniture and equipment 4,327,000 3,119,000
--------------- ----------------
14,570,000 11,064,000
Less: accumulated depreciation 2,396,000 1,507,000
--------------- ----------------
$ 12,174,000 $ 9,557,000
=============== ================
Depreciation expense in 2002, 2001 and 2000 totaled $910,000, $556,000 and
$441,000, respectively.
In January of 2003 the Bank signed an option to purchase an existing building
situated on 2.75 acres of land for approximately $1.3 million. Subject to
pending due diligence and various regulatory changes and approvals, the Bank
plans to demolish the existing building and design and construct a four-story
facility on this property. This facility would serve as the new location for the
Bank's current downtown facility and the loan operations function currently
housed at one of the Bank's branch locations.
NOTE 5 - DEPOSITS
Deposits at year-end are summarized as follows:
December 31, 2002 December 31, 2001 Percent
----------------- ----------------- Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Noninterest-bearing
demand $ 62,405,000 8.3% $ 43,162,000 7.6% 44.6%
Interest-bearing
checking 28,130,000 3.7 22,188,000 3.9 26.8
Money market 8,592,000 1.1 5,578,000 1.0 54.1
Savings 69,461,000 9.2 47,157,000 8.3 47.3
Time, under $100,000 7,002,000 0.9 6,144,000 1.1 14.0
Time, $100,000 and
over 66,005,000 8.8 52,601,000 9.2 25.5
---------------- -------- ---------------- ------- --------
241,595,000 32.0 176,830,000 31.1 36.6
Out-of-area time,
under $100,000 85,557,000 11.4 83,789,000 14.7 2.1
Out-of-area time,
$100,000 and over 426,961,000 56.6 308,458,000 54.2 38.4
---------------- -------- ---------------- ------- --------
512,518,000 68.0 392,247,000 68.9 30.7
---------------- -------- ---------------- ------- --------
$ 754,113,000 100.0% $ 569,077,000 100.0% 32.5%
================ ======== ================ ======= ========
Out-of-area certificates of deposit consist of certificates obtained from
depositors outside of the primary market area. As of December 31, 2002,
out-of-area certificates of deposit totaling $498.3 million were obtained
through deposit brokers, with the remaining $14.2 million obtained directly from
the depositors.
(Continued)
F-36
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 5 - DEPOSITS (Continued)
The following table depicts the maturity distribution for time deposits at
year-end.
2002 2001
---- ----
In one year $ 437,070,000 $ 289,176,000
In two years 100,855,000 107,469,000
In three years 16,119,000 45,386,000
In four years 12,849,000 77,000
In five years 18,632,000 8,884,000
-------------- ---------------
$ 585,525,000 $ 450,992,000
============== ===============
The following table depicts the maturity distribution for certificates of
deposit with balances of $100,000 or more at year-end.
2002 2001
---- ----
Up to three months $ 115,615,000 $ 90,156,000
Three months to six months 110,401,000 69,947,000
Six months to twelve months 146,156,000 68,981,000
Over twelve months 120,794,000 131,975,000
-------------- ---------------
$ 492,966,000 $ 361,059,000
============== ===============
NOTE 6 - SHORT-TERM BORROWINGS
Information relating to short-term borrowings, comprised entirely of securities
sold under agreements to repurchase, at year-end is summarized below:
2002 2001
---- ----
Outstanding balance at year-end $ 50,335,000 $ 36,485,000
Weighted average interest rate at year-end 1.54% 2.21%
Average daily balance during the year 43,468,000 34,596,000
Weighted average interest rate during the year 2.03% 3.42%
Maximum month end balance during the year 52,000,000 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 repurchase agreements are
recorded as assets of the Bank and are primarily held in safekeeping by
correspondent banks. Repurchase agreements are offered principally to certain
large deposit customers as uninsured deposit equivalent investments. Repurchase
agreements are secured by securities with a market value of $57.2 million and
$48.5 million at year-end 2002 and 2001, respectively.
(Continued)
F-37
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows.
2002 2001
---- ----
Maturities September 2003 through December 2004, fixed rates
from 1.69% to 2.39%, averaging 1.97% $ 15,000,000 $ 0
--------------- --------------
Total $ 15,000,000 $ 0
=============== ==============
Each advance is payable at its maturity date, and is subject to a prepayment fee
if paid prior to the maturity date. The advances are collateralized by
residential mortgage loans, first mortgage liens on multi-family residential
property loans and first mortgage liens on commercial real estate property loans
under a blanket lien arrangement, which totaled $99.0 million at year-end 2002.
Maturities over the next five years are:
2003 $ 10,000,000
2004 5,000,000
2005 0
2006 0
2007 0
NOTE 8 - FEDERAL INCOME TAXES
The consolidated provision for income taxes is as follows:
2002 2001 2000
---- ---- ----
Current $ 4,060,000 $ 2,838,000 $ 1,913,000
Deferred benefit (893,000) (848,000) (610,000)
--------------- --------------- ----------------
Tax expense $ 3,167,000 $ 1,990,000 $ 1,303,000
============== ============== ===============
Income tax expense was less than the amount computed by applying the statutory
federal income tax rate to income before income taxes. The reasons for the
difference are as follows:
2002 2001 2000
---- ---- ----
Statutory rates $ 3,714,000 $ 2,201,000 $ 1,393,000
Increase (decrease) from
Tax-exempt interest (429,000) (264,000) (110,000)
Other expenses (118,000) 53,000 20,000
--------------- -------------- ---------------
Tax expense $ 3,167,000 $ 1,990,000 $ 1,303,000
============== ============== ===============
(Continued)
F-38
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 8 - FEDERAL INCOME TAXES (Continued)
The net deferred tax asset recorded includes the following amounts of deferred
tax assets and liabilities:
2002 2001
---- ----
Deferred tax assets
Allowance for loan and lease losses $ 3,619,000 $ 2,780,000
Start-up/pre-opening expenses 8,000 34,000
Deferred loan fees 243,000 171,000
Deferred compensation 196,000 82,000
Other 18,000 20,000
-------------- ---------------
4,084,000 3,087,000
Deferred tax liabilities
Unrealized gain on securities available for sale 543,000 210,000
Accretion 14,000 12,000
Depreciation 173,000 71,000
-------------- ---------------
730,000 293,000
-------------- ---------------
Net deferred tax asset $ 3,354,000 $ 2,794,000
============== ===============
A valuation allowance related to deferred tax assets is required when it is
considered more likely than not that all or part of the benefits related to such
assets will not be realized. Management has determined that no valuation
allowance was required at year-end 2002 or 2001.
NOTE 9 - STOCK OPTION PLANS
Stock option plans are used to reward directors and employees and provide them
with additional equity interest. Stock options granted to non-employee directors
are at 125% of the market price on the date of grant, fully vest after five
years and expire ten years from the date of grant. Stock options granted to
employees are granted at the market price on the date of grant, fully vest after
one to three years and expire ten years from the date of grant. At year-end
2002, there were 88,555 shares authorized for future option grants. Information
about option grants follows.
A summary of the activity in the plan is as follows.
2 0 0 2 2 0 0 1 2 0 0 0
------- ------- -------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at
beginning
of year 229,839 $ 11.14 183,552 $ 9.99 140,926 $ 9.93
Granted 44,878 20.36 46,287 15.71 42,626 10.17
Exercised (578) 9.99 0 0
Forfeited or expired (2,204) 15.13 0 0
----------- --------- ---------- --------- ---------- --------
Outstanding at
end of year 271,935 $ 12.63 229,839 $ 11.14 183,552 $ 9.99
========== ========= ========== ======== ========== ========
Options exercisable
at year-end 218,792 176,958 125,880
========== ========== ==========
Fair value of options
granted during year $ 447,000 $ 363,000 $ 155,000
========== ========== ==========
(Continued)
F-39
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 9 - STOCK OPTION PLANS (Continued)
Options outstanding at year-end 2002 were as follows:
Outstanding Exercisable
-------------------------------------------- ------------------------
Weighted Average Weighted Weighted
Range of Remaining Average Average
Exercise Contractual Exercise Exercise
Prices Number Life Price Number Price
- ------ ------ ---- ----- ------- -----
$ 8.00 - $10.00 108,909 5.6 Years $ 9.14 108,909 $ 9.14
$10.01 - $12.00 74,065 5.7 Years 11.24 74,065 11.24
$14.01 - $16.00 36,920 8.8 Years 15.12 35,818 15.12
$18.01 - $20.00 45,216 9.6 Years 19.50 0 NA
$24.01 - $26.00 6,825 9.8 Years 24.52 0 NA
---------- --------- ----- --------- ------
Outstanding at year end 271,935 6.8 Years $ 12.63 218,792 $ 10.83
========== ========= ===== ========= ======
Options outstanding at year-end 2002, 2001 and 2000 were as follows:
2002 2001 2000
---- ---- ----
Minimum exercise price $ 8.64 $ 8.64 $ 8.64
Maximum exercise price 24.52 18.91 11.77
Average remaining option term 6.8 Years 7.3 Years 7.6 Years
NOTE 10 - RELATED PARTIES
Certain directors and executive officers of the Bank, including their immediate
families and companies in which they are principal owners, were loan customers
of the Bank. At year-end 2002 and 2001, the Bank had $7.1 million and $7.9
million in loan commitments to directors and executive officers, of which $3.0
million and $3.3 million were outstanding at year-end 2002 and 2001,
respectively, as reflected in the following table.
2002 2001
---- ----
Beginning balance $ 3,323,000 $ 3,914,000
New loans 965,000 1,215,000
Repayments (1,337,000) (1,806,000)
--------------- ---------------
Ending balance $ 2,951,000 $ 3,323,000
============== ===============
Related party deposits and repurchase agreements totaled $16.4 million at
year-end 2002 and $13.9 million at year-end 2001.
(Continued)
F-40
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 11 - COMMITMENTS AND OFF-BALANCE-SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. Loan commitments to extend credit are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in excess
of the amount recognized, if any, in the balance sheet. The Bank's maximum
exposure to loan loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby letters of
credit is represented by the contractual notional amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. Collateral, such as
accounts receivable, securities, inventory, property and equipment, is generally
obtained based on management's credit assessment of the borrower.
Fair value of the Bank's off-balance sheet instruments (commitments to extend
credit and standby letters of credit) is based on rates currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standing. At year-end 2002 and 2001,
the rates on existing off-balance sheet instruments were substantially
equivalent to current market rates, considering the underlying credit standing
of the counterparties.
The Bank's maximum exposure to credit losses for loan commitments and standby
letters of credit outstanding at year-end was as follows:
2002 2001
---- ----
Commercial unused lines of credit $ 131,161,000 $ 110,787,000
Unused lines of credit secured by 1 -- 4 family
residential properties 12,381,000 8,181,000
Credit card unused lines of credit 5,824,000 6,212,000
Other consumer unused lines of credit 4,415,000 3,965,000
Commitments to make loans 24,267,000 25,966,000
Standby letters of credit 39,338,000 36,377,000
----------------- -----------------
$ 217,386,000 $ 191,488,000
================= =================
The Bank was required to have $2.8 million and $1.1 million of cash on hand or
on deposit with the Federal Reserve Bank of Chicago to meet regulatory reserve
and clearing requirements at year-end 2002 and 2001. These balances do not earn
interest.
The Bank leases its downtown Grand Rapids facility under an operating lease
agreement. Total rental expense for the lease for 2002, 2001 and 2000 was
$170,000, $165,000 and $161,000, respectively. Future minimum rentals under this
lease, which expires on August 31, 2007, as of year-end 2002 are as follows:
2003 $ 174,000
2004 174,000
2005 174,000
2006 174,000
2007 116,000
-------------
$ 812,000
=============
(Continued)
F-41
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 12 - BENEFIT PLANS
The Bank has a 401(k) benefit plan that covers substantially all of its
employees. The Bank's 2002, 2001 and 2000 matching 401(k) contribution charged
to expense was $239,000, $173,000 and $136,000, respectively. The percent of the
Bank's matching contributions to the 401(k) is determined annually by the Board
of Directors. The 401(k) benefit plan allows employee contributions up to 15% of
their compensation, which are matched at 100% of the first 5% of the
compensation contributed. Matching contributions are immediately vested.
The Bank has a deferred compensation plan in which all persons serving on the
Board of Directors may defer all or portions of annual retainer and meeting
fees, with distributions to be paid only upon termination of service as a
director. The deferred amounts are categorized on Mercantile's consolidated
financial statements as long term borrowings. Up until September 30, 2001, the
deferred balances were paid interest at a rate equal to 75% of the prime rate,
adjusted at the beginning of each calendar quarter. The deferred compensation
plan was amended, effective October 1, 2001, to increase the interest rate from
75% of the prime rate to 100% of the prime rate. Interest expense for the plan
during 2002, 2001 and 2000 was $11,000, $6,000 and $2,000, respectively.
The Bank has a non-qualified deferred compensation program in which selected
officers may defer all or portions of salary and bonus payments. The deferred
amounts are categorized on Mercantile's consolidated financial statements as
other borrowed money. The deferred balances are paid interest as a rate equal to
the prime rate, adjusted at the beginning of each calendar quarter. Interest
expense for the plan during 2002 and 2001 was $10,000 and $2,000, respectively.
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as
follows at year-end.
2 0 0 2 2 0 0 1
------- -------
Carrying Fair Carrying Fair
Values Values Values Values
------ ------ ------ ------
Financial assets
Cash and cash equivalents $ 28,117,000 $ 28,117,000 $ 19,938,000 $ 19,938,000
Securities available for sale 59,614,000 59,614,000 52,054,000 52,054,000
Securities held to maturity 36,493,000 37,985,000 25,979,000 26,183,000
Federal Home Loan Bank stock 786,000 786,000 785,000 785,000
Loans, net 760,664,000 785,203,000 578,754,000 602,442,000
Bank owned life insurance policies 14,876,000 14,876,000 3,991,000 3,991,000
Accrued interest receivable 3,336,000 3,336,000 2,811,000 2,811,000
Financial liabilities
Deposits 754,113,000 758,422,000 569,077,000 576,575,000
Securities sold under agreements
to repurchase 50,335,000 50,335,000 36,485,000 36,485,000
Federal Home Loan Bank advances 15,000,000 15,000,000 0 0
Accrued interest payable 4,713,000 4,713,000 4,618,000 4,618,000
Trust preferred securities 16,000,000 20,050,000 16,000,000 18,874,000
(Continued)
F-42
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Carrying amount is the estimated fair value for cash and cash equivalents,
Federal Home Loan Bank stock, accrued interest receivable and payable, bank
owned life insurance policies, demand deposits, securities sold under agreements
to repurchase, and variable rate loans or deposits that reprice frequently and
fully. Security fair values are based on market prices or dealer quotes, and if
no such information is available, on the rate and term of the security and
information about the issuer. For fixed rate loans or deposits and for variable
rate loans or deposits with infrequent repricing or repricing limits, fair value
is based on discounted cash flows using current market rates applied to the
estimated life and credit risk. Carrying amount is the estimated fair value of
FHLB advances as they were taken out late in 2002. Fair value of trust preferred
securities is based on current rates for similar financing. Fair value of off
balance sheet items is estimated to be nominal.
NOTE 14 - EARNINGS PER SHARE
The factors used in the earnings per share computation follow.
2002 2001 2000
---- ---- ----
Basic
Net income $ 7,757,000 $ 4,483,000 $ 2,795,000
============== ============= ==============
Weighted average common shares outstanding 5,405,703 4,022,972 2,862,202
-------------- ------------- --------------
Basic earnings per common share $ 1.43 $ 1.11 $ 0.98
============== ============= ==============
Diluted
Net income $ 7,757,000 $ 4,483,000 $ 2,795,000
============== ============= ==============
Weighted average common shares outstanding for
basic earnings per common share 5,405,703 4,022,972 2,862,202
Add: Dilutive effects of assumed exercises of
stock options 97,620 60,965 8,062
-------------- ------------- --------------
Average shares and dilutive potential
common shares 5,503,323 4,083,937 2,870,264
============== ============= ==============
Diluted earnings per common share $ 1.41 $ 1.10 $ 0.97
============== ============= ==============
Stock options for 44,878, 46,287 and 107,151 shares of common stock were not
considered in computing diluted earnings per common share for 2002, 2001 and
2000, respectively, because they were antidilutive.
(Continued)
F-43
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 15 - TRUST PREFERRED SECURITIES
Capital Trust, a business trust subsidiary of Mercantile, sold 1.6 million
Cumulative Preferred Securities ("trust preferred securities") at $10.00 per
trust preferred security in a September 1999 offering. The proceeds from the
sale of the trust preferred securities were used by MBWM Capital Trust I to
purchase an equivalent amount of subordinated debentures from Mercantile. The
trust preferred securities carry a fixed rate of 9.60%, have a stated maturity
of 30 years, and, in effect, are guaranteed by Mercantile. The securities are
redeemable at par after 5 years. Distributions on the trust preferred securities
are payable quarterly on January 15, April 15, July 15 and October 15. The first
distribution was paid on October 15, 1999. Under certain circumstances,
distributions may be deferred for up to 20 calendar quarters. However, during
any such deferrals, interest accrues on any unpaid distributions at the rate of
9.60% per annum. The trust preferred securities are carried on Mercantile's
consolidated balance sheet as a liability, and the interest expense is recorded
on Mercantile's consolidated statement of income.
NOTE 16 - SALE OF COMMON STOCK
During 2001, Mercantile sold in aggregate approximately 2.3 million shares of
common stock, raising $35.0 million net of issuance costs. Substantially all of
the net proceeds were contributed to the Bank as capital to provide support for
asset growth, fund investments in loans and securities and for general corporate
purposes.
NOTE 17 - REGULATORY MATTERS
Mercantile and the Bank are subject to regulatory capital requirements
administered by federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under regulatory
accounting practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and other
factors, and the regulators can lower classifications in certain cases. Failure
to meet various capital requirements can initiate regulatory action that could
have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
(Continued)
F-44
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 17 - REGULATORY MATTERS (Continued)
At year end, actual capital levels (in thousands) and minimum required levels
for Mercantile and the Bank were:
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
2002
- ----
Total capital (to risk
weighted assets)
Consolidated $ 105,671 12.1% $ 69,862 8.0% $ 87,328 10.0%
Bank 102,810 11.8 69,728 8.0 87,160 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 94,781 10.9 34,931 4.0 52,397 6.0
Bank 91,920 10.6 34,864 4.0 52,296 6.0
Tier 1 capital (to average
assets)
Consolidated 94,781 10.7 35,355 4.0 44,193 5.0
Bank 91,920 10.4 35,313 4.0 44,142 5.0
2001
- ----
Total capital (to risk
weighted assets)
Consolidated $ 95,430 14.3% $ 53,584 8.0% $ 66,980 10.0%
Bank 92,683 13.9 53,404 8.0 66,754 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 87,057 13.0 26,797 4.0 40,195 6.0
Bank 84,337 12.6 26,708 4.0 40,062 6.0
Tier 1 capital (to average
assets)
Consolidated 87,057 13.0 26,786 4.0 33,482 5.0
Bank 84,337 12.6 26,722 4.0 33,403 5.0
The Bank was categorized as well capitalized at year-end 2002 and 2001.
Federal and state banking laws and regulations place certain restrictions on the
amount of dividends the Bank can transfer to Mercantile and on the capital
levels that must be maintained. At year-end 2002, under the most restrictive of
these regulations (to remain well capitalized), the Bank could distribute
approximately $9.8 million to Mercantile as dividends without prior regulatory
approval.
The capital levels as of year-end 2002 and year-end 2001 include an adjustment
for the 1.6 million trust preferred securities issued by Capital Trust in
September 1999 subject to certain limitations. Federal Reserve guidelines limit
the amount of trust preferred securities which can be included in Tier 1 capital
of Mercantile to 25% of total Tier 1 capital. At year-end 2002 and year-end
2001, all $16.0 million of the trust preferred securities were included as Tier
1 capital of Mercantile.
(Continued)
F-45
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 18 - OTHER COMPREHENSIVE INCOME
Other comprehensive income components and related taxes were as follows.
2002 2001 2000
---- ---- ----
Unrealized holding gains and losses on $ 1,249,000 $ 386,000 $ 1,379,000
available-for-sale securities
Reclassification adjustments for gains
and losses later recognized in income (270,000) (207,000) 275,000
--------------- --------------- --------------
Net unrealized gains and losses 979,000 179,000 1,654,000
Tax effect (333,000) (61,000) (563,000)
--------------- --------------- --------------
Other comprehensive income $ 646,000 $ 118,000 $ 1,091,000
============== =============== ==============
NOTE 19 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Earnings per Share
Interest Net Interest Net ------------------
Income Income Income Basic Fully Diluted
------ ------ ------ ----- -------------
2002
- ----
First quarter $ 11,040,000 $ 5,034,000 $ 1,604,000 $ 0.29 $ 0.30
Second quarter 11,639,000 5,735,000 1,716,000 0.32 0.31
Third quarter 12,318,000 6,282,000 2,156,000 0.40 0.39
Fourth quarter 12,635,000 6,603,000 2,281,000 0.42 0.41
2001
- ----
First quarter $ 10,856,000 $ 3,462,000 $ 915,000 $ 0.30 $ 0.30
Second quarter 11,011,000 3,698,000 777,000 0.23 0.23
Third quarter 11,530,000 4,352,000 1,338,000 0.29 0.29
Fourth quarter 11,222,000 4,906,000 1,453,000 0.29 0.28
2000
- ----
First quarter $ 7,864,000 $ 2,797,000 $ 500,000 $ 0.17 $ 0.17
Second quarter 8,848,000 3,004,000 636,000 0.23 0.23
Third quarter 9,741,000 3,133,000 778,000 0.28 0.28
Fourth quarter 10,382,000 3,341,000 881,000 0.30 0.29
(Continued)
F-46
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 20 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company only financial statements.
CONDENSED BALANCE SHEETS
2002 2001
---- ----
ASSETS
Cash and cash equivalents $ 845,000 $ 626,000
Investment in subsidiaries 93,479,000 85,250,000
Other assets 2,445,000 2,462,000
--------------- ----------------
Total assets $ 96,769,000 $ 88,338,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 440,000 $ 380,000
Guaranteed preferred beneficial interests in the
Corporation's subordinated debentures 16,495,000 16,495,000
Shareholders' equity 79,834,000 71,463,000
--------------- ----------------
Total liabilities and shareholders' equity $ 96,769,000 $ 88,338,000
=============== ================
CONDENSED STATEMENTS OF INCOME
2002 2001 2000
---- ---- ----
Income
Dividends from subsidiaries $ 1,583,000 $ 1,583,000 $ 1,583,000
Other 18,000 22,000 30,000
-------------- ------------- --------------
Total income 1,601,000 1,605,000 1,613,000
Expenses
Interest expense 1,617,000 1,617,000 1,617,000
Other operating expenses 512,000 543,000 433,000
-------------- ------------- --------------
Total expenses 2,129,000 2,160,000 2,050,000
-------------- ------------- --------------
INCOME (LOSS) BEFORE INCOME TAX AND EQUITY IN
UNDISTRIBUTED NET INCOME (LOSS) OF SUBSIDIARIES (528,000) (555,000) (437,000)
Federal income tax expense (benefit) (702,000) (698,000) (649,000)
Equity in undistributed net income of subsidiary 7,583,000 4,340,000 2,583,000
-------------- ------------- --------------
NET INCOME $ 7,757,000 $ 4,483,000 $ 2,795,000
============== ============= ==============
(Continued)
F-47
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and 2001
NOTE 20 -- MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,757,000 $ 4,483,000 $ 2,795,000
Adjustments to reconcile net income to net
cash from operating activities
Equity in undistributed income of subsidiary (7,583,000) (4,340,000) (2,583,000)
Change in other assets 17,000 (662,000) (267,000)
Change in other liabilities 60,000 10,000 12,000
-------------- ------------- --------------
Net cash from operating activities 251,000 (509,000) (44,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from sale of common stock (37,000) 35,009,000 0
Capital investment into Mercantile Bank of
West Michigan 0 (34,500,000) 0
Stock option exercises 6,000 0 0
Fraction shares paid (1,000) (1,000) 0
--------------- -------------- --------------
Net cash from financing activities (32,000) 508,000 0
--------------- ------------- --------------
Net change in cash and cash equivalents 219,000 (1,000) (44,000)
Cash and cash equivalents at beginning of period 626,000 627,000 671,000
-------------- ------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 845,000 $ 626,000 $ 627,000
============== ============= ==============
(Continued)
F-48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 6, 2003.
MERCANTILE BANK CORPORATION
/s/ Gerald R. Johnson, Jr.
--------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 6, 2003.
/s/ Betty S. Burton /s/ Susan K. Jones
- ------------------- ------------------
Betty S. Burton, Director Susan K. Jones, Director
/s/ David M. Cassard /s/ Lawrence W. Larsen
- -------------------- ----------------------
David M. Cassard, Director Lawrence W. Larsen, Director
/s/ Edward J. Clark /s/ Calvin D. Murdock
- ------------------- ---------------------
Edward J. Clark, Director Calvin D. Murdock, Director
/s/ Peter A. Cordes /s/ Michael H. Price
- ------------------- --------------------
Peter A. Cordes, Director Michael H. Price, Director,
President and Chief Operating
Officer
/s/ C. John Gill /s/ Dale J. Visser
- ---------------- ------------------
C. John Gill, Director Dale J. Visser, Director
/s/ Doyle A. Hayes /s/ Donald Williams
- ------------------ -------------------
Doyle A. Hayes, Director Donald Williams, Director
/s/ David M. Hecht /s/ Robert M. Wynalda
- ------------------ ---------------------
David M. Hecht, Director Robert M. Wynalda, Director
/s/ Gerald R. Johnson, Jr. /s/ Charles E. Christmas
- -------------------------- ------------------------
Gerald R. Johnson, Jr., Chairman Charles E. Christmas, Senior Vice
of the Board and Chief Executive President, Chief Financial Officer
Officer (principal executive officer) and Treasurer (principal financial
and accounting officer)
CERTIFICATIONS
CERTIFICATION BY PRINCIPAL EXECUTIVE OFFICER
I, Gerald R. Johnson, Jr., Chairman and Chief Executive Officer of Mercantile
Bank Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Mercantile Bank
Corporation (the "registrant");
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer 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 annual 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 annual report (the "Evaluation Date");
and
c) presented in this annual 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 officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of 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 officer and I have indicated in this
annual 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: March 6, 2003 /s/ Gerald R. Johnson, Jr.
-------------------------------------
Gerald R. Johnson, Jr.
Chairman and Chief Executive Officer
CERTIFICATION BY PRINCIPAL FINANCIAL OFFICER
I, Charles E. Christmas, Senior Vice President, Chief Financial Officer and
Treasurer of Mercantile Bank Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Mercantile Bank
Corporation (the "registrant");
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officer 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 annual 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 annual report (the "Evaluation Date");
and
c) presented in this annual 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 officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of 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 officer and I have indicated in this
annual 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: March 6, 2003 /s/ Charles E. Christmas
--------------------------------------------
Charles E. Christmas
Senior Vice President, Chief Financial Officer
and Treasurer
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
3.1 Our Articles of Incorporation are incorporated by
reference to exhibit 3.1 of our Registration
Statement on Form SB-2 (Commission File no.
333-33081) that became effective on October 23,
1997
3.2 Our Amended and Restated Bylaws dated as of
January 16, 2003 are incorporated by reference to
exhibit 3.2 of our Registration Statement on Form
S-3 (Commission File No. 333-103376) that became
effective on February 21, 2003
10.1 Our 1997 Employee Stock Option Plan is
incorporated by reference to exhibit 10.1 of our
Registration Statement on Form SB-2 (Commission
File No. 333-33081) that became effective on
October 23, 1997 (management contract or
compensatory plan)
10.2 Lease Agreement between our bank and Division
Avenue Partners, L.L.C. dated August 16, 1997, is
incorporated by reference to exhibit 10.2 of our
Registration Statement on Form SB-2 (Commission
File No. 333-33081) that became effective October
23, 1997
10.3 Agreement between Fiserve Solutions, Inc. and our
bank dated September 10, 1997, is incorporated by
reference to exhibit 10.3 of our Registration
Statement on Form SB-2 (Commission File No.
333-33081) that became effective on October 23,
1997.
10.4 Extension Agreement of Data Processing Contract
between Fiserve Solutions, Inc. and our bank dated
May 12, 2000 extending the agreement between
Fiserve Solutions, Inc. and our bank dated
September 10, 1997, is incorporated by reference
to exhibit 10.15 of our Form 10-K for the fiscal
year ended December 31, 2000 (Commission File No.
000-26719)
10.5 Extension Agreement of Data Processing Contract
between Fiserve Solutions, Inc. and our bank dated
November 22, 2002 extending the agreement between
Fiserve Solutions, Inc. and our bank dated
September 10, 1997
10.6 Mercantile Bank of West Michigan Deferred
Compensation Plan for Members of the Board of
Directors (1999) is incorporated by reference to
Exhibit 10.6 of the Registration Statement of the
company and our trust on Form SB-2 (Commission
File Nos. 333-84313 and 333-84313-01) that became
effective on September 13, 1999.
10.7 Subordinated Indenture dated as of September 17,
1999 between the company and Wilmington Trust
Company, as Trustee, relating to 9.60% Junior
Subordinated Debentures due 2029 is incorporated
by reference to Exhibit 4.1 of the Registration
Statement of the company and our trust on Form
SB-2 (Commission File Nos. 333-84313 and
333-84313-01) that become effective on September
13, 1999
10.8 Amended and Restated Trust Agreement dated as of
September 17, 1999 among the company, as
depositor, Wilmington Trust Company, as Property
Trustee, Wilmington Trust Company, as Delaware
Trustee, and the Administrative Trustees is
incorporated by reference to Exhibit 4.5 of the
Registration Statement of the company and our
trust on Form SB-2 (Commission File Nos. 333-84313
and 333-84313-01) that became effective on
September 13, 1999
EXHIBIT NO. EXHIBIT DESCRIPTION
10.9 Preferred Securities Guarantee Agreement between
the company and Wilmington Trust Company dated
September 17, 1999, is incorporated by reference
to Exhibit 4.7 of the Registration Statement of
the company and our trust on Form SB-2 (Commission
File Nos. 333-84313 and 333-84313-01) that became
effective on September 13, 1999
10.10 Agreement as to Expenses and Liabilities dated as
of September 17, 1999, between the company and our
trust (included as Exhibit D to Exhibit 10.8)
10.11 Mercantile Bank Corporation 2000 Employee Stock
Option Plan, approved by the shareholders at the
annual meeting on April 20, 2000, is incorporated
by reference to exhibit 10.14 of our Form 10-K for
the fiscal year ended December 31, 2000
(Commission File No. 000-26719)
10.12 Amended and Restated Employment Agreement dated as
of October 12, 2000, among the company, our bank
and Gerald R. Johnson, Jr., is incorporated by
reference to exhibit 10.16 of our Form 10-K for
the fiscal year ended December 31, 2000
(Commission File No. 000-26719) (management
contract or compensatory plan)
10.13 Amended and Restated Employment Agreement dated as
of October 12, 2000, among the company, our bank
and Michael H. Price, is incorporated by reference
to exhibit 10.17 of our Form 10-K for the fiscal
year ended December 31, 2000 (Commission File No.
000-26719) (management contract or compensatory
plan)
10.14 Employment Agreement dated as of October 12, 2000,
among the company, our bank and Robert B.
Kaminski, is incorporated by reference to exhibit
10.18 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.15 Employment Agreement dated as of October 12, 2000,
among the company, our bank and Charles E.
Christmas, is incorporated by reference to exhibit
10.19 of our Form 10-K for the fiscal year ended
December 31, 2000 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.16 Agreement between our bank and C.D. Barnes dated
October 28, 2000, on Amendment to Standard Form of
Agreement Between Owner and Construction Manager
where the Construction Manager is also the
Constructor, is incorporated by reference to
exhibit 10.20 of our Form 10-K for the fiscal year
ended December 31, 2000 (Commission File No.
000-26719)
10.17 Amended and Restated Employment Agreement dated as
of October 18, 2001, among the company, our bank
and Gerald R. Johnson, Jr., is incorporated by
reference to exhibit 10.21 of our Form 10-K for
the fiscal year ended December 31, 2001
(Commission File No. 000-26719) (management
contract or compensatory plan)
10.18 Amended and Restated Employment Agreement dated as
of October 18, 2001, among the company, our bank
and Michael H. Price, is incorporated by reference
to exhibit 10.22 of our Form 10-K for the fiscal
year ended December 31, 2001 (Commission File No.
000-26719) (management contract or compensatory
plan)
10.19 Employment Agreement dated as of October 18, 2001,
among the company, our bank and Robert B.
Kaminski, is incorporated by reference to exhibit
10.23 of our Form 10-K for the fiscal year ended
December 31, 2001 (Commission File No. 000-26719)
(management contract or compensatory plan)
EXHIBIT NO. EXHIBIT DESCRIPTION
10.20 Employment Agreement dated as of October 18, 2001,
among the company, our bank and Charles E.
Christmas, is incorporated by reference to exhibit
10.23 of our Form 10-K for the fiscal year ended
December 31, 2001 (Commission File No. 000-26719)
(management contract or compensatory plan)
10.21 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Gerald R. Johnson, Jr. (management contract or
compensatory plan)
10.22 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Michael H. Price (management contract or
compensatory plan)
10.23 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Robert B. Kaminski (management contract or
compensatory plan)
10.24 Amendment to Employment Agreement dated as of
October 17, 2002, among the company, our bank and
Charles E. Christmas (management contract or
compensatory plan)
10.25 Agreement between our bank and Visser Brothers
Construction Inc. dated May 8, 2002, on Standard
Form of Agreement Between Owner and Contractor
where the basis of payment is a stipulated sum
10.26 Mercantile Bank Corporation Independent Director
Stock Option Plan, approved by the shareholders at
the annual meeting on April 18, 2002
21 Subsidiaries of the Company
23 Consent of Independent Accountants
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