Back to GetFilings.com
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, 2004
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 (IRS Employer Identification Number)
Incorporation or Organization)
5650 BYRON CENTER AVENUE SW,
WYOMING, MICHIGAN 49519
(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 to Section 12(g) of the Act:
COMMON STOCK
(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. [ ]
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, was approximately $239.2 million.
As of February 10, 2005, there were issued and outstanding 7,210,743 shares
of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2005 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.
Mercantile Bank Mortgage Company initiated business in October 2000 as a
subsidiary of our bank, and was reorganized as Mercantile Bank Mortgage Company,
LLC ("our mortgage company"), on January 1, 2004. On February 7, 2002,
Mercantile BIDCO, Inc. ("our BIDCO"), a 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
subsidiary of our bank, commenced operations during 2002 to offer insurance
products. Mercantile Bank Real Estate Co., L.L.C., ("our real estate company"),
a subsidiary of our bank, was organized on July 21, 2003, principally to
develop, construct and own a new facility to be constructed in downtown Grand
Rapids which will serve as our bank's new main office and Mercantile Bank
Corporation's headquarters. Mercantile Bank Capital Trust I ("the Mercantile
trust"), a business trust subsidiary, was formed in September 2004 to issue
trust preferred securities.
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, three
private placements of common stock during 2001, a public offering of common
stock in August 2001 and a public offering of common stock in September 2003. In
addition, we raised capital through a public offering of $16.0 million of trust
preferred securities in 1999, which was refinanced by a $32.0 million private
placement of trust preferred securities in 2004. 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 permitted 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 seven offices, provides commercial and retail banking
services primarily to small- to medium-sized businesses based in and around the
Grand Rapids and Holland metropolitan areas. These offices consist of a main
office located at 216 North Division Avenue, Grand Rapids, Michigan, a
combination branch and retail loan center located at 4613 Alpine Avenue,
Comstock Park, Michigan, a combination branch and operations center located at
5610 Byron Center Avenue SW, Wyoming, Michigan, branches located at 4860
Broadmoor, Kentwood, Michigan, 3156 Knapp Street NE, Grand Rapids, Michigan, and
880 16th Street, Holland, Michigan and an administration facility located at
5650 Byron Center Avenue SW, Wyoming, Michigan.
2.
Our bank makes secured and unsecured commercial, construction, mortgage and
consumer loans, and accepts checking, savings and time deposits. Our bank owns
six 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 branch
locations. Our bank does not have trust powers. In December 2001, our bank
entered into a joint brokerage services and marketing agreement with Raymond
James Financial Services, Inc. to make available to its customers financial
planning, retail brokerage, equity research, insurance and annuities, retirement
planning, trust services and estate planning.
OUR MORTGAGE COMPANY
Our mortgage company's predecessor, Mercantile Bank 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 Mercantile Bank Mortgage Company. On the same date
our bank also transferred its residential mortgage origination function to
Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile Bank Mortgage
Company was reorganized as Mercantile Bank Mortgage Company, LLC, a limited
liability company, which is 99% owned by our bank and 1% owned by our insurance
company. The reorganization had no impact on the company's financial position or
results of operations. 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 Hub International 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 Hub International 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 Hub
International. Our insurance company receives commissions based upon written
premiums produced under the Agency and Institution Agreement.
OUR REAL ESTATE COMPANY
Our real estate company was organized on July 21, 2003, principally to
develop, construct and own a new facility to be constructed in downtown Grand
Rapids which will serve as our bank's new main office and Mercantile Bank
Corporation's headquarters. Our real estate company is 99% owned by our bank and
1% owned by our insurance company.
3.
THE MERCANTILE TRUST
In 2004 we formed the Mercantile trust, a Delaware business trust.
Mercantile trust's business and affairs are conducted by its property trustee, a
Delaware trust company, and three individual administrative trustees who are
employees and officers of the company. Mercantile trust was established for the
purpose of issuing and selling its Series A and Series B trust preferred
securities and common securities, and used the proceeds from the sales of those
securities to acquire Series A and Series B Floating Rate Notes issued by the
company. Substantially all of the net proceeds received by the company from the
Series A transaction were used to redeem the trust preferred securities that had
been issued by MBWM Capital Trust I in September 1999. Substantially all of the
net proceeds received by the company from the Series B transaction were
contributed to our bank as capital. The Series A and Series B Floating Rate
Notes are categorized on our consolidated financial statements as subordinated
debentures. Additional information regarding Mercantile trust is incorporated by
reference to "Note 15 - Subordinated Debentures" and "Note 17 - Regulatory
Matters" of the Consolidated Financial Statements included in this Annual Report
on pages F-52 through F-54.
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, maintain employment, and mitigate
economic recessions. The policies of the Federal Reserve Board have a major
effect upon the levels of bank loans, investments and deposits through its open
market operations in United States government securities, and through its
regulation of, among other things, the discount rate on borrowings of member
banks and the reserve requirements against member bank deposits. Our bank
maintains reserves directly with the Federal Reserve Bank of Chicago to the
extent required by law. It is not possible to predict the nature and impact of
future changes in monetary and fiscal policies.
REGULATION AND SUPERVISION
As a bank holding company under the Bank Holding Company Act, we are
required to file an annual report with the Federal Reserve Board and such
additional information as the Federal Reserve Board may require. We are also
subject to examination by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding
companies that have not qualified as financial holding companies to banking and
the management of banking organizations, and to certain non-banking activities.
These non-banking activities include those activities that the Federal Reserve
Board found, by order or regulation as of the day prior to enactment of the
Gramm-Leach-Bliley Act, to be so closely related to banking as to be a proper
incident to banking. These non-banking activities include, among other things:
operating a mortgage company, finance company, 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
activities of our mortgage company and our BIDCO discussed above, neither we nor
any of our subsidiaries engages in any of the non-banking activities listed
above.
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 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.
4.
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 of the expanded activities.
Our bank is subject to restrictions imposed by federal law and regulation.
Among other things, 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 or bank holding company, if, after
the acquisition, we would own or control more than 5% of the voting shares of
the bank or bank holding company. Acquisitions of banking organizations across
state lines are subject to certain restrictions imposed by Federal and state law
and regulations.
EMPLOYEES
As of December 31, 2004, we and our bank employed 164 full-time and 45
part-time persons. Management believes that relations with employees are good.
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 for 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.
5.
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 $2.0 million,
and $7.5 million for our bank's Chairman of the Board and its President and
Chief Executive Officer; however, the $7.5 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 $4.0 million, up to the legal lending limit of
approximately $33.6 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 15 lenders, with almost 220 years of combined commercial lending
experience, ten of whom have 15 years or more 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. Commercial loans and leases typically have an interest rate that is
fixed to maturity or is tied to the national prime rate.
We evaluate many aspects of a commercial loan 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 loans, and no material loans to energy
producing customers. We have only limited exposure to companies engaged in
agricultural-related activities.
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.
6.
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, virtually 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.
Our independent loan and lease 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. 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. Our watch list credits are reviewed monthly by our Watch List
Committee, which is comprised of personnel from the administration, lending and
loan and lease review functions.
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. As of December 31, 2004, loans and leases placed in nonaccrual status
totaled $2.8 million, or 0.22% of total loans. As of the same date there were no
loans and leases past due 90 days or more and still accruing interest. As of
December 31, 2004, there were no other significant loans and leases where known
information about credit problems of borrowers warranted the placing of the
loans or leases in a nonaccrual status. 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-42 and F-43 included in this Annual Report.
7.
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 almost 20 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-42 and F-43 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.
INVESTMENTS
Bank Holding Company Investments. The principle investment of our bank
holding company are the investments in the common stock of our bank and the
common securities of Mercantile trust. Other funds of our bank holding company
may be invested from time to time in various debt instruments.
As a bank holding company, we are also permitted to make portfolio
investments in equity securities and to make equity investments in subsidiaries
engaged in a variety of non-banking activities, which include real
estate-related activities such as 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. In
addition, our bank holding company's qualification as a financial holding
company enables us to make equity investments in companies engaged in a broader
range of financial activities than we could do without that qualification. Such
expanded activities include 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. Our bank holding
company has no plans at this time to make directly any of these equity
investments at the bank holding company level. Our Board of Directors may,
however, alter the investment policy at any time without shareholder approval.
8.
In addition, so long as our bank holding company is qualified as a
financial holding company, it would be permitted, as part of the business of
underwriting or merchant banking activity and under certain circumstances and
procedures, to invest in shares or other ownership interests in, or assets of,
companies engaged in non-financial activities. In order to make those
investments, our bank holding company would be required (i) to become, or to
have an affiliate that is, a registered securities broker or dealer or a
registered municipal securities dealer, or (ii) to control both an insurance
company engaged in underwriting insurance (other than credit insurance) or
issuing annuities, and a registered investment adviser that furnishes investment
advice to an insurance company. We do not currently have any securities,
insurance, or investment advisory affiliates of the required types, nor does our
bank holding company have any current plans to make any of the equity
investments described in this paragraph.
Our Bank's Investments. 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 the equity investments permitted for
our bank under various conditions and subject in some instances to amount
limitations, are shares of a subsidiary insurance agency, mortgage company, real
estate company, or Michigan business and industrial development company, such as
our insurance company, our mortgage company, our real estate company, or our
BIDCO. Under another such exception, in certain circumstances and with prior
notice to or 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 bank's 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-39
through F-41 included in this Annual Report.
COMPETITION
Our primary market area for loans and core deposits is 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 with 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 larger 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.
9.
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. We do not intend the address of our website to be an active
link or to otherwise incorporate the contents of our website into this Annual
Report.
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, Grand Rapids, Michigan.
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 are 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 which 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 company's and bank's
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 2003 our bank designed and constructed 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 is one story, of masonry construction, and has
approximately 3,500 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 3156 Knapp Street NE, Grand Rapids, Michigan.
10.
During 2003 our bank designed and started construction of a new four-story
facility located approximately two miles north from the center of downtown Grand
Rapids. 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 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, as well as the company's and bank's
administration function currently located in Wyoming, Michigan. The facility
will consist of approximately 55,000 square feet of usable space and contain
multiple drive-through lanes with ample parking. The address of this facility is
310 Leonard Street NW, Grand Rapids, Michigan. Completion date for this facility
is expected during the second quarter of 2005.
During 2003 our bank designed and started construction of a new two-story
facility located in Holland, Michigan. This facility, which was completed during
the fourth quarter of 2004, serves as a full service banking center for the
Holland area, including commercial lending, retail lending and a full service
branch. The facility consists of approximately 30,000 square feet of usable
space and contains multiple drive-through lanes with ample parking. The address
of this facility is 880 East 16th Street, Holland, 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
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the Nasdaq National Market under the symbol
"MBWM". At February 1, 2005, there were 255 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.
11.
The following table shows the high and low bid prices for our common stock
as reported by the Nasdaq National Market for the periods indicated, and the
quarterly cash dividends paid by us during those periods. The prices do not
include retail mark-up, mark-down or commission, but have been adjusted for the
5% stock dividends paid on May 3, 2004 and February 3, 2003.
HIGH LOW DIVIDEND
------ ------ --------
2004
First Quarter ..................................... $38.77 $32.97 $0.09
Second Quarter .................................... 37.28 31.55 0.09
Third Quarter ..................................... 36.05 32.82 0.09
Fourth Quarter .................................... 44.00 34.51 0.09
2003
First Quarter ..................................... $25.32 $20.78 $0.08
Second Quarter .................................... 27.38 22.66 0.08
Third Quarter ..................................... 32.59 26.65 0.08
Fourth Quarter .................................... 35.44 29.97 0.08
Holders of our common stock are entitled to receive dividends that the
Board of Directors may declare from time to time. We may only pay dividends out
of funds that are legally available for that purpose. 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 subordinated
debentures, we would be precluded from paying dividends on our common stock if
an event of default has occurred and is continuing under the subordinated
debentures, or if we exercised our right to defer payments of interest on the
subordinated debentures, until the deferral ended.
On January 11, 2005, we declared a $0.10 per share cash dividend on our
common stock, payable on March 10, 2005 to record holders as of February 10,
2005. We currently expect to continue to pay a quarterly cash dividend, although
there can be no assurance that we will continue to do so.
On October 12, 2004, we issued 15,000 shares of our common stock to one of
our employees upon their exercise of employee stock options issued under our
1997 Employee Stock Option Plan. We received a weighted average exercise price
of $8.227 per share aggregating $123,405.00. The exercise price for these shares
was substantially paid by the employee delivering to us common stock of the
company that he already owned having an aggregate value of $123,388.40, with the
difference paid in cash. Also on October 12, 2004, we issued 1,000 shares of our
common stock to another one of our employees upon their exercise of employee
stock options issued under our 1997 Employee Stock Option Plan. We received a
weighted average exercise price of $8.227 per share aggregating $8,227.00. The
exercise price for these shares was substantially paid by the employee
delivering to us common stock of the company that he already owned having an
aggregate value of $8,190.67, with the difference paid in cash. On October 13,
2004, we issued 1,000 shares of our common stock to one of our employees upon
their exercise of employee stock options issued under our 1997 Employee Stock
Option Plan. We received a weighted average exercise price of $8.227 per share
aggregating $8,227.00. The exercise price for these shares was substantially
paid by the employee delivering to us common stock of the company that he
already owned having an aggregate value of $8,195.01, with the difference paid
in cash. The shares issued under the 1997 Employee Stock Option Plan 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.
12.
Issuer Purchases of Equity Securities
(c) Total Number of
(a) Total Shares Purchased as (d) Maximum Number of
Number of (b) Average Part of Publicly Shares that May Yet Be
Shares Price Paid Per Announced Plans or Purchased Under the
Period Purchased Share Programs Plans or Programs
- ------ --------- -------------- ------------------- ----------------------
October 1 - 31 3,703 $37.746 0 0
November 1 - 30 0 N/A 0 0
December 1 - 31 0 N/A 0 0
Total 3,703 $37.746 0 0
The shares shown in column (a) above as having been purchased were acquired from
three of our employees when they used shares of common stock that they already
owned to pay part of the exercise price when exercising stock options issued
under our employee stock option plans.
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-25 in this
Annual Report is incorporated here by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the heading "Market Risk Analysis" on pages F-22
through F-25 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 Reports of Independent Registered Public Accounting Firm on
pages F-26 through F-56 in this Annual Report are incorporated here by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
13.
ITEM 9A. CONTROLS AND PROCEDURES
As of December 31, 2004, 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, 2004. There have been no significant changes in our internal
controls over financial reporting during the quarter ended December 31, 2004,
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f). Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
we conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in Internal Control -
Integrated Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2004. Our management's
assessment of the effectiveness of our internal control over financial reporting
as of December 31, 2004 has been audited by Crowe Chizek and Company LLC, an
independent registered public accounting firm, as stated in their report which
is included herein.
ITEM 9B. OTHER INFORMATION
On October 28, 2004, the Board of Directors of our bank approved the bank's
non-lender bonus plan for 2005. Under the plan, non-lender officers and other
non-lender employees of our bank may receive bonuses for 2005 up to a specified
percentage of their annual base salary. For our Chairman and Chief Executive
Officer, and our President and Chief Operating Officer, the percentage is 50%.
For our Executive Vice President and Secretary, and our Senior Vice President,
Chief Financial Officer and Treasurer, the percentage is 45%. It is anticipated
that for bonuses under the plan, they will be payable only to the extent that
after taking into account all of the payments under the plan, our after tax net
operating income for 2005 would equal or exceed 120% of the prior year's after
tax net income. A copy of the plan is included as an exhibit to this Annual
Report.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information presented under the captions "Information about Directors,
Nominees and Executive Officers" and "Section 16(a) Beneficial Ownership
Compliance" in the definitive Proxy Statement of Mercantile for its April 28,
2005 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.
We have a separately-designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934. The
members of the Audit Committee consist of Betty S. Burton, David M. Cassard, C.
John Gill, David M. Hecht Calvin D. Murdock and Merle J. Prins. The Board of
Directors has determined that Mr. Cassard, a member of the Audit Committee, is
qualified as an audit committee financial expert, as that term is defined in the
rules of the Securities and Exchange Commission. Mr. Cassard is independent, as
independence for audit committee members is defined in the listing standards of
the Nasdaq Stock Market and the rules of the Securities and Exchange Commission.
14.
We have adopted a Code of Ethics that applies to all of our directors,
officers and employees, including our principal executive officer, principal
financial officer, principal accounting officer or controller, and persons
performing similar functions. The Code of Ethics is posted on our website
(www.mercbank.com). We intend to post amendments to or waivers from our Code of
Ethics, of the type referred to in Item 5.05 of Form 8-K, to the extent
applicable to our principal executive officer, principal financial officer,
principal accounting officer or controller, and persons performing similar
functions, on our website.
ITEM 11. EXECUTIVE COMPENSATION
The information presented under the captions "Director Compensation,"
"Compensation Committee Interlocks and Insider Participation," "Summary
Compensation Table," "Option Grants in 2004," "Aggregated Stock Option Exercises
in 2004 and Year End Option Values" and "Employment Agreements", in the Proxy
Statement is incorporated here by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information presented under the caption "Stock Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is incorporated here by
reference.
The following table summarizes information, as of December 31, 2004,
relating to compensation plans under which equity securities are authorized for
issuance.
Number of securities
remaining available for
Number of securities to Weighted average exercise future issuance under
be issued upon exercise price of outstanding equity compensation plans
of outstanding options, options, warrants and (excluding securities
Plan Category warrants and rights rights reflected in column (a))
- ------------- ----------------------- ------------------------- -------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders (1) 281,822 $19.60 262,994
Equity compensation plans
not approved by security
holders 0 0 0
Total 281,822 $19.60 262,994
(1) These plans are Mercantile's 1997 Employee Stock Option Plan, 2000 Employee
Stock Option Plan, 2004 Employee Stock Option Plan and Independent Director
Stock Option Plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information presented under the caption "Certain Transactions" in the
Proxy Statement is incorporated here by reference.
15.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information presented under the caption "Fees to Independent Auditors
for 2004 and 2003" in the Proxy Statement is incorporated here by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements. The following financial statements and reports of
independent registered public accounting firm of Mercantile Bank Corporation and
its subsidiaries are filed as part of this report:
Reports of Independent Registered Public Accounting Firm dated February 26,
2005
Consolidated Balance Sheets --- December 31, 2004 and 2003
Consolidated Statements of Income for each of the three years in the period
ended December 31, 2004
Consolidated Statements of Changes in Shareholders' Equity for each of the
three years in the period ended December 31, 2004
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2004
Notes to Consolidated Financial Statements
The financial statements, the notes to financial statements, and the
reports of independent registered public accounting firm listed above are
incorporated by reference in Item 8 of this report.
(2) Financial Statement Schedules
Not applicable
(b) Exhibits:
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Our Articles of Incorporation are incorporated by reference to
exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2004
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 *
10.2 Our 2000 Employee Stock Option Plan is incorporated by reference
to exhibit 10.14 of our Form 10-K for the year ended December 31,
2000 *
10.3 Our 2004 Employee Stock Option Plan is incorporated by reference
to exhibit 10.1 of our Form 10-Q for the quarter ended September
30, 2004 *
16.
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
10.4 Form of Stock Option Agreement for options under the 2004 Employee
Stock Option Plan is incorporated by reference to exhibit 10.2 of
our Form 10-Q for the quarter ended September 30, 2004 *
10.5 Our Independent Director Stock Option Plan is incorporated by
reference to exhibit 10.26 of our Form 10-K for the year ended
December 31, 2002 *
10.6 Form of Stock Option Agreement for options under the Independent
Director Stock Option Plan is incorporated by reference to exhibit
10.1 of our Form 8-K dated October 21, 2004 *
10.7 Nonlender Bonus Plan is incorporated by reference to exhibit 10.3
of our Form 10-Q for the quarter ended September 30, 2004 *
10.8 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 *
10.9 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
10.10 Agreement between Fiserv 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
10.11 Extension Agreement of Data Processing Contract between Fiserv
Solutions, Inc. and our bank dated May 12, 2000 extending the
agreement between Fiserv Solutions, Inc. and our bank dated
September 10, 1997, is incorporated by reference to exhibit 10.15
of our Form 10-K for the year ended December 31, 2000
10.12 Extension Agreement of Data Processing Contract between Fiserv
Solutions, Inc. and our bank dated November 22, 2002 extending the
agreement between Fiserv Solutions, Inc. and our bank dated
September 10, 1997, is incorporated by reference to exhibit 10.5
of our Form 10-K for the year ended December 31, 2002
10.13 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 year ended December 31, 2001 *
10.14 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 year ended December 31, 2001 *
10.15 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 year ended
December 31, 2001 *
17.
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
10.16 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 year ended
December 31, 2001 *
10.17 Amendment to Employment Agreement dated as of October 17, 2002,
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 year ended December 31, 2002 *
10.18 Amendment to Employment Agreement dated as of October 17, 2002,
among the company, our bank and Michael H. Price, is incorporated
by reference to exhibit 10.22 of our Form 10-K for the year ended
December 31, 2002 *
10.19 Amendment to Employment Agreement dated as of October 17, 2002,
among the company, our bank and Robert B. Kaminski, is
incorporated by reference to exhibit 10.23 of our Form 10-K for
the year ended December 31, 2002 *
10.20 Amendment to Employment Agreement dated as of October 17, 2002,
among the company, our bank and Charles E. Christmas, is
incorporated by reference to exhibit 10.24 of our Form 10-K for
the year ended December 31, 2002 *
10.21 Amendment to Employment Agreement dated as of October 28, 2004,
among the company, our bank and Robert B. Kaminski *
10.22 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, is
incorporated by reference to exhibit 10.25 of our Form 10-K for
the year ended December 31, 2002
10.23 Agreement between our real estate company and Visser Brothers,
Inc. dated November 20, 2003, on Standard Form of Agreement
Between Owner and Contractor where the basis of payment is a
stipulated sum is incorporated by reference to exhibit 10.22 of
our Form 10-K for the year ended December 31, 2003
10.24 Agreement between our bank and Rockford Construction Company,
Inc., dated December 3, 2003, on Standard Form of Agreement
Between Owner and Contractor where the basis of payment is a
stipulated sum is incorporated by reference to exhibit 10.23 of
our Form 10-K for the year ended December 31, 2003
10.25 Junior Subordinated Indenture between us and Wilmington Trust
Company dated September 16, 2004 providing for the issuance of the
Series A and Series B Floating Rate Junior Subordinated Notes due
2034 is incorporated by reference to exhibit 10.1 of our Form 8-K
dated December 15, 2004
10.26 Amended and Restated Trust Agreement dated September 16, 2004 for
Mercantile Bank Capital Trust I is incorporated by reference to
exhibit 10.2 of our Form 8-K dated December 15, 2004
10.27 Placement Agreement between us, Mercantile Bank Capital Trust I,
and SunTrust Capital Markets, Inc. dated September 16, 2004 is
incorporated by reference to exhibit 10.3 of our Form 8-K dated
December 15, 2004
18.
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
10.28 Guarantee Agreement dated September 16, 2004 between Mercantile as
Guarantor and Wilmington Trust Company as Guarantee Trustee is
incorporated by reference to exhibit 10.4 of our Form 8-K dated
December 15, 2004
21 Subsidiaries of the company
23 Consent of Independent Registered Public Accounting Firm
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
* - Management contract or compensatory plan
(c) Financial Statements Not Included In Annual Report
Not applicable
19.
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
F-1
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
CONTENTS
SELECTED FINANCIAL DATA.................................................. F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS..................................... F-4
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM................. F-26
REPORT BY MERCANTILE BANK CORPORATION'S MANAGEMENT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING...................................... F-28
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS........................................... F-29
CONSOLIDATED STATEMENTS OF INCOME..................................... F-30
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY............ F-31
CONSOLIDATED STATEMENTS OF CASH FLOWS................................. F-33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............................ F-34
F-2
SELECTED FINANCIAL DATA
2004 2003 2002 2001 2000
---------- ---------- -------- -------- --------
(In thousands except per share data)
CONSOLIDATED RESULTS OF OPERATIONS:
Interest income $ 69,022 $ 54,658 $ 47,632 $ 44,619 $ 36,835
Interest expense 26,595 23,395 24,026 28,249 24,608
---------- ---------- -------- -------- --------
Net interest income 42,427 31,263 23,606 16,370 12,227
Provision for loan and lease losses 4,674 3,800 3,002 2,370 1,854
Noninterest income 4,302 4,409 3,101 1,927 1,240
Noninterest expense 23,198 18,071 12,781 9,454 7,515
---------- ---------- -------- -------- --------
Income before income tax expense 18,857 13,801 10,924 6,473 4,098
Income tax expense 5,136 3,785 3,167 1,990 1,303
---------- ---------- -------- -------- --------
Net income $ 13,721 $ 10,016 $ 7,757 $ 4,483 $ 2,795
========== ========== ======== ======== ========
CONSOLIDATED BALANCE SHEET DATA:
Total assets $1,536,119 $1,203,337 $922,360 $699,187 $513,251
Cash and cash equivalents 20,811 16,564 28,117 19,938 18,102
Securities 152,965 121,510 96,893 78,818 60,457
Loans and leases, net of deferred fees 1,317,124 1,035,963 771,554 587,248 429,804
Allowance for loan and lease losses 17,819 14,379 10,890 8,494 6,302
Bank owned life insurance policies 23,750 16,441 14,876 3,991 0
Deposits 1,159,181 902,892 754,113 569,077 425,740
Securities sold under agreements to repurchase 56,317 49,545 50,335 36,485 32,151
Federal Home Loan Bank advances 120,000 90,000 15,000 0 0
Subordinated debentures 32,990 16,495 16,495 16,495 16,495
Shareholders' equity 141,617 130,201 79,834 71,463 31,854
CONSOLIDATED FINANCIAL RATIOS:
Return on average assets 0.99% 0.96% 0.97% 0.74% 0.63%
Return on average shareholders' equity 10.16% 10.61% 10.30% 9.05% 9.48%
Average shareholders' equity to average assets 9.79% 9.00% 9.45% 8.21% 6.63%
Nonperforming loans and leases to loans and leases 0.22% 0.17% 0.10% 0.24% 0.02%
Allowance for loan and lease losses to loans 1.35% 1.39% 1.41% 1.45% 1.47%
Tier 1 leverage capital 11.53% 12.49% 10.72% 13.00% 8.59%
Tier 1 leverage risk-based capital 11.82% 12.60% 10.85% 13.00% 8.59%
Total risk-based capital 13.03% 13.84% 12.10% 14.25% 10.97%
PER SHARE DATA:
Net Income:
Basic $ 1.91 $ 1.65 $ 1.36 $ 1.05 $ 0.93
Diluted 1.87 1.61 1.34 1.04 0.92
Book value at end of period 19.69 18.17 14.03 12.56 10.55
Dividends declared 0.36 0.32 NA NA NA
Dividend payout ratio 18.60% 18.41% NA NA NA
NA - Not Applicable
F-3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion and other portions of this Annual Report contain
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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Management's Discussion and Analysis of financial condition and results of
operations are based on Mercantile Bank Corporation's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. Material
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for loan and lease losses, and
actual results could differ from those estimates.
The allowance for loan and lease losses is maintained at a level we believe is
adequate to absorb probable losses identified and inherent in the loan and lease
portfolio. Our evaluation of the adequacy of the allowance for loan and lease
losses is an estimate based on reviews of individual loans, assessments of the
impact of current and anticipated economic conditions on the portfolio, and
historical loss experience. The allowance for loan and leases losses represents
management's best estimate, but significant downturns in circumstances relating
to loan and lease quality or economic conditions could result in a requirement
for an increased allowance for loan and lease losses in the near future.
Likewise, an upturn in loan and lease quality or improved economic conditions
may result in a decline in the required allowance for loan and lease losses. In
either instance unanticipated changes could have a significant impact on
operating earnings.
The allowance for loan and lease losses is increased through a provision charged
to operating expense. Uncollectible loans and leases are charged-off through the
allowance for loan and lease losses. Recoveries of loans and leases previously
charged-off are added to the allowance for loan and lease losses. A loan is
considered impaired when it is probable that contractual interest and principal
payments will not be collected either for the amounts or by the dates as
scheduled in the loan agreement. Our policy for recognizing income on impaired
loans is to accrue interest unless a loan is placed on nonaccrual status.
F-4
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 consolidated subsidiary, Mercantile Bank
of West Michigan ("our bank"), and of Mercantile Bank Mortgage Company, LLC
("our mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO"), Mercantile Bank
Real Estate Co., L.L.C. ("our real estate company") and Mercantile Insurance
Center, Inc. (our insurance company"), 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.
Mercantile Bank Capital Trust I ("the Mercantile trust"), a business trust
established by the company, was incorporated in 2004 for the purpose of issuing
Series A and Series B Preferred Securities. On September 16, 2004, the
Mercantile trust sold the Series A Preferred Securities in a private sale for
$16.0 million, and also sold $495,000 of Series A Common Securities to
Mercantile Bank Corporation. The proceeds of the Series A Preferred Securities
and the Series A Common Securities were used by the Mercantile trust to purchase
$16,495,000 of Series A Floating Rate Notes that were issued by Mercantile Bank
Corporation on September 16, 2004. Mercantile Bank Corporation used the proceeds
of the Series A Floating Rate Notes to finance the redemption on September 17,
2004 of the $16.0 million of 9.60% Cumulative Preferred Securities issued in
1999 by MBWM Capital Trust I. On December 10, 2004, the Mercantile trust sold
the Series B Preferred Securities in a private sale for $16.0 million, and also
sold $495,000 of Series B Common Securities to Mercantile Bank Corporation. The
proceeds of the Series B Preferred Securities and the Series B Common Securities
were used by the Mercantile trust to purchase $16,495,000 of Series B Floating
Rate Notes that were issued by Mercantile Bank Corporation on December 10, 2004.
Substantially all of the net proceeds of the Series B Floating Rate Notes were
contributed to our bank as capital to provide support for asset growth, fund
investments in loans and securities and for general corporate purposes.
The only significant assets of the Mercantile trust are the Series A and Series
B Floating Rate Notes, and the only significant liabilities of the Mercantile
trust are the Series A and Series B Preferred Securities. The Series A and
Series B Floating Rate Notes are categorized on the company's consolidated
balance sheet as subordinated debentures and the interest expense is recorded on
the company's consolidated statement of income under interest expense on
long-term borrowings.
Our mortgage company's predecessor, Mercantile Bank Mortgage Company, was formed
to increase the profitability and efficiency of the company's mortgage loan
operations. Mercantile Bank Mortgage Company 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. On
the same date our bank had also transferred its residential mortgage origination
function to Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile
Bank Mortgage Company was reorganized as Mercantile Bank Mortgage Company, LLC,
a limited liability 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.
F-5
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 Hub International 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 Hub International 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 Hub
International. Our insurance company receives commissions based upon written
premiums produced under the Agency and Institution Agreement.
Our real estate company was organized on July 21, 2003, principally to develop,
construct and own a new facility to be constructed in downtown Grand Rapids
which will serve as our bank's new main office and Mercantile Bank Corporation's
headquarters.
FINANCIAL CONDITION
We continued to experience significant asset growth during 2004. Assets
increased from $1,203.3 million on December 31, 2003 to $1,536.1 million on
December 31, 2004. This represents an increase in total assets of $332.8
million, or 27.7%. The increase in total assets was primarily comprised of a
$277.7 million increase in net loans and a $31.5 million increase in securities.
The increase in assets was primarily funded by a $256.3 million increase in
deposits, a $30.0 million increase in Federal Home Loan Bank advances, a $16.5
million increase in subordinated debentures and a $11.4 million increase in
shareholder's equity.
EARNING ASSETS
Average earning assets equaled 95.3% of average total assets during 2004,
compared to 95.2% during 2003. Although we experienced significant asset growth
during 2004, 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 and lease portfolio, which equaled 89.6% of average earnings assets
during 2004, is primarily comprised of commercial loans and leases. Constituting
90.3% of average loans and leases and growing by $250.7 million during 2004, the
commercial loan and lease portfolio represent loans to businesses generally
located within our market area. Approximately 69% of the commercial loan and
lease 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 and lease portfolio in commercial loans and leases and the rapid growth
of this portion of our lending business are 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 15 commercial lenders have over 220 years of combined
commercial lending experience, ten of whom have 15 years or more experience. Of
each of the loan categories that we originate, commercial loans and leases are
most efficiently originated and managed, thus limiting overhead costs by
necessitating the attention of fewer full-time employees. Our commercial lending
business generates the greatest amount of local deposits and is virtually our
only source of significant demand deposits.
Residential mortgage and consumer lending, while averaging only 9.7% of average
loans during 2004, also experienced strong 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, 2004, according to scheduled repayments of principal on fixed rate
loans and repricing frequency on variable rate loans. 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.
F-6
0-1 1-5 After 5
Year Years Years Total
------------ ------------ ----------- --------------
Construction and land development $117,910,000 $ 17,898,000 $ 897,000 $ 136,705,000
Real estate - secured by 1-4 family
properties 78,370,000 31,274,000 12,991,000 122,635,000
Real estate - secured by multi-family
properties 25,725,000 9,458,000 0 35,183,000
Real estate - secured by
nonresidential properties 440,121,000 189,044,000 20,250,000 649,415,000
Commercial 321,821,000 40,321,000 3,473,000 365,615,000
Leases 367,000 2,206,000 0 2,573,000
Consumer 1,770,000 3,174,000 54,000 4,998,000
------------ ------------ ----------- --------------
$986,084,000 $293,375,000 $37,665,000 $1,317,124,000
============ ============ =========== ==============
Fixed rate loans $ 31,489,000 $292,319,000 $37,665,000 $ 361,473,000
Floating rate loans 954,595,000 1,056,000 0 955,651,000
------------ ------------ ----------- --------------
$986,084,000 $293,375,000 $37,665,000 $1,317,124,000
============ ============ =========== ==============
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 2004. As of
December 31, 2004, past due and nonaccrual loans and leases totaled $2.8
million, or 0.22% of total loans and leases. At December 31, 2003, past due and
nonaccrual loans totaled $1.8 million, or 0.17% of total loans. Net loan and
lease charge-offs during 2004 totaled $1.2 million, or 0.10% of average total
loans and leases. During 2003 net loan and lease charge-offs totaled $311,000,
or 0.04% of average total loans and leases. Over 98% of the loan portfolio
consists of loans extended directly to companies or individuals doing business
and residing within our market area. The remaining portion is comprised of
commercial loans participated with certain unaffiliated commercial banks outside
the immediate area, which are underwritten using the same loan criteria as
though our bank was the originating bank.
The following table summarizes nonperforming loans and troubled debt
restructurings.
December 31,2004 December 31, 2003 December 31, 2002 December 31, 2001 December 31, 2000
---------------- ----------------- ----------------- ----------------- -----------------
Loans on nonaccrual
status $2,842,000 $ 233,000 $796,000 $382,000 $95,000
Loans 90 days or more
past due and accruing
interest 0 1,552,000 0 0 0
Troubled debt
restructurings 0 0 0 0 0
---------- ---------- -------- -------- -------
Total $2,842,000 $1,785,000 $796,000 $382,000 $95,000
========== ========== ======== ======== =======
F-7
The following table summarizes changes in the allowance for loan and lease
losses for the past five years.
2004 2003 2002 2001 2000
-------------- -------------- ------------ ------------ ------------
Loan and leases outstanding at year-end $1,317,124,000 $1,035,963,000 $771,554,000 $587,248,000 $429,804,000
============== ============== ============ ============ ============
Daily average balance of loans and
leases outstanding $1,177,568,000 $ 887,512,000 $669,781,000 $500,965,000 $372,428,000
============== ============== ============ ============ ============
Balance of allowance at beginning of year $ 14,379,000 $ 10,890,000 $ 8,494,000 $ 6,302,000 $ 4,620,000
Loans and leases charged-off:
Commercial, financial and agricultural (1,328,000) (471,000) (696,000) (247,000) (147,000)
Construction and land development 0 0 0 0 0
Leases 0 0 0 0 0
Residential real estate (16,000) (26,000) 0 (4,000) 0
Instalment loans to individuals (61,000) (99,000) (10,000) (1,000) (38,000)
-------------- -------------- ------------ ------------ ------------
Total loans and leases charged-off (1,405,000) (596,000) (706,000) (252,000) (185,000)
Recoveries of previously charged-off
loans and leases:
Commercial, financial and agricultural 150,000 257,000 78,000 73,000 13,000
Construction and land development 0 0 0 0 0
Leases 0 0 0 0 0
Residential real estate 0 78,000 4,000 0 0
Instalment loans to individuals 21,000 6,000 18,000 1,000 0
-------------- -------------- ------------ ------------ ------------
Total recoveries 171,000 285,000 100,000 74,000 13,000
-------------- -------------- ------------ ------------ ------------
Net charge-offs (1,234,000) (311,000) (606,000) (178,000) (172,000)
Provision for loan and leases losses 4,674,000 3,800,000 3,002,000 2,370,000 1,854,000
-------------- -------------- ------------ ------------ ------------
Balance of allowance at year-end $ 17,819,000 $ 14,379,000 $ 10,890,000 $ 8,494,000 $ 6,302,000
============== ============== ============ ============ ============
Ratio of net charge-offs during the
period to average loans and leases
outstanding during the period (0.10%) (0.04%) (0.09%) (0.04%) (0.05%)
============== ============== ============ ============ ============
Ratio of allowance to loans and leases
outstanding at end of the period 1.35% 1.39% 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 and lease
portfolio, third party analysis of the loan and lease administration processes
and portfolio and general economic conditions. In addition, the rapid commercial
loan and lease growth is taken into account.
The Reserve Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan and lease
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 almost 20 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-8
The following table illustrates the breakdown of the allowance balance to loan
type (dollars in thousands) and of the total loan and lease portfolio (in
percentages).
December 31, 2004 December 31, 2003 December 31, 2002 December 31, 2001 December 31, 2000
------------------- ------------------- ------------------- ------------------ ------------------
Loan Loan Loan Loan Loan
Amount Portfolio Amount Portfolio Amount Portfolio Amount Portfolio Amount Portfolio
------- --------- ------- --------- ------- --------- ------ --------- ------ ---------
Commercial,
financial and
agricultural $15,457 79.8% $12,220 79.0% $ 9,188 77.9% $7,172 81.0% $5,259 81.6%
Construction and
land development 1,581 10.3 1,571 11.4 1,143 13.5 785 10.7 580 9.0
Leases 39 0.2 26 0.2 11 0.1 0 NA 0 NA
Residential real
estate 557 9.3 450 8.9 443 7.9 453 7.2 369 7.8
Instalment loans
to individuals 185 0.4 112 0.5 105 0.6 84 1.1 94 1.6
Unallocated 0 NA 0 NA 0 NA 0 NA 0 NA
------- ----- ------- ----- ------- ----- ------ ----- ------ -----
Total $17,819 100.0% $14,379 100.0% $10,890 100.0% $8,494 100.0% $6,302 100.0%
======= ===== ======= ===== ======= ===== ====== ===== ====== =====
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 2004,
increasing from $121.5 million on December 31, 2003 to $153.0 million at
December 31, 2004. During 2004, the securities portfolio equaled 9.9% 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, 2004, the portfolio was comprised of high
credit quality U.S. Government Agency issued bonds (37%), municipal general
obligation and revenue bonds (34%), U.S. Government Agency issued and guaranteed
mortgage-backed securities (25%) and Federal Home Loan Bank stock (4%).
F-9
The following table reflects the composition of the securities portfolio.
December 31, 2004 December 31, 2003 December 31, 2002
------------------------- ------------------------- ------------------------
Carrying Carrying Carrying
Value Percentage Value Percentage Value Percentage
------------ ---------- ------------ ---------- ----------- ----------
U.S. Government
agency debt obligations $ 56,025,000 38.3% $ 34,078,000 29.2% $16,338,000 17.0%
Mortgage-backed securities 37,801,000 25.9 37,343,000 32.1 43,276,000 45.0
Municipal general
obligations 45,063,000 30.8 38,594,000 33.1 29,578,000 30.8
Municipal revenue bonds 7,278,000 5.0 6,518,000 5.6 6,915,000 7.2
------------ ----- ------------ ----- ----------- -----
Total $146,167,000 100.0% $116,533,000 100.0% $96,107,000 100.0%
All securities, with the exception of tax-exempt municipal bonds, have been
designated as "available for sale" as defined in Financial Accounting Standards
Board Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Securities designated as available for sale are stated at
fair value, with the unrealized gains and losses, net of income tax, reported as
a separate component of shareholders' equity in accumulated other comprehensive
income. The fair value of securities designated as available for sale at
December 31, 2004 and 2003 was $93.8 million and $71.4 million, respectively.
The net unrealized gain recorded at December 31, 2004 and 2003, was $0.2 million
and $0.3 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, 2004 and 2003, held to maturity securities
had an amortized cost of $52.3 million and $45.1 million and a fair value of
$54.6 million and $47.1 million, respectively.
The following table shows by class of maturities as of December 31, 2004, 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 56,025,000 5.04%
Over ten years 0 NA
------------ ----
56,025,000 5.04
Obligations of states and political subdivisions
One year or less 906,000 6.89
Over one through five years 4,947,000 6.88
Over five through ten years 9,771,000 6.79
Over ten years 36,717,000 6.67
------------ ----
52,341,000 6.72
Mortgage-backed securities 37,801,000 4.75
------------ ----
$146,167,000 5.57%
============ ====
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent
basis.
F-10
Federal funds sold, consisting of excess funds sold overnight to correspondent
banks, are used to manage daily liquidity needs and interest rate sensitivity.
During 2004, the average balance of these funds equaled 0.5% of average earning
assets. This level is well within our internal policy guidelines and is not
expected to change significantly in the near future.
Cash and cash equivalents increased from $16.6 million at December 31, 2003, to
$20.8 million on December 31, 2004, an increase of $4.2 million. The increase
was primarily the result of larger amounts of deposits made by our deposit
customers on the last day of 2004 when compared to the last day of 2003. Our
commercial lending and wholesale funding focus results in relatively large
day-to-day fluctuations of our cash and cash equivalent balances; however,
relative to our asset size the balances are generally stable. Cash and cash
equivalent balances averaged $38.1 million, or 2.8% of average assets during
2004, compared to $28.7 million, or 2.7% of average assets, during 2003.
Net premises and equipment increased from $15.3 million at December 31, 2003, to
$24.6 million on December 31, 2004, an increase of $9.3 million. The increase
primarily reflects the land purchase and construction costs associated with our
new banking facility in Holland, and the land purchase and initial construction
costs associated with our planned new main office in downtown Grand Rapids.
SOURCE OF FUNDS
Our major source of funds is from deposits and Federal Home Loan Bank ("FHLB")
advances. Total deposits increased from $902.9 million at December 31, 2003, to
$1,159.2 million on December 31, 2004, an increase of $256.3 million, or 28.4%.
Included within these numbers is the success we achieved in generating deposit
growth from customers located within the market area during 2004. Local deposits
increased from $311.3 million at December 31, 2003, to $388.0 million on
December 31, 2004, an increase of $76.7 million, or 24.7%. 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 and FHLB advances. Out-of-area deposits increased from $591.6
million at December 31, 2003, to $771.2 million on December 31, 2004, an
increase of $179.6 million, or 30.3%. FHLB advances increased from $90.0 million
at December 31, 2003, to $120.0 million on December 31, 2004, an increase of
$30.0 million. At December 31, 2004, local deposits and securities sold under
agreements to repurchase ("repurchase agreements") equaled 32.9% of funding
liabilities, compared to 34.4% on December 31, 2003.
During 2004 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 $30.8 million, or 25.9%. Leading the growth was noninterest-bearing
demand accounts. Comprised primarily of business loan customers,
noninterest-bearing demand accounts grew $25.2 million, or 32.9%, and equaled
7.3% of average total liabilities during 2004. Interest-bearing checking
accounts increased $3.4 million, or 10.0%, and equaled 2.7% of average total
liabilities during 2004. Money market deposit accounts increased $2.2 million,
or 27.0%, and equaled 0.7% of average total liabilities during 2004. 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 Federal law and 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 2004, savings account balances recorded an increase of $27.7 million, or
27.2%, and equaled 10.9% 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.
F-11
Certificates of deposit purchased by customers located within the market area
increased during 2004, growing from $90.5 million at December 31, 2003, to
$108.7 million on December 31, 2004, a growth rate of 20.2%. These deposits
accounted for 7.7% of average total liabilities during 2004. The growth was
primarily attributable to individuals and municipalities. 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 2004, certificates of deposit obtained from customers located outside of
the market area increased by $179.5 million, and represented 55.0% of average
total liabilities during 2004. At December 31, 2004, out-of-area deposits
totaled $771.2 million. Out-of-area deposits consist primarily of certificates
of deposit placed by deposit brokers for a fee, but also include certificates of
deposit obtained from the deposit owners directly. The owners of the out-of-area
deposits include individuals, businesses and governmental units located
throughout the country. Out-of-area deposits are utilized to support our asset
growth, and are generally a lower cost source of funds when compared to the
interest rates that would have to be offered in the local market to generate a
sufficient level of funds. During most of 2004 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.
Repurchase agreements increased $6.8 million and equaled 4.0% of average total
liabilities during 2004. As part of our sweep account program, collected funds
from certain business noninterest-bearing checking accounts are invested in
overnight interest-bearing repurchase agreements. Although not considered a
deposit account and therefore not afforded federal deposit insurance, the
repurchase agreements have characteristics very similar to that of an
interest-bearing checking deposit account.
FHLB advances increased $30.0 million and equaled 9.1% of average total
liabilities during 2004. FHLB 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 at December 31, 2004 totaled $193.5 million. We first started to
use FHLB advances in late 2002, and expect to continue to use this funding
source, along with out-of-area certificates of deposit, as part of our wholesale
funding program.
Subordinated debentures increased $16.5 million and equaled 1.4% of average
total liabilities during 2004. In September of 2004 we refinanced our then
existing $16.5 million in subordinated debentures by issuing a new subordinated
debenture in an equal dollar amount. In December of 2004 we issued an additional
$16.5 million in subordinated debentures, with substantially all of the net
proceeds contributed to our bank as capital to provide support for asset growth,
fund investments in loans and securities and for general corporate purposes.
Shareholders' equity increased $11.4 million and equaled 9.8% of average assets
during 2004. The increase was primarily attributable to net income from
operations. Net income from operations totaled $13.7 million during 2004.
Negatively impacting shareholders' equity during 2004 was the payment of cash
dividends, which totaled $2.6 million.
F-12
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003
SUMMARY
We recorded strong earnings performance during 2004. Net income was $13.7
million, or $1.91 per basic share and $1.87 per diluted share. This earnings
performance compares favorably to net income of $10.0 million, or $1.65 per
basic share and $1.61 per diluted share, recorded in 2003. The $3.7 million
improvement in net income represents an increase of 37.0%, while diluted
earnings per share were up 16.1%, with the difference primarily reflecting the
impact of our common stock sale during 2003 and resulting increases in average
common shares outstanding during 2004. The earnings improvement during 2004 over
that of 2003 is primarily attributable to increased net interest income and
improved operating efficiencies resulting from asset growth, strong credit
culture and controlled overhead expenses. We expect our percentage rate of loan
growth to exceed the banking industry average in 2005.
Net income for 2004 includes an $845,000 ($548,000 after-tax) write-off
associated with the unamortized balance of issuance costs related to the
redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued
in 1999 by MBWM Capital Trust I. Excluding this one-time expense, net income for
2004 was $14.3 million ($1.99 per basic share and $1.94 per diluted share),
which represents a 42.5% increase over net income of $10.0 million ($1.65 per
basic share and $1.61 per diluted share) recorded during 2003. We believe
excluding the impact of the one-time charge from 2004 operating results and
performance measures allows a more meaningful comparison of 2004 results to 2003
results; therefore, the following discussion of our results of operations for
the years ended December 31, 2004 and December 31, 2003 includes both GAAP and
non-GAAP facts and figures where appropriate.
The following table shows some of the key performance and equity ratios for the
years ended December 31, 2004 and 2003.
2004 2003
----- -----
Return on average total assets 0.99% 0.97%
Return on average equity 10.16 10.61
Dividend payout ratio 18.58 18.42
Average equity to average assets 9.79 9.00
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 $70.0 million and $26.6 million during 2004, respectively, providing for
net interest income of $43.4 million. This performance compares favorably to
that of 2003 when interest income and interest expense were $55.5 million and
$23.4 million, respectively, providing for net interest income of $32.1 million.
In comparing 2004 with 2003, interest income increased 26.2%, interest expense
was up 13.7% and net interest income increased 35.3%. 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 improved from 3.21% in 2003 to 3.30% in 2004, an increase of
2.8%.
The following table depicts the average balance, interest earned and paid, and
weighted average rate of our assets, liabilities and shareholders' equity during
2004, 2003 and 2002 (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
35%. Securities interest income was increased by $957,000, $808,000 and $611,000
in 2004, 2003 and 2002, respectively.
F-13
Years ended December 31,
-------------------------------------------------------------------------------------------------
2004 2003 2002
------------------------------- ------------------------------- -----------------------------
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- ------- -------- -------- -------
Taxable securities $ 82,107 $ 3,935 4.79% $ 64,957 $ 2,978 4.58% $ 53,509 $ 3,023 5.65%
Tax-exempt
securities 48,322 3,174 6.57 40,695 2,730 6.71 29,956 2,056 6.86
---------- -------- ---------- ------- -------- ------- ----
Total securities 130,429 7,109 5.45 105,652 5,708 5.40 83,465 5,079 6.09
Loans and leases 1,177,568 62,791 5.33 887,512 49,700 5.60 669,781 43,032 6.42
Short-term
investments 593 4 0.67 369 1 0.27 194 2 1.03
Federal funds sold 5,942 75 1.26 5,083 57 1.12 7,901 130 1.65
---------- -------- ---------- ------- -------- -------
Total earning
assets 1,314,532 69,979 5.32 998,616 55,466 5.55 761,341 48,243 6.34
Allowance for loan
and lease losses (16,203) (12,471) (9,620)
Cash and due
from banks 31,587 23,285 18,568
Other non-earning
assets 49,262 39,767 27,377
---------- ---------- --------
Total assets $1,379,178 $1,049,197 $797,666
========== ========== ========
Interest-bearing
demand
deposits $ 32,994 $ 427 1.29% $ 28,406 $ 353 1.24% $ 22,354 $ 399 1.78%
Savings deposits 136,214 2,497 1.83 82,754 1,446 1.75 58,679 1,381 2.35
Money market
accounts 8,788 129 1.47 8,488 111 1.31 6,870 127 1.85
Time deposits 780,867 18,733 2.40 652,200 18,197 2.79 518,271 19,561 3.77
---------- ------- ---------- ------- -------- -------
Total interest-
bearing
deposits 958,863 21,786 2.27 771,848 20,107 2.61 606,174 21,468 3.54
Short-term
borrowings 55,816 877 1.57 49,480 712 1.44 44,395 899 2.03
Federal Home Loan
Bank advances 112,869 2,471 2.19 46,630 921 1.98 1,014 20 1.97
Long-term
borrowings 18,938 1,461 7.71 17,394 1,655 9.51 16,936 1,639 9.68
---------- -------- ---------- ------- -------- -------
Total interest-
bearing
liabilities 1,146,486 26,595 2.32 885,352 23,395 2.64 668,519 24,026 3.59
-------- ------- -------
Demand deposits 90,534 63,150 48,140
Other liabilities 7,156 6,329 5,702
---------- ---------- --------
Total liabilities 1,244,176 954,831 722,361
Average equity 135,002 94,366 75,305
---------- ---------- --------
Total liabilities
and equity $1,379,178 $1,049,197 $797,666
========== ========== ========
Net interest
income $ 43,384 $32,071 $24,217
======== ======= =======
Rate spread 3.00% 2.91% 2.75%
==== ==== ====
Net interest
margin 3.30% 3.21% 3.18%
==== ==== ====
F-14
Years ended December 31,
---------------------------------------------------------------------------------
2004 over 2003 2003 over 2002
--------------------------------------- ---------------------------------------
Total Volume Rate Total Volume Rate
----------- ----------- ----------- ----------- ----------- -----------
Increase (decrease) in interest income
Taxable securities $ 957,000 $ 817,000 $ 140,000 $ (45,000) $ 582,000 $ (627,000)
Tax exempt securities 444,000 502,000 (58,000) 674,000 721,000 (47,000)
Loans 13,091,000 15,566,000 (2,475,000) 6,668,000 12,701,000 (6,033,000)
Short term investments 3,000 1,000 2,000 (1,000) 1,000 (2,000)
Federal funds sold 18,000 10,000 8,000 (73,000) (38,000) (35,000)
----------- ----------- ----------- ----------- ----------- -----------
Net change in tax-equivalent
income 14,513,000 16,896,000 (2,383,000) 7,223,000 13,967,000 (6,744,000)
Increase (decrease) in interest expense
Interest-bearing demand deposits 74,000 59,000 15,000 (46,000) 93,000 (139,000)
Savings deposits 1,051,000 977,000 74,000 66,000 477,000 (411,000)
Money market accounts 18,000 4,000 14,000 (16,000) 26,000 (42,000)
Time deposits 536,000 3,296,000 (2,760,000) (1,365,000) 4,399,000 (5,764,000)
Short term borrowings 165,000 96,000 69,000 (187,000) 94,000 (281,000)
Federal Home Loan Bank
advances 1,550,000 1,440,000 110,000 901,000 901,000 0
Long term borrowings (194,000) 138,000 (332,000) 16,000 44,000 (28,000)
----------- ----------- ----------- ----------- ----------- -----------
Net change in interest
expense 3,200,000 6,010,000 (2,810,000) (631,000) 6,034,000 (6,665,000)
----------- ----------- ----------- ----------- ----------- -----------
Net change in tax-equivalent
net interest income $11,313,000 $10,886,000 $ 427,000 $ 7,854,000 $ 7,933,000 $ (79,000)
=========== =========== =========== =========== =========== ===========
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 $14.5 million during 2004 from that earned in 2003, totaling
$70.0 million in 2004 compared to $55.5 million in the previous year. The
increase is primarily due to the growth in earning assets, which more than
offset the impact of a lower interest rate environment during 2004 when compared
to 2003. Reflecting the lower interest rates, the yield on average earning
assets decreased from 5.55% recorded in 2003 to 5.32% in 2004.
The growth in interest income is primarily attributable to an increase in
earning assets. During 2004, earning assets averaged $1,314.5 million, a level
substantially higher than the average earning assets of $998.6 million during
2003. Growth in average total loans and leases, totaling $290.1 million,
comprised 91.8% of the increase in average earnings assets during 2004. Interest
income generated from the loan and lease portfolio increased $13.1 million
during 2004 over the level earned in 2003, comprised of an increase of $15.6
million from the growth in the loan and lease portfolio which was partially
offset by a decrease of $2.5 million due to the decline in the yield earned on
the loan portfolio to 5.33% from 5.60%. The decline in the loan and lease
portfolio yield is primarily due to lower market interest rates during 2004 than
in 2003, and a higher percentage of loans and leases at the lower floating rate
pricing arrangement versus a higher fixed interest rate arrangement.
Growth in the securities portfolio, combined with a slight increase in yield,
also added to the increase in interest income during 2004 over that of 2003.
Average securities increased by $24.7 million in 2004, increasing from $105.7
million in 2003 to $130.4 million in 2004. The growth equated to an increase in
interest income of $1.3 million, while an increase in the yield earned on the
securities portfolio from 5.40% to 5.45% added an additional $0.1 million to
interest income. Interest income earned on federal funds sold increased by
$18,000 due to a $0.9 million increase in the average balance and a slightly
higher yield during 2004.
F-15
Interest expense is primarily generated from interest-bearing deposits, and to a
lesser degree repurchase agreements, FHLB advances and subordinated debentures.
Interest expense increased $3.2 million during 2004 from that paid in 2003,
totaling $26.6 million in 2004 compared to $23.4 million in the previous year.
The increase in interest expense is primarily attributable to the impact of an
increase in interest-bearing liabilities during 2004, which was only partially
offset by a lower interest rate environment during 2004 when compared to 2003.
Interest-bearing liabilities averaged $1,146.5 million during 2004, a level
substantially higher than the average interest-bearing liabilities of $885.4
million during 2003. This growth resulted in increased interest expense of $6.0
million. A decrease in interest expense of $2.8 million was recorded during 2004
due to lower interest rates on certificates of deposit and subordinated
debentures, which more than offset the impact of higher interest rates on all
other interest-bearing liabilities. The cost of average interest-bearing
liabilities decreased from the 2.64% recorded in 2003 to 2.32% in 2004.
Growth in average certificates of deposits, totaling $128.7 million, comprised
49.3% of the increase in average interest-bearing liabilities between 2004 and
2003. Average FHLB advances increased $66.2 million, or 25.4% of the increase in
average interest-bearing liabilities. The certificate of deposit growth during
2004 equated to an increase in interest expense of $3.3 million; however, a
decrease in interest expense of $2.8 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 during
most of 2004. FHLB advance growth during 2004 equated to an increase in interest
expense of $1.4 million, with an increased average rate adding an additional
$0.1 million to interest expense.
Growth in average savings deposits, totaling $53.5 million, equated to an
increase in interest expense of $1.0 million, with an additional interest
expense of $0.1 million recorded due to an increase in the average rate paid
during 2004. Growth in average interest-bearing checking accounts and money
market accounts, totaling a combined $4.9 million, equated to an increase in
interest expense of $0.1 million, with only a nominal amount of additional
interest expense recorded due to a slightly higher average rate paid during
2004. Average short term borrowings, comprised of repurchase agreements and
federal funds purchased, increased $6.3 million during 2004, resulting in
increased interest expense of $0.1 million, with an additional interest expense
of $0.1 million recorded due to an increase in the average rate paid during
2004.
Growth of $1.5 million in average long-term borrowings, comprised primarily of
subordinated debentures but also including deferred director and officer
compensation programs, equated to an increase in interest expense of $0.1
million during 2004; however, a decline in the average rate paid on subordinated
debentures resulting from the September 2004 refinance, equated to a $0.3
million reduction of interest expense during 2004.
PROVISION FOR LOAN AND LEASE LOSSES
Primarily reflecting continued loan and lease growth, combined with an increase
in net loan and leases losses, the provision for loan and lease losses totaled
$4.7 million during 2004, compared to the $3.8 million expensed during 2003. The
allowance as a percentage of total loans outstanding as of December 31, 2004 was
1.35%, compared to 1.39% at year-end 2003. Loan and lease growth during 2004
equaled $281.2 million, compared to loan and lease growth of $264.4 million
during 2003. Net loan and lease charge-offs during 2004 totaled $1.2 million, or
0.10% of average total loans and leases. Net loan and lease charge-offs during
2003 totaled $0.3 million, or 0.04% of average total loans and leases.
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 and lease
portfolio, third party analysis of the loan and lease administration processes
and portfolio and general economic conditions. In addition, the rapid commercial
loan and lease growth is taken into account.
F-16
The Reserve Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan and lease
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 almost 20 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
Noninterest income totaled $4.3 million in 2004, a slight decline from the $4.4
million earned in 2003. Increased fee income on virtually all
non-mortgage-related products and services was just shy of offsetting a large
decline in residential mortgage-related fee income. Deposit and repurchase
agreement service charges increased $0.1 million in 2004 from the amount earned
in 2003, primarily reflecting the growth in the number of deposit accounts and
modest increases in the deposit fee structure which was partially offset by a
lower deposit earnings credit rate during 2004. Fees on commercial letters of
credit increased during 2004 when compared to 2003, although the increase
generally reflects the change in recognizing the fees that occurred in early
2003 whereby fees had to be recognized into income over the life of the letter
of credit instead of immediately upon issuing the letter of credit, rather than
an increase in the level of letters of credit outstanding. Reflecting a decrease
in volume of refinance activity resulting from a higher interest rate
environment, fees earned on referring residential mortgage loan applicants to
various third parties totaled $0.4 million in 2004, down from the $1.0 million
earned in 2003. Aggregate net gains on the sale of loans and securities during
2004 virtually equaled the level of net gains on the sale of loans and
securities during 2003.
NONINTEREST EXPENSE
Noninterest expense during 2004 totaled $23.2 million, an increase of 28.4% over
the $18.1 million expensed in 2003. Of the $5.1 million growth in overhead
costs, $2.6 million (51.0%) was in salaries and benefits, and primarily reflects
the increase in full-time equivalent employees from 161 at year-end 2003 to 194
at year-end 2004 and annual pay increases. Occupancy, furniture and equipment
costs increased $0.3 million (11.9%) in 2004 over that expensed in 2003,
primarily reflecting the opening of our Holland banking office in October of
2004 and our increased staffing level.
Noninterest expense during 2004 includes an $845,000 write-off associated with
the unamortized balance of issuance costs related to the redemption of the $16.0
million of 9.60% Cumulative Preferred Securities issued in 1999 by the MBWM
trust. Excluding this one-time write-off, noninterest expense during 2004
totaled $22.4 million, an increase of 23.7% over the $18.1 million expensed in
2003.
While the dollar volume of noninterest costs has increased, the growth of net
interest income and fee income has increased by a much higher degree.
Noninterest costs during 2004 were $5.1 million higher than the level of
overhead costs expensed during 2003; however, net interest income and fee income
increased a combined $11.1 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, reflected improvement during 2004 and remained
well below banking industry averages. Computed by dividing noninterest expenses
by net interest income plus noninterest income, the efficiency ratio was 49.6%
during 2004, compared to 50.7% during 2003. If the one-time write-off addressed
above is excluded from the calculation, our 2004 efficiency ratio improves to
47.8%.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $5.1 million in 2004, an increase of $1.4
million, or 35.7% over the $3.8 million expensed during 2003. The increase is
primarily due to the growth in our pre-federal income tax profitability. Our
effective tax rate in 2004 was 27.2%, compared to 27.4% in 2003.
F-17
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002
SUMMARY
We recorded strong earnings performance during 2003. Net income was $10.0
million, or $1.65 per basic share and $1.61 per diluted share. This earnings
performance compares very favorably to net income of $7.8 million, or $1.36 per
basic share and $1.34 per diluted share, recorded in 2002. The $2.2 million
improvement in net income represents an increase of 29.1%, while diluted
earnings per share were up 20.1%, with the difference primarily reflecting the
impact of our common stock sale during 2003 and resulting increases in average
common shares outstanding. The earnings improvement during 2003 over that of
2002 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.
The following table shows some of the key performance and equity ratios for the
years ended December 31, 2003 and 2002.
2003 2002
----- -----
Return on average total assets 0.96% 0.97%
Return on average equity 10.61 10.30
Dividend payout ratio 18.42 NA
Average equity to average assets 9.00 9.45
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 $55.5 million and $23.4 million during 2003, respectively, providing for
net interest income of $32.1 million. This performance compares favorably to
that of 2002 when interest income and interest expense were $48.2 million and
$24.0 million, respectively, providing for net interest income of $24.2 million.
In comparing 2003 with 2002, interest income increased 15.0%, interest expense
was down 2.6% and net interest income increased 32.4%. 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 slightly from 3.18% in 2002 to 3.21% in 2003, an
increase of 0.9%.
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 $7.3 million during 2003 from that earned in 2002, totaling
$55.5 million in 2003 compared to $48.2 million in the previous year. The
increase is due to the growth in earning assets, which more than offset the
impact of a lower interest rate environment in 2003. Reflecting the lower
interest rates, the yield on average earning assets decreased from 6.34%
recorded in 2002 to 5.55% in 2003.
The growth in interest income is attributable to an increase in earning assets.
During 2003, earning assets averaged $998.6 million, a level substantially
higher than the average earning assets of $761.3 million during 2002. Growth in
average total loans and leases, totaling $217.7 million, comprised 91.7% of the
increase in average earnings assets. Interest income generated from the loan and
lease portfolio increased $6.7 million during 2003 over the level earned in
2002, comprised of an increase of $12.7 million from the growth in the loan and
lease portfolio which was partially offset by a decrease of $6.0 million due to
the decline in the yield earned on the loan portfolio to 5.60% from 6.42%. The
decline in the loan and lease portfolio yield is primarily due to lower market
interest rates during 2003 and a higher percentage of loans and leases at the
lower floating rate pricing arrangement versus a higher fixed interest rate
arrangement.
F-18
Growth in the securities portfolio also added to the increase in interest income
during 2003 over that of 2002. Average securities increased by $22.2 million in
2003, increasing from $83.5 million in 2002 to $105.7 million in 2003. The
growth equated to an increase in interest income of $1.3 million, which was
partially offset by a decrease of $0.7 million due to the decline in the yield
earned on the securities portfolio to 5.40% from 6.09%. Interest income earned
on federal funds sold decreased by $73,000 due to a $2.8 million decrease in the
average balance and a lower yield during 2003. The lower yield on securities and
federal funds sold is primarily the result of lower market interest rates during
2003.
Interest expense is primarily generated from interest-bearing deposits, and to a
lesser degree repurchase agreements, FHLB advances and subordinated debentures.
Interest expense decreased $0.6 million during 2003 from that paid in 2002,
totaling $23.4 million in 2003 compared to $24.0 million in the previous year.
The decline in interest expense is primarily attributable to the impact of a
lower interest rate environment during 2003, which more than offset the impact
of the increase in interest-bearing liabilities during 2003. Interest-bearing
liabilities averaged $885.4 million during 2003, a level substantially higher
than the average interest-bearing liabilities of $668.5 million during 2002.
This growth resulted in increased interest expense of $6.0 million; however, a
decrease in interest expense of $6.6 million was recorded during 2003 due to
lower market interest rates on all interest-bearing liability categories except
FHLB advances and subordinated debentures. The cost of average interest-bearing
liabilities decreased from the 3.59% recorded in 2002 to 2.64% in 2003.
Growth in average certificates of deposits, totaling $133.9 million, comprised
61.7% of the increase in average interest-bearing liabilities between 2003 and
2002. Average FHLB advances increased $45.6 million, or 21.0% of the increase in
average interest-bearing liabilities. The certificate of deposit growth during
2003 equated to an increase in interest expense of $4.4 million; however, a
decrease in interest expense of $5.8 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. FHLB
advance growth during 2003 equated to an increase in interest expense of $0.9
million, with the average interest rate remaining virtually unchanged.
Growth in average savings deposits, totaling $24.1 million, equated to an
increase in interest expense of $0.5 million, while a decrease in interest
expense of $0.4 million was recorded due to the decline in the average rate paid
during 2003. Growth in average interest-bearing checking accounts and money
market accounts, totaling $7.7 million, equated to an increase in interest
expense of $0.1 million, while a decrease in interest expense of $0.2 million
was recorded due to the decline in the average rate paid during 2003. Average
short term borrowings, comprised of repurchase agreements and federal funds
purchased, increased $5.1 million during 2003, resulting in increased interest
expense of $0.1 million; however, a decrease of $0.3 million in interest expense
was recorded due to the decline in the average rate paid.
PROVISION FOR LOAN AND LEASE LOSSES
Primarily reflecting continued significant loan and lease growth, the provision
for loan and lease losses totaled $3.8 million during 2003, compared to the $3.0
million expensed during 2002. The allowance as a percentage of total loans
outstanding as of December 31, 2003 was 1.39%, compared to 1.41% at year-end
2002. Loan and lease growth during 2003 equaled $264.4 million, compared to net
loan and lease growth of $184.3 million during 2002. Net loan and lease
charge-offs during 2003 totaled $0.3 million, or 0.04% of average total loans
and leases. Net loan and lease charge-offs during 2002 totaled $0.6 million, or
0.09% of average total loans and leases.
NONINTEREST INCOME
Noninterest income totaled $4.4 million in 2003, an increase of 42.2% over the
$3.1 million earned in 2002. Deposit and repurchase agreement service charges
totaled $1.2 million in 2003, an increase of $0.2 million, or 28.7%, from the
amount earned in 2002. 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 lower interest rate environment, fees earned on
referring residential mortgage loan applicants to various third parties totaled
$1.0 million in 2003, up from the $0.5 million earned in 2002. Noninterest
income related to the cash surrender value of bank owned life insurance policies
("BOLI") totaled $0.8 million in 2003, up from the $0.4 million recorded in
2002. 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
during 2003.
F-19
In addition to providing interest income and secondary liquidity, our securities
portfolio plays an integral role in managing our net interest margin. During
2003 we consummated several bond swap transactions, resulting in a net gain on
the sales of securities of $321,000. We also consummated several bond swap
transactions during 2002, resulting in a net gain on the sales of securities of
$270,000. All of the bond swap transactions during 2003 and 2002 were
consummated in reaction to declining interest rate environments 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
2003, we sold 25 mortgage-backed securities with an aggregate par value of $15.2
million, while in 2002 we sold 18 mortgage-backed securities with an aggregate
par value of $13.5 million. Proceeds from the bond sales were reinvested into
mortgage-backed securities containing different underlying interest rate risk
characteristics than were contained within the mortgage-backed securities that
were sold.
NONINTEREST EXPENSE
Noninterest expense during 2003 totaled $18.1 million, an increase of 41.4% over
the $12.8 million expensed in 2002. Of the $5.3 million growth in overhead
costs, $3.6 million (67.9%) was in salaries and benefits, and primarily reflects
the increase in full-time equivalent employees from 117 at year-end 2002 to 161
at year-end 2003, 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 $0.6 million (31.7%) in 2003 over that expensed in
2002, primarily reflecting the opening of our Kentwood branch in December 2002,
our Knapps Corner branch and retail loan production office in Holland, Michigan
in May 2003. 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 has increased, the growth of net
interest income and fee income has increased by a much higher degree.
Noninterest costs during 2003 were $5.3 million higher than the level of
overhead costs expensed during 2002; however, net interest income and fee income
increased a combined $9.0 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, reflected slight deterioration during 2003 but
remained well below banking industry averages. Computed by dividing noninterest
expenses by net interest income plus noninterest income, the efficiency ratio
was 50.7% during 2003, compared to 47.9% during 2002. The deterioration is
primarily due to the increase in staff and the opening of the three offices
noted above.
FEDERAL INCOME TAX EXPENSE
Federal income tax expense was $3.8 million in 2003, an increase of $0.6
million, or 19.5% over the $3.2 million expensed during 2002. 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 29.0% in 2002 to 27.4% in 2003.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for our asset growth. Shareholders' equity was $141.6 million and $130.2
million at December 31, 2004 and 2003, respectively. The $11.4 million increase
during 2004 is primarily attributable to net income from operations. Net income
from operations totaled $13.7 million during 2004. Negatively impacting
shareholders' equity during 2004 was the payment of cash dividends, which
totaled $2.6 million.
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. Our and our bank's capital ratios
as of December 31, 2004 and 2003 are disclosed under Note 17 on pages F-52
through F-54 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
April 7, 2004, we declared a 5% common stock dividend, payable on May 3, 2004 to
record holders as of April 16, 2004. This represented the fourth straight year
we had declared and paid a 5% stock dividend. Also, during 2004 we declared and
paid a $0.09 per common share cash dividend in each calendar quarter, totaling
$2.6 million. On January 11, 2005, we declared a $0.10 per common share cash
dividend that will be paid on March 10, 2005 to shareholders of record on
February 10, 2005.
F-20
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 net deposit and repurchase agreement growth from depositors located in
the market area increased by $83.5 million, or 23.1%, during 2004, the growth
was not sufficient to meet the substantial loan growth of $281.2 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, 2004, out-of-area
deposits totaled $771.2 million, or 63.4% of combined deposits and repurchase
agreements, an increase in dollar volume from the $591.6 million outstanding,
and an increase from the 62.1% level of combined deposits and repurchase
agreements, as of December 31, 2003.
As a member of the Federal Home Loan Bank of Indianapolis, our bank has access
to the FHLB advance borrowing programs. As of December 31, 2004, advances
totaled $120.0 million, compared to $90.0 million outstanding as of December 31,
2003. Our borrowing line of credit at December 31, 2004 totaled $193.5 million,
with availability of approximately $65.0 million.
We have the ability to borrow money on a daily basis through correspondent banks
using established federal funds purchased lines. During 2004, our federal funds
purchased position averaged $5.9 million, compared to an average federal funds
sold position of $5.9 million. At December 31, 2004, our established unsecured
federal funds purchased lines totaled $50.0 million.
The following table reflects, as of December 31, 2004, significant fixed and
determinable contractual obligations to third parties by payment date.
One to Three Three to Five Over Five
One Year or Less Years Years Years Total
---------------- ------------ ------------- ----------- ------------
Deposits without a stated maturity $220,820,000 $ 0 $ 0 $ 0 $220,820,000
Certificates of deposits 609,055,000 231,123,000 39,710,000 0 879,888,000
Short term borrowings 71,317,000 0 0 0 71,317,000
Federal Home Loan Bank advances 65,000,000 55,000,000 0 0 120,000,000
Subordinated debentures 0 0 0 32,990,000 32,990,000
Other borrowed money 0 0 0 1,609,000 1,609,000
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, 2004, we had a total of $320.8 million in
unfunded loan commitments and $56.5 million in unfunded standby letters of
credit. Of the total unfunded loan commitments, $265.4 million were commitments
available as lines of credit to be drawn at any time as customers' cash needs
vary, and $55.4 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.
F-21
The following table depicts our loan commitments at the end of the past three
years.
December 31, 2004 December 31, 2003 December 31, 2002
----------------- ----------------- -----------------
Commercial unused lines of credit $226,935,000 $176,943,000 $131,161,000
Unused lines of credit secured by 1-4 family
residential properties 24,988,000 19,020,000 12,381,000
Credit card unused lines of credit 8,307,000 8,990,000 5,824,000
Other consumer unused lines of credit 5,155,000 5,569,000 4,415,000
Commitments to make loans 55,440,000 73,570,000 24,267,000
Standby letters of credit 56,464,000 57,918,000 39,338,000
------------ ------------ ------------
Total $377,289,000 $342,010,000 $217,386,000
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-22
The following table depicts our GAP position as of December 31, 2004 (dollars in
thousands).
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
-------- --------- -------- -------- ----------
Assets:
Commercial loans (1) $884,981 $ 20,595 $256,722 $ 24,620 $1,186,918
Leases 335 32 2,206 2,573
Residential real estate loans 76,084 2,286 31,274 12,991 122,635
Consumer loans 1,578 192 3,174 54 4,998
Securities (2) 6,798 1,134 20,547 124,486 152,965
Short term investments 149 149
Allowance for loan and lease
losses (17,819) (17,819)
Other assets 83,700 83,700
-------- --------- -------- -------- ----------
Total assets 969,925 24,239 313,923 228,032 1,536,119
Liabilities:
Interest-bearing checking 37,649 37,649
Savings 129,374 129,374
Money market accounts 10,528 10,528
Time deposits under $100,000 27,688 33,846 38,258 99,792
Time deposits $100,000 and over 181,526 365,994 232,576 780,096
Short term borrowings 71,317 71,317
Federal Home Loan Bank
advances 25,000 50,000 45,000 120,000
Long term borrowings 34,599 34,599
Noninterest-bearing checking 101,742 101,742
Other liabilities 9,405 9,405
-------- --------- -------- -------- ----------
Total liabilities 517,681 449,840 315,834 111,147 1,394,502
Shareholders' equity 141,617 141,617
-------- --------- -------- -------- ----------
Total sources of funds 517,681 449,840 315,834 252,764 1,536,119
-------- --------- -------- -------- ----------
Net asset (liability) GAP $452,244 $(425,601) $ (1,911) $(24,732)
======== ========= ======== ========
Cumulative GAP $452,244 $ 26,643 $ 24,732
======== ========= ========
Percent of cumulative GAP to
total assets 29.4% 1.7% 1.6%
======== ========= ========
(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 expected maturities based
upon prepayment trends as of December 31, 2004.
F-23
The following table depicts our GAP position as of December 31, 2003 (dollars in
thousands).
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
-------- --------- -------- -------- ----------
Assets:
Commercial loans (1) $415,721 $ 23,811 $443,925 $ 53,022 $ 936,479
Leases 2,309 2,309
Residential real estate loans 45,884 3,160 33,040 10,255 92,339
Consumer loans 1,577 253 2,938 68 4,836
Securities (2) 6,073 3,048 24,197 88,192 121,510
Short term investments 255 255
Allowance for loan and lease
losses (14,379) (14,379)
Other assets 59,483 59,483
-------- --------- -------- -------- ----------
Total assets 469,510 30,272 506,409 196,641 1,202,832
Liabilities:
Interest-bearing checking 34,241 34,241
Savings 101,710 101,710
Money market accounts 8,290 8,290
Time deposits under $100,000 20,802 57,888 27,552 106,242
Time deposits $100,000 and over 123,040 288,719 164,071 575,830
Short term borrowings 55,545 55,545
Federal Home Loan Bank
advances 10,000 35,000 45,000 90,000
Long term borrowings 1,114 16,000 17,114
Noninterest-bearing checking 76,579 76,579
Other liabilities 7,080 7,080
-------- --------- -------- -------- ----------
Total liabilities 354,742 381,607 236,623 99,659 1,072,631
Shareholders' equity 130,201 130,201
-------- --------- -------- -------- ----------
Total sources of funds 354,742 381,607 236,623 229,860 1,202,832
-------- --------- -------- -------- ----------
Net asset (liability) GAP $114,768 $(351,335) $269,786 $(33,219)
======== ========= ======== ========
Cumulative GAP $114,768 $(236,567) $ 33,219
======== ========= ========
Percent of cumulative GAP to
total assets 9.5% (19.7)% 2.8%
======== ========= ========
(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 expected maturities based
upon prepayment trends as of December 31, 2003.
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-24
We conducted multiple simulations as of December 31, 2004, in which it was
assumed that changes in market interest rates occurred ranging from up 300 basis
points to down 300 basis points in equal quarterly instalments over the next
twelve months. 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 $(3,649,000) (8.3)%
Interest rates down 100 basis points (2,057,000) (4.7)
No change in interest rates (719,000) (1.6)
Interest rates up 100 basis points 1,179,000 2.7
Interest rates up 200 basis points 3,071,000 7.0
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-25
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2004 and 2003, 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, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2004 and 2003, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2004 in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Mercantile Bank
Corporation's internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
and our report dated February 24, 2005 expressed an unqualified opinion thereon.
/s/ Crowe Chizek and Company LLC
----------------------------------------
Crowe Chizek and Company LLC
Grand Rapids, Michigan
February 24, 2005
F-26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Wyoming, Michigan
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that
Mercantile Bank Corporation maintained effective internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Mercantile Bank Corporation's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit
We conducted our audit in accordance with the standards of the Public Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Mercantile Bank Corporation
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Also in our
opinion, Mercantile Bank Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements of Mercantile Bank Corporation and our report dated February 24, 2005
expressed an unqualified opinion on those consolidated financial statements.
/s/ Crowe Chizek and Company LLC
----------------------------------------
Crowe Chizek and Company LLC
Grand Rapids, Michigan
February 24, 2005
F-27
February 24, 2005
REPORT BY MERCANTILE BANK CORPORATION'S MANAGEMENT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective system
of internal control over financial reporting presented in conformity with
generally accepted accounting principles. The system contains monitoring
mechanisms, and actions are taken to correct deficiencies identified. There are
inherent limitations in the effectiveness of any system of internal control.
Accordingly, even an effective system of internal control can provide only
reasonable assurance with respect to financial statement preparation.
Management assessed the Company's systems of internal control over financial
reporting presented in conformity with generally accepted principles as of
December 31, 2004. This assessment was based on criteria for effective internal
control over financial reporting described in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, management believes that, as of December
31, 2004, Mercantile Bank Corporation maintained effective control over
financial reporting presented in conformity with generally accepted accounting
principles based on those criteria.
The Company's independent auditors have issued an audit report on our assessment
of the Company's internal control over financial reporting.
Mercantile Bank Corporation
/s/ Gerald R. Johnson, Jr.
- -----------------------------------------------
Gerald R. Johnson, Jr.
Chairman and Chief Executive Officer
/s/ Charles E. Christmas
- -----------------------------------------------
Charles E. Christmas
Senior Vice President - Chief Financial Officer
F-28
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
2004 2003
-------------- --------------
ASSETS
Cash and due from banks $ 20,662,000 $ 16,309,000
Short term investments 149,000 255,000
-------------- --------------
Total cash and cash equivalents 20,811,000 16,564,000
Securities available for sale 93,826,000 71,421,000
Securities held to maturity (fair value of $54,621,000 at
December 31, 2004 and $47,102,000 at December 31, 2003) 52,341,000 45,112,000
Federal Home Loan Bank stock 6,798,000 4,977,000
Total loans and leases 1,317,124,000 1,035,963,000
Allowance for loan and lease losses (17,819,000) (14,379,000)
-------------- --------------
Total loans and leases, net 1,299,305,000 1,021,584,000
Premises and equipment, net 24,572,000 15,305,000
Bank owned life insurance policies 23,750,000 16,441,000
Accrued interest receivable 5,644,000 4,098,000
Other assets 9,072,000 7,835,000
-------------- --------------
Total assets $1,536,119,000 $1,203,337,000
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 101,742,000 $ 76,579,000
Interest-bearing 1,057,439,000 826,313,000
-------------- --------------
Total 1,159,181,000 902,892,000
Securities sold under agreements to repurchase 56,317,000 49,545,000
Federal funds purchased 15,000,000 6,000,000
Federal Home Loan Bank advances 120,000,000 90,000,000
Subordinated debentures 32,990,000 16,495,000
Other borrowed money 1,609,000 1,114,000
Accrued expenses and other liabilities 9,405,000 7,090,000
-------------- --------------
Total liabilities 1,394,502,000 1,073,136,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued 0 0
Common stock, no par value; 20,000,000 shares
authorized; 7,192,461 and 6,805,914 shares issued
and outstanding at December 31, 2004 and 2003 131,010,000 118,560,000
Retained earnings 10,475,000 11,421,000
Accumulated other comprehensive income 132,000 220,000
-------------- --------------
Total shareholders' equity 141,617,000 130,201,000
-------------- --------------
Total liabilities and shareholders' equity $1,536,119,000 $1,203,337,000
============== ==============
See accompanying notes to consolidated financial statements.
F-29
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2004, 2003 and 2002
2004 2003 2002
----------- ----------- -----------
Interest income
Loans and leases, including fees $62,791,000 $49,700,000 $43,032,000
Securities, taxable 3,935,000 2,978,000 3,023,000
Securities, tax-exempt 2,217,000 1,922,000 1,445,000
Federal funds sold 75,000 57,000 130,000
Short-term investments 4,000 1,000 2,000
----------- ----------- -----------
Total interest income 69,022,000 54,658,000 47,632,000
Interest expense
Deposits 21,786,000 20,107,000 21,468,000
Short-term borrowings 877,000 712,000 899,000
Federal Home Loan Bank advances 2,471,000 921,000 20,000
Long-term borrowings 1,461,000 1,655,000 1,639,000
----------- ----------- -----------
Total interest expense 26,595,000 23,395,000 24,026,000
----------- ----------- -----------
NET INTEREST INCOME 42,427,000 31,263,000 23,606,000
Provision for loan and lease losses 4,674,000 3,800,000 3,002,000
----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES 37,753,000 27,463,000 20,604,000
Noninterest income
Service charges on accounts 1,255,000 1,178,000 915,000
Increase in cash surrender value of bank owned life
insurance policies 735,000 780,000 409,000
Letter of credit fees 450,000 189,000 307,000
Mortgage loan referral fees 440,000 987,000 534,000
Gain on sale of loans 225,000 0 0
Gain on sale of securities 78,000 321,000 270,000
Other income 1,119,000 954,000 666,000
----------- ----------- -----------
Total noninterest income 4,302,000 4,409,000 3,101,000
Noninterest expense
Salaries and benefits 13,956,000 11,371,000 7,771,000
Occupancy 1,588,000 1,386,000 1,069,000
Furniture and equipment 1,093,000 1,009,000 749,000
Data processing 880,000 822,000 571,000
Advertising 465,000 325,000 300,000
Other expense 5,216,000 3,158,000 2,321,000
----------- ----------- -----------
Total noninterest expenses 23,198,000 18,071,000 12,781,000
----------- ----------- -----------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 18,857,000 13,801,000 10,924,000
Federal income tax expense 5,136,000 3,785,000 3,167,000
----------- ----------- -----------
NET INCOME $13,721,000 $10,016,000 $ 7,757,000
=========== =========== ===========
Earnings per share:
Basic $ 1.91 $ 1.65 $ 1.36
=========== =========== ===========
Diluted $ 1.87 $ 1.61 $ 1.34
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-30
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2004, 2003 and 2002
Accumulated Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income/(Loss) Equity
------------ ----------- ----------------- -------------
BALANCES, JANUARY 1, 2002 $ 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, 606 shares 6,000 6,000
Comprehensive income:
Net income 7,757,000 7,757,000
Change in net unrealized gain on securities
available for sale, net of reclassifications
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
Sale of common stock, net of issuance
costs, 1,443,336 shares 42,818,000 42,818,000
Employee stock purchase plan, 1,974 shares 57,000 57,000
Dividend reinvestment plan, 3,884 shares 119,000 119,000
Stock option exercises, 31,912 shares 301,000 301,000
Stock tendered for stock option
exercises, 10,892 shares (265,000) (265,000)
Cash dividends ($0.32 per share) (1,845,000) (1,845,000)
Comprehensive income:
Net income 10,016,000 10,016,000
Change in net unrealized gain on securities
available for sale, net of reclassifications
and tax effect (834,000) (834,000)
------------
Total comprehensive income 9,182,000
------------ ----------- ---------- ------------
BALANCES, DECEMBER 31, 2003 118,560,000 11,421,000 220,000 130,201,000
See accompanying notes to consolidated financial statements.
F-31
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)
Years ended December 31, 2004, 2003 and 2002
Accumulated Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income/(Loss) Equity
------------ ------------ ----------------- -------------
BALANCES, DECEMBER 31, 2003 118,560,000 11,421,000 220,000 130,201,000
Payment of 5% stock dividend 12,111,000 (12,115,000) (4,000)
Employee stock purchase plan, 2,167 shares 79,000 79,000
Dividend reinvestment plan, 3,406 shares 123,000 123,000
Stock option exercises, 51,726 shares 524,000 524,000
Stock tendered for stock option
exercises, 10,938 shares (387,000) (387,000)
Cash dividends ($0.36 per share) (2,552,000) (2,552,000)
Comprehensive income:
Net income 13,721,000 13,721,000
Change in net unrealized gain on securities
available for sale, net of reclassifications
and tax effect (88,000) (88,000)
------------
Total comprehensive income 13,633,000
------------ ------------ -------- ------------
BALANCES, DECEMBER 31, 2004 $131,010,000 $ 10,475,000 $132,000 $141,617,000
============ ============ ======== ============
See accompanying notes to consolidated financial statements.
F-32
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2004, 2003 and 2002
2004 2003 2002
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 13,721,000 $ 10,016,000 $ 7,757,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 1,699,000 1,948,000 1,366,000
Provision for loan and lease losses 4,674,000 3,800,000 3,002,000
Gain on sale of loans (225,000) 0 0
Gain on sale of securities (78,000) (321,000) (270,000)
Net change in
Accrued interest receivable (1,546,000) (762,000) (525,000)
Bank owned life insurance policies (735,000) (780,000) (409,000)
Other assets (1,478,000) (1,377,000) (1,484,000)
Accrued expenses and other liabilities 2,315,000 1,083,000 579,000
------------- ------------- -------------
Net cash from operating activities 18,347,000 13,607,000 10,016,000
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of:
Securities available for sale (54,718,000) (58,388,000) (41,074,000)
Securities held to maturity (8,521,000) (10,126,000) (11,783,000)
Federal Home Loan Bank stock (1,821,000) (4,191,000) (1,000)
Proceeds from:
Sales of securities available for sale 1,748,000 15,983,000 13,997,000
Maturities, calls and repayments of
securities available for sale 30,382,000 29,153,000 20,493,000
Maturities, calls and repayments of
securities held to maturity 1,256,000 1,495,000 1,255,000
Loan originations and payments, net (282,170,000) (264,720,000) (184,912,000)
Purchases of premises and equipment, net (10,516,000) (4,293,000) (3,527,000)
Purchases of bank owned life insurance policies (6,574,000) (785,000) (10,476,000)
------------- ------------- -------------
Net cash from investing activities (330,934,000) (295,872,000) (216,028,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 256,289,000 148,779,000 185,036,000
Net increase/(decrease) in securities sold under
agreements to repurchase 6,772,000 (790,000) 13,850,000
Proceeds from Federal Home Loan Bank advances 75,000,000 95,000,000 15,000,000
Pay-off of Federal Home Loan Bank advances (45,000,000) (20,000,000) 0
Proceeds from issuance of subordinated debentures 32,990,000 0 0
Pay-off of subordinated debentures (16,495,000) 0 0
Net increase in other borrowed money 9,495,000 6,538,000 337,000
Net proceeds from sale of common stock 0 42,818,000 (37,000)
Cash paid in lieu of fractional shares on stock dividend (4,000) 0 (1,000)
Employee stock purchase plan 79,000 57,000 0
Dividend reinvestment plan 123,000 119,000 0
Stock option exercises, net 137,000 36,000 6,000
Cash dividends (2,552,000) (1,845,000) 0
------------- ------------- -------------
Net cash from financing activities 316,834,000 270,712,000 214,191,000
------------- ------------- -------------
Net change in cash and cash equivalents 4,247,000 (11,553,000) 8,179,000
Cash and cash equivalents at beginning of period 16,564,000 28,117,000 19,938,000
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 20,811,000 $ 16,564,000 $ 28,117,000
============= ============= =============
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest $ 25,107,000 $ 23,261,000 $ 23,883,000
Federal income tax 6,125,000 4,985,000 4,165,000
See accompanying notes to consolidated financial statements.
F-33
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of Mercantile Bank Corporation ("Mercantile") and its subsidiary,
Mercantile Bank of West Michigan ("Bank"), and of Mercantile Bank Mortgage
Company, LLC ("Mortgage Company"), Mercantile BIDCO, Inc. ("Mercantile BIDCO"),
Mercantile Bank Real Estate Co., L.L.C. ("Mercantile Real Estate") and
Mercantile Insurance Center, Inc. ("Mercantile Insurance"), subsidiaries of our
bank, after elimination of significant intercompany transactions and accounts.
Mercantile Bank Capital Trust I ("Mercantile Trust"), a business trust formed by
the company, was incorporated in 2004 for the purpose of issuing Series A and
Series B Preferred Securities. On September 16, 2004, the Mercantile Trust sold
the Series A Preferred Securities in a private sale for $16.0 million, and also
sold $495,000 of Series A Common Securities to Mercantile. The proceeds of the
Series A Preferred Securities and the Series A Common Securities were used by
Mercantile Trust to purchase $16,495,000 of Series A Floating Rate Notes that
were issued by Mercantile on September 16, 2004. Mercantile used the proceeds of
the Series A Floating Rate Notes to finance the redemption on September 17, 2004
of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by
MBWM Capital Trust I. On December 10, 2004, Mercantile Trust sold the Series B
Preferred Securities in a private sale for $16.0 million, and also sold $495,000
of Series B Common Securities to Mercantile. The proceeds of the Series B
Preferred Securities and the Series B Common Securities were used by Mercantile
Trust to purchase $16,495,000 of Series B Floating Rate Notes that were issued
by Mercantile on December 10, 2004. Substantially all of the net proceeds of the
Series B Floating Rate Notes were contributed to the Bank as capital to provide
support for asset growth, fund investments in loans and securities and for
general corporate purposes.
The only significant assets of Mercantile Trust are the Series A and Series B
Floating Rate Notes, and the only significant liabilities of Mercantile Trust
are the Series A and Series B Preferred Securities. The Series A and Series B
Floating Rate Notes are categorized on the company's consolidated balance sheet
as subordinated debentures and the interest expense is recorded on the company's
consolidated statement of income under interest expense on long-term borrowings.
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. 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 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 and investment securities.
Mercantile Trust was formed during 2004. All of the common securities of this
special purpose trust are owned by Mercantile. Mercantile Trust exists solely to
issue capital securities.
(Continued)
F-34
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Mercantile Bank Mortgage Company was formed during 2000. A subsidiary of the
Bank, Mercantile Bank Mortgage Company had been established to increase the
profitability and efficiency of the mortgage loan operations. Mercantile Bank
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
Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile Bank Mortgage
Company was reorganized as Mercantile Bank Mortgage Company, LLC, a limited
liability company, which is 99% owned by the Bank and 1% owned by Mercantile
Insurance. Mortgage loans originated and held by the Mercantile Bank 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 Hub
International. 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
Hub International. Mercantile Insurance receives commissions based upon written
premiums produced under the Agency and Institutions Agreement.
Mercantile Real Estate was organized on July 21, 2003, principally to develop,
construct, and own a new facility to be constructed in downtown Grand Rapids
which will serve as our bank's new main office and Mercantile's new
headquarters.
Mercantile filed an election to become a financial holding company pursuant to
Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board
regulations effective March 23, 2000.
Use of Estimates: To prepare financial statements in conformity with accounting
principles generally accepted in the United States of America, management makes
estimates and assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ. The allowance for loan
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 (including
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.
(Continued)
F-35
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
Declines in the fair value of securities below their cost that are other than
temporary are reflected as realized losses. In estimating other-than-temporary
losses, management considers: (1) the length of time and extent that fair value
has been less than cost, (2) the financial condition and near term prospects of
the issuer, and (3) our ability and intent to hold the security for a period
sufficient to allow for any anticipated recovery in fair value.
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.
Loans Held for Sale: Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of aggregate cost or market, as
determined by outstanding commitments from investors. Net unrealized losses, if
any, are recorded as a valuation allowance and charged to earnings. Such loans
are sold service released.
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.
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.
Transfer of Financial Assets: Transfers of financial assets are accounted for as
sales, when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when: (1) the assets have been
isolated from the corporation, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the corporation does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.
(Continued)
F-36
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Premises and Equipment: Land is carried at cost. Premises and equipment are
stated at cost less accumulated depreciation. Building and related components
are depreciated using the straight-line method with useful lives ranging from 5
to 33 years. Furniture, fixtures and equipment are depreciated using the
straight-line method with useful lives ranging from 3 to 7 years. 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
fair value.
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 Bank has purchased life insurance policies on
certain key officers. Bank 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
FASB Statement 123, Accounting for Stock-Based Compensation.
2004 2003 2002
----------- ----------- ----------
Net income as reported $13,721,000 $10,016,000 $7,757,000
Deduct: Stock-based compensation expense
determined under fair value based method 323,000 378,000 337,000
Pro forma net income 13,398,000 9,638,000 7,420,000
Basic earnings per share as reported $ 1.91 $ 1.65 $ 1.36
Pro forma basic earnings per share 1.87 1.59 1.30
Diluted earnings per share as reported $ 1.87 $ 1.61 $ 1.34
Pro forma diluted earnings per share 1.82 1.55 1.28
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
2004 2003 2002
------ ------ -------
Risk-free interest rate 3.45% 3.25% 4.78%
Expected option life 7 Years 7 Years 10 Years
Expected stock price volatility 22% 22% 30%
Dividend yield 1% 1% 0%
(Continued)
F-37
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 and Loan Commitments: Financial instruments include
off-balance-sheet credit instruments, such as commitments to make loans and
commercial 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. Instruments, such as standby letters of credit
that are considered financial guarantees in accordance with FASB Interpretation
No. 45, are recorded at fair value.
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 May 3, 2004, February 3, 2003 and February 1, 2002.
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.
New Accounting Pronouncements: FAS 123, Revised, requires all public companies
to record compensation cost for stock options provided to employees in return
for employment service. The cost is measured at the fair value of the options
when granted, and this cost is expensed over the employment service period,
which is normally the vesting period of the options. This will apply to awards
granted or modified after the first quarter or year beginning after June 15,
2005. Compensation cost will also be recorded for prior option grants that vest
after the date of adoption. The effect on results of operations will depend on
the level of future option grants and the calculation of the fair value of the
options granted at such future date, as well as the vesting periods provided,
and so cannot currently be predicted. Existing options that will vest after
adoption date are expected to result in additional compensation expense of
approximately $187,000 during the balance of 2005, and $36,000 in 2006 and
$27,000 in 2007. There will be no significant effect on financial position as
total equity will not change.
SOP 03-3 requires that a valuation allowance for loans acquired in a transfer,
including in a business combination, reflect only losses incurred after
acquisition and should not be recorded at acquisition. It applies to any loan
acquired in a transfer that showed evidence of credit quality deterioration
since it was made.
The effect of these new standards on the Corporation's financial position and
results of operations is not expected to be material upon and after adoption.
(Continued)
F-38
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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.
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.
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
----------- ---------- ---------- -----------
2004
U.S. Government agency
debt obligations $55,912,000 $241,000 $(128,000) $56,025,000
Mortgage-backed securities 37,711,000 255,000 (165,000) 37,801,000
----------- -------- ---------- -----------
$93,623,000 $496,000 $(293,000) $93,826,000
=========== ======== ========== ===========
2003
U.S. Government agency
debt obligations $34,014,000 $223,000 $(159,000) $34,078,000
Mortgage-backed securities 37,074,000 414,000 (145,000) 37,343,000
----------- -------- ---------- -----------
$71,088,000 $637,000 $(304,000) $71,421,000
=========== ======== ========== ===========
(Continued)
F-39
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 2 - SECURITIES (Continued)
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
----------- ------------ ------------ -----------
2004
Municipal general obligation bonds $45,063,000 $2,066,000 $ (88,000) $47,041,000
Municipal revenue bonds 7,278,000 325,000 (23,000) 7,580,000
----------- ---------- --------- -----------
$52,341,000 $2,391,000 $(111,000) $54,621,000
=========== ========== ========= ===========
2003
Municipal general obligation bonds $38,594,000 $1,829,000 $(122,000) $40,301,000
Municipal revenue bonds 6,518,000 303,000 (20,000) 6,801,000
----------- ---------- --------- -----------
$45,112,000 $2,132,000 $(142,000) $47,102,000
=========== ========== ========= ===========
Securities with unrealized losses not recognized in income are as follows:
Less than 12 Months 12 Months or More Total
------------------------ ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Description of Securities Value Loss Value Loss Value Loss
- ------------------------- ----------- ---------- ----------- ---------- ----------- ----------
2004
U.S. Government agency
debt obligations $ 1,976,000 $ (22,000) $ 3,893,000 $(106,000) $ 5,869,000 $(128,000)
Mortgage-backed securities 5,666,000 (16,000) 10,532,000 (149,000) 16,198,000 (165,000)
Municipal general
obligation bonds 744,000 (8,000) 2,357,000 (80,000) 3,101,000 (88,000)
Municipal revenue bonds 813,000 (9,000) 536,000 (14,000) 1,349,000 (23,000)
----------- ---------- ----------- ---------- ----------- ----------
$ 9,199,000 $ (55,000) $17,318,000 $(349,000) $26,517,000 $(404,000)
=========== ========== =========== ========== =========== ==========
2003
U.S. Government agency
debt obligations $ 5,827,000 $(159,000) $ 0 $ 0 $ 5,827,000 $(159,000)
Mortgage-backed securities 12,975,000 (145,000) 0 0 12,975,000 (145,000)
Municipal general
obligation bonds 4,318,000 (118,000) 1,082,000 (4,000) 5,400,000 (122,000)
Municipal revenue bonds 532,000 (20,000) 0 0 532,000 (20,000)
----------- ---------- ----------- ---------- ----------- ----------
$23,652,000 $(442,000) $ 1,082,000 $ (4,000) $24,734,000 $(446,000)
=========== ========== =========== ========== =========== ==========
(Continued)
F-40
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 2 - SECURITIES (Continued)
We evaluate securities for other-than-temporary impairment at least on a
quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to the length of time and the extent to
which the fair value has been less than cost, the financial condition and
near-term prospects of the issuer, and the intent and ability we have to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. In analyzing an issuer's financial
condition, we may consider whether the securities are issued by the federal
government or its agencies, whether downgrades by bond rating agencies have
occurred and the results of reviews of the issuer's financial condition.
At December 31, 2004, $26.5 million in debt securities have unrealized losses
with aggregate depreciation of 1.5% from the amortized cost basis. In analyzing
an issuer's financial condition, we considered whether the securities were
issued by the federal government or its agencies, whether downgrades by bond
rating agencies had occurred, and industry analysts' reports. As we have the
ability to hold debt securities until maturity, or for the foreseeable future if
classified as available for sale, no declines are deemed to be other than
temporary.
The amortized cost and fair values of debt securities at year-end 2004, 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.
The maturities of securities and their weighted average yields at December 31,
2004 are shown in the following table. The yields for municipal securities are
shown at their tax equivalent yield.
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 6.89% $ 906,000 $ 924,000 NA $ 0 $ 0
Due from one to five years 6.88 4,947,000 5,289,000 NA 0 0
Due from five to ten years 6.79 9,771,000 10,460,000 5.04% 55,912,000 56,025,000
Due after ten years 6.67 36,717,000 37,948,000 NA 0 0
Mortgage-backed NA 0 0 4.75 37,711,000 37,801,000
----------- ----------- ----------- -----------
6.72% $52,341,000 $54,621,000 4.92% $93,623,000 $93,826,000
=========== =========== =========== ===========
During 2004, securities with an aggregate amortized cost basis of $1.7 million
were sold, resulting in a gross realized gain of $78,000. During 2003,
securities with an aggregate amortized cost basis of $15.7 million were sold,
resulting in a gross realized gain of $324,000 and a gross realized loss of
$3,000. During 2002, securities with a gross amortized cost basis of $13.7
million were sold, resulting in a gross realized gain of $270,000.
At year-end 2004 and 2003, the amortized cost of securities issued by the state
of Michigan and all its political subdivisions totaled $52.3 million and $45.1
million, with an estimated market value of $54.6 million and $47.1 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 $70.9 million and $61.4 million at December 31, 2004 and
2003, respectively.
(Continued)
F-41
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 3 - LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Year-end loans and leases are as follows:
December 31, 2004 December 31, 2003 Percent
---------------------- ---------------------- Increase/
Balance % Balance % (Decrease)
-------------- ----- -------------- ----- ----------
Real Estate:
Construction and land
development $ 136,705,000 10.3% $ 117,649,000 11.4% 16.2%
Secured by 1 - 4
family properties 122,635,000 9.3 92,339,000 8.9 32.8
Secured by multi-
family properties 35,183,000 2.7 28,950,000 2.8 21.5
Secured by
nonresidential properties 649,415,000 49.3 485,080,000 46.8 33.9
Commercial 365,615,000 27.8 304,800,000 29.4 20.0
Leases 2,573,000 0.2 2,309,000 0.2 11.4
Consumer 4,998,000 0.4 4,836,000 0.5 3.3
-------------- ----- -------------- ----- ----
$1,317,124,000 100.0% $1,035,963,000 100.0% 27.1%
============== ===== ============== ===== ====
Activity in the allowance for loan and lease losses is as follows:
2004 2003 2002
----------- ----------- -----------
Beginning balance $14,379,000 $10,890,000 $ 8,494,000
Provision for loan and lease losses 4,674,000 3,800,000 3,002,000
Charge-offs (1,405,000) (596,000) (706,000)
Recoveries 171,000 285,000 100,000
----------- ----------- -----------
Ending balance $17,819,000 $14,379,000 $10,890,000
=========== =========== ===========
2004 2003
---------- ----------
Impaired loans and leases were as follows:
Year-end loans with no allocated allowance for loan and lease losses $ 0 $ 0
Year-end loans with allocated allowance for loan and lease losses 2,729,000 1,785,000
---------- ----------
$2,729,000 $1,785,000
========== ==========
Amount of the allowance for loan and lease losses allocated $ 477,000 $ 321,000
Average of impaired loans during the year 2,845,000 581,000
The Bank recognized interest income of $21,000 on impaired loans during 2004 and
$140,000 during 2003, all accounted for on a cash basis. The Bank did not
recognize any interest income on impaired loans during 2002. Nonperforming loans
includes both smaller balance homogenous loans that are collectively evaluated
for impairment and individually classified impaired loans.
(Continued)
F-42
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 3 - LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Nonperforming loans and leases were as follows:
Loans and leases past due over 90 days still accruing interest $ 0 $1,552,000
Nonaccrual loans and leases 2,842,000 233,000
---------- ----------
$2,842,000 $1,785,000
========== ==========
Concentrations within the loan portfolio were as follows at year-end:
2004 2003
----------------------------- -----------------------------
Percentage of Percentage of
Balance Loan Portfolio Balance Loan Portfolio
------------ -------------- ------------ --------------
Commercial real estate loans to
lessors of non-residential
buildings $364,230,000 27.7% $259,690,000 25.1%
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment are as follows:
2004 2003
----------- -----------
Land and improvements $ 6,482,000 $ 5,745,000
Buildings and leasehold improvements 16,547,000 8,183,000
Furniture and equipment 6,327,000 4,935,000
----------- -----------
29,356,000 18,863,000
Less: accumulated depreciation 4,784,000 3,558,000
----------- -----------
$24,572,000 $15,305,000
=========== ===========
Depreciation expense in 2004, 2003 and 2002 totaled $1,248,000, $1,162,000 and
$910,000, respectively.
(Continued)
F-43
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 5 - DEPOSITS
Deposits at year-end are summarized as follows:
December 31, 2004 December 31, 2003 Percent
---------------------- -------------------- Increase/
Balance % Balance % (Decrease)
-------------- ----- ------------ ----- ----------
Noninterest-bearing
demand $ 101,742,000 8.8% $ 76,579,000 8.5% 32.9%
Interest-bearing
checking 37,649,000 3.2 34,241,000 3.8 10.0
Money market 10,528,000 0.9 8,290,000 0.9 27.0
Savings 129,374,000 11.2 101,710,000 11.3 27.2
Time, under $100,000 8,963,000 0.8 8,163,000 0.9 9.8
Time, $100,000 and
over 99,760,000 8.6 82,288,000 9.1 21.2
-------------- ----- ------------ ----- ----
388,016,000 33.5 311,271,000 34.5 24.7
Out-of-area time,
under $100,000 90,829,000 7.8 98,079,000 10.9 (7.4)
Out-of-area time,
$100,000 and over 680,336,000 58.7 493,542,000 54.6 37.8
-------------- ----- ------------ ----- ----
771,165,000 66.5 591,621,000 65.5 30.3
-------------- ----- ------------ ----- ----
$1,159,181,000 100.0% $902,892,000 100.0% 28.4%
============== ===== ============ ===== ====
Out-of-area certificates of deposit consist of certificates obtained from
depositors outside of the primary market area. As of December 31, 2004,
out-of-area certificates of deposit totaling $753.6 million were obtained
through deposit brokers, with the remaining $17.6 million obtained directly from
the depositors.
The following table depicts the maturity distribution for time deposits at
year-end.
2004 2003
------------ ------------
In one year $609,055,000 $490,450,000
In two years 191,079,000 119,376,000
In three years 40,044,000 34,172,000
In four years 21,252,000 19,957,000
In five years 18,458,000 18,117,000
------------ ------------
$879,888,000 $682,072,000
============ ============
The following table depicts the maturity distribution for certificates of
deposit with balances of $100,000 or more at year-end.
2004 2003
------------ ------------
Up to three months $181,526,000 $123,040,000
Three months to six months 136,349,000 142,231,000
Six months to twelve months 229,645,000 146,488,000
Over twelve months 232,576,000 164,071,000
------------ ------------
$780,096,000 $575,830,000
============ ============
(Continued)
F-44
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
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:
2004 2003
----------- -----------
Outstanding balance at year-end $56,317,000 $49,545,000
Weighted average interest rate at year-end 1.90% 1.38%
Average daily balance during the year 49,935,000 45,865,000
Weighted average interest rate during the year 1.57% 1.45%
Maximum month end balance during the year 61,678,000 55,270,000
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 were secured by securities with a market value of $69.9 million and
$60.4 million at year-end 2004 and 2003, respectively.
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows.
2004 2003
------------ -----------
Maturities January 2005 through December 2006, fixed rates
from 1.66% to 3.47%, averaging 2.51% 110,000,000 0
Maturities in May 2006, floating rates tied to Libor indices,
averaging 2.32% 10,000,000 0
Maturities January 2004 through September 2006, fixed rates
from 1.54% to 3.21%, averaging 2.07% 0 90,000,000
------------ -----------
$120,000,000 $90,000,000
============ ===========
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 the Bank, under a blanket lien
arrangement. Our borrowing line of credit as of December 31, 2004 totaled $193.5
million.
Maturities over the next five years are:
2005 $65,000,000
2006 55,000,000
2007 0
2008 0
2009 0
(Continued)
F-45
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 8 - FEDERAL INCOME TAXES
The consolidated provision for income taxes is as follows:
2004 2003 2002
---------- ----------- ----------
Current $5,981,000 $ 5,153,000 $4,060,000
Deferred benefit (845,000) (1,253,000) (893,000)
Effect of restating deferred tax asset @ 35% 0 (115,000) 0
---------- ----------- ----------
Tax expense $5,136,000 $ 3,785,000 $3,167,000
========== =========== ==========
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:
2004 2003 2002
---------- ---------- ----------
Statutory rates $6,600,000 $4,830,000 $3,714,000
Increase (decrease) from
Tax-exempt interest (708,000) (606,000) (429,000)
Life insurance (257,000) (273,000) (139,000)
Effect of tax bracket surcharge 0 (100,000) 0
Rehabilitation tax credits (429,000) 0 0
Other (70,000) (66,000) 21,000
---------- ---------- ----------
Tax expense $5,136,000 $3,785,000 $3,167,000
========== ========== ==========
The net deferred tax asset recorded includes the following amounts of deferred
tax assets and liabilities:
2004 2003
---------- ----------
Deferred tax assets
Allowance for loan and lease losses $6,237,000 $4,983,000
Deferred loan fees 401,000 360,000
Deferred compensation 563,000 390,000
Other 27,000 33,000
---------- ----------
7,228,000 5,766,000
Deferred tax liabilities
Unrealized gain on securities available for sale 71,000 113,000
Depreciation 711,000 383,000
Other 407,000 118,000
---------- ----------
1,189,000 614,000
---------- ----------
Net deferred tax asset $6,039,000 $5,152,000
========== ==========
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 2004 or 2003.
(Continued)
F-46
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
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, generally fully
vest after one year and expire ten years from the date of grant. At year-end
2004, there were 262,994 shares authorized for future option grants. Information
about option grants follows.
A summary of the activity in the plan is as follows.
2004 2003 2002
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------- -------- -------- -------- -------- --------
Outstanding at
beginning of year 291,978 $14.98 285,466 $12.03 241,279 $10.61
Granted 42,050 40.16 39,761 32.13 47,106 19.39
Exercised (51,726) 10.14 (31,912) 9.43 (606) 9.51
Forfeited or expired (420) 30.81 (1,337) 28.78 (2,313) 14.41
-------- ------ -------- ------ -------- ------
Outstanding at
end of year 281,882 $19.60 291,978 $14.98 285,466 $12.03
======== ====== ======== ====== ======== ======
Options exercisable
at year-end 219,354 $15.02 238,254 $11.84 229,731 $10.31
======== ====== ======== ====== ======== ======
Fair value of options
granted during year $ 10.86 $ 7.97 $ 9.50
======== ======== ========
Options outstanding at year-end 2004 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 73,155 4.0 Years $ 8.92 73,155 $ 8.92
$10.01 - $12.00 43,009 4.1 Years 11.02 43,009 11.02
$14.01 - $16.00 33,550 6.8 Years 14.40 33,550 14.40
$18.01 - $20.00 44,952 7.6 Years 18.57 38,016 18.68
$22.01 - $24.00 6,612 7.8 Years 23.36 0 NA
$30.01 - $32.00 32,254 8.8 Years 30.81 31,624 30.81
$38.01 - $40.00 41,850 9.7 Years 38.91 0 NA
$46.01 - $48.00 6,500 9.8 Years 46.63 0 NA
------- --------- -------
Outstanding at year end 281,882 6.5 Years $19.60 219,354 $15.02
======= ========= =======
(Continued)
F-47
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 9 - STOCK OPTION PLANS (Continued)
Options outstanding at year-end 2004, 2003 and 2002 were as follows:
2004 2003 2002
--------- --------- ---------
Minimum exercise price $ 8.23 $ 8.23 $ 8.23
Maximum exercise price 46.63 38.52 23.36
Average remaining option term 6.5 Years 6.5 Years 6.8 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 2004 and 2003, the Bank had $14.2 million and $11.3
million in loan commitments to directors and executive officers, of which $10.2
million and $6.3 million were outstanding at year-end 2004 and 2003,
respectively, as reflected in the following table.
2004 2003
----------- -----------
Beginning balance $ 6,271,000 $ 2,951,000
New loans 5,209,000 4,914,000
Repayments (1,270,000) (1,594,000)
----------- -----------
Ending balance $10,210,000 $ 6,271,000
=========== ===========
Related party deposits and repurchase agreements totaled $15.5 million at
year-end 2004 and $11.3 million at year-end 2003.
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. If required,
estimated loss exposure resulting from these instruments is expensed and
recorded as a liability.
(Continued)
F-48
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 11 - COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
At year-end 2004 and 2003, 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:
2004 2003
------------ ------------
Commercial unused lines of credit $226,935,000 $176,943,000
Unused lines of credit secured by 1 - 4 family
residential properties 24,988,000 19,020,000
Credit card unused lines of credit 8,307,000 8,990,000
Other consumer unused lines of credit 5,155,000 5,569,000
Commitments to make loans 55,440,000 73,570,000
Standby letters of credit 56,464,000 57,918,000
------------ ------------
$377,289,000 $342,010,000
============ ============
The following instruments are considered financial guarantees under FASB
Interpretation 45. These instruments are carried at fair value.
2004 2003
---------------------- ----------------------
Contract Carrying Contract Carrying
Amount Value Amount Value
----------- -------- ----------- --------
Standby letters of credit $56,464,000 $226,000 $57,918,000 $296,000
The Bank was required to have $7.7 million and $4.5 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 2004 and 2003. 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 2004, 2003 and 2002 was
$180,000, $175,000 and $170,000, respectively. Future minimum rentals under this
lease, which expires on August 31, 2007, as of year-end 2004 are as follows:
2005 $184,000
2006 184,000
2007 123,000
--------
$491,000
========
NOTE 12 - BENEFIT PLANS
Mercantile has a 401(k) benefit plan that covers substantially all of its
employees. Mercantile's 2004, 2003 and 2002 matching 401(k) contribution charged
to expense was $413,000, $327,000 and $239,000, respectively. The percent of
Mercantile'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.
(Continued)
F-49
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 12 - BENEFIT PLANS (Continued)
Mercantile has a deferred compensation plan in which all persons serving on the
Board of Directors may defer all or portions of annual retainer and meeting
fees, with distributions to be paid only upon termination of service as a
director. The deferred amounts are categorized on Mercantile's financial
statements as other borrowed money. The deferred balances are paid interest at a
rate equal to the prime rate, adjusted at the beginning of each calendar
quarter. Interest expense for the plan during 2004, 2003 and 2002 was $21,000,
$15,000 and $11,000, respectively.
Mercantile has a non-qualified deferred compensation program in which selected
officers may defer all or portions of salary and bonus payments. The deferred
amounts are categorized on Mercantile's financial statements as other borrowed
money. The deferred balances are paid interest at a rate equal to the prime
rate, adjusted at the beginning of each calendar quarter. Interest expense for
the plan during 2004, 2003 and 2002 was $38,000, $22,000 and $10,000,
respectively.
The Mercantile Bank Corporation Employee Stock Purchase Plan of 2002 ("Stock
Purchase Plan") is a non-compensatory plan intended to encourage full- and
part-time employees of Mercantile and its subsidiaries to promote the best
interests of Mercantile and to align employees' interests with the interests' of
Mercantile's shareholders by permitting employees to purchase shares of
Mercantile common stock through regular payroll deductions. Shares are purchased
on the last business day of each calendar quarter at a price equal to the
average, rounded to the nearest whole cent, of the highest and lowest sales
prices of Mercantile's common stock reported on The Nasdaq Stock Market.
Originally, 25,000 shares of common stock may be issued under the Stock Purchase
Plan; however, the number of shares has been and may continue to be adjusted in
the future to reflect stock dividends and other changes in Mercantile's
capitalization. The numbers of shares issued under the Stock Purchase Plan
totaled 2,167 and 1,974 in 2004 and 2003, respectively. As of December 31, 2004,
there were 23,421 shares available under the Stock Purchase Plan.
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as
follows at year-end.
2004 2003
------------------------------- -------------------------------
Carrying Fair Carrying Fair
Values Values Values Values
-------------- -------------- -------------- --------------
Financial assets
Cash and cash equivalents $ 20,811,000 $ 20,811,000 $ 16,564,000 $ 16,564,000
Securities available for sale 93,826,000 93,826,000 71,421,000 71,421,000
Securities held to maturity 52,341,000 54,621,000 45,112,000 47,102,000
Federal Home Loan Bank stock 6,798,000 6,798,000 4,977,000 4,977,000
Loans, net 1,299,305,000 1,316,831,000 1,021,584,000 1,038,404,000
Bank owned life insurance policies 23,750,000 23,750,000 16,441,000 16,441,000
Accrued interest receivable 5,644,000 5,644,000 4,098,000 4,098,000
Financial liabilities
Deposits 1,159,181,000 1,155,016,000 902,892,000 903,278,000
Securities sold under agreements
to repurchase 56,317,000 56,317,000 49,545,000 49,545,000
Federal Home Loan Bank advances 120,000,000 119,936,000 90,000,000 90,305,000
Accrued interest payable 6,297,000 6,297,000 4,799,000 4,799,000
Subordinated debentures 32,990,000 32,990,000 16,495,000 23,088,000
(Continued)
F-50
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
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. Fair value of subordinated debentures and
Federal Home Loan Bank advances 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.
2004 2003 2002
----------- ----------- ----------
Basic
Net income $13,721,000 $10,016,000 $7,757,000
=========== =========== ==========
Weighted average common shares outstanding 7,174,320 6,070,648 5,675,988
----------- ----------- ----------
Basic earnings per common share $ 1.91 $ 1.65 $ 1.37
=========== =========== ==========
Diluted
Net income $13,721,000 $10,016,000 $7,757,000
=========== =========== ==========
Weighted average common shares outstanding for
basic earnings per common share 7,174,320 6,070,648 5,675,988
Add: Dilutive effects of assumed exercises of
stock options 179,693 145,010 102,501
----------- ----------- ----------
Average shares and dilutive potential
common shares 7,354,013 6,215,658 5,778,489
=========== =========== ==========
Diluted earnings per common share $ 1.87 $ 1.61 $ 1.34
=========== =========== ==========
Stock options for 48,350, 37,730 and 44,878 shares of common stock were not
considered in computing diluted earnings per common share for 2004, 2003 and
2002, respectively, because they were antidilutive.
(Continued)
F-51
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 15 - SUBORDINATED DEBENTURES
Mercantile Trust, a business trust formed by the company, was incorporated in
2004 for the purpose of issuing Series A and Series B Preferred Securities. On
September 16, 2004, Mercantile Trust sold the Series A Preferred Securities in a
private sale for $16.0 million, and also sold $495,000 of Series A Common
Securities to Mercantile. The proceeds of the Series A Preferred Securities and
the Series A Common Securities were used by Mercantile Trust to purchase
$16,495,000 of Series A Floating Rate Notes that were issued by Mercantile on
September 16, 2004. Mercantile used the proceeds of the Series A Floating Rate
Notes to finance the redemption on September 17, 2004 of the $16.0 million of
9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. On
December 10, 2004, Mercantile Trust sold the Series B Preferred Securities in a
private sale for $16.0 million, and also sold $495,000 of Series B Common
Securities to Mercantile. The proceeds of the Series B Preferred Securities and
the Series B Common Securities were used by Mercantile Trust to purchase
$16,495,000 of Series B Floating Rate Notes that were issued by Mercantile on
December 10, 2004. Substantially all of the net proceeds of the Series B
Floating Rate Notes were contributed to our bank as capital to provide support
for asset growth, fund investments in loans and securities and for general
corporate purposes.
The only significant assets of Mercantile Trust are the Series A and Series B
Floating Rate Notes, and the only significant liabilities of Mercantile Trust
are the Series A and Series B Preferred Securities. The Series A and Series B
Floating Rate Notes are categorized on the company's consolidated balance sheet
as subordinated debentures and the interest expense is recorded on the company's
consolidated statement of income under interest expense on long-term borrowings.
NOTE 16 - SALE OF COMMON STOCK
During 2003, Mercantile sold in aggregate approximately 1.4 million shares of
common stock, raising $43.0 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 an institution is adequately
capitalized, regulatory approval is required to accept brokered deposits. If an
institution is undercapitalized, capital distributions are limited, as is asset
growth and expansion, and plans for capital restoration are required. At
year-end 2004 and 2003, the most recent regulatory notifications categorized the
Bank as well capitalized under the regulatory framework for prompt corrective
action. There are no conditions or events since that notification that we
believe has changed the Bank's category.
(Continued)
F-52
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
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
-------- ----- -------- ----- -------- -----
2004
Total capital (to risk
weighted assets)
Consolidated $191,304 13.0% $117,426 8.0% $146,782 10.0%
Bank 188,075 12.8 117,288 8.0 146,610 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 173,485 11.8 58,713 4.0 88,070 6.0
Bank 170,256 11.6 58,644 4.0 87,966 6.0
Tier 1 capital (to average
assets)
Consolidated 173,485 11.5 60,182 4.0 75,227 5.0
Bank 170,256 11.3 60,088 4.0 75,110 5.0
2003
Total capital (to risk
weighted assets)
Consolidated $160,360 13.8% $ 92,711 8.0% $115,888 10.0%
Bank 156,950 13.6 92,556 8.0 115,695 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 145,981 12.6 46,356 4.0 69,533 6.0
Bank 142,571 12.3 46,278 4.0 69,417 6.0
Tier 1 capital (to average
assets)
Consolidated 145,981 12.5 46,756 4.0 58,444 5.0
Bank 142,571 12.2 46,703 4.0 58,378 5.0
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 2004, under the most restrictive of
these regulations (to remain well capitalized), the Bank could distribute
approximately $38.3 million to Mercantile as dividends without prior regulatory
approval.
The capital levels as of year-end 2004 include $32.0 million trust preferred
securities issued by Mercantile Trust in September 2004 and December 2004
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 2004, all $32.0 million of the trust
preferred securities were included as Tier 1 capital of Mercantile.
(Continued)
F-53
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 17 - REGULATORY MATTERS (Continued)
The capital levels as of year-end 2003 include $16.0 million trust preferred
securities issued by MBWM Capital Trust I 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 2003, all $16.0 million of the trust preferred
securities were included as Tier 1 capital of Mercantile.
NOTE 18 - OTHER COMPREHENSIVE INCOME/(LOSS)
Other comprehensive income/(loss) components and related taxes were as follows.
2004 2003 2002
--------- ----------- ----------
Unrealized holding gains and losses on
available-for-sale securities $(208,000) $(1,586,000) $1,249,000
Reclassification adjustments for gains
and losses later recognized in income (78,000) (321,000) (270,000)
--------- ----------- ----------
Net unrealized gains and losses (130,000) (1,265,000) 979,000
Tax effect of unrealized holding gains and
losses on available-for-sale securities 70,000 539,000 (425,000)
Tax effect of reclassification adjustments for
gains and losses later recognized in income (28,000) (108,000) 92,000
--------- ----------- ----------
Other comprehensive income/(loss) $ (88,000) $ (834,000) $ 646,000
========= =========== ==========
NOTE 19 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Earnings per Share
Interest Net Interest Net ---------------------
Income Income Income Basic Fully Diluted
----------- ------------ ---------- ----- -------------
2004
First quarter $15,354,000 $ 9,489,000 $2,973,000 $0.42 $0.41
Second quarter 16,130,000 10,000,000 3,146,000 0.44 0.43
Third quarter 17,819,000 10,856,000 3,114,000 0.43 0.42
Fourth quarter 19,719,000 12,082,000 4,488,000 0.62 0.61
2003
First quarter $12,675,000 $ 6,794,000 $2,233,000 $0.39 $0.38
Second quarter 13,433,000 7,511,000 2,540,000 0.45 0.44
Third quarter 13,854,000 8,057,000 2,228,000 0.38 0.37
Fourth quarter 14,696,000 8,949,000 3,015,000 0.43 0.42
2002
First quarter $11,040,000 $ 5,034,000 $1,604,000 $0.28 $0.29
Second quarter 11,639,000 5,735,000 1,716,000 0.30 0.29
Third quarter 12,318,000 6,282,000 2,156,000 0.38 0.37
Fourth quarter 12,635,000 6,603,000 2,281,000 0.40 0.39
(Continued)
F-54
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 20 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY) CONDENSED FINANCIAL
STATEMENTS
Following are condensed parent company only financial statements.
CONDENSED BALANCE SHEETS
2004 2003
------------ ------------
ASSETS
Cash and cash equivalents $ 1,644,000 $ 1,408,000
Investment in bank subsidiary 170,389,000 142,791,000
Other assets 2,792,000 2,855,000
------------ ------------
Total assets $174,825,000 $147,054,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 218,000 $ 358,000
Subordinated debentures 32,990,000 16,495,000
Shareholders' equity 141,617,000 130,201,000
------------ ------------
Total liabilities and shareholders' equity $174,825,000 $147,054,000
============ ============
CONDENSED STATEMENTS OF INCOME
2004 2003 2002
----------- ----------- ----------
Income
Dividends from subsidiaries $ 4,032,000 $ 3,455,000 $1,583,000
Other 25,000 14,000 18,000
----------- ----------- ----------
Total income 4,057,000 3,469,000 1,601,000
Expenses
Interest expense 1,402,000 1,617,000 1,617,000
Other operating expenses 1,666,000 611,000 512,000
----------- ----------- ----------
Total expenses 3,068,000 2,228,000 2,129,000
----------- ----------- ----------
INCOME (LOSS) BEFORE INCOME TAX AND EQUITY IN
UNDISTRIBUTED NET INCOME (LOSS) OF SUBSIDIARIES 989,000 1,241,000 (528,000)
Federal income tax expense (benefit) (1,051,000) (724,000) (702,000)
Equity in undistributed net income of subsidiary 11,681,000 8,051,000 7,583,000
----------- ----------- ----------
NET INCOME $13,721,000 $10,016,000 $7,757,000
=========== =========== ==========
(Continued)
F-55
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004 and 2003
NOTE 20 - MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
2004 2003 2002
------------ ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 13,721,000 $ 10,016,000 $ 7,757,000
Adjustments to reconcile net income to net
cash from operating activities
Equity in undistributed income of subsidiary (11,681,000) (8,051,000) (7,583,000)
Change in other assets 553,000 95,000 17,000
Change in other liabilities (140,000) (82,000) 60,000
------------ ------------ -----------
Net cash from operating activities 2,453,000 1,978,000 251,000
CASH FLOWS FROM INVESTING ACTIVITIES
Net capital investment into subsidiaries (16,495,000) (42,600,000) 0
------------ ------------ -----------
Net cash from investing activities (16,495,000) (42,600,000) 0
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from sale of common stock 0 42,818,000 (37,000)
Proceeds from the issuance of subordinated debentures 32,990,000 0 0
Pay-off of subordinated debentures (16,495,000) 0 0
Stock option exercises, net 137,000 36,000 6,000
Employee stock purchase plan 79,000 57,000 0
Dividend reinvestment plan 123,000 119,000 0
Cash dividends (2,552,000) (1,845,000) 0
Fraction shares paid (4,000) 0 (1,000)
------------ ------------ -----------
Net cash from financing activities 14,278,000 41,185,000 (32,000)
------------ ------------ -----------
Net change in cash and cash equivalents 236,000 563,000 219,000
Cash and cash equivalents at beginning of period 1,408,000 845,000 626,000
------------ ------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,644,000 $ 1,408,000 $ 845,000
============ ============ ===========
F-56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on February 24, 2005.
MERCANTILE BANK CORPORATION
/s/ Gerald R. Johnson, Jr.
-------------------------------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on February 24, 2005.
/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/ Merle J. Prins
- ------------------------------------- ----------------------------------------
C. John Gill, Director Merle J. Prins, Director
/s/ Doyle A. Hayes /s/ Dale J. Visser
- ------------------------------------- ----------------------------------------
Doyle A. Hayes, Director Dale J. Visser, Director
/s/ David M. Hecht /s/ Donald Williams, Sr.
- ------------------------------------- ----------------------------------------
David M. Hecht, Director Donald Williams, Sr., Director
/s/ Gerald R. Johnson, Jr. /s/ Charles E. Christmas
- ------------------------------------- ----------------------------------------
Gerald R. Johnson, Jr., Chairman of Charles E. Christmas, Senior Vice
the Board and Chief Executive President, Chief Financial Officer
Officer (principal executive and Treasurer (principal financial
officer) and accounting officer)
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
3.1 Our Articles of Incorporation are incorporated by reference to
exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2004
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 *
10.2 Our 2000 Employee Stock Option Plan is incorporated by reference
to exhibit 10.14 of our Form 10-K for the year ended December 31,
2000 *
10.3 Our 2004 Employee Stock Option Plan is incorporated by reference
to exhibit 10.1 of our Form 10-Q for the quarter ended September
30, 2004 *
10.4 Form of Stock Option Agreement for options under the 2004 Employee
Stock Option Plan is incorporated by reference to exhibit 10.2 of
our Form 10-Q for the quarter ended September 30, 2004 *
10.5 Our Independent Director Stock Option Plan is incorporated by
reference to exhibit 10.26 of our Form 10-K for the year ended
December 31, 2002 *
10.6 Form of Stock Option Agreement for options under the Independent
Director Stock Option Plan is incorporated by reference to exhibit
10.1 of our Form 8-K dated October 21, 2004 *
10.7 Nonlender Bonus Plan is incorporated by reference to exhibit 10.3
of our Form 10-Q for the quarter ended September 30, 2004 *
10.8 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 *
10.9 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
10.10 Agreement between Fiserv 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
10.11 Extension Agreement of Data Processing Contract between Fiserv
Solutions, Inc. and our bank dated May 12, 2000 extending the
agreement between Fiserv Solutions, Inc. and our bank dated
September 10, 1997, is incorporated by reference to exhibit 10.15
of our Form 10-K for the year ended December 31, 2000
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
10.12 Extension Agreement of Data Processing Contract between Fiserv
Solutions, Inc. and our bank dated November 22, 2002 extending the
agreement between Fiserv Solutions, Inc. and our bank dated
September 10, 1997, is incorporated by reference to exhibit 10.5
of our Form 10-K for the year ended December 31, 2002
10.13 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 year ended December 31, 2001 *
10.14 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 year ended December 31, 2001 *
10.15 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 year ended
December 31, 2001 *
10.16 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 year ended
December 31, 2001 *
10.17 Amendment to Employment Agreement dated as of October 17, 2002,
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 year ended December 31, 2002 *
10.18 Amendment to Employment Agreement dated as of October 17, 2002,
among the company, our bank and Michael H. Price, is incorporated
by reference to exhibit 10.22 of our Form 10-K for the year ended
December 31, 2002 *
10.19 Amendment to Employment Agreement dated as of October 17, 2002,
among the company, our bank and Robert B. Kaminski, is
incorporated by reference to exhibit 10.23 of our Form 10-K for
the year ended December 31, 2002 *
10.20 Amendment to Employment Agreement dated as of October 17, 2002,
among the company, our bank and Charles E. Christmas, is
incorporated by reference to exhibit 10.24 of our Form 10-K for
the year ended December 31, 2002 *
10.21 Amendment to Employment Agreement dated as of October 28, 2004,
among the company, our bank and Robert B. Kaminski *
10.22 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, is
incorporated by reference to exhibit 10.25 of our Form 10-K for
the year ended December 31, 2002
10.23 Agreement between our real estate company and Visser Brothers,
Inc. dated November 20, 2003, on Standard Form of Agreement
Between Owner and Contractor where the basis of payment is a
stipulated sum is incorporated by reference to exhibit 10.22 of
our Form 10-K for the year ended December 31, 2003
10.24 Agreement between our bank and Rockford Construction Company,
Inc., dated December 3, 2003, on Standard Form of Agreement
Between Owner and Contractor where the basis of payment is a
stipulated sum is incorporated by reference to exhibit 10.23 of
our Form 10-K for the year ended December 31, 2003
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- -------------------
10.25 Junior Subordinated Indenture between us and Wilmington Trust
Company dated September 16, 2004 providing for the issuance of the
Series A and Series B Floating Rate Junior Subordinated Notes due
2034 is incorporated by reference to exhibit 10.1 of our Form 8-K
dated December 15, 2004
10.26 Amended and Restated Trust Agreement dated September 16, 2004 for
Mercantile Bank Capital Trust I is incorporated by reference to
exhibit 10.2 of our Form 8-K dated December 15, 2004
10.27 Placement Agreement between us, Mercantile Bank Capital Trust I,
and SunTrust Capital Markets, Inc. dated September 16, 2004 is
incorporated by reference to exhibit 10.3 of our Form 8-K dated
December 15, 2004
10.28 Guarantee Agreement dated September 16, 2004 between Mercantile as
Guarantor and Wilmington Trust Company as Guarantee Trustee is
incorporated by reference to exhibit 10.4 of our Form 8-K dated
December 15, 2004
21 Subsidiaries of the company
23 Consent of Independent Registered Public Accounting Firm
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
* - Management contract or compensatory plan