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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File No. 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-3360865
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5650 BYRON CENTER AVENUE SW, WYOMING, MI 49519
(Address of principal executive offices) (Zip Code)
(616) 406-3777
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
At May 6, 2005, there were 7,219,017 shares of Common Stock outstanding.
MARCANTILE BANK CORPORATION
INDEX
Page No.
--------
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2005 (Unaudited) and December 31, 2004................................... 1
Consolidated Statements of Income and Comprehensive Income -
Three Months Ended March 31, 2005 (Unaudited) and
March 31, 2004 (Unaudited)......................................................... 2
Consolidated Statement of Changes in Shareholders' Equity -
Three Months Ended March 31, 2005 (Unaudited) and
March 31, 2004 (Unaudited)........................................................ 3
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 2005 (Unaudited) and
March 31, 2004 (Unaudited)......................................................... 4
Notes to Consolidated Financial Statements (Unaudited)................................. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 22
Item 4. Controls and Procedures....................................................... 24
PART II. Other Information
Item 1. Legal Proceedings............................................................. 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds................... 25
Item 3. Defaults upon Senior Securities............................................... 25
Item 4. Submission of Matters to a Vote of Security Holders........................... 25
Item 5. Other Information............................................................. 26
Item 6. Exhibits...................................................................... 26
Signatures............................................................................. 27
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2005 2004
---- ----
(Unaudited)
ASSETS
Cash and due from banks $ 39,255,000 $ 20,662,000
Short-term investments 942,000 149,000
Federal funds sold 33,400,000 0
--------------- ----------------
Total cash and cash equivalents 73,597,000 20,811,000
Securities available for sale 102,733,000 93,826,000
Securities held to maturity (fair value of $58,622,000 at
March 31, 2005 and $54,621,000 at December 31, 2004) 57,023,000 52,341,000
Federal Home Loan Bank stock 7,022,000 6,798,000
Total loans and leases 1,374,577,000 1,317,124,000
Allowance for loan and lease losses (18,097,000) (17,819,000)
--------------- ----------------
Total loans and leases, net 1,356,480,000 1,299,305,000
Premises and equipment, net 26,576,000 24,572,000
Bank owned life insurance policies 23,986,000 23,750,000
Accrued interest receivable 6,883,000 5,644,000
Other assets 10,576,000 9,072,000
--------------- ----------------
Total assets $ 1,664,876,000 $ 1,536,119,000
=============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 135,544,000 $ 101,742,000
Interest-bearing 1,154,473,000 1,057,439,000
--------------- ----------------
Total deposits 1,290,017,000 1,159,181,000
Securities sold under agreements to repurchase 60,208,000 56,317,000
Federal funds purchased 0 15,000,000
Federal Home Loan Bank advances 125,000,000 120,000,000
Subordinated debentures 32,990,000 32,990,000
Other borrowed money 1,916,000 1,609,000
Accrued expenses and other liabilities 10,244,000 9,405,000
--------------- ----------------
Total liabilities 1,520,375,000 1,394,502,000
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;
7,212,268 shares outstanding at March 31, 2005 and
7,192,461 shares outstanding at December 31, 2004 131,113,000 131,010,000
Retained earnings 14,116,000 10,475,000
Accumulated other comprehensive income (loss) (728,000) 132,000
--------------- ----------------
Total shareholders' equity 144,501,000 141,617,000
--------------- ----------------
Total liabilities and shareholders' equity $ 1,664,876,000 $ 1,536,119,000
=============== ================
See accompanying notes to consolidated financial statements.
1.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Three Months
Ended Ended
March 31, March 31,
2005 2004
-------------- ---------------
Interest income
Loans and leases, including fees $ 19,772,000 $ 13,908,000
Investment securities 1,887,000 1,426,000
Federal funds sold 44,000 19,000
Short-term investments 2,000 1,000
-------------- ---------------
Total interest income 21,705,000 15,354,000
Interest expense
Deposits 7,440,000 4,750,000
Short-term borrowings 338,000 170,000
Federal Home Loan Bank advances 857,000 529,000
Long-term borrowings 415,000 416,000
-------------- ---------------
Total interest expense 9,050,000 5,865,000
-------------- ---------------
NET INTEREST INCOME 12,655,000 9,489,000
Provision for loan and lease losses 725,000 1,244,000
-------------- ---------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 11,930,000 8,245,000
Noninterest income
Service charges on accounts 338,000 299,000
Net gain on sales of securities 0 78,000
Other income 872,000 662,000
-------------- ---------------
Total noninterest income 1,210,000 1,039,000
Noninterest expense
Salaries and benefits 4,159,000 3,283,000
Occupancy 518,000 386,000
Furniture and equipment 288,000 273,000
Other expense 1,885,000 1,213,000
-------------- ---------------
Total noninterest expenses 6,850,000 5,155,000
-------------- ---------------
INCOME BEFORE FEDERAL INCOME TAX EXPENSE 6,290,000 4,129,000
Federal income tax expense 1,928,000 1,156,000
============== ===============
NET INCOME $ 4,362,000 $ 2,973,000
============== ===============
COMPREHENSIVE INCOME $ 3,502,000 $ 3,363,000
============== ===============
Basic earnings per share $ 0.61 $ 0.42
============== ===============
Diluted earnings per share $ 0.59 $ 0.41
============== ===============
Cash dividends per share $ 0.10 $ 0.09
============== ===============
Average basic shares outstanding 7,206,322 7,158,970
============== ===============
Average diluted shares outstanding 7,345,543 7,314,126
============== ===============
See accompanying notes to consolidated financial statements.
2.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income (Loss) Equity
--------------- --------------- ------------- ----------------
BALANCE, JANUARY 1, 2004 $ 118,560,000 $ 11,421,000 $ 220,000 $ 130,201,000
Payment of 5% stock dividend, 341,337 shares 12,111,000 (12,115,000) (4,000)
Employee stock purchase plan, 504 shares 17,000 17,000
Dividend reinvestment plan, 556 shares 19,000 19,000
Stock option exercises, 26,784 shares 274,000 274,000
Stock tendered for stock option exercises,
5,462 shares (186,000) (186,000)
Cash dividends ($0.09 per share) (613,000) (613,000)
Comprehensive income:
Net income for the period from
January 1, 2004 through March 31, 2004 2,973,000 2,973,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassifications and tax effect 390,000 390,000
----------------
Total comprehensive income 3,363,000
--------------- --------------- ----------- ----------------
BALANCE, MARCH 31, 2004 $ 130,795,000 $ 1,666,000 $ 610,000 $ 133,071,000
=============== =============== =========== ================
BALANCE, JANUARY 1, 2005 $ 131,010,000 $ 10,475,000 $ 132,000 $ 141,617,000
Employee stock purchase plan, 416 shares 17,000 17,000
Dividend reinvestment plan, 823 shares 33,000 33,000
Stock option exercises, 22,497 shares 225,000 225,000
Stock tendered for stock option exercises,
3,929 shares (172,000) (172,000)
Cash dividends ($0.10 per share) (721,000) (721,000)
Comprehensive income:
Net income for the period from
January 1, 2005 through March 31, 2005 4,362,000 4,362,000
Change in net unrealized gain (loss)
on securities available for sale,
net of reclassifications and tax effect (860,000) (860,000)
----------------
Total comprehensive income 3,502,000
--------------- --------------- ----------- ----------------
BALANCE, MARCH 31, 2005 $ 131,113,000 $ 14,116,000 $ (728,000) $ 144,501,000
=============== =============== =========== ================
See accompanying notes to consolidated financial statements.
3.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Three Months
Ended Ended
March 31, 2005 March 31, 2004
--------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,362,000 $ 2,973,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 490,000 412,000
Provision for loan and lease losses 725,000 1,244,000
Net gain on sales of securities 0 (78,000)
Net change in:
Accrued interest receivable (1,239,000) (726,000)
Bank owned life insurance policies (236,000) (177,000)
Other assets (1,129,000) 431,000
Accrued expenses and other liabilities 839,000 (1,033,000)
--------------- ----------------
Net cash from operating activities 3,812,000 3,046,000
CASH FLOWS FROM INVESTING ACTIVITIES
Loan and lease originations and payments, net (57,900,000) (75,475,000)
Purchases of:
Securities available for sale (15,756,000) (2,994,000)
Securities held to maturity (4,895,000) (1,426,000)
Federal Home Loan Bank stock (224,000) (807,000)
Proceeds from:
Sales of available for sale securities 0 1,748,000
Maturities, calls and repayments of
available for sale securities 5,510,000 8,324,000
Maturities, calls and repayments of
held to maturity securities 201,000 0
Purchases of premises and equipment, net (2,378,000) (1,579,000)
--------------- ----------------
Net cash from investing activities (75,442,000) (72,209,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 130,836,000 92,442,000
Net increase (decrease) in securities sold under agreements to repurchase 3,891,000 (7,932,000)
Net increase (decrease) in federal funds purchase (15,000,000) (6,000,000)
Proceeds from new Federal Home Loan Bank advances 20,000,000 20,000,000
Maturities of Federal Home Loan Bank advances (15,000,000) (10,000,000)
Net increase in other borrowed money 307,000 247,000
Employee stock purchase plan 17,000 17,000
Dividend reinvestment plan 33,000 19,000
Stock option exercises, net 53,000 88,000
Cash paid in lieu of fractional shares on stock dividend 0 (4,000)
Payment of cash dividend (721,000) (613,000)
--------------- ----------------
Net cash from financing activities 124,416,000 88,264,000
--------------- ----------------
Net change in cash and cash equivalents 52,786,000 19,101,000
Cash and cash equivalents at beginning of period 20,811,000 16,564,000
--------------- ----------------
Cash and cash equivalents at end of period $ 73,597,000 $ 35,665,000
=============== ================
Supplemental disclosures of cash flow information Cash paid during the period
for: Interest $ 7,726,000 $ 5,951,000
Federal income tax 325,000 375,000
See accompanying notes to consolidated financial statements.
4.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The unaudited financial statements for the three
months ended March 31, 2005 include the consolidated results of operations
of Mercantile Bank Corporation and its consolidated subsidiaries. These
subsidiaries include Mercantile Bank of West Michigan ("our bank"), our
bank's four subsidiaries, Mercantile Bank Mortgage Company, LLC ("our
mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO"), Mercantile Bank
Real Estate Co., LLC ("our real estate company"), and Mercantile Insurance
Center, Inc. ("our insurance center"). These consolidated financial
statements have been prepared in accordance with the instructions for Form
10-Q and Item 303(b) of Regulation S-K and do not include all disclosures
required by accounting principles generally accepted in the United States
of America for a complete presentation of our financial condition and
results of operations. In the opinion of management, the information
reflects all adjustments (consisting only of normal recurring adjustments)
which are necessary in order to make the financial statements not
misleading and for a fair presentation of the results of operations for
such periods. The results for the period ended March 31, 2005 should not
be considered as indicative of results for a full year. For further
information, refer to the consolidated financial statements and footnotes
included in our annual report on Form 10-K for the year ended December 31,
2004.
Mercantile Bank Capital Trust I ("the trust"), a business trust formed by
Mercantile Bank Corporation, sold 16,000 trust preferred securities at
$1,000.00 per trust preferred security in a September 2004 offering. The
trust sold an additional 16,000 trust preferred securities at $1,000.00
per trust preferred security in a December 2004 offering. Mercantile Bank
Corporation issued subordinated debentures to the trust in exchange for
the proceeds of the offerings. The debentures and related debt issuance
costs represent the sole assets of the trust. Under current accounting
guidance, FASB Interpretation No. 46, as revised in December 2003, the
trust is not consolidated. Accordingly, Mercantile Bank Corporation does
not report the securities issued by the trust as liabilities, but instead
reports as liabilities the subordinated debentures issued by Mercantile
Bank Corporation and held by the trust, as these are not eliminated in
consolidation. The effect of not consolidating the trust does not
significantly change the amounts reported as Mercantile Bank Corporation's
assets, liabilities, equity or interest expense.
Allowance for Loan and Lease Losses: The allowance for loan and lease
losses ("Allowance") 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 lease's existing rate
or at the fair value of collateral if repayment is expected solely from
the collateral. Loans and leases are evaluated for impairment when
payments are delayed, typically 30 days or more, or when serious
deficiencies are identified within the credit relationship.
(Continued)
5.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock Compensation: Employee compensation expense under stock option plans
is reported using the intrinsic value method. No stock-based compensation
cost is reflected in net income, as all options granted had an exercise
price equal to or greater than the market price of the underlying common
stock at date of grant. The following table illustrates the effect on net
income and earnings per share if expense was measured using the fair value
recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation.
Three Months Three Months
Ended Ended
March 31, 2005 March 31, 2004
-------------- --------------
Net income as reported $ 4,362,000 $ 2,973,000
Deduct: Stock-based compensation expense
determined under fair value based method 94,000 63,000
Pro forma net income 4,268,000 2,910,000
Basic earnings per share as reported $ 0.61 $ 0.42
Pro forma basic earnings per share 0.59 0.41
Diluted earnings per share as reported $ 0.59 $ 0.41
Pro forma diluted earnings per share 0.58 0.40
The pro forma effects are computed using option pricing models, using the
following weighted-average assumptions as of grant date.
Risk-free interest rate 3.73% 3.65%
Expected option life 7 Years 7 Years
Expected stock price volatility 23% 25%
Dividend yield 1.00% 1.00%
(Continued)
6.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. LOANS
Our total loans at March 31, 2005 were $1,374.6 million compared to
$1,317.1 million at December 31, 2004, an increase of $57.5 million, or
4.4%. The components of our outstanding balances at March 31, 2005 and
December 31, 2004, and percentage increase in loans from the end of 2004
to the end of the first quarter 2005 are as follows:
Percent
March 31, 2005 December 31, 2004 Increase/
Balance % Balance % (Decrease)
--------------- ------ --------------- ------ ---------
Real Estate:
Construction and land
development $ 145,289,000 10.6% $ 136,705,000 10.3% 6.3%
Secured by 1-4 family
properties 126,216,000 9.2 122,635,000 9.3 2.9
Secured by multi-family
properties 34,897,000 2.5 35,183,000 2.7 (0.8)
Secured by nonresidential
properties 670,328,000 48.8 649,415,000 49.3 3.2
Commercial 391,369,000 28.5 365,615,000 27.8 7.0
Leases 1,693,000 0.1 2,573,000 0.2 (34.2)
Consumer 4,785,000 0.3 4,998,000 0.4 (4.3)
--------------- ------ --------------- ------ ----
Total loans and leases $ 1,374,577,000 100.0% $ 1,317,124,000 100.0% 4.4%
=============== ====== =============== ====== ====
3. ALLOWANCE FOR LOAN AND LEASE LOSSES
The following is a summary of the change in our allowance for loan and
lease losses account for the three months ended March 31:
2005 2004
-------------- ---------------
Balance at January 1 $ 17,819,000 $ 14,379,000
Charge-offs (493,000) (298,000)
Recoveries 46,000 12,000
Provision for loan and lease losses 725,000 1,244,000
-------------- ---------------
Balance at March 31 $ 18,097,000 $ 15,337,000
============== ===============
(Continued)
7.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. PREMISES AND EQUIPMENT, NET
Premises and equipment are comprised of the following:
March 31, December 31,
2005 2004
-------------- ---------------
Land and improvements $ 6,482,000 $ 6,482,000
Buildings and leasehold improvements 18,050,000 16,547,000
Furniture and equipment 7,201,000 6,327,000
-------------- ---------------
31,733,000 29,356,000
Less accumulated depreciation 5,157,000 4,784,000
-------------- ---------------
Premises and equipment, net $ 26,576,000 $ 24,572,000
============== ===============
Depreciation expense amounted to $374,000 during the first quarter of
2005, compared to $304,000 in the first quarter of 2004.
5. DEPOSITS
Our total deposits at March 31, 2005 were $1,290.0 million compared to
$1,159.2 million at December 31, 2004, an increase of $130.8 million, or
11.3%. The components of our outstanding balances at March 31, 2005 and
December 31, 2004, and percentage increase in deposits from the end of
2004 to the end of the first quarter 2005 are as follows:
Percent
March 31, 2005 December 31, 2004 Increase/
Balance % Balance % (Decrease)
-------------- ----- -------------- ----- ----------
Noninterest-bearing demand $ 135,544,000 10.5% $ 101,742,000 8.8% 33.2%
Interest-bearing checking 35,896,000 2.8 37,649,000 3.2 (4.7)
Money market 7,864,000 0.6 10,528,000 0.9 (25.3)
Savings 119,773,000 9.3 129,374,000 11.2 (7.4)
Time, under $100,000 12,955,000 1.0 8,963,000 0.8 44.5
Time, $100,000 and over 106,340,000 8.2 99,760,000 8.6 6.6
-------------- ----- -------------- ----- -----
418,372,000 32.4 388,016,000 33.5 7.8
Out-of-area time,
under $100,000 91,811,000 7.1 90,829,000 7.8 1.1
Out-of-area time,
$100,000 and over 779,834,000 60.5 680,336,000 58.7 14.6
-------------- ----- -------------- ----- -----
871,645,000 67.6 771,165,000 66.5 13.0
-------------- ----- -------------- ----- -----
Total deposits $1,290,017,000 100.0% $1,159,181,000 100.0% 11.3%
============== ===== ============== ===== =====
(Continued)
8.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. SHORT-TERM BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
March 31, December 31,
2005 2004
------------- -------------
Outstanding balance at end of period $ 60,208,000 $ 56,317,000
Average interest rate at end of period 2.11% 1.90%
Average balance during the period $ 56,898,000 $ 49,935,000
Average interest rate during the period 2.03% 1.57%
Maximum month end balance during the period $ 60,208,000 $ 61,678,000
Securities sold under agreements to repurchase (repurchase agreements)
generally have original maturities of less than one year. Repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as liabilities. Securities involved with the
agreements are recorded as assets of our bank and are primarily held in
safekeeping by correspondent banks. Repurchase agreements are offered
principally to certain large deposit customers as uninsured deposit
equivalent investments.
7. FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at March 31, 2005 and December 31, 2004 were as
follows.
March 31, December 31,
2005 2004
-------------- --------------
Maturities April 2004 through January 2007,
fixed rates from 1.81% to 3.70%, averaging 2.79% $ 115,000,000 $ 0
Maturities in May 2006, floating raters tied to
Libor indices, averaging 2.90% 10,000,000 0
Maturities January 2005 through December 2006,
fixed rates from 1.66% to 3.47%, averaging 2.51% 0 110,000,000
Maturities in May 2006, floating raters tied to
Libor indices, averaging 2.32% 0 10,000,000
-------------- --------------
$ 125,000,000 $ 120,000,000
============== ==============
Each advance is payable at its maturity date, and is subject to a
prepayment fee if paid prior to the maturity date. The advances are
collateralized by residential mortgage loans, first mortgage liens on
multi-family residential property loans, first mortgage liens on
commercial real estate property loans, and substantially all other assets
of our bank, under a blanket lien arrangement. Our borrowing line of
credit as of March 31, 2005 totaled $196.7 million, with availability
approximating $63.7 million.
(Continued)
9.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. FEDERAL HOME LOAN BANK ADVANCES (Continued)
Maturities of currently outstanding FHLB advances during the next five
years are:
2005 $ 50,000,000
2006 70,000,000
2007 5,000,000
2008 0
2009 0
8. COMMITMENTS AND OFF-BALANCE SHEET RISK
Our bank is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of 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 our bank to guarantee the performance of
a customer to a third party. Commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. Since
many of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements.
These instruments involve, to varying degrees, elements of credit risk in
excess of the amount recognized, if any, in the balance sheet. Our bank's
maximum exposure to loan loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional
amount of those instruments. Our bank uses the same credit policies in
making commitments and conditional obligations as it does for on-balance
sheet instruments. Collateral, such as accounts receivable, securities,
inventory, property and equipment, is generally obtained based on
management's credit assessment of the borrower. If required, estimated
loss exposure resulting from these instruments is expensed and recorded as
a liability. The balance of the liability account was $0.5 million and
$0.2 million as of March 31, 2005 and December 31, 2004, respectively.
A summary of the contractual amounts of our financial instruments with
off-balance sheet risk at March 31, 2005 and December 31, 2004 follows:
March 31, December 31,
2005 2004
--------------- ----------------
Commercial unused lines of credit $ 214,667,000 $ 226,935,000
Unused lines of credit secured by 1 - 4 family
residential properties 25,945,000 24,988,000
Credit card unused lines of credit 7,218,000 8,307,000
Other consumer unused lines of credit 8,429,000 5,155,000
Commitments to extend credit 64,222,000 55,440,000
Standby letters of credit 58,437,000 56,464,000
--------------- ----------------
$ 378,918,000 $ 377,289,000
=============== ================
(Continued)
10.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS
We are subject to regulatory capital requirements administered by federal
banking agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and
certain off-balance sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain
cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on our
financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent overall financial condition. If
adequately capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are
required.
Our actual capital levels (dollars in thousands) and minimum required
levels were:
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
-------------------- --------------------- ---------------------
March 31, 2005 Amount Ratio Amount Ratio Amount Ratio
- ------------------------- ----------- ----- ----------- ----- ----------- -----
Total capital (to risk
weighted assets)
Consolidated $ 195,326 12.7% $ 122,970 8.0% $ 153,712 10.0%
Bank 192,111 12.5 122,886 8.0 153,608 10.0
Tier 1 capital (to risk
weighted assets)
Consolidated 177,229 11.5 61,485 4.0 92,228 6.0
Bank 174,014 11.3 61,443 4.0 92,165 6.0
Tier 1 capital (to
average assets)
Consolidated 177,229 11.1 63,671 4.0 79,589 5.0
Bank 174,014 10.9 63,625 4.0 79,531 5.0
(Continued)
11.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS (Continued)
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
-------------------- --------------------- ---------------------
December 31, 2004 Amount Ratio Amount Ratio Amount Ratio
- ------------------------- ----------- ----- ----------- ----- ----------- -----
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
The consolidated capital levels as of March 31, 2005 and December 31, 2004
include the $32.0 million in trust preferred securities issued by the
trust subject to certain limitations. Federal Reserve guidelines limit the
amount of trust preferred securities which can be included in our Tier 1
capital to 25% of total Tier 1 capital. As of March 31, 2005 and December
31, 2004, all $32.0 million of the trust preferred securities were
included as Tier 1 capital.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound
banking practices. On January 11, 2005, we declared a $0.10 per share cash
dividend on our common stock, which was paid on March 10, 2005 to record
holders as of February 10, 2005. The $0.10 per share cash dividend
represents an 11.1% increase from the $0.09 per share cash dividend that
was paid during each of the four quarters during 2004. On April 6, 2005,
we declared a $0.11 per share cash dividend on our common stock, which is
payable on June 10, 2005 to record holders as of May 10, 2005.
10. BENEFIT PLANS
We sponsor an employee stock purchase plan which allows employees to defer
after-tax payroll dollars and purchase our stock on a quarterly basis. We
have registered 26,250 shares of common stock to be issued and purchased
under the plan; however, the plan allows for shares to be purchased
directly from us or on the open market. During the three months ended
March 31, 2005, we issued 416 shares under the plan.
(Continued)
12.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and about our company. Words such as
"anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is
likely," "plans," "projects," variations of such words and similar expressions
are intended to identify such forward-looking statements. These statements are
not guarantees of future performance and involve certain risks, uncertainties
and assumptions ("Future Factors") that are difficult to predict with regard to
timing, extent, likelihood and degree of occurrence. Therefore, actual results
and outcomes may materially differ from what may be expressed or forecasted in
such forward-looking statements. We undertake no obligation to update, amend, or
clarify forward looking statements, whether as a result of new information,
future events (whether anticipated or unanticipated), or otherwise.
Future Factors include changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; and changes in the national and local economy. These are representative
of the Future Factors that could cause a difference between an ultimate actual
outcome and a preceding forward-looking statement.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, Mercantile Bank of West Michigan
("our bank"), our bank's four subsidiaries Mercantile Bank Mortgage Company
("our mortgage company"), Mercantile BIDCO, Inc. ("our BIDCO"), Mercantile Bank
Real Estate Co., LLC ("our real estate company") and Mercantile Insurance
Center, Inc. ("our insurance company"), at March 31, 2005 to December 31, 2004
and the results of operations for the three months ended March 31, 2005 and
March 31, 2004. This discussion should be read in conjunction with the interim
consolidated financial statements and footnotes included therein. Unless the
text clearly suggests otherwise, references in this report to "us," "we," "our"
or "the company" include Mercantile Bank Corporation and its consolidated
subsidiaries referred to above.
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles are complex and require management to
apply significant judgment to various accounting, reporting and disclosure
matters. Management must use assumptions and estimates to apply these principles
where actual measurements are not possible or practical. The Management's
Discussion and Analysis of Financial Condition and Results of Operations should
be read in conjunction with our unaudited financial statements included in this
report. For a complete discussion of our significant accounting policies, see
footnotes to our Consolidated Financial Statements included on pages F-34
through F-39 in our Form 10-K for the fiscal year ended December 31, 2004
(Commission file number 000-26719). Below is a discussion of our Allowance for
Loan and Lease Losses policy. This policy is critical because it is highly
dependent upon subjective or complex judgments, assumptions and estimates.
Changes in such estimates may have a significant impact on the financial
statements, and actual results may differ from those estimates. Management has
reviewed the application of this policy with the Audit Committee of the
Company's Board of Directors.
13.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Allowance for Loan and Lease Losses: The allowance for loan and lease losses
("Allowance") 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
lease's existing rate or at the fair value of collateral if repayment is
expected solely from the collateral. Loans and leases are evaluated for
impairment when payments are delayed, typically 30 days or more, or when serious
deficiencies are identified within the credit relationship.
RECENT EVENTS
On April 18, 2005, we issued a press release announcing that our bank has
formalized its intention to expand into the Lansing, Michigan marketplace. We
expect to assemble an initial team of commercial and retail lenders, branch and
business development personnel and support staff in the near future, who will
work out of a leased facility until we acquire land and construct our own
facility within the next two to three years.
FINANCIAL CONDITION
During the first three months of 2005, our assets increased from $1,536.1
million on December 31, 2004, to $1,664.9 million on March 31, 2005. This
represents a total increase in assets of $128.8 million, or 8.4%. The asset
growth was comprised primarily of a $57.2 million increase in net loans, a $13.8
million increase in securities and a $52.8 million increase in cash and cash
equivalents. The increase in total assets was primarily funded by a $130.8
million increase in deposits.
Commercial loans and leases increased by $54.1 million during the first three
months of 2005, and at March 31, 2005 totaled $1,243.6 million, or 90.5% of the
total loan and lease portfolio. The continued significant concentration of the
loan and lease portfolio in commercial loans and leases and the rapid growth of
this portion of our lending business is consistent with our stated strategy of
focusing a substantial amount of our efforts on "wholesale" banking. Corporate
and business lending continues to be an area of expertise of 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 our primary
source of demand deposits.
14.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Residential mortgage loans increased by $3.6 million during the first three
months of 2005, while the balance of our consumer loan portfolio declined by
$0.2 million. As of March 31, 2005, residential mortgage and consumer loans
totaled a combined $131.0 million, or 9.5% of the total loan and lease
portfolio. Although we plan to increase our non-commercial loan portfolios in
future periods, given our wholesale banking strategy, we expect the commercial
sector of the lending efforts and resultant assets to remain the dominant loan
portfolio category.
Management believes the quality of our loan and lease portfolio remains strong.
Net loan and lease charge-offs during the first three months of 2005 totaled
$447,000, or 0.13% of average total loans and leases on an annualized basis.
During the first quarter of 2004, net loan and lease charge-offs equaled 0.11%
of average total loans and leases on an annualized basis. Nonperforming assets
at March 31, 2005 totaled $5.2 million, or 0.31% of period-ending total assets.
At March 31, 2004, nonperforming assets totaled $3.1 million, or 0.24% of
period-ending total assets. Nonperforming assets at December 31, 2004 totaled
$2.8 million, or 0.19% of period-ending total assets. The $2.4 million increase
in nonperforming assets during the first quarter of 2005 is primarily
attributable to two commercial loan relationships being placed into nonaccrual
status. We believe we have instilled a strong credit culture within our lending
departments as it pertains to the underwriting and administration processes,
which in part is reflected in our loan and lease charge-off and delinquency
ratios. Over 98% of the loan and lease portfolio consists of loans extended
directly to companies and individuals doing business and residing within our
market area. The remaining portion is comprised of commercial loans participated
with certain commercial banks outside the immediate area, which we underwrite
using the same loan underwriting criteria as though our bank was the originating
bank.
Securities increased by $13.8 million during the first three months of 2005.
Purchases during the first three months of 2005 totaled $20.9 million, while
proceeds from maturities, calls and repayments of securities totaled $5.7
million. Our securities portfolio primarily consists of U.S. Government Agency
bonds, mortgage-backed securities issued or guaranteed by U.S. Government
Agencies, investment-grade tax-exempt municipal securities and Federal Home Loan
Bank of Indianapolis ("FHLBI") stock.
Cash and cash equivalents increased $52.8 million during the first three months
of 2005, totaling $73.6 million on March 31, 2005. Cash and due from bank
balances were up $18.6 million and federal funds sold increased $33.4 million.
Our commercial lending and wholesale funding focus results in relatively large
day-to-day fluctuations of our cash and cash equivalent balances. The average
cash and cash equivalents during the first three months of 2005 equaled $41.1
million, well below the relatively high balance of $73.6 million on March 31,
2005, but well above the relatively low balance of $20.8 million on December 31,
2004.
15.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Premises and equipment at March 31, 2005 equaled $26.6 million, an increase of
$2.0 million over the past three months and an increase of $10.0 million during
the past twelve months. The vast majority of the increase relates to our bank's
construction of two new banking facilities. On April 30, 2003, our bank
purchased an existing building situated on 2.75 acres of land located about two
miles north of downtown Grand Rapids for $1.3 million. The building has been
demolished, and we are now in the final construction phase of building a new
four-story facility on this property. This facility will serve as the new
location for our current downtown leased facility, which includes our commercial
lending function and a branch operation, and will house the administration and
loan operations functions currently housed at other of our locations. Expected
completion date is May 16, 2005. On September 29, 2003, our bank purchased ten
acres of land located in Holland, Michigan for $0.9 million. We constructed a
new two-story facility on this property to serve as the new location for our
current full-service branch and lending office which had been operating out of a
leased facility. This newly constructed facility opened on October 25, 2004.
Deposits increased $130.8 million during the first three months of 2005,
totaling $1,290.0 million at March 31, 2005. Local deposits increased $30.4
million, while out-of-area deposits increased $100.4 million. As a percent of
total deposits, local deposits decreased from 33.5% on December 31, 2004, to
32.4% at March 31, 2005. Noninterest-bearing demand deposits, comprising 10.5%
of total deposits, increased $33.8 million during the first three months of
2005. Savings deposits (9.3% of total deposits) decreased $9.6 million,
interest-bearing checking accounts (2.8% of total deposits) decreased $1.8
million and money market deposit accounts (0.6% of total deposits) decreased
$2.7 million during the first three months of 2005. Local certificates of
deposit, comprising 9.2% of total deposits, increased by $10.6 million during
the first three months of 2005.
Out-of-area deposits increased $100.4 million during the first three months of
2005, totaling $871.6 million at March 31, 2005. Out-of-area deposits consist
primarily of certificates of deposit obtained from depositors located outside
our market area and placed by deposit brokers for a fee, but also include
certificates of deposit obtained from the deposit owners directly. Out-of-area
deposits are utilized to support our asset growth, and are generally a lower
cost source of funds when compared to the deposit interest rates that would have
to be offered in the local market to generate a sufficient level of funds.
During the first three months of 2005 rates paid on new out-of-area certificates
of deposit were generally slightly higher than rates paid on new certificates of
deposit issued to local customers. Overhead costs associated with 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 generally
have and are expected to increase as new business, governmental and consumer
deposit relationships are established, our relatively high reliance on
out-of-area deposits will likely continue.
Securities sold under agreements to repurchase ("repurchase agreements")
increased by $3.9 million during the first three months of 2005, totaling $60.2
million as of March 31, 2005. As part of our sweep account program, collected
funds from certain business noninterest-bearing checking accounts are invested
into over-night interest-bearing repurchase agreements. Although not considered
a deposit account and therefore not afforded federal deposit insurance, the
repurchase agreements have characteristics very similar to that of our business
checking deposit accounts.
16.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Federal funds purchased declined by $15.0 million during the first three months
of 2005, with a zero balance as of March 31, 2005. FHLBI advances increased by
$5.0 million during the first three months of 2005, totaling $125.0 million as
of March 31, 2005. The advances are collateralized by residential mortgage
loans, first mortgage liens on multi-family residential property loans, first
mortgage liens on commercial real estate property loans, and substantially all
other assets of our bank, under a blanket lien arrangement. Our borrowing line
of credit as of March 31, 2005 totaled $196.7 million, with availability
approximating $63.7 million. FHLBI advances, along with out-of-area deposits,
are the primary components of our wholesale funding program.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed
funds, capital or cash flow from the repayment of loans and securities. These
funds are used to meet deposit withdrawals, maintain reserve requirements, fund
loans and support our operations. Liquidity is primarily achieved through the
growth of deposits (both local and out-of-area) and advances from the FHLBI, as
well as liquid assets such as securities available for sale, matured securities,
and federal funds sold. Asset and liability management is the process of
managing the balance sheet to achieve a mix of earning assets and liabilities
that maximizes profitability, while providing adequate liquidity.
Our liquidity strategy is to fund loan growth with deposits and repurchase
agreements and to maintain an adequate level of short- and medium-term
investments to meet typical daily loan and deposit activity. Although deposit
and repurchase agreement growth from depositors located in our market area has
generally consistently increased, this growth has not been sufficient to meet
the substantial loan growth and provide monies for additional investing
activities. To assist in providing the additional needed funds, we have
regularly obtained monies from wholesale funding sources. Wholesale funds,
comprised of certificates of deposit from customers outside our market area and
advances from the FHLBI, totaled $996.6 million, or 67.6% of combined deposits
and borrowed funds as of March 31, 2005. As of December 31, 2004, wholesale
funds totaled $891.2 million, or 66.7% of combined deposits and borrowed funds.
Reliance on wholesale funds is expected to continue due to our anticipated
future asset growth.
As a member of the FHLBI, our bank has access to the FHLBI's borrowing programs.
At March 31, 2005, advances from the FHLBI totaled $125.0 million, up from the
$120.0 million outstanding at December 31, 2004. Based on available collateral
at March 31, 2005, our bank could borrow an additional $63.7 million.
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established unsecured federal funds purchased lines, totaling $50.0
million as of March 31, 2005. The average balance of federal funds purchased
during the first three months of 2005 equaled $8.4 million, compared to a $7.0
million average federal funds sold position during the same time period.
In addition to typical loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of March 31, 2005, our bank had a total of $320.5 million in unfunded
loan commitments and $58.4 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $256.3 million were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $64.2
million were for loan commitments expected to close and become funded within the
next three to six months. We monitor fluctuations in loan balances and
commitment levels, and include such data in managing overall liquidity.
17.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $2.9 million during
the first three months of 2005, from $141.6 million on December 31, 2004, to
$144.5 million at March 31, 2005. The increase is primarily attributable to net
income of $4.4 million recorded during the first quarter of 2005. Shareholders'
equity was negatively impacted during the first quarter of 2005 by the payment
of cash dividends totaling $0.7 million and a $0.9 million mark-to-market
adjustment for available for sale securities as defined in SFAS No. 115.
Shareholders' equity also increased $0.1 million from the issuance of a total of
19,807 new shares of common stock resulting from our dividend reinvestment plan,
employee stock purchase plan and stock option exercises.
We are subject to regulatory capital requirements primarily administered by
federal bank regulatory agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. The capital ratios of the company and our
bank as of March 31, 2005 and December 31, 2004 are disclosed under Note 9 of
the Notes to Consolidated Financial Statements.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. We paid a $0.10 per share cash dividend on March 10, 2005, and on
April 6, 2005, we declared a $0.11 per share cash dividend payable on June 10,
2005 to record holders as of May 10, 2005.
RESULTS OF OPERATIONS
Net income for the first quarter of 2005 was $4.4 million ($0.61 per basic share
and $0.59 per diluted share), which represents a 46.7% increase over net income
of $3.0 million ($0.42 per basic share and $0.41 per diluted share) recorded
during the first quarter of 2004. The improvement in net income is primarily the
result of higher net interest income, lower provision expense and greater
operating efficiency.
Interest income during the first quarter of 2005 was $21.7 million, an increase
of 41.4% over the $15.4 million earned during the first quarter of 2004. The
growth in interest income is primarily attributable to the growth in earning
assets and an increasing interest rate environment. During the first three
months of 2005 earning assets averaged $1,511.9 million, $315.0 million higher
than the average earning assets of $1,196.9 million during the same time period
in 2004. Average loans were up $277.6 million and securities increased $38.5
million. Also positively impacting the growth in interest income was the
increased yield on earning assets. During the first three months of 2005 and
2004, earning assets had a weighted average rate (tax equivalent-adjusted basis)
of 5.89% and 5.24%, respectively. With approximately 78% of our total loans and
leases tied to the prime rate, our asset yield has benefited from recent
increases in the prime rate. Between June 30, 2004 and March 31, 2005, the
Federal Open Market Committee raised the target federal funds rate by a total of
175 basis points, with the prime rate increasing by the same magnitude.
18.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Interest expense during the first quarter of 2005 was $9.1 million, an increase
of 54.3% over the $5.9 million expensed during the first quarter of 2004. The
increase in interest expense is primarily attributable to an increase in
interest-bearing liabilities necessitated by asset growth and a higher interest
rate environment. During the first three months of 2005 interest-bearing
liabilities averaged $1,335.8 million, $292.5 million higher than the average
interest-bearing liabilities of $1,043.3 million during the same time period in
2004. Average interest-bearing deposits were up $234.8 million, FHLBI advances
increased $25.0 million, long-term borrowings were up $17.0 million and
short-term borrowings increased $15.8 million. Adding to the increased interest
expense was the rise in the cost of interest-bearing liabilities. During the
first three months of 2005 and 2004, interest-bearing liabilities had a weighted
average rate of 2.75% and 2.20%, respectively. The higher weighted average cost
of interest-bearing liabilities is primarily due to the increase in market
interest rates.
Net interest income during the first quarter of 2005 was $12.7 million, an
increase of 33.4% over the $9.5 million earned during the first quarter of 2004.
The increase in net interest income was due to the growth in earning assets and
improved net interest margin. The net interest margin increased from 3.26%
during the first three months of 2004 to 3.46% during the first three months of
2005, primarily reflecting the overall positive impact of the recent increasing
interest rate environment.
The following table sets forth certain information relating to our consolidated
average interest earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the first
quarter of 2005 and 2004. Such yields and costs are derived by dividing income
or expense by the average daily balance of assets or liabilities, respectively,
for the period presented. Tax-exempt securities interest income and yield have
been computed on a tax equivalent basis using a marginal tax rate of 35%.
Securities interest income was increased by $261,000 and $226,000 in the first
quarter of 2005 and 2004, respectively, for this adjustment.
19.
Quarters ended March 31,
2005 2004
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ----------- -------- ------------ ---------- -------
(dollars in thousands)
Loans and leases $ 1,345,336 $ 19,772 5.96 $ 1,067,710 $ 13,908 5.24
Investment securities 158,860 2,148 5.41 120,344 1,652 5.49
Federal funds sold 7,036 44 2.51 8,033 19 0.94
Short-term investments 659 2 1.31 850 1 0.30
------------ ----------- ---- ------------ ---------- ----
Total interest - earning
assets 1,511,891 21,966 5.89 1,196,937 15,580 5.24
Allowance for loan
and lease losses (18,150) (14,825)
Other assets 98,023 68,621
------------ ------------
Total assets $ 1,591,764 $ 1,250,733
============ ============
Interest-bearing
deposits $ 1,111,026 $ 7,440 2.72 $ 876,239 $ 4,750 2.18
Short-term borrowings 65,274 338 2.10 49,505 170 1.38
Federal Home Loan
Bank advances 124,778 857 2.75 99,780 529 2.12
Long-term borrowings 34,732 415 4.78 17,736 416 9.38
------------ ----------- ---- ------------ ---------- ----
Total interest-bearing
liabilities 1,335,810 9,050 2.75 1,043,260 5,865 2.20
Noninterest-bearing
deposits 103,864 70,323
Other liabilities 8,922 5,789
Shareholders' equity 143,169 131,361
------------ ----------- ---- ------------ ---------- ----
Total liabilities and
shareholders' equity $ 1,591,765 $ 1,250,733
============ ============
Net interest income $ 12,916 $ 9,715
=========== ==========
Net interest rate spread 3.14% 3.04%
==== ====
Net interest rate spread
on average assets 3.29 3.12
==== ====
Net interest margin on
earning assets 3.46 3.26
==== ====
20.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Provisions to the Allowance during the first quarter of 2005 were $0.7 million,
compared to the $1.2 million that was expensed during the first quarter of 2004.
The decrease primarily reflects the lower volume of loan and lease growth and a
decline in the reserve coverage ratio, which was partially offset by higher net
loan charge-offs. Loan and lease growth during the first quarter of 2005 was
$57.5 million, compared to loan and lease growth of $75.2 million during the
same time period in 2004. Net loan and lease charge-offs of $447,000 were
recorded during the first three months of 2005, compared to net loan and lease
charge-offs of $286,000 during the same time period in 2004. The Allowance as a
percentage of total loans and leases outstanding as of March 31, 2005 was 1.32%,
compared to 1.38% at March 31, 2004.
In each accounting period, the 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 administration processes and loan and lease portfolio, and general economic
conditions. In addition, the rapid growth of the loan and lease portfolio 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 loan and lease
portfolio, 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 during the first quarter of 2005 was $1.2 million, an
increase of 16.5% over the $1.0 million earned during the first quarter of 2004.
Service charge income on deposits and repurchase agreements increased $39,000
(13.0%) during the first quarter of 2005 primarily due to new accounts opened
during the last twelve months and adjustments in our deposit fee structure.
During the first quarter of 2005 we recorded increased fee income in virtually
all major fee income categories with the exception of our mortgage banking
operations which had a slight decline. There were no securities gains during the
first quarter of 2005, compared to the $78,000 that was recorded during the same
time period in 2004.
Noninterest expense during the first quarter of 2005 was $6.9 million, an
increase of 32.9% over the $5.2 million expensed during the first quarter of
2004. Employee salary and benefit expenses were $0.9 million higher during the
first quarter of 2005 than the level expensed during the same time period in
2004, primarily reflecting the hiring of additional staff and merit annual pay
raises. The level of full-time equivalent employees increased from 167 at the
end of the first quarter in 2004 to 212 at the end of the first quarter in 2005,
an increase of 26.9%. Occupancy and furniture and equipment costs increased
$147,000 during the first quarter of 2005 over the level expensed during the
same time period of 2004, primarily reflecting the opening of our new Holland
facility and increased staff. During the first quarter of 2005 we increased an
accrual for the estimated exposure related to an unfunded commercial letter of
credit by expensing $0.3 million to other non-interest expense, increasing the
accrual to $0.5 million. There was no such expense during the first quarter of
2004. General overhead costs also increased, primarily reflecting the additional
expenses required to administer the significantly increased asset base.
21.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Monitoring and controlling noninterest costs, while at the same time providing
high quality service to customers, is a key component to our business strategy.
While the dollar volume of noninterest costs has increased, the rate of growth
has been lower than the rate of increase in net interest income and noninterest
income. Noninterest expenses increased by $1.7 million during the first quarter
of 2005 over the amount expensed during the first quarter of 2004; however, net
revenues (net interest income plus noninterest income) increased at a
substantially higher level of $3.3 million during the same time period. The
efficiency ratio, a banking industry standardized calculation that attempts to
reflect the utilization of overhead costs, deteriorated slightly from 49.0%
during the first quarter of 2004 to 49.4% during the first quarter of 2005.
Federal income tax expense was $1.9 million during the first three months of
2005, an increase of 66.8% over the $1.2 million expensed during the same time
period in 2004. The increase is primarily due to the higher level of net income
before federal income tax.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity risk. All of our transactions are denominated in U.S. dollars with no
specific foreign exchange exposure. We have only limited agricultural-related
loan assets and therefore have no significant exposure to changes in commodity
prices. Any impact that changes in foreign exchange rates and commodity prices
would have on interest rates are assumed to be insignificant. Interest rate risk
is the exposure of our financial condition to adverse movements in interest
rates. We derive our income primarily from the excess of interest collected on
our interest-earning assets over the interest paid on our interest-bearing
liabilities. The rates of interest we earn on our assets and owe on our
liabilities generally are established contractually for a period of time. Since
market interest rates change over time, we are exposed to lower profitability if
we cannot adapt to interest rate changes. Accepting interest rate risk can be an
important source of profitability and shareholder value; however, excessive
levels of interest rate risk could pose a significant threat to our earnings and
capital base. Accordingly, effective risk management that maintains interest
rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. Our interest rate risk management process seeks to ensure
that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity. In evaluating the quantitative level of
interest rate risk we assess the existing and potential future effects of
changes in interest rates on our financial condition, including capital
adequacy, earnings, liquidity and asset quality.
We use two interest rate risk measurement techniques. The first, which is
commonly referred to as GAP analysis, measures the difference between the dollar
amounts of interest sensitive assets and liabilities that will be refinanced or
repriced during a given time period. A significant repricing gap could result in
a negative impact to our net interest margin during periods of changing market
interest rates. The following table depicts our GAP position as of March 31,
2005 (dollars in thousands):
22.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
------------ ------------ ------------ ------------ ------------
Assets:
Commercial loans and leases (1) $ 951,800 $ 26,191 $ 229,608 $ 35,977 $ 1,243,576
Residential real estate loans 74,381 3,379 35,767 12,689 126,216
Consumer loans 1,156 519 3,058 52 4,785
Investment securities (2) 8,743 354 19,095 138,586 166,778
Federal funds sold 33,400 33,400
Short-term investments 942 942
Allowance for loan and lease losses (18,097) (18,097)
Other assets 107,276 107,276
------------ ------------ ------------ ------------ ------------
Total assets 1,070,422 30,443 287,528 276,483 1,664,876
Liabilities:
Interest-bearing checking 35,896 35,896
Savings 119,773 119,773
Money market accounts 7,864 7,864
Time deposits less than $100,000 23,109 41,514 40,143 104,766
Time deposits $100,000 and over 178,304 437,102 270,768 886,174
Short-term borrowings 60,208 60,208
FHLB advances 20,000 55,000 50,000 125,000
Long-term borrowings 34,906 34,906
Noninterest-bearing checking 135,544 135,544
Other liabilities 10,244 10,244
------------ ------------ ------------ ------------ ------------
Total liabilities 480,060 533,616 360,911 145,788 1,520,375
Shareholders' equity 144,501 144,501
------------ ------------ ------------ ------------ ------------
Total sources of funds 480,060 533,616 360,911 290,289 1,664,876
------------ ------------ ------------ ------------ ------------
Net asset (liability) GAP $ 590,362 $ (503,173) $ (73,383) $ (13,806)
============ ============= ============ ============
Cumulative GAP $ 590,362 $ 87,189 $ 13,806
============ ============ ============
Percent of cumulative GAP to
total assets 35.5% 5.2% 0.8%
============ ============ ============
(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 average life calculations
based upon prepayment trends as of March 31, 2005.
The second interest rate risk measurement we use is commonly referred to as net
interest income simulation analysis. We believe that this methodology provides a
more accurate measurement of interest rate risk than the GAP analysis, and
therefore, serves as our primary interest rate risk measurement technique. The
simulation model assesses the direction and magnitude of variations in net
interest income resulting from potential changes in market interest rates. Key
assumptions in the model include prepayment speeds on various loan and
investment assets; cash flows and maturities of interest sensitive assets and
liabilities; and changes in market conditions impacting loan and deposit volume
and pricing. These assumptions are inherently uncertain, subject to fluctuation
and revision in a dynamic environment; therefore, the model cannot precisely
estimate net interest income or exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes and
changes in market conditions and our strategies, among other factors.
23.
MERCANTILE BANK CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
We conducted multiple simulations as of March 31, 2005, whereby it was assumed
that changes in market interest rates occurred ranging from up 200 basis points
to down 200 basis points in equal quarterly instalments over the next twelve
months. The following table reflects the suggested impact on our net interest
income over the next twelve months, which are well within our policy parameters
established to manage and monitor interest rate risk.
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
- ------------------------------------ ------------------- -------------------
Interest rates down 200 basis points $ (4,408,000) (8.4%)
Interest rates down 100 basis points (2,688,000) (5.1)
No change in interest rates (1,154,000) (2.2)
Interest rates up 100 basis points 1,008,000 1.9
Interest rates up 200 basis points 3,166,000 6.1
In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of other variables, including: the growth,
composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; economic and competitive conditions; potential
changes in lending, investing, and deposit gathering strategies; client
preferences; and other factors.
ITEM 4. CONTROLS AND PROCEDURES
As of March 31, 2005, 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 March
31, 2005.
24.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, we may be involved in various legal proceedings that are
incidental to our business. In our opinion, we are not a party to any current
legal proceedings that are material to our financial condition, either
individually or in the aggregate.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On January 26, 2005, we issued 3,000 shares of our common stock to one of our
employees upon his exercise of employee stock options issued under our 1997
Employee Stock Option Plan. We received a weighted average exercise price of
$11.213 per share aggregating $33,639 for these shares. The exercise price for
these shares was substantially paid by the executive officer delivering to us
common stock of the company that he already owned having an aggregate value of
$33,637, with the difference paid in cash. On January 27, 2005, we issued 15,000
shares of our common stock to one of our employees upon his 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 for
these shares. The exercise price for these shares was substantially paid by the
executive officer delivering to us common stock of the company that he already
owned having an aggregate value of $123,394, 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.
Issuer Purchases of Equity Securities
(c)Total Number of
(a) Total Shares Purchased as (d) Maximum Number
Number of (b) Average Part of Publicly of Shares that May Yet
Shares Price Paid Per Announced Plans or Be Purchased Under the
Period Purchased Share Programs Plans or Programs
- --------------- ------------- -------------- ------------------- ------------------------
January 1 - 31 3,802 $ 43.796 0 0
February 1 - 28 127 45.175 0 0
March 1 - 31 0 N/A 0 0
----- --------- -- --
Total 3,929 43.841 0 0
----- --------- -- --
The shares shown in column (a) above as having been purchased were acquired from
four 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 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
25.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. 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
11 Statement re Computation of Per Share Earnings
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
26.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on May 6, 2005.
MERCANTILE BANK CORPORATION
By: /s/ Gerald R. Johnson Jr.
------------------------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief Executive
Officer
(Principal Executive Officer)
By: /s/ Charles E. Christmas
------------------------------------------
Charles E. Christmas
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
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
11 Statement re Computation of Per Share Earnings
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification