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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-3360865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5650 BYRON CENTER AVENUE SW, WYOMING, MICHIGAN 49509
(Address of principal executive offices) (Zip Code)
(616) 406-3777
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
At November 13, 2003, there were 6,804,912 shares of Common Stock outstanding.
1
MERCANTILE BANK CORPORATION
INDEX
Page No.
--------
PART 1. Financial Information
Item I. Financial Statements
Consolidated Balance Sheets -
September 30, 2003 (Unaudited) and December 31, 2002................................. 3
Consolidated Statements of Income and Comprehensive Income -
Three and Nine Months Ended September 30, 2003 (Unaudited)
and September 30, 2002 (Unaudited)................................................... 4
Consolidated Statements of Changes in Shareholders' Equity -
Nine Months Ended September 30, 2003 (Unaudited)
and September 30, 2002 (Unaudited)................................................... 5
Consolidated Statements of Cash Flows -
Three and Nine Months Ended September 30, 2003 (Unaudited)
and September 30, 2002 (Unaudited)................................................... 6
Notes to Consolidated Financial Statements (Unaudited)................................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................................. 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 25
Item 4. Controls and Procedures....................................................... 27
PART II. Other Information
Item 1. Legal Proceedings............................................................. 28
Item 2. Changes in Securities and Use of Proceeds..................................... 28
Item 3. Defaults upon Senior Securities............................................... 28
Item 4. Submission of Matters to a Vote of Security Holders........................... 28
Item 5. Other Information............................................................. 28
Item 6. Exhibits and Reports on Form 8-K.............................................. 28
Signatures............................................................................. 30
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 32,600,000 $ 23,404,000
Short-term investments 230,000 213,000
Federal funds sold 11,800,000 4,500,000
--------------- ---------------
Total cash and cash equivalents 44,630,000 28,117,000
Securities available for sale 61,579,000 59,614,000
Securities held to maturity (fair value of $43,947,000 at
September 30, 2003 and $37,985,000 at December 31, 2002) 42,444,000 36,493,000
Federal Home Loan Bank stock 3,927,000 786,000
Total loans and leases 972,191,000 771,554,000
Allowance for loan and lease losses (13,482,000) (10,890,000)
--------------- ---------------
Total loans and leases, net 958,709,000 760,664,000
Premises and equipment, net 15,229,000 12,174,000
Bank owned life insurance policies 16,013,000 14,876,000
Accrued interest receivable 4,142,000 3,336,000
Other assets 7,210,000 5,795,000
--------------- ---------------
Total assets $ 1,153,883,000 $ 921,855,000
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 77,448,000 $ 62,405,000
Interest-bearing 812,133,000 691,708,000
--------------- ---------------
Total 889,581,000 754,113,000
Securities sold under agreements to repurchase 48,310,000 50,335,000
Federal Home Loan Bank advances 70,000,000 15,000,000
Other borrowed money 1,012,000 576,000
Accrued expenses and other liabilities 6,823,000 5,997,000
Trust preferred securities 16,000,000 16,000,000
--------------- ---------------
Total liabilities 1,031,726,000 842,021,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value: 9,000,000 shares authorized;
6,624,868 shares outstanding at September 30, 2003 and
5,405,706 shares outstanding at December 31, 2002 113,118,000 75,530,000
Retained earnings 8,951,000 3,250,000
Accumulated other comprehensive income 88,000 1,054,000
--------------- ---------------
Total shareholders' equity 122,157,000 79,834,000
--------------- ---------------
Total liabilities and shareholders' equity $ 1,153,883,000 $ 921,855,000
=============== ===============
See accompanying notes to consolidated financial statements.
3
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Loans, including fees $ 12,679,000 $ 11,132,000 $ 36,345,000 $ 31,553,000
Investment securities 1,164,000 1,144,000 3,566,000 3,344,000
Federal funds sold 11,000 41,000 50,000 98,000
Short-term investments 0 1,000 1,000 2,000
------------- ------------- ------------- --------------
Total interest income 13,854,000 12,318,000 39,962,000 34,997,000
Interest expense
Deposits 4,952,000 5,396,000 15,353,000 16,086,000
Short-term borrowings 168,000 242,000 512,000 668,000
Federal Home Loan Bank advances 274,000 0 531,000 0
Long-term borrowings 403,000 398,000 1,204,000 1,192,000
------------- ------------- ------------- --------------
Total interest expense 5,797,000 6,036,000 17,600,000 17,946,000
------------- ------------- ------------- --------------
NET INTEREST INCOME 8,057,000 6,282,000 22,362,000 17,051,000
Provision for loan and lease losses 1,380,000 880,000 2,850,000 2,022,000
------------- ------------- ------------- --------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 6,677,000 5,402,000 19,512,000 15,029,000
Noninterest income
Service charges on accounts 303,000 243,000 852,000 660,000
Net gain on sales of securities 59,000 121,000 271,000 270,000
Other income 697,000 555,000 2,148,000 1,119,000
------------- ------------- ------------- --------------
Total noninterest income 1,059,000 919,000 3,271,000 2,049,000
Noninterest expense
Salaries and benefits 3,029,000 2,020,000 8,285,000 5,648,000
Occupancy 353,000 265,000 1,032,000 796,000
Furniture and equipment 272,000 183,000 738,000 545,000
Other expense 1,110,000 803,000 3,099,000 2,328,000
------------- ------------- ------------- --------------
Total noninterest expenses 4,764,000 3,271,000 13,154,000 9,317,000
------------- ------------- ------------- --------------
INCOME BEFORE FEDERAL INCOME
TAX EXPENSE 2,972,000 3,050,000 9,629,000 7,761,000
Federal income tax expense 744,000 894,000 2,628,000 2,285,000
------------- ------------- ------------- --------------
NET INCOME $ 2,228,000 $ 2,156,000 $ 7,001,000 $ 5,476,000
============= ============= ============= ==============
COMPREHENSIVE INCOME $ 1,611,000 $ 2,556,000 $ 6,035,000 $ 6,148,000
============= ============= ============= ==============
Basic earnings per share $ 0.40 $ 0.40 $ 1.28 $ 1.01
============= ============= ============= ==============
Diluted earnings per share $ 0.39 $ 0.39 $ 1.25 $ 1.00
============= ============= ============= ==============
Average basic shares outstanding 5,516,702 5,405,759 5,450,496 5,405,685
============= ============= ============= ==============
Average diluted shares outstanding 5,662,342 5,500,028 5,583,474 5,502,697
============= ============= ============= ==============
See accompanying notes to consolidated financial statements.
4
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income Equity
----- -------- ------ -------
BALANCE, JANUARY 1, 2002 $ 69,406,000 $ 1,649,000 $ 408,000 $ 71,463,000
Comprehensive income:
Net income for the period from
January 1, 2002 through
September 30, 2002 5,476,000 5,476,000
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect 672,000 672,000
-------------
Total comprehensive income 6,148,000
-------------
Stock option exercise, 578 shares 6,000 6,000
Issuance costs from December 2001
common stock sale (37,000) (37,000)
------------- ----------- ----------- -------------
BALANCE, SEPTEMBER 30, 2002 $ 69,375,000 $ 7,125,000 $ 1,080,000 $ 77,580,000
============= =========== =========== =============
BALANCE, JANUARY 1, 2003 $ 75,530,000 $ 3,250,000 $ 1,054,000 $ 79,834,000
Comprehensive income:
Net income for the period from
January 1, 2003 through
September 30, 2003 7,001,000 7,001,000
Change in net unrealized gain
(loss) on securities available
for sale, net of tax effect (966,000) (966,000)
-------------
Total comprehensive income 6,035,000
-------------
Net proceeds from common stock
sale, 1,195,310 shares 37,437,000 37,437,000
Common stock cash dividends (1,300,000) (1,300,000)
Cash dividend reinvestment plan, 2,462 shares 77,000 77,000
Employee stock purchase plan, 1,367 shares 38,000 38,000
Stock option exercises, 20,023 shares 36,000 36,000
------------- ----------- ----------- -------------
BALANCE, SEPTEMBER 30, 2003 $ 113,118,000 $ 8,951,000 $ 88,000 $ 122,157,000
============= =========== =========== =============
See accompanying notes to consolidated financial statements.
5
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,228,000 $ 2,156,000 $ 7,001,000 $ 5,476,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 535,000 315,000 1,502,000 924,000
Provision for loan and lease losses 1,380,000 880,000 2,850,000 2,022,000
Net gain on sales of loans (16,000) 0 (16,000) 0
Net gain on sales of securities (59,000) (121,000) (271,000) (270,000)
Net change in:
Accrued interest receivable (681,000) (479,000) (806,000) (633,000)
Bank owned life insurance policies (197,000) (116,000) (602,000) (208,000)
Other assets (408,000) 102,000 (1,109,000) (892,000)
Accrued expenses and other liabilities 705,000 1,095,000 826,000 583,000
------------- ------------- ------------- -------------
Net cash from operating activities 3,487,000 3,832,000 9,375,000 7,002,000
CASH FLOWS FROM INVESTING ACTIVITIES
Loans and leases originations and payments, net (106,222,000) (49,586,000) (200,879,000) (130,274,000)
Purchases of:
Securities available for sale (11,847,000) (9,510,000) (36,976,000) (28,481,000)
Securities held to maturity (2,234,000) (1,392,000) (6,873,000) (6,173,000)
Federal Home Loan Bank stock (1,677,000) 0 (3,141,000) (1,000)
Proceeds from:
Sales of available for sale securities 3,150,000 3,425,000 11,486,000 13,997,000
Maturities, calls and repayments of
available for sale securities 7,061,000 4,653,000 21,888,000 12,557,000
Maturities, calls and repayments of
held to maturity securities 381,000 0 915,000 1,005,000
Purchases of premises and equipment, net (1,366,000) (616,000) (3,914,000) (2,428,000)
Purchases of bank owned life insurance policies (235,000) (10,475,000) (535,000) (10,475,000)
------------- ------------- ------------- -------------
Net cash from investing activities (112,989,000) (63,501,000) (218,029,000) (150,273,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 45,994,000 77,502,000 135,468,000 153,073,000
Net proceeds from the sale of common stock 37,437,000 0 37,437,000 (37,000)
Stock option exercises 9,000 0 36,000 6,000
Employee stock purchase plan 14,000 0 38,000 0
Cash dividend reinvestment plan 63,000 0 77,000 0
Payment of cash dividends (434,000) 0 (1,300,000) 0
Net increase in Federal Home Loan Bank advances 25,000,000 0 55,000,000 0
Net increase (decrease) in other borrowed money 90,000 (1,247,000) 436,000 277,000
Net increase (decrease) in securities sold under
agreements to repurchase 8,620,000 8,499,000 (2,025,000) 11,650,000
------------- ------------- ------------- -------------
Net cash from financing activities 116,793,000 84,754,000 225,167,000 164,969,000
------------- ------------- ------------- -------------
Net change in cash and cash equivalents 7,291,000 25,085,000 16,513,000 21,698,000
Cash and cash equivalents at beginning of period 37,339,000 16,551,000 28,117,000 19,938,000
------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 44,630,000 $ 41,636,000 $ 44,630,000 $ 41,636,000
============= ============= ============= =============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 5,742,000 $ 5,243,000 $ 17,466,000 $ 17,618,000
Federal income tax 1,150,000 850,000 3,725,000 2,805,000
See accompanying notes to consolidated financial statements.
6
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation: The unaudited financial statements for the three and
nine months ended September 30, 2003 include the consolidated results of
operations of Mercantile Bank Corporation and its consolidated
subsidiaries. These subsidiaries include Mercantile Bank of West Michigan
("our bank"), our bank's three wholly-owned subsidiaries, Mercantile Bank
Mortgage Company ("our mortgage company"), Mercantile BIDCO, Inc. ("our
BIDCO") and Mercantile Insurance Center, Inc. ("our insurance center"), and
our subsidiary MBWM Capital Trust I ("the trust"). These consolidated
financial statements have been prepared in accordance with the instructions
for Form 10-Q and Item 303(b) of Regulation S-K and do not include all
disclosures required by accounting principles generally accepted in the
United States of America for a complete presentation of our financial
condition and results of operations. In the opinion of management, the
information reflects all adjustments (consisting only of normal recurring
adjustments) which are necessary in order to make the financial statements
not misleading and for a fair presentation of the results of operations for
such periods. The results for the periods ended September 30, 2003 should
not be considered as indicative of results for a full year. For further
information, refer to the consolidated financial statements and footnotes
included in our annual report on Form 10-K for the year ended December 31,
2002.
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 uncollectability of a loan or lease balance is
confirmed.
A loan or lease is impaired when full payment under the loan or lease terms
is not expected. Impairment is evaluated in aggregate for smaller-balance
loans of similar nature such as residential mortgage, consumer and credit
card loans, and on an individual loan basis for other loans. If a loan or
lease is impaired, a portion of the allowance is allocated so that the loan
or lease is reported, net, at the present value of estimated future cash
flows using the loan's or lease's existing rate or at the fair value of
collateral if repayment is expected solely from the collateral. Loans and
leases are evaluated for impairment when payments are delayed, typically 90
days or more, or when the internal grading system indicates a doubtful
classification.
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 FASB Statement No. 123, Accounting for
Stock-Based Compensation.
(Continued)
7
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Quarter ended Nine months ended
Sept 30, 2003 Sept 30, 2002 Sept 30, 2003 Sept 30, 2002
------------- ------------- ------------- -------------
Net income as reported $ 2,228,000 $ 2,156,000 $ 7,001,000 $ 5,476,000
Deduct: Stock-based compensation
expense determined under fair
value based method 81,000 63,000 244,000 190,000
------------- ------------- ------------- -------------
Pro forma net income 2,147,000 2,093,000 6,757,000 5,286,000
Basic earnings per share as reported $ 0.40 $ 0.40 $ 1.28 $ 1.01
Pro forma basic earnings per share 0.39 0.39 1.24 0.98
Diluted earnings per share
as reported $ 0.39 $ 0.39 $ 1.25 $ 1.00
Pro forma diluted earnings per share 0.38 0.38 1.21 0.96
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
Quarter ended Nine months ended
Sept 30, 2003 Sept 30, 2002 Sept 30, 2003 Sept 30, 2002
------------- ------------- ------------- -------------
Risk-free interest rate 3.25% 5.25% 3.25% 5.25%
Expected option life 7 Years 10 Years 7 Years 10 Years
Expected stock price volatility 25% 42% 22% 32%
Dividend yield 1.00% 0% 1.25% 0%
(Continued)
8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. LOANS
Our total loans and leases at September 30, 2003 were $972.2 million
compared to $771.6 million at December 31, 2002, an increase of $200.6
million or 26.0%. The components of our outstanding balances at September
30, 2003 and December 31, 2002, and the percentage changes in loans and
leases from the end of 2002 to the end of the third quarter 2003 are as
follows:
Percent
September 30, 2003 December 31, 2002 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Real Estate:
Construction and land
development $ 131,349,000 13.5% $ 103,900,000 13.5% 26.4%
Secured by 1-4 family
properties 81,096,000 8.3 60,828,000 7.9 33.3
Secured by multi-family
properties 18,510,000 1.9 13,025,000 1.7 42.1
Secured by nonresidential
properties 436,987,000 45.0 357,431,000 46.3 22.3
Commercial 298,063,000 30.7 230,662,000 29.9 29.2
Leases 1,049,000 0.1 850,000 0.1 23.4
Consumer 5,137,000 0.5 4,858,000 0.6 5.7
--------------- ----- --------------- ----- -----
Total loans and leases $ 972,191,000 100.0% $ 771,554,000 100.0% 26.0%
=============== ===== =============== ===== ====
3. ALLOWANCE FOR LOAN AND LEASE LOSSES
The following is a summary of the change in our allowance for loan and
lease losses account for the three and nine months ended September 30:
Three months ended Nine months ended
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Balance at beginning of
period $ 12,158,000 $ 9,562,000 $ 10,890,000 $ 8,494,000
Charge-offs (95,000) (250,000) (524,000) (419,000)
Recoveries 39,000 1,000 266,000 96,000
Provision for loan and
lease losses 1,380,000 880,000 2,850,000 2,022,000
------------- ------------- ------------- --------------
Balance at September 30 $ 13,482,000 $ 10,193,000 $ 13,482,000 $ 10,193,000
============= ============= ============= ==============
(Continued)
9
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. PREMISES AND EQUIPMENT, NET
Premises and equipment are comprised of the following:
September 30, December 31,
2003 2002
---- ----
Land and improvements $ 5,736,000 $ 3,234,000
Buildings and leasehold improvements 7,888,000 7,009,000
Furniture and equipment 4,860,000 4,327,000
-------------- -------------
18,484,000 14,570,000
Less accumulated depreciation 3,255,000 2,396,000
-------------- -------------
Premises and equipment, net $ 15,229,000 $ 12,174,000
============== =============
Depreciation expense amounted to $308,000 during the third quarter of 2003,
compared to $221,000 in the third quarter of 2002. Depreciation expense
amounted to $859,000 during the first nine months of 2003, compared to
$657,000 during the first nine months of 2002.
5. DEPOSITS
Our total deposits at September 30, 2003 were $889.6 million compared to
$754.1 million at December 31, 2002, an increase of $135.5 million, or
18.0%. The components of our outstanding balances at September 30, 2003 and
December 31, 2002, and percentage change in deposits from the end of 2002
to the end of the third quarter 2003 are as follows:
Percent
September 30, 2003 December 31, 2002 Increase/
Balance % Balance % (Decrease)
------- - ------- - ----------
Noninterest-bearing demand $ 77,448,000 8.7% $ 62,405,000 8.3% 24.1%
Interest-bearing checking 28,468,000 3.2 28,130,000 3.7 1.2
Money market 9,179,000 1.0 8,592,000 1.1 6.8
Savings 94,537,000 10.7 69,461,000 9.2 36.1
Time, under $100,000 8,261,000 0.9 7,002,000 0.9 18.0
Time, $100,000 and over 87,389,000 9.8 66,005,000 8.8 32.4
------------ ----- ------------ ----- ----
305,282,000 34.3 241,595,000 32.0 26.4
Out-of-area time,
under $100,000 101,647,000 11.4 85,557,000 11.4 18.8
Out-of-area time,
$100,000 and over 482,652,000 54.3 426,961,000 56.6 13.0
------------ ----- ------------ ----- ----
584,299,000 65.7 512,518,000 68.0 14.0
------------ ----- ------------ ----- ----
Total deposits $889,581,000 100.0% $754,113,000 100.0% 18.0%
============ ===== ============ ===== ====
(Continued)
10
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
September 30, December 31,
2003 2002
---- ----
Outstanding balance at end of period $ 48,310,000 $ 50,335,000
Average interest rate at end of period 1.39% 1.54%
Average balance during the period $ 43,563,000 $ 43,468,000
Average interest rate during the period 1.47% 2.03%
Maximum month end balance during the period $ 48,310,000 $ 52,000,000
Securities sold under agreements to repurchase (repurchase agreements)
generally have original maturities of less than one year. Repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as liabilities. Securities involved with the
agreements are recorded as assets of our bank and are primarily held in
safekeeping by correspondent banks. Repurchase agreements are offered
principally to certain large deposit customers as deposit equivalent
investments.
7. FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at September 30, 2003 and December 31, 2002 were
as follows.
September 30, December 31,
2003 2002
---- ----
Maturities October 2003 through September, 2006,
fixed rates from 1.53% to 3.21%, averaging 2.04% $70,000,000 0
Maturities September 2003 through December 2004,
fixed rates from 1.69% to 2.39%, averaging 1.97% 0 $15,000,000
----------- -----------
Total Federal Home Loan Bank advances $70,000,000 $15,000,000
=========== ===========
Each advance is payable at its maturity date, and is subject to a
prepayment fee if paid prior to the maturity date. The advances are
collateralized by residential mortgage loans, first mortgage liens on
multi-family residential property loans, first mortgage liens on commercial
real estate property loans, and substantially all other assets of our bank,
under a blanket lien arrangement. Our borrowing line of credit as of
September 30, 2003 totaled $132.1 million, with availability approximating
about $54.0 million.
(Continued)
11
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. FEDERAL HOME LOAN BANK ADVANCES (Continued)
Maturities of currently outstanding FHLB advances during the next five
years are:
2003 $ 15,000,000
2004 25,000,000
2005 20,000,000
2006 10,000,000
2007 0
8. COMMITMENTS AND OFF-BALANCE-SHEET RISK
Our bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of our customers.
These financial instruments include commitments to extend credit and
standby letters of credit. Loan commitments to extend credit are agreements
to lend to a customer as long as there is no violation of any condition
established in the contract. Standby letters of credit are conditional
commitments issued by our bank to guarantee the performance of a customer
to a third party. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in
excess of the amount recognized, if any, in the balance sheet. Our bank's
maximum exposure to loan loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount
of those instruments. Our bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. Collateral, such as accounts receivable, securities,
inventory, property and equipment, is generally obtained based on
management's credit assessment of the borrower.
A summary of the notional or contractual amounts of our financial
instruments with off-balance-sheet risk at September 30, 2003 and December
31, 2002 follows:
September 30, December 31,
2003 2002
---- ----
Commercial unused lines of credit $ 169,963,000 $ 131,161,000
Unused lines of credit secured by 1-4 family
residential properties 17,377,000 12,381,000
Credit card unused lines of credit 8,368,000 5,824,000
Other consumer unused lines of credit 4,528,000 4,415,000
Commitments to make loans 43,365,000 24,267,000
Standby letters of credit 43,771,000 39,338,000
-------------- ---------------
Total loan and lease commitments $ 287,372,000 $ 217,386,000
============== ===============
(Continued)
12
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. SALE OF COMMON STOCK
On September 19, 2003, the Company sold 1,195,310 shares of common stock in
a public offering, raising $37.4 million net of underwriting costs.
Substantially all of the net proceeds were contributed to our bank as a
capital injection. On October 17, 2003, the Company sold an additional
179,296 shares of common stock as the underwriters exercised their 30-day
over-allotment option, raising an additional $5.6 million net of
underwriting costs. Substantially all of the net proceeds were contributed
to our bank as a capital injection.
10. REGULATORY MATTERS
We are subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain
cases. Failure to meet various capital requirements can initiate regulatory
action that could have a direct material effect on our financial
statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent overall financial condition. If
adequately capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are required.
(Continued)
13
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
10. REGULATORY MATTERS (Continued)
Our actual capital levels and minimum required levels were (dollars in
thousands):
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
------ ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
September 30, 2003
Total capital (to risk
weighted assets)
Consolidated $ 151,550 13.9% $ 87,050 8.0% $ 108,812 10.0%
Bank 148,055 13.6 86,838 8.0 108,547 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 138,068 12.7 43,525 4.0 65,287 6.0
Bank 134,573 12.4 43,419 4.0 65,129 6.0
Tier 1 capital (to
average assets)
Consolidated 138,068 12.8 43,333 4.0 54,164 5.0
Bank 134,573 12.5 43,253 4.0 54,066 5.0
December 31, 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
Both the Company and our bank were categorized as well capitalized at September
30, 2003 and year-end 2002.
(Continued)
14
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
10. REGULATORY MATTERS (Continued)
The trust sold 1.6 million Cumulative Preferred Securities ("trust
preferred securities") at $10.00 per trust preferred security in a
September 1999 offering. The proceeds from the sale were used by the trust
to purchase an equivalent amount of subordinated debentures from the
company. The trust preferred securities carry a fixed rate of 9.60%, have a
stated maturity of 30 years, and, in effect, are guaranteed by the company.
The securities are redeemable at par after 5 years. Distributions on the
trust preferred securities are payable quarterly on January 15, April 15,
July 15, and October 15. The first distribution was paid on October 15,
1999. Under certain circumstances, distributions may be deferred for up to
20 calendar quarters. However, during any such deferrals, interest accrues
on any unpaid distributions at the rate of 9.60% per annum.
The Company's capital levels as of September 30, 2003 include an adjustment
for the 1.6 million trust preferred securities issued by the trust subject
to certain limitations. Federal Reserve guidelines limit the amount of
trust preferred securities which can be included in Tier 1 capital of the
company to 25% of total Tier 1 capital. As of September 30, 2003, the
entire $16.0 million of the trust preferred securities were included as
Tier 1 capital.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound
banking practices. We declared a 5% stock dividend on January 6, 2003, that
was paid on February 3, 2003, to record holders as of January 17, 2003. We
have also paid three cash dividends on our common stock during 2003. On
January 6, 2003, we declared a $0.08 per share cash dividend payable on
March 10, 2003, to record holders as of February 10, 2003. On April 8,
2003, we declared a $0.08 per share cash dividend payable on June 10, 2003,
to record holders as of May 12, 2003. On July 8, 2003, we declared a $0.08
per share cash dividend payable on September 10, 2003, to record holders as
of August 11, 2003. On October 6, 2003, we declared a $0.08 per share cash
dividend payable on December 10, 2003, to record holders as of November 10,
2003.
11. BENEFIT PLANS
We sponsor an employee stock purchase plan which allows employees to defer
after-tax payroll dollars and purchase our common stock on a quarterly
basis. We have registered 26,250 shares of common stock to be issued and
purchased under the plan. The plan allows for shares to be purchased
directly from us or on the open market. During the nine months ended
September 30, 2003, we issued the first 1,367 shares under the plan.
15
MERCANTILE BANK CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and about our company. Words such as
"anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is
likely", "plans", "projects", variations of such words and similar expressions
are intended to identify such forward-looking statements. These statements are
not guarantees of future performance and involve certain risks, uncertainties
and assumptions ("Future Factors") that are difficult to predict with regard to
timing, extent, likelihood and degree of occurrence. Therefore, actual results
and outcomes may materially differ from what may be expressed or forecasted in
such forward-looking statements. We undertake no obligation to update, amend, or
clarify forward looking statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; and changes in the national and local economy. These are representative
of the Future Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, Mercantile Bank of West Michigan
("our bank"), our bank's three wholly-owned subsidiaries Mercantile Bank
Mortgage Company ("our mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO")
and Mercantile Insurance Center, Inc. ("our insurance center"), and our
subsidiary MBWM Capital Trust I ("the trust"), at September 30, 2003 to December
31, 2002 and the results of operations for the three and nine months ended
September 30, 2003 and September 30, 2002. This discussion should be read in
conjunction with the interim consolidated financial statements and footnotes
included in this report. Unless the text clearly suggests otherwise, references
in this report to "us," "we," "our," or "the company" include Mercantile Bank
Corporation and its consolidated subsidiaries referred to above.
During the third quarter of 2003, we were engaged in preliminary discussions
with one or more financial institutions to explore the possibility of an
acquisition by us. To date the discussions have been exploratory in nature and
no likely candidate has been identified. We expect that such discussions may
occur from time-to-time with these or other financial institutions in future
periods.
16
MERCANTILE BANK CORPORATION
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles are complex and require management to
apply significant judgment to various accounting, reporting and disclosure
matters. Management must use assumptions and estimates to apply these principles
where actual measurements are not possible or practical. The Management's
Discussion and Analysis of Financial Condition and Results of Operations should
be read in conjunction with our unaudited financial statements included in this
report. For a complete discussion of our significant accounting policies, see
footnotes to our Consolidated Financial Statements included on pages F-28
through F-32 in our Form 10-K for the fiscal year ended December 31, 2002
(Commission file number 000-26719). Below is a discussion of our Allowance for
Loan and Lease Losses policy. This policy is critical because it is highly
dependent upon subjective or complex judgments, assumptions and estimates.
Changes in such estimates may have a significant impact on the financial
statements, and actual results may differ from those estimates. Management has
reviewed the application of this policy with the Audit Committee of the
Company's Board of Directors.
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 uncollectability of a loan or
lease balance is confirmed.
A loan or lease is impaired when full payment under the loan or lease terms is
not expected. Impairment is evaluated in aggregate for smaller-balance loans of
similar nature such as residential mortgage, consumer and credit card loans, and
on an individual loan basis for other loans. If a loan or lease is impaired, a
portion of the allowance is allocated so that the loan or lease is reported,
net, at the present value of estimated future cash flows using the loan's or
lease's existing rate or at the fair value of collateral if repayment is
expected solely from the collateral. Loans and leases are evaluated for
impairment when payments are delayed, typically 90 days or more, or when the
internal grading system indicates a doubtful classification.
FINANCIAL CONDITION
During the first nine months of 2003, our assets increased from $921.9 million
on December 31, 2002, to $1,153.9 million on September 30, 2003. This represents
a total increase in assets of $232.0 million, or 25.2%. The asset growth was
comprised primarily of a $198.0 million increase in net loans, an increase of
$16.5 million in cash and cash equivalents and an $11.1 million increase in
securities. The increase in assets was primarily funded by a $135.5 million
increase in deposits, an increase of $55.0 million in Federal Home Loan Bank
advances and a $37.6 million increase in common stock.
Commercial loans and leases increased by $180.1 million during the first nine
months of 2003, and at September 30, 2003 totaled $886.0 million, or 91.1% of
the total loan and lease portfolio. The continued significant concentration of
the loan and lease portfolio in commercial loans and leases and the rapid growth
of this portion of our lending business is consistent with our stated strategy
of focusing a substantial amount of efforts on "wholesale" banking. Corporate
and business lending continues to be an area of expertise of our senior
management team, and our 13 commercial lenders have an average commercial
lending experience of approximately 15 years. Of each of the loan categories
that we originate, we originate and manage commercial loans and leases most
efficiently; thus reducing overhead costs by necessitating the attention of
fewer employees. Our commercial lending business generates the greatest amount
of local deposits, and is virtually the only source of significant demand
deposits.
17
MERCANTILE BANK CORPORATION
Residential mortgage loans increased by $20.3 million and consumer loans
increased by $0.3 million during the first nine months of 2003. As of September
30, 2003, residential mortgage and consumer loans totaled a combined $86.2
million, or 8.9% of the total loan and lease portfolio. Although we plan to
increase our non-commercial loan portfolios in future periods, given our
wholesale banking strategy, we expect the commercial sector of the lending
efforts and resultant assets to remain the dominant loan portfolio category.
Management believes the quality of our loan and lease portfolio remains strong.
Net loan and lease charge-offs during the first nine months of 2003 totaled
$258,000, or 0.04% of average total loans and leases on an annualized basis.
Past due and nonaccrual loans and leases at September 30, 2003 totaled $287,000,
or 0.03% of total loans and leases. We believe we have instilled a strong credit
culture within our lending departments as it pertains to the underwriting and
administration processes, which in part is reflected in our loan and lease
charge-off and delinquency ratios. Over 98% of the loan portfolio consists of
loans extended directly to companies and individuals doing business and residing
within our market area. The remaining portion is comprised of commercial loans
participated with certain commercial banks outside the immediate area, which we
underwrite using the same loan underwriting criteria as though our bank was the
originating bank.
Securities increased by $11.1 million, or 11.4%, during the first nine months of
2003. Purchases during the first nine months of 2003 totaled $47.0 million.
Proceeds from the sales of securities totaled $11.5 million, while proceeds from
the maturities, calls and repayments of securities totaled $22.8 million. Our
securities portfolio consists of U.S. Government Agency bonds, mortgage-backed
securities issued or guaranteed by U.S. Government Agencies, investment-grade
municipal securities and Federal Home Loan Bank of Indianapolis ("FHLBI") stock.
Cash and cash equivalents increased $16.5 million, or 58.7%, during the first
nine months of 2003, totaling $44.6 million on September 30, 2003. Cash and due
from bank balances were up $9.2 million and federal funds sold increased $7.3
million. Our commercial lending and wholesale funding focus results in
relatively large day-to-day fluctuations of our cash and cash equivalent
balances. The average balance of cash and cash equivalents during the first nine
months of 2003 equaled $28.8 million, or approximately 35% below the balance at
September 30, 2003.
On April 30, 2003, our bank purchased an existing building situated on 2.75
acres of land located about two miles north of the center of downtown Grand
Rapids for approximately $1.3 million. We plan 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 current downtown facility, which includes
a vast majority of our commercial lending function, and will house the
administration and loan operations functions currently housed at other of our
locations. Expected completion date of the new facility is during the latter
part of 2005. On September 29, 2003, our bank purchased ten acres of land
located in Holland, Michigan for approximately $0.9 million. Subject to
regulatory approvals, we plan to design and construct a two-story facility on
this property. This facility will serve as the new location for our current loan
production office which currently operates out of a leased facility, and will
also house a full-service branch and part of our commercial lending function.
Expected completion date of the new facility is during the latter part of 2004.
18
MERCANTILE BANK CORPORATION
Deposits increased $135.5 million during the first nine months of 2003, totaling
$889.6 million at September 30, 2003. Local deposits increased $63.7 million, or
26.4%, while out-of-area deposits increased $71.8 million, or 14.0%. As a
percent of total deposits, local deposits increased from 32.0% on December 31,
2002, to 34.3% on September 30, 2003. Noninterest-bearing demand deposits,
comprising 8.7% of total deposits, increased $15.0 million during the first nine
months of 2003. Savings deposits (10.7% of total deposits) increased $25.1
million, money market deposit accounts (1.0% of total deposits) increased $0.6
million and interest-bearing checking deposits (3.2% of total deposits)
increased $0.3 million during the first nine months of 2003. Local certificates
of deposit, comprising 10.7% of total deposits, increased by $22.6 million
during the first nine months of 2003.
Out-of-area deposits increased $71.8 million during the first nine months of
2003, totaling $584.3 million, or 65.7% of total deposits, as of September 30,
2003. Out-of-area deposits consist primarily of certificates of deposit obtained
from depositors located outside our market area and placed by deposit brokers
for a fee, but also include certificates of deposit obtained from the deposit
owners directly. Out-of-area deposits are utilized to support our asset growth,
and are generally a lower cost source of funds when compared to the interest
rates that would have to be offered in the local market to generate a sufficient
level of funds. During the first nine months of 2003 rates paid on new
out-of-area certificates of deposit were generally lower than rates paid on new
certificates of deposit issued to local customers. In addition, the overhead
costs associated with the out-of-area deposits are considerably less than the
overhead costs that would be incurred to administer a similar level of local
deposits. Although local deposits have and are expected to increase as new
business, governmental and consumer deposit relationships are established and as
existing customers increase their deposit accounts, our relatively high reliance
on out-of-area deposits will likely continue.
Securities sold under agreements to repurchase ("repurchase agreements")
decreased by $2.0 million during the first nine months of 2003, totaling $48.3
million as of September 30, 2003. As part of our sweep account program,
collected funds from certain business noninterest-bearing checking accounts are
invested into over-night interest-bearing repurchase agreements. Although not
considered a deposit account and therefore not afforded federal deposit
insurance, the repurchase agreements have characteristics very similar to that
of our business checking deposit accounts.
FHLBI advances increased by $55.0 million during the first nine months of 2003,
totaling $70.0 million as of September 30, 2003. The advances are collateralized
by residential mortgage loans, first mortgage liens on multi-family residential
property loans, first mortgage liens on commercial real estate property loans,
and substantially all other assets of our bank, under a blanket lien
arrangement. The amount available under our borrowing line of credit totaled
approximately $54.0 million as of September 30, 2003. FHLBI advances, along with
out-of-area deposits, are the primary components of our wholesale funding
program.
Common stock increased by $37.6 million during the first nine months of 2003,
totaling $113.1 million as of September 30, 2003. A vast majority of the
increase was due to the sale of common stock through a public offering completed
in September, whereby we sold 1,195,310 shares at a price of $33.26 per share.
Net proceeds from the sale, after deducting for underwriting expenses,
approximated $37.4 million.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment of loans and securities. These
funds are used to meet deposit withdrawals, maintain reserve requirements, fund
loans and support our operations. Liquidity is primarily achieved through the
growth of deposits (both local and out-of-area) and advances from the FHLBI, as
well as liquid assets such as securities available for sale, matured securities,
and federal funds sold. Asset and liability management is the process of
managing our balance sheet to achieve a mix of earning assets and liabilities
that maximizes profitability, while providing adequate liquidity.
19
MERCANTILE BANK CORPORATION
Our liquidity strategy is to fund loan growth with deposits and repurchase
agreements and to maintain an adequate level of short- and medium-term
investments to meet typical daily loan and deposit activity. Although deposit
and repurchase agreement growth from depositors located in the market area have
consistently increased, this growth has not been sufficient to meet our
substantial loan growth and provide monies for additional investing activities.
To assist in providing the additional needed funds, we have regularly obtained
monies from wholesale funding sources. Wholesale funds, comprised of
certificates of deposit from customers outside our market area, and since the
fourth quarter of 2002, advances from the FHLBI, totaled $654.3 million, or
64.9%, of combined deposits and borrowed funds. As of December 31, 2002,
wholesale funds totaled $527.5 million, or 64.3%, of combined deposits and
borrowed funds. Reliance on wholesale funds is expected to continue due to our
anticipated future asset growth.
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established unsecured federal funds purchased lines, totaling $35.0
million as of September 30, 2003. The average balance of federal funds purchased
during the first nine months of 2003 equaled $3.3 million, compared to a $5.8
million average federal funds sold position.
As a member of the FHLBI, our bank has access to the FHLBI's borrowing programs.
As of September 30, 2003, advances from the FHLBI totaled $70.0 million, up from
the $15.0 million outstanding at December 31, 2002. Based on available
collateral at September 30, 2003, our bank could borrow up to approximately
$54.0 million.
In addition to typical loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of September 30, 2003, our bank had a total of $243.6 million in
unfunded loan commitments and $43.8 million in unfunded standby letters of
credit. Of the total unfunded loan commitments, $200.2 million were commitments
available as lines of credit to be drawn at any time as customers' cash needs
vary, and $43.4 million were for loan commitments expected to close and become
funded within the next three to six months. We monitor fluctuations in loan
balances and commitment levels, and include such data in managing overall
liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $42.4 million during
the first nine months of 2003, from $79.8 million on December 31, 2002, to
$122.2 million at September 30, 2003. The increase is primarily attributable to
the sale of common stock and net income. During September we sold 1,195,310
shares of common stock in a public offering, raising $37.4 million net of
underwriting costs. Substantially all of the net proceeds were contributed to
our bank as a capital injection. Net income of $7.0 million was recorded during
the first nine months of 2003. Shareholders' equity was negatively impacted
during the first nine months of 2003 by the payment of cash dividends totaling
$1.3 million and a $1.0 million mark-to-market adjustment for available for sale
securities as defined in SFAS No. 115.
On October 17, 2003, the Company sold an additional 179,296 shares of common
stock as the underwriters exercised their 30-day over-allotment option, raising
an additional $5.6 million net of underwriting costs. Substantially all of the
net proceeds were contributed to our bank as a capital injection.
20
MERCANTILE BANK CORPORATION
In September 1999 we, through the trust, issued 1.6 million shares of trust
preferred securities at $10.00 per trust preferred security. Substantially all
of the net proceeds were contributed to our bank as capital and were used to
support growth in assets, fund investments in loans and securities, and for
general corporate purposes. Although not part of shareholder's equity, subject
to certain limitations the trust preferred securities are considered a component
of capital for purposes of calculating regulatory capital ratios. At September
30, 2003, the entire $16.0 million of trust preferred securities were included
as Tier 1 capital.
We are subject to regulatory capital requirements primarily administered by
federal bank regulatory agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. Since our bank commenced operations, both
the company and our bank have been categorized as "Well Capitalized," the
highest classification contained within the banking regulations. The capital
ratios of the company and our bank as of September 30, 2003 and December 31,
2002 are disclosed under Note 10 of the Notes to Consolidated Financial
Statements.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. We declared a 5% stock dividend on January 6, 2003, which was paid on
February 3, 2003 to record holders as of January 17, 2003. We have also paid
three cash dividends on our common stock during 2003. We paid a $0.08 per share
cash dividend on March 10, 2003, June 10, 2003 and on September 10, 2003. On
October 6, 2003, we declared a $0.08 per share cash dividend payable on December
10, 2003, to record holders as of November 10, 2003.
RESULTS OF OPERATIONS
Net income for the third quarter of 2003 was $2.23 million ($0.40 per basic
share and $0.39 per diluted share), which represents a 3.3% increase over net
income of $2.16 million ($0.40 per basic share and $0.39 per diluted share)
recorded during the third quarter of 2002. Net income for the first nine months
of 2003 was $7.0 million ($1.28 per basic share and $1.25 per diluted share),
which represents a 27.8% increase over net income of $5.5 million ($1.01 per
basic share and $1.00 per diluted share) recorded during the first nine months
of 2002. During both time periods net income was positively impacted by an
increase in net interest income, higher noninterest income and greater employee
efficiency. Higher provision expense driven by significantly higher loan growth
negatively impacted net income, especially during the third quarter of 2003.
Interest income during the third quarter of 2003 was $13.9 million, an increase
of 12.5% over the $12.3 million earned during the third quarter of 2002.
Interest income during the first nine months of 2003 was $40.0 million, an
increase of 14.2% over the $35.0 million earned during the first nine months of
2002. The growth in interest income during both time periods is primarily
attributable to an increase in earning assets, which more than offset the
negative impact of a declining interest rate environment. During the third
quarter of 2003 earning assets averaged $1,029.2 million, $246.8 million higher
than the average earning assets of $782.4 million during the third quarter of
2002. Average loans were up $230.4 million and securities increased $21.3
million, while federal funds sold were down $5.2 million. During the first nine
months of 2003 earning assets averaged $959.1 million, $223.2 million higher
than the average earning assets of $735.9 million during the same time period in
2002. Average loans were up $202.3 million and securities increased $22.6
million, while federal funds sold were down $1.8 million. During the third
quarter of 2003 and 2002, earning assets had a weighted average yield (tax
equivalent-adjusted basis) of 5.49% and 6.33%, respectively. During the first
nine months of 2003 and 2002 earning assets had a weighted average yield of
5.38% and 6.17%, respectively. The decrease in weighted average yields is
primarily due to the decline in market interest rates.
21
MERCANTILE BANK CORPORATION
Interest expense during the third quarter of 2003 was $5.8 million, a decrease
of 4.0% from the $6.0 million expensed during the third quarter of 2002.
Interest expense during the first nine months of 2003 was $17.6 million, a
decrease of 1.9% from the $17.9 million expensed during the first nine months of
2002. The decrease in interest expense is primarily attributable to the overall
decline of market interest rates, which more than offset the increase in funding
liabilities necessitated by the growth in assets. During the third quarter of
2003, interest-bearing liabilities averaged $921.8 million, $234.0 million
higher than average interest-bearing liabilities of $687.8 million during the
third quarter of 2002. Average interest-bearing deposits were up $174.2 million
and FHLBI advances increased $56.5 million. During the first nine months of 2003
interest-bearing liabilities averaged $858.3 million, $213.8 million higher than
average interest-bearing funds of $644.5 million during the same time period in
2002. Average interest-bearing deposits were up $170.5 million and FHLBI
advances increased $37.5 million. During the third quarter of 2003 and 2002,
interest-bearing liabilities had a weighted average rate of 2.50% and 3.48%,
respectively. During the first nine months of 2003 and 2002 interest-bearing
liabilities had a weighted average rate of 2.74% and 3.72%, respectively. The
decrease in the weighted average cost of interest-bearing liabilities in 2003 is
primarily due to the decline in market interest rates.
Net interest income during the third quarter of 2003 was $8.1 million, an
increase of 28.3% over the $6.3 million earned during the third quarter of 2002.
Net interest income during the first nine months of 2003 was $22.4 million, an
increase of 31.1% over the $17.1 million earned during the same time period in
2002. The increase in net interest income was due to growth in earning assets.
The net interest margin declined from 3.27% during the third quarter of 2002 to
3.19% in third quarter of 2003, but increased from 3.18% during the first nine
months of 2002 to 3.20% in the first nine months of 2003.
The following table sets forth certain information relating to our consolidated
average interest earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the third
quarter of 2003 and 2002. Such yields and costs are derived by dividing income
or expense by the average daily balance of assets or liabilities, respectively,
for the period presented. Tax-exempt securities interest income and yield have
been computed on a tax equivalent basis using a marginal tax rate of 34%.
Securities interest income was increased by $207,000 and $159,000 in the third
quarter of 2003 and 2002, respectively, for this adjustment.
22
MERCANTILE BANK CORPORATION
Quarters ended September 30,
-----------------------------------------------------------------------------------
2 0 0 3 2 0 0 2
--------------------------------------- ---------------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
ASSETS
Loans $ 918,966 $ 12,679 5.47% $ 688,550 $ 11,132 6.41%
Investment securities 105,485 1,371 5.20 84,163 1,303 6.19
Federal funds sold 4,309 11 0.97 9,527 41 1.68
Short term investments 444 0 0.50 195 1 1.25
----------- ----------- ----------- -----------
Total interest-earning
assets 1,029,204 14,061 5.49 782,435 12,477 6.33
Allowance for loan
and lease losses (12,842) (9,927)
Other assets 66,464 48,641
----------- -----------
Total assets $ 1,082,826 $ 821,149
=========== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $ 798,947 4,952 2.46 $ 624,792 5,396 3.43%
Short-term borrowings 49,437 168 1.35 46,540 242 2.06
FHLB advances 56,467 274 1.90 0 0 NA
Long-term borrowings 16,958 403 9.51 16,485 398 9.66
----------- ----------- ----------- -----------
Total interest-bearing
liabilities 921,809 5,797 2.50 687,817 6,036 3.48
Noninterest-bearing
deposits 68,344 51,869
Other liabilities 6,163 5,113
Shareholders' equity 86,510 76,350
----------- ----------- ---- ----------- ----------- ----
Total liability and
shareholders' equity $ 1,082,826 $ 821,149
=========== ===========
Net interest income $ 8,264 $ 6,441
=========== ===========
Net interest rate spread 2.99% 2.85%
==== ====
Net interest rate spread
on average assets 3.02% 3.11%
==== ====
Net interest margin on
earning assets 3.19% 3.27%
==== ====
Provisions to the allowance for loan and lease losses during the third quarter
of 2003 were $1.4 million, compared to the $0.9 million expensed during the
third quarter of 2002. Provisions to the allowance for loan and lease losses
during the first nine months of 2003 were $2.9 million, compared to the $2.0
million that was expensed during the same time period in 2002. The increase
during both time periods primarily reflects the higher volume of loan growth.
Net loan charge-offs during the third quarter of 2003 were $56,000 compared to
net loan charge-offs of $249,000 during the third quarter of 2002. During the
first nine months of 2003 net loan charge-offs totaled $258,000 compared to net
loan charge-offs of $323,000 during the same time period in 2002. The allowance
for loan and lease losses as a percentage of total loans outstanding as of
September 30, 2003 was 1.39%, compared to 1.41% at December 31, 2002.
In each accounting period, the allowance for loan and lease losses is adjusted
to the amount believed necessary to maintain the allowance for loan and lease
losses at adequate levels. Through the loan review and credit departments, we
attempt to allocate specific portions of the allowance for loan and lease losses
based on specifically identifiable problem loans and leases. The evaluation of
the allowance for loan and lease losses is further based on, although not
limited to, consideration of the internally prepared Loan Loss Reserve Analysis
("Reserve Analysis"), composition of the loan and lease portfolio, third party
analysis of the loan administration processes and loan portfolio and general
economic conditions. In addition, the rapid growth of the loan and lease
portfolio is taken into account.
23
MERCANTILE BANK CORPORATION
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 loan and lease portfolio,
reserve allocation factors are based upon the loan ratings as determined by our
comprehensive loan rating paradigm that is administered by our loan review
function. For retail loans, reserve allocation factors are based upon the type
of credit. The reserve allocation factors are based on the experience of senior
management making similar loans in the same community over the past 15 years.
The Reserve Analysis is reviewed regularly by senior management and the Board of
Directors and is adjusted periodically based upon identifiable trends and
experience.
Noninterest income during the third quarter of 2003 was $1.1 million, an
increase of 15.2% over the $0.9 million earned during the third quarter of 2002.
Noninterest income during the first nine months of 2003 was $3.3 million, an
increase of 59.6% over the $2.0 million earned during the same time period in
2002. Service charge income on deposits and repurchase agreements increased
$60,000 (24.7%) during the third quarter of 2003 over that earned in the third
quarter of 2002, and during the first nine months of 2003 increased $192,000
(29.1%) over that earned in the comparable time period in 2002. The increases
during both time periods primarily results from new accounts opened during the
last twelve months, decline in the earnings credit rate and adjustments in our
deposit fee structure. Primarily reflecting the low and declining interest rate
environment and resulting increase in residential mortgage loan refinancings,
fees earned on referring residential mortgage loan applicants to third parties
and selling residential mortgage loans to third parties increased from $147,000
earned during the third quarter of 2002 to $275,000 recorded during the third
quarter of 2003, and increased from $318,000 earned during the first nine months
of 2002 to $851,000 recorded during the first nine months of 2003. Noninterest
income related to an increase in the cash surrender value of bank owned life
insurance policies ("BOLI") totaled $197,000 during the third quarter of 2003
compared to $116,000 earned during the third quarter of 2002, and totaled
$602,000 during the first nine months of 2003 compared to $208,000 earned during
the first nine months of 2002. The growth in income related to BOLI primarily
results from additional BOLI policies purchased during the past twelve months.
Gains recognized on the sales of securities totaled $59,000 during the third
quarter of 2003, resulting from the sale of four mortgage-backed securities with
an aggregate book value of $3.1 million. The sales were transacted as part of
our interest rate risk management program. The sales proceeds were used to
purchase mortgage-backed securities with different underlying interest rate risk
characteristics than those contained in the securities that were sold.
Noninterest expense during the third quarter of 2003 was $4.8 million, an
increase of 45.6% over the $3.3 million expensed during the same time period in
2002. Noninterest expense during the first nine months of 2003 was $13.2
million, an increase of 41.2% over the $9.3 million expensed during the same
time period in 2002. Employee salary and benefit expenses were $1.0 million
higher during the third quarter of 2003 than the level expensed during the third
quarter of 2002, and were $2.6 million higher during the first nine months of
2003 than the level expensed during the first nine months of 2002. The increases
during both time periods primarily resulted from the hiring of additional staff
and merit annual pay increases. The level of full-time equivalent employees
increased from 113 at September 30, 2002 to 156 as of September 30, 2003.
Occupancy and furniture and equipment costs increased $177,000 in the third
quarter of 2003 over the level expensed in the third quarter of 2002, and
increased $429,000 during the first nine months of 2003 over the level expensed
during the first nine months of 2002 primarily reflecting the opening of two new
branch facilities and a loan production office during the past ten months.
General overhead costs also increased, reflecting the additional expenses
required to administer our significantly increased asset base.
24
MERCANTILE BANK CORPORATION
Monitoring and controlling noninterest costs, while at the same time providing
high quality service to customers, is a key component to our business strategy.
While the dollar volume of noninterest costs has increased, the rate of growth
has been lower than the rate of increase in net interest income and noninterest
income. Noninterest expenses increased by $1.5 million during the third quarter
of 2003 over the amount expensed during the third quarter of 2002, and increased
by $3.8 million during the first nine months of 2003 over the amount expensed
during the first nine months of 2002. However, net revenues (net interest income
plus noninterest income) increased at a higher level of $1.9 million and $6.5
million during the same time periods, respectively.
Federal income tax expense was $0.7 million and $0.9 million during the third
quarter of 2003 and 2002, respectively. Although net income before tax was
similar during both time periods, federal income tax expense was lower during
the third quarter of 2003 primarily due to a reduction in our effective tax
rate. Federal income tax expense was $2.6 million and $2.3 million during the
first nine months of 2003 and 2002, respectively. The increase was primarily due
to an increase in net income before federal income tax expense, which more than
offset a decline in our effective tax rate.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity risk. All of our transactions are denominated in U.S. dollars with no
specific foreign exchange exposure. We have only limited agricultural-related
loan assets and therefore have no significant exposure to changes in commodity
prices. Any impact that changes in foreign exchange rates and commodity prices
would have on interest rates are assumed to be insignificant. Interest rate risk
is the exposure of our financial condition to adverse movements in interest
rates. We derive our income primarily from the excess of interest collected on
our interest-earning assets over the interest paid on our interest-bearing
liabilities. The rates of interest we earn on our assets and owe on our
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, we are exposed to lower profitability if
we cannot adapt to interest rate changes. Accepting interest rate risk can be an
important source of profitability and shareholder value; however, excessive
levels of interest rate risk could pose a significant threat to our earnings and
capital base. Accordingly, effective risk management that maintains interest
rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. Our interest rate risk management process seeks to ensure
that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk, we assess the existing and potential future effects of
changes in interest rates on our financial condition, including capital
adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is
commonly referred to as GAP analysis, measures the difference between the dollar
amounts of interest sensitive assets and liabilities that will be refinanced or
repriced during a given time period. A significant repricing gap could result in
a negative impact to our net interest margin during periods of changing market
interest rates. The following table depicts our GAP position as of September 30,
2003 (dollars in thousands):
25
MERCANTILE BANK CORPORATION
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------ ------ ----- ----- -----
Assets:
Commercial loans and leases (1) $ 386,634 $ 27,272 $ 424,252 $ 47,800 $ 885,958
Residential real estate loans 41,829 2,668 27,410 9,189 81,096
Consumer loans 1,164 641 3,262 70 5,137
Investment securities (2) 3,933 5,059 29,453 69,505 107,950
Federal funds sold 11,800 11,800
Short-term investments 230 230
Allowance for loan and lease losses (13,482) (13,482)
Other assets 75,194 75,194
----------- ----------- ----------- ----------- -----------
Total assets 445,590 35,640 484,377 188,276 1,153,883
Liabilities:
Interest-bearing checking 28,468 28,468
Savings 94,537 94,537
Money market accounts 9,179 9,179
Time deposits < $100,000 22,299 54,958 32,651 109,908
Time deposits $100,000 and over 124,246 302,902 142,893 570,041
Short-term borrowings 48,310 48,310
FHLB advances 15,000 20,000 35,000 70,000
Long-term borrowings 1,012 16,000 17,012
Noninterest-bearing checking 77,448 77,448
Other liabilities 6,823 6,823
----------- ----------- ----------- ----------- -----------
Total liabilities 343,051 377,860 210,544 100,271 1,031,726
Shareholders' equity 122,157 122,157
----------- ----------- ----------- ----------- -----------
Total sources of funds 343,051 377,860 210,544 222,428 1,153,883
----------- ----------- ----------- ----------- -----------
Net asset (liability) GAP $ 102,539 $ (342,220) $ 273,833 $ (34,152)
=========== =========== =========== ===========
Cumulative GAP $ 102,539 $ (239,681) $ 34,152
=========== =========== ===========
Percent of cumulative GAP to
total assets 8.9% (20.7)% 3.0%
=========== =========== ===========
(1) Floating rate loans that are currently at interest rate floors are treated
as fixed rate loans and are reflected using maturity date and not repricing
frequency.
(2) Mortgage-backed securities are categorized by average life calculations
based upon prepayment trends as of September 30, 2003.
26
MERCANTILE BANK CORPORATION
The second interest rate risk measurement we use is commonly referred to as net
interest income simulation analysis. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, serves as our primary interest rate risk measurement technique. The
simulation model assesses the direction and magnitude of variations in net
interest income resulting from potential changes in market interest rates. Key
assumptions in the model include prepayment speeds on various loan and
investment assets; cash flows and maturities of interest-sensitive assets and
liabilities; and changes in market conditions impacting loan and deposit volume
and pricing. These assumptions are inherently uncertain, subject to fluctuation
and revision in a dynamic environment; therefore, the model cannot precisely
estimate net interest income or exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes and
changes in market conditions and our strategies, among other factors.
We conducted multiple simulations as of September 30, 2003, whereby it was
assumed that a simultaneous, instant and sustained change in market interest
rates occurred. The following table reflects the suggested impact on our net
interest income over the next twelve months, which are well within our policy
parameters established to manage and monitor interest rate risk.
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
- ---------------------- ------------------- -------------------
Interest rates down 200 basis points $ (504,000) (1.5)%
Interest rates down 100 basis points 316,000 1.0
No change in interest rates 841,000 2.6
Interest rates up 100 basis points 1,657,000 5.1
Interest rates up 200 basis points 2,482,000 7.6
The increase in our net interest income under all interest rate scenarios except
the down 200 basis points scenario reflects the expected repricing of local and
out-of-area certificates of deposit during the next twelve months. Unlike
interest rates on our floating rate loans that declined since the beginning of
2001 as market interest rates began to decline, our certificates of deposit have
fixed interest rates and only reprice at maturity. Throughout the remainder of
2003 and into 2004 we have a large volume of certificates of deposit that will
mature and are expected to be refinanced at lower interest rates.
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of other variables, including the growth,
composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; economic and competitive conditions; potential
changes in lending, investing and deposit gathering strategies; client
preferences; and other factors.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2003, an evaluation was performed under the supervision of
and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures. Based on that evaluation,
our management, including our Chief Executive Officer and Chief Financial
Officer, concluded that our disclosure controls and procedures were effective as
of September 30, 2003.
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that are
incidental to our business. In our opinion, we are not a party to any current
legal proceedings that are material to our financial condition, either
individually or in the aggregate.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On February 10, 2003 we issued 7,500 shares of our common stock to two of our
executive officers upon their exercise of employee stock options issued under
our 1997 Employee Stock Option Plan. We received a weighted average exercise
price of $8.782 per share aggregating $65,865 for these shares. These shares
were substantially paid by the executive officers delivering to us common stock
of the company that they already owned having an aggregate value of $62,987,
with the difference paid in cash. On August 11, 2003 we issued 6,000 shares of
our common stock to two of our executive officers upon their exercise of
employee stock options issued under our 1997 Employee Stock Option Plan. We
received a weighted average exercise price of $8.638 per share aggregating
$51,828 for these shares. These shares were paid by the executive officers
delivering to us common stock of the company that they already owned having an
aggregate value of $43,167, with the difference paid in cash. These shares were
issued in reliance on an exemption from registration under the Securities Act of
1933 based on Section 4(2) of that Act, and Regulation D issued under that Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NO. EXHIBIT DESCRIPTION
3.1 Articles of Incorporation are incorporated by reference to Exhibit
3.1 of our Registration Statement on Form SB-2 (Commission File no.
333-33081) that became effective on October 23, 1997
3.2 Our 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
11 Statement re Computation of Per Share Earnings
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
28
(b) Reports of Form 8-K
During the third quarter of 2003, the Company furnished the following
report on Form 8-K:
i) Dated July 9, 2003, pertaining to the Company's press release
issued on July 9, 2003 reporting financial results and earnings
for its second quarter of 2003
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 13, 2003.
MERCANTILE BANK CORPORATION
By: /s/ Gerald R. Johnson, Jr.
------------------------------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Charles E. Christmas
------------------------------------------------
Charles E. Christmas
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
30
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
3.1 Articles of Incorporation are incorporated by
reference to Exhibit 3.1 of our Registration
Statement on Form SB-2 (Commission File no.
333-33081) that became effective on October 23, 1997
3.2 Our 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
11 Statement re Computation of Per Share Earnings
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification