Attached files
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EX-31.1 - EX-31.1 - Mercantile Bancorp, Inc. | c62831exv31w1.htm |
EX-31.2 - EX-31.2 - Mercantile Bancorp, Inc. | c62831exv31w2.htm |
EX-32.2 - EX-32.2 - Mercantile Bancorp, Inc. | c62831exv32w2.htm |
EX-32.1 - EX-32.1 - Mercantile Bancorp, Inc. | c62831exv32w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
Amendment No. 1
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 001-32434
MERCANTILE BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware | 37-1149138 | |
(State or other jurisdiction of | (I.R.S. Employer | |
Incorporation or organization) | Identification No.) |
200 North 33rd Street
Quincy, ILLINOIS 62301
(Address of principal executive offices including zip code)
(217) 223-7300
(Registrants telephone number, including area code)
Quincy, ILLINOIS 62301
(Address of principal executive offices including zip code)
(217) 223-7300
(Registrants 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 þ No o.
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Website, if any, every Interactive Data File requested to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.
o Large Accelerated Filer | o Accelerated Filer | þ Non-Accelerated Filer
(Do not check if a smaller reporting company) |
o Smaller Reporting Company |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the
Act) Yes o No þ.
As of November 12, 2010 the number of outstanding shares of Common Stock, par value $0.4167 per
share was 8,703,330.
MERCANTILE BANCORP, INC. |
||||||||
FORM 10-Q/A |
||||||||
TABLE OF CONTENTS |
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3-4 | ||||||||
PART I | ||||||||
5 | ||||||||
6 | ||||||||
7 | ||||||||
8-22 | ||||||||
22-47 | ||||||||
48 | ||||||||
48 | ||||||||
PART II | ||||||||
48 | ||||||||
49-50 | ||||||||
50 | ||||||||
50 | ||||||||
51 | ||||||||
51 | ||||||||
51 | ||||||||
Exhibits | ||||||||
Section 302 Certifications |
||||||||
Section 906 Certifications |
||||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32.1 | ||||||||
EX-32.2 |
2
Table of Contents
Mercantile Bancorp, Inc.
Quarterly Report on Form 10-Q/A for the period ended September 30, 2010
Quarterly Report on Form 10-Q/A for the period ended September 30, 2010
EXPLANATORY NOTE
Mercantile Bancorp, Inc. (the Company), is filing this Amendment to its quarterly report on Form
10-Q for the period ended September 30, 2010, originally filed on November 15, 2010, in order to
restate previously reported results for this period. The Amendment reflects an increase in net loss
of approximately $15.0 million for the three and nine months ended September 30, 2010. The Company
previously announced its intentions to file this Form 10-Q/A on Form 8-K filed on December 28,
2010. This restatement of the Companys results for the three and nine months ended September 30,
2010 is necessary to reflect an additional provision for loan losses of approximately $6.2 million
and to increase the valuation allowance related to its deferred tax assets by approximately $10.3
million. These increases in the Companys net loss were partially offset by an increase in the net
loss attributable to the noncontrolling interest of approximately $1.5 million.
The increase in the provision for loan losses for the quarter ended September 30, 2010, reflected
in this restatement, is the result of a determination made by the Company to increase its provision
for loan losses after Mercantile Bank, the Companys largest subsidiary bank, received the results
of a recent, regularly scheduled safety and soundness examination conducted jointly by the Federal
Deposit Insurance Corporation (the FDIC) and the Illinois Division of Financial Institutions (the
IDFI) and completed in December 2010. Subsequent to the receipt of the results of its
examination, Mercantile Bank amended its September 30, 2010 call report on December 17, 2010, to
reflect an additional approximately $6.2 million in loan loss provision. The additional loan loss
provision was required to increase the allowance for loan losses to a level deemed appropriate by
Company management following the additional write-down of two commercial real estate loans by
Mercantile Bank. As a result of the examination, Mercantile Bank reviewed Financial Accounting
Standards Board Accounting Standards Codification (ASC) Topic 855, Subsequent Events;
reassessed it evaluation of potential impairment losses as required by ASC Topic 310,
Receivables; and reviewed information about the valuation of the underlying loan collateral and
the financial condition of the borrowers that became known to Mercantile Bank following September
30, 2010, and determined that it was appropriate to record the write-down of the two impaired
commercial real estate loans and make the additional adjustments retroactive to the third quarter
of 2010.
As a result of the additional loan write-downs and provisions for loan losses made retroactive to
the third quarter of 2010, the Company re-evaluated its allowance for loan loss (ALLL)
calculation as of September 30, 2010, including both the general and specific reserves and
incorporated into its re-evaluation the revised historical loss experience factor created by the
additional write-downs. Each of the Companys subsidiary banks performs a quarterly ALLL
calculation which the Company utilizes to evaluate the adequacy of the total ALLL on a consolidated
basis. Each of these calculations is designed to quantify an acceptable range rather than a
specific amount. The Companys re-evaluation of the consolidated ALLL as of September 30, 2010,
based on the additional approximately $6.2 million of loan write-downs at Mercantile Bank, resulted
in a determination by the Company that the difference between the calculated amount and the balance
reflected in the restated financial statements as of September 30, 2010 was within the acceptable
range.
Due to the determination to record additional loan loss provisions in the third quarter of
2010, the Companys capital ratios were reduced and the Company re-evaluated the adequacy of the
valuation allowance established for its deferred tax assets. Based on its analysis, the Company
determined that it was no longer more likely than not that it could generate sufficient taxable
income to realize the deferred tax assets in future near-term periods as defined by generally
accepted accounting principles, and accordingly recognized an additional valuation allowance in the
third quarter of 2010 in the amount of approximately $10.3 million, representing the full remaining
balance of the Companys and each of its subsidiary banks deferred tax assets prior to the
adjustment.
Included in the Companys additional approximately $10.3 million deferred tax asset valuation
allowance was approximately $3.4 million related to Mid-America Bancorp, Inc. (Mid-America). This
adjustment increased Mid-Americas net loss for the three and nine months ended September 30, 2010
by approximately $3.4 million, thereby increasing the Companys net loss attributable to the
noncontrolling interest for those same periods by approximately $1.5 million.
As a result of the changes noted above and as reflected in this Form 10-Q/A, the Company recognized
a net loss of approximately $22.5 million (or $2.62 loss per share) for the three months ended
September 30, 2010, compared to the previously reported net loss of $7.5 million (or $0.89 loss per
share). For the nine months ended September 30, 2010, the Company recognized a net loss of
approximately $26.0 million (or $3.38 loss per share), compared to the previously reported net loss
of $11.0 million (or $1.66 loss per share).
Based on the need to revise the unaudited condensed consolidated financial statements for the three
and nine months ended September 30, 2010, the Companys management and the Audit Committee of the
Board of Directors have
3
Table of Contents
taken steps recently to re-evaluate the Companys internal control over financial reporting,
subsequent to September 30, 2010, and have concluded there is a material weakness in their design
of such internal controls. The material weakness relates to the identification and communication
of subsequent events. The Companys Board of Directors has implemented several steps to improve
the process for timely identification and communication of subsequent events to the Audit Committee
and thus will remediate this material weakness. Included in these steps are the following:
| Appointment of a Chief Lending Officer at Mercantile Bank, whose responsibilities will include: oversight of lending policies and procedures to ensure adequate risk management and compliance with banking regulations at each of the Companys subsidiary banks; management of loan portfolio credit quality, underwriting standards and problem resolution; evaluation of the adequacy of the ALLL; review and interpretation of banking laws and accounting guidance, along with communication of pertinent information to lending management; and, reporting and recommendations to the Audit Committee and Board of Directors of problem asset management and related processes. |
| Revision of the loan policy at each of the Companys subsidiary banks to clearly define what constitutes a subsequent event and more clearly identify the procedures to follow to ensure proper accounting and reporting of the impact of such subsequent events. |
| Revision of the loan policy at each of the Companys subsidiary banks to address the banks participation in SNC loans, including procedures to follow upon receipt of a SNC exam report, execution of directives indicated in the report and appeal procedures with the lead bank and the FDIC in the event management disagrees with the findings in the report. |
Further discussion regarding the Companys assessment of the adequacy of its allowance for loan
losses and its valuation allowance for deferred tax assets can be found in Item 2 Managements
Discussion and Analysis of Financial Condition and Results of Operations. While the Company is
amending only certain portions of the Quarterly Report on Form 10-Q for the period ended September
30, 2010, for convenience and ease of future reference, the entire Quarterly Report for the period
ended September 30, 2010 is reflected in this Form 10-Q/A.
4
Table of Contents
PART I
FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements.
MERCANTILE BANCORP, INC.
Condensed Consolidated Balance Sheets
(In thousands, except par value and share data)
Condensed Consolidated Balance Sheets
(In thousands, except par value and share data)
September 30, | ||||||||
2010 | ||||||||
(Unaudited) | December 31, | |||||||
Restated (1) | 2009 | |||||||
Assets |
||||||||
Cash and due from banks |
$ | 9,239 | $ | 8,606 | ||||
Interest-bearing demand deposits |
75,936 | 94,623 | ||||||
Federal funds sold |
9,919 | 18,038 | ||||||
Cash and cash equivalents |
95,094 | 121,267 | ||||||
Available-for-sale securities |
117,434 | 128,150 | ||||||
Held-to-maturity securities (fair values of $1,535 and $2,411) |
1,481 | 2,334 | ||||||
Loans held for sale |
2,871 | 681 | ||||||
Loans, net of allowance for loan losses of $25,866 and $18,851 |
675,442 | 757,138 | ||||||
Interest receivable |
3,881 | 3,962 | ||||||
Foreclosed assets held for sale, net |
26,126 | 16,409 | ||||||
Federal Home Loan Bank stock |
2,884 | 2,900 | ||||||
Cost method investments in common stock |
1,392 | 1,392 | ||||||
Deferred income taxes |
| 10,212 | ||||||
Mortgage servicing rights |
880 | 885 | ||||||
Cash surrender value of life insurance |
15,430 | 15,011 | ||||||
Premises and equipment, net |
24,330 | 25,670 | ||||||
Core deposit and other intangibles |
946 | 1,066 | ||||||
Other assets |
13,860 | 17,413 | ||||||
Discontinued operations, assets held for sale |
| 285,992 | ||||||
Total assets |
$ | 982,051 | $ | 1,390,482 | ||||
Liabilities |
||||||||
Deposits |
||||||||
Demand |
$ | 102,595 | $ | 108,318 | ||||
Savings, NOW and money market |
225,920 | 251,030 | ||||||
Time |
444,908 | 421,412 | ||||||
Brokered time |
95,486 | 173,764 | ||||||
Total deposits |
868,909 | 954,524 | ||||||
Short-term borrowings |
10,906 | 30,740 | ||||||
Long-term debt |
15,000 | 25,172 | ||||||
Junior subordinated debentures |
61,858 | 61,858 | ||||||
Interest payable |
6,258 | 4,114 | ||||||
Other liabilities |
4,742 | 4,827 | ||||||
Discontinued operations, liabilities held for sale |
| 264,044 | ||||||
Total liabilities |
967,673 | 1,345,279 | ||||||
Commitments and Contingent Liabilities (Note 10) |
||||||||
Equity |
||||||||
Mercantile Bancorp, Inc. stockholders equity |
||||||||
Common stock, $0.42 par value; authorized 30,000,000 shares; |
||||||||
Issued 8,887,113 shares at September 30, 2010 and December 31, 2009 |
||||||||
Outstanding 8,703,330 shares at September 30, 2010 and December
31, 2009 |
3,629 | 3,629 | ||||||
Additional paid-in capital |
11,919 | 11,919 | ||||||
Retained earnings (deficit) |
(928 | ) | 25,095 | |||||
Accumulated other comprehensive income |
2,815 | 2,954 | ||||||
17,435 | 43,597 | |||||||
Treasury stock, at cost |
||||||||
Common; 183,783 shares at September 30, 2010 and December 31, 2009 |
(2,295 | ) | (2,295 | ) | ||||
Total Mercantile Bancorp, Inc. stockholders equity |
15,140 | 41,302 | ||||||
Noncontrolling interest |
(762 | ) | 3,901 | |||||
Total equity |
14,378 | 45,203 | ||||||
Total liabilities and equity |
$ | 982,051 | $ | 1,390,482 | ||||
See accompanying notes to condensed consolidated financial statements
(1) | Refer to Explanatory Note on page 3 and note 13 of this document |
5
Table of Contents
MERCANTILE BANCORP, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Three months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Restated (1) | Restated (1) | |||||||||||||||
Interest and Dividend Income |
||||||||||||||||
Loans |
||||||||||||||||
Taxable |
$ | 9,990 | $ | 11,033 | $ | 29,751 | $ | 33,414 | ||||||||
Tax exempt |
235 | 158 | 707 | 504 | ||||||||||||
Securities |
||||||||||||||||
Taxable |
847 | 1,032 | 2,743 | 3,334 | ||||||||||||
Tax exempt |
231 | 234 | 737 | 714 | ||||||||||||
Federal funds sold |
6 | 3 | 21 | 11 | ||||||||||||
Dividends on Federal Home Loan Bank Stock |
2 | 2 | 9 | 11 | ||||||||||||
Deposits with financial institutions and other |
43 | 8 | 161 | 160 | ||||||||||||
Total interest and dividend income |
11,354 | 12,470 | 34,129 | 38,148 | ||||||||||||
Interest Expense |
||||||||||||||||
Deposits |
3,911 | 4,986 | 11,970 | 17,000 | ||||||||||||
Short-term borrowings |
45 | 614 | 282 | 1,783 | ||||||||||||
Long-term debt and junior subordinated debentures |
1,033 | 1,166 | 3,091 | 3,608 | ||||||||||||
Total interest expense |
4,989 | 6,766 | 15,343 | 22,391 | ||||||||||||
Net Interest Income |
6,365 | 5,704 | 18,786 | 15,757 | ||||||||||||
Provision for Loan Losses |
11,560 | 5,341 | 22,700 | 17,644 | ||||||||||||
Net Interest Income (Expense) After Provision For Loan Losses |
(5,195 | ) | 363 | (3,914 | ) | (1,887 | ) | |||||||||
Noninterest Income |
||||||||||||||||
Fiduciary activities |
581 | 569 | 1,744 | 1,705 | ||||||||||||
Brokerage fees |
243 | 302 | 899 | 742 | ||||||||||||
Customer service fees |
400 | 439 | 1,183 | 1,221 | ||||||||||||
Other service charges and fees |
195 | 142 | 564 | 382 | ||||||||||||
Gains (losses) on sales of assets, net |
(3 | ) | (6 | ) | 5 | (17 | ) | |||||||||
Net gains on investments in common stock |
39 | | 39 | | ||||||||||||
Net gains on loan sales |
248 | 157 | 466 | 1,046 | ||||||||||||
Loan servicing fees |
126 | 122 | 373 | 349 | ||||||||||||
Net increase in cash surrender value of life insurance |
143 | 176 | 420 | 434 | ||||||||||||
Other |
158 | 14 | 569 | 121 | ||||||||||||
Total noninterest income |
2,130 | 1,915 | 6,262 | 5,983 | ||||||||||||
Noninterest Expense |
||||||||||||||||
Salaries and employee benefits |
4,310 | 4,432 | 13,004 | 13,234 | ||||||||||||
Net occupancy expense |
675 | 467 | 1,899 | 1,658 | ||||||||||||
Equipment expense |
552 | 712 | 1,721 | 1,928 | ||||||||||||
Deposit insurance premium |
645 | 561 | 1,717 | 2,259 | ||||||||||||
Professional fees |
610 | 665 | 1,566 | 2,210 | ||||||||||||
Postage and supplies |
131 | 164 | 406 | 465 | ||||||||||||
Losses on foreclosed assets, net |
508 | 512 | 890 | 2,067 | ||||||||||||
Other than temporary losses on available-for-sale
securities and cost method investments |
| 692 | 566 | 3,238 | ||||||||||||
Goodwill impairment losses |
| | | 30,417 | ||||||||||||
Amortization of mortgage servicing rights |
117 | 38 | 196 | 379 | ||||||||||||
Other |
1,577 | 1,175 | 4,422 | 3,785 | ||||||||||||
Total noninterest expense |
9,125 | 9,418 | 26,387 | 61,640 | ||||||||||||
Loss from Continuing Operations Before Income Taxes |
(12,190 | ) | (7,140 | ) | (24,039 | ) | (57,544 | ) | ||||||||
Income Tax Expense (Benefit) |
13,114 | (2,971 | ) | 10,077 | (10,321 | ) | ||||||||||
Loss from Continuing Operations |
(25,304 | ) | (4,169 | ) | (34,116 | ) | (47,223 | ) | ||||||||
Discontinued Operations |
||||||||||||||||
Income (loss) from discontinued operations (including
gain on sale in 2010 of $4,496), net of income tax
expense of $1,733 and $355, respectively |
219 | 2,321 | 3,429 | (8,474 | ) | |||||||||||
Net Loss |
(25,085 | ) | (1,848 | ) | (30,687 | ) | (55,697 | ) | ||||||||
Less: Net loss attributable to the
Noncontrolling interest |
(2,551 | ) | (488 | ) | (4,662 | ) | (1,415 | ) | ||||||||
Net Loss attributable to Mercantile Bancorp, Inc. |
$ | (22,534 | ) | $ | (1,360 | ) | $ | (26,025 | ) | $ | (54,282 | ) | ||||
Weighted Average Shares Outstanding |
8,703,330 | 8,703,330 | 8,703,330 | 8,703,330 | ||||||||||||
Basic Earnings (Loss) Per Share |
||||||||||||||||
Continuing operations |
$ | (2.62 | ) | $ | (0.42 | ) | $ | (3.38 | ) | $ | (5.27 | ) | ||||
Discontinued operations |
$ | 0.03 | $ | 0.27 | $ | 0.39 | $ | (0.97 | ) | |||||||
See accompanying notes to condensed consolidated financial statements
(1) | Refer to Explanatory Note on page 3 and note 13 of this document |
6
Table of Contents
MERCANTILE BANCORP, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Nine Months Ended September 30 | 2010 | 2009 | ||||||
Restated (1) | ||||||||
Operating Activities |
||||||||
Net loss before attribution of noncontrolling interest |
$ | (30,687 | ) | $ | (55,697 | ) | ||
Net loss attributable to noncontrolling interest |
(4,662 | ) | (1,415 | ) | ||||
Net income (loss) attributable to Mercantile Bancorp, Inc. |
(26,025 | ) | (54,282 | ) | ||||
Items not requiring (providing) cash |
||||||||
Depreciation |
1,358 | 2,065 | ||||||
Provision for loan losses |
22,748 | 18,736 | ||||||
Amortization (accretion) of premiums and discounts on securities |
482 | 256 | ||||||
Amortization (depreciation) of core deposit intangibles and other purchase accounting adjustments |
120 | (13 | ) | |||||
Deferred income taxes |
10,762 | (3,886 | ) | |||||
Other-than-temporary losses on available-for-sale and cost method investments |
566 | 3,238 | ||||||
Losses on foreclosed assets |
890 | 2,158 | ||||||
Gains on loan sales |
(474 | ) | (1,740 | ) | ||||
Recovery of mortgage servicing rights |
| (244 | ) | |||||
Amortization of mortgage servicing rights |
196 | 399 | ||||||
(Gain) on sale of Marine Bank & Trust and Brown County State Bank |
(4,496 | ) | | |||||
Net (gains) losses on sale of premises and equipment |
(5 | ) | 23 | |||||
Net (gains) on investments of common stock |
(39 | ) | | |||||
Federal Home Loan Bank stock dividends |
(6 | ) | (9 | ) | ||||
Net increase in cash surrender value of life insurance |
(458 | ) | (825 | ) | ||||
Goodwill impairment |
| 44,650 | ||||||
Changes in |
||||||||
Loans originated for sale |
(38,828 | ) | (93,806 | ) | ||||
Proceeds from sales of loans |
36,914 | 97,240 | ||||||
Interest receivable |
102 | 472 | ||||||
Other assets |
3,272 | 635 | ||||||
Interest payable |
2,140 | 712 | ||||||
Other liabilities |
(113 | ) | 2,624 | |||||
Noncontrolling interest in subsidiary |
(4,662 | ) | (1,415 | ) | ||||
Net cash provided by operating activities |
4,444 | 16,988 | ||||||
Investing Activities |
||||||||
Cash paid in acquisition of HNB Financial, net of cash received |
| 3 | ||||||
Cash received from sales of Marine Bank & Trust and Brown County State Bank |
14,823 | | ||||||
Purchases of available-for-sale securities |
(19,821 | ) | (49,508 | ) | ||||
Proceeds from maturities of available-for-sale securities |
31,116 | 41,082 | ||||||
Proceeds from the sales of available-for-sale securities |
373 | | ||||||
Proceeds from maturities of held-to-maturity securities |
947 | 2,325 | ||||||
Net change in loans |
43,183 | 39,667 | ||||||
Purchases of premises and equipment |
(55 | ) | (592 | ) | ||||
Purchase of Federal Home Loan Bank stock |
| (80 | ) | |||||
Proceeds from sales of Federal Home Loan Bank stock |
22 | 718 | ||||||
Proceeds from sales of foreclosed assets |
8,422 | 1,070 | ||||||
Purchase of bank-owned life insurance |
| (1,000 | ) | |||||
Net cash provided by investing activities |
79,010 | 33,685 | ||||||
Financing Activities |
||||||||
Net increase (decrease) in demand deposits, money market, NOW and savings accounts |
(38,123 | ) | 20,816 | |||||
Net (decrease) in time and brokered time deposits |
(54,406 | ) | (57,301 | ) | ||||
Net increase (decrease) in short-term borrowings |
(9,050 | ) | 8,398 | |||||
Net increase in long-term debt |
| 500 | ||||||
Repayments of long-term debt |
(10,172 | ) | (11,500 | ) | ||||
Net cash used in financing activities |
(111,751 | ) | (39,087 | ) | ||||
Increase (Decrease) In Cash and Cash Equivalents |
(28,297 | ) | 11,586 | |||||
Cash and Cash Equivalents, Beginning of Period |
123,391 | 89,821 | ||||||
Cash and Cash Equivalents, End of Period |
$ | 95,094 | $ | 101,407 | ||||
Supplemental Cash Flows Information |
||||||||
Interest paid |
$ | 14,335 | $ | 29,750 | ||||
Income taxes paid (received) |
$ | (530 | ) | $ | (3,811 | ) | ||
Real estate acquired in settlement of loans |
$ | 19,029 | $ | 7,475 |
See accompanying notes to condensed consolidated financial statements
(1) | Refer to Explanatory Note on page 3 and note 13 of this document |
7
Table of Contents
MERCANTILE BANCORP, INC.
Notes to Condensed Consolidated Financial Statements
(table dollar amounts in thousands)
(table dollar amounts in thousands)
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements include the accounts of Mercantile
Bancorp, Inc. (the Company) and its wholly and majority owned subsidiaries, Mercantile Bank,
Royal Palm Bancorp, Inc. (the sole shareholder of Royal Palm Bank) and Mid-America Bancorp, Inc.
(the sole shareholder of Heartland Bank), (Banks). All material inter-company accounts and
transactions have been eliminated in the accompanying unaudited condensed consolidated financial
statements of the Company. These financial statements also include the accounts of HNB National
Bank prior to its exchange in November 2009, and the accounts of Marine Bank & Trust and Brown
County State Bank prior to their sales in February 2010.
The accompanying unaudited condensed consolidated financial statements were prepared in accordance
with accounting principles generally accepted in the United States of America for interim financial
information and with the instructions for Form 10-Q. In the opinion of management, the unaudited
condensed consolidated financial statements reflect all adjustments, consisting only of normal and
recurring adjustments, necessary to present fairly the Companys unaudited condensed consolidated
financial statements for the nine months ended September 30, 2010 and 2009. Interim period results
are not necessarily indicative of results of operations or cash flows for a full-year period. The
2009 year-end condensed consolidated balance sheet data was derived from the audited financial
statements, but certain information and disclosures required by accounting principles generally
accepted in the United States of America have been condensed or omitted.
These unaudited condensed consolidated financial statements and the notes thereto should be read in
conjunction with the Companys audited consolidated financial statements for the year ended
December 31, 2009, appearing in the Companys Annual Report on Form 10-K filed in 2010.
2. EARNINGS (LOSS) PER COMMON SHARE
Basic and diluted earnings (loss) per share have been computed by the weighted-average number of
common shares outstanding during the period.
3. RECENT ACCOUNTING PRONOUNCEMENTS
FASB ASC Topic 310, Receivables: Disclosures about the Credit Quality of Financing Receivables
and the Allowance for Credit Losses. On July 21, 2010, new authoritative accounting guidance
(Accounting Standards Update No. 2010-20) under ASC Topic 310 was issued which requires an entity
to provide more information in their disclosures about the credit quality of their financing
receivables and the credit reserves held against them. This statement addresses only disclosures
and does not change recognition or measurement. The new authoritative accounting guidance under ASC
Topic 310 will be effective for the Companys financial statements as of December 31, 2010, as it
relates to disclosures required as of the end of a reporting period. Disclosures that relate to
activity during a reporting period will be required beginning on or after January 1, 2011.
FSAB ASC Topic 815, Derivatives and Hedging. New authoritative accounting guidance (Accounting
Standards Update no. 2010-11) under ASC Topic 815 clarifies that the only form of an embedded
credit derivative that relate to the subordination of one financial instrument to another. Entities
that have contract containing an embedded credit derivative feature in a form other than such
subordination may need to separately account for the embedded credit derivative feature. The
provisions of Topic 815 were effective for the Company on July 1, 2010 and did not have an impact
on the Companys financial statements.
FASB ASC Topic 820, Fair Value Measurements and Disclosures Improving Disclosures about Fair
Value Measurements. New authoritative accounting guidance (Accounting Standards Update 2010-06) in
this update requires new disclosures about significant transfers in and out of Level 1 and Level 2
fair value measurements. The amendments also require a reporting entity to provide information
about activity for purchases, sales, issuances, and settlements in Level 3 fair value measurements
and clarify disclosures about the level of disaggregation and disclosures about inputs and
valuation techniques. This update became effective for the Company for interim and annual reporting
periods beginning after December 15, 2009 and did not have a significant impact on the Companys
financial statements
FASB ASC Topic 860, Transfers and Servicing Accounting for Transfers of Financial Assets. New
authoritative accounting guidance (Accounting Standards Update No. 2009-16) under ASC Topic 860
amends prior guidance to
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enhance reporting about transfers of financial assets, including
securitization transactions, and where companies have continuing exposure to the risks related to
transferred financial assets. ASC Topic 860 eliminates the concept of a qualifying special-purpose
entity and changes the requirements for derecognizing financial assets. The provision became
effective on January 1, 2010 and did not have a significant impact on the Companys financial
statements.
4. FEDERAL HOME LOAN BANK STOCK
Federal Home Loan Bank stock is stated at cost and is a required investment for institutions that
are members of the Federal Home Loan Bank system. The required investment in the common stock is
based on a predetermined formula. The Company owned approximately $1.9 million of Federal Home Loan
Bank of Chicago (FHLB) stock as of September 30, 2010 and December 31, 2009. During the third
quarter of 2007, FHLB received a Cease and Desist Order from their regulator, the Federal Housing
Finance Board. The order prohibits capital stock repurchases and
redemptions until a time to be determined by the Federal Housing Finance Board. The FHLB will
continue to provide liquidity and funding through advances and purchase loans through the Mortgage
Partnership Facility program. With regard to dividends, the FHLB will continue to assess its
dividend capacity each quarter and may make appropriate request for approval from its regulator.
The FHLB did not pay a dividend during the calendar year of 2009 or the first three quarters of
2010. Management performed an analysis and, based on currently available information, determined
the investment in this FHLB stock was not impaired as of September 30, 2010 and December 31, 2009.
5. SECURITIES
The amortized cost and fair values of securities are as follows:
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | ||||||||||||||
Cost | Gains | Losses | Fair Value | |||||||||||||
Available-for-sale Securities: |
||||||||||||||||
September 30, 2010: |
||||||||||||||||
U.S. Government agencies |
$ | 3,914 | $ | 100 | $ | | $ | 4,014 | ||||||||
Mortgage-backed securities: |
||||||||||||||||
GSE residential |
75,070 | 2,214 | (2 | ) | 77,282 | |||||||||||
State and political subdivisions |
32,625 | 956 | (239 | ) | 33,342 | |||||||||||
Equity securities |
2,674 | 122 | | 2,796 | ||||||||||||
$ | 114,283 | $ | 3,392 | $ | (241 | ) | $ | 117,434 | ||||||||
December 31, 2009: |
||||||||||||||||
Mortgage-backed securities: |
||||||||||||||||
GSE residential |
$ | 92,710 | $ | 2,789 | $ | (145 | ) | $ | 95,354 | |||||||
State and political subdivisions |
28,525 | 1,019 | (5 | ) | 29,539 | |||||||||||
Equity securities |
3,603 | 162 | (508 | ) | 3,257 | |||||||||||
$ | 124,838 | $ | 3,970 | $ | (658 | ) | $ | 128,150 | ||||||||
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | ||||||||||||||
Cost | Gains | Losses | Fair Value | |||||||||||||
Held-to-maturity Securities: |
||||||||||||||||
September 30, 2010: |
||||||||||||||||
Mortgage-backed securities: |
||||||||||||||||
GSE residential |
$ | 1,481 | $ | 54 | $ | | $ | 1,535 | ||||||||
December 31, 2009: |
||||||||||||||||
Mortgage-backed securities: |
||||||||||||||||
GSE residential |
$ | 2,334 | $ | 77 | $ | | $ | 2,411 | ||||||||
The amortized cost and fair value of available-for-sale securities and held-to-maturity securities
at September 30, 2010, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because issuers may have the right to call or prepay obligations with
or without call or prepayment penalties.
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Available-for-sale | Held-to-maturity | |||||||||||||||
Amortized | Fair | Amortized | Fair | |||||||||||||
Cost | Value | Cost | Value | |||||||||||||
Within one year |
$ | 3,605 | $ | 3,605 | $ | | $ | | ||||||||
One to five years |
20,227 | 21,109 | | | ||||||||||||
Five to ten years |
10,656 | 10,704 | | | ||||||||||||
After ten years |
2,051 | 1,938 | | | ||||||||||||
36,539 | 37,356 | | | |||||||||||||
Mortgage-backed securities: |
||||||||||||||||
GSE residential |
75,070 | 77,282 | 1,481 | 1,535 | ||||||||||||
Equity securities |
2,674 | 2,796 | | | ||||||||||||
Totals |
$ | 114,283 | $ | 117,434 | $ | 1,481 | $ | 1,535 | ||||||||
The carrying value of securities pledged as collateral, to secure public deposits, Federal Home
Loan Bank advances, repurchase agreements and for other purposes, amounted to $32.9 million at
September 30, 2010 and $47.4 million at December 31, 2009.
During the nine months ended September 30, 2010, the Company recognized other-than-temporary
impairment charges of $566 thousand on two of its investments in stock of other financial
institutions, which are carried as available-for-sale securities. Impairments are determined based
on the difference between the Companys carrying value and quoted market prices for the stocks as
of September 30, 2010. In making the determination of impairment for each of its investments, the
Company considered the duration of the loss, prospects for recovery in a reasonable period of time
and the significance of the loss compared to carrying value.
The following table shows the Companys gross unrealized losses and fair value, aggregated by
investment category and length of time that individual securities have been in a continuous
unrealized loss position at September 30, 2010 and December 31, 2009:
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Description of | Unrealized | Unrealized | Unrealized | |||||||||||||||||||||
Securities | Fair Value | Losses | Fair Value | Losses | Fair Value | Losses | ||||||||||||||||||
September 30, 2010 |
||||||||||||||||||||||||
Mortgage-backed securities: GSE residential |
$ | 368 | $ | (2 | ) | $ | | $ | | $ | 368 | $ | (2 | ) | ||||||||||
State and political subdivisions |
5,081 | (239 | ) | | | 5,081 | (239 | ) | ||||||||||||||||
Equity securities |
| | | | | | ||||||||||||||||||
Total temporarily impaired securities |
$ | 5,449 | $ | (241 | ) | $ | | $ | | $ | 5,449 | $ | (241 | ) | ||||||||||
December 31, 2009 |
||||||||||||||||||||||||
Mortgage-backed securities: GSE residential |
$ | 12,518 | $ | (145 | ) | $ | 92 | $ | | $ | 12,610 | $ | (145 | ) | ||||||||||
State and political subdivisions |
1,831 | (5 | ) | 182 | | 2,013 | (5 | ) | ||||||||||||||||
Equity securities |
2,839 | (508 | ) | | | 2,839 | (508 | ) | ||||||||||||||||
Total temporarily impaired securities |
$ | 17,188 | $ | (658 | ) | $ | 274 | $ | | $ | 17,462 | $ | (658 | ) | ||||||||||
At September 30, 2010, securities in an unrealized loss position in the investment portfolio are
minimal. The Companys mortgage-backed securities and state and political subdivision securities
are in a loss position due to interest rate changes, not credit events. Those unrealized losses are
considered temporary and management has the ability and intent to hold them for the foreseeable
future. Their fair value is expected to recover as the investments approach their maturity date or
there is a downward shift in interest rates. The Company has one equity security with an
unrealized loss due to the downturn in the market of the financial services industry. The
unrealized loss was not due to credit losses at the specific financial institution itself and is
expected to recover in the future.
6. COST METHOD INVESTMENTS IN COMMON STOCK
The Company has minority investments in the common stock of other community banks, which are not
publicly traded, that are recorded under the cost method of accounting. The Company had
investments in three community banks at September 30, 2010 and December 31, 2009 with a carrying
value of $1.4 million.
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The Companys cost method investments are reviewed for impairment based on each investees
earnings performance, asset quality, changes in the economic environment, and current and projected
future cash flows. Based on these reviews, the Company determined none of its investments to be
other-than-temporarily impaired as of September 30, 2010.
7. FAIR VALUE MEASUREMENT
ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the measurement date. ASC 820
also establishes a fair value hierarchy, which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
In accordance with ASC 820, the Company groups its financial assets and financial liabilities
measured at fair value in three levels, based on the markets in which the assets and liabilities
are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1 | Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. | ||
Level 2 | Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. | ||
Level 3 | Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
Recurring Basis
Following is a description of the valuation methodologies used for instruments measured at fair
value on a recurring basis and recognized in the accompanying balance sheet.
Available-for-sale securities The fair values of available-for-sale securities are determined by
various valuation methodologies. Where quoted market prices are available in an active market,
securities are classified within Level 1. Level 1 securities include exchange-traded equities. If
quoted market prices are not available, then fair values are estimated by using pricing models or
quoted prices of securities with similar characteristics. For these investments, the inputs used by
the pricing service to determine fair value may include one or a combination of observable inputs
such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets,
bench mark securities, bids, offers and reference data market research publications and are
classified within Level 2 of the valuation hierarchy. Level 2 securities include obligations of
U.S. government corporations and agencies, obligations of states and political subdivisions,
mortgage-backed securities, collateralized mortgage obligations and corporate bonds. In certain
cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3
of the hierarchy and include local state and political subdivisions, debentures, and other illiquid
equity securities.
The following table presents the Companys assets that are measured at fair value on a recurring
basis and the level within the ASC 820 hierarchy in which their fair value measurements fall as of
September 30, 2010 and December 31, 2009 (in thousands):
Fair Value Measurements Using | ||||||||||||||||
Quotes Prices in | Significant Other | Significant | ||||||||||||||
Active Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
September 30, 2010 | Fair Value | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
U.S. Government agencies |
$ | 4,014 | $ | | $ | 4,014 | $ | | ||||||||
Mortgage-backed
securities: |
||||||||||||||||
GSE
residential |
77,282 | | 77,282 | | ||||||||||||
State and political
subdivisions |
33,342 | | 33,342 | | ||||||||||||
Equity securities |
2,796 | 2,699 | | 97 | ||||||||||||
$ | 117,434 | $ | 2,699 | $ | 114,638 | $ | 97 | |||||||||
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Fair Value Measurements Using | ||||||||||||||||
Quotes Prices in | Significant Other | Significant | ||||||||||||||
Active Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
December 31, 2009 | Fair Value | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Mortgage-backed
securities: |
||||||||||||||||
GSE
residential |
$ | 95,354 | $ | | $ | 95,354 | $ | | ||||||||
State and political
subdivisions |
29,539 | | 29,500 | 39 | ||||||||||||
Equity securities |
3,257 | 3,161 | | 96 | ||||||||||||
$ | 128,150 | $ | 3,161 | $ | 124,854 | $ | 135 | |||||||||
Management values Level 3 securities based on exit prices for which management believes it could
receive if they were to sell these securities. This value approximates costs for a majority of
these investments. There were no changes in valuation techniques for the Level 3 securities during
the period. The change in fair value of assets measured using significant unobservable (Level 3)
inputs on a recurring basis for the three and nine months ended September 30, 2010 and 2009 is
summarized as follows (in thousands):
For the Three Months Ended | For the Nine Months Ended | |||||||||||||||
September 30 | September 30 | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Beginning balance |
$ | 97 | $ | 1,447 | $ | 135 | $ | 2,006 | ||||||||
Total realized and unrealized
gains and losses: |
||||||||||||||||
Included in net income |
| | | | ||||||||||||
Included in other
comprehensive income |
| | | | ||||||||||||
Purchases, issuances and settlements |
| (58 | ) | (38 | ) | (617 | ) | |||||||||
Transfers in and/or out of Level 3 |
| | | | ||||||||||||
Balance, September 30 |
$ | 97 | $ | 1,389 | $ | 97 | $ | 1,389 | ||||||||
Total gains or losses for the
period included in net income
attributable to the change in
unrealized gains or losses related
to assets and liabilities still
held at the reporting date |
$ | | $ | | $ | | $ | | ||||||||
Nonrecurring Basis
Following is a description of the valuation methodologies used for assets measured at fair value on
a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general
classification of such assets pursuant to the valuation hierarchy.
Impaired loans (Collateral Dependent) Loans for which it is probable that the Company will not
collect all principal and interest due according to contractual terms are measured for impairment.
Allowable methods for determining the amount of impairment include estimating fair value using the
fair value of the collateral for collateral dependent loans.
If the impaired loan is identified as collateral dependent, then the fair value method of measuring
the amount of impairment is utilized. This method requires obtaining a current independent
appraisal of the collateral and applying a discount factor to the value. Impaired loans that are
collateral dependent are classified within Level 3 of the fair value hierarchy.
Foreclosed Assets Held for Sale Other real estate consists of properties obtained through
foreclosure or in satisfaction of loans. These properties are reported at the lower of cost or
fair value, determined on the basis of current appraisals, comparable sales, and other estimates of
value obtained principally from independent sources, adjusted for selling costs. At the time of
foreclosure, any excess of the loan balance over the fair value of the real estate held as
collateral is recorded as a charge against the allowance for loan losses. Gains or losses on sale
and any subsequent adjustments to the value are recorded as a component of the income statement.
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Mortgage Servicing Rights Mortgage servicing rights do not trade in an active, open market with
readily observable prices. Accordingly, fair value is estimated using discounted cash flow models.
Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3
of the hierarchy.
Cost Method Investments Cost method investments do not trade in an active, open market with
readily observable prices. The cost method investments are periodically reviewed for impairment
based on each investees earnings performance, asset quality, changes in the economic environment,
and current and projected future cash flows. Due to the nature of the valuation inputs, cost
method investments are classified within Level 3 of the hierarchy.
The following table presents the fair value measurement of assets measured at fair value on a
nonrecurring basis during the period and the level within the ASC 820 fair value hierarchy in which
the fair value measurements fall at September 30, 2010 and December 31, 2009:
Fair Value Measurements Using | ||||||||||||||||
Quotes Prices in | Significant Other | Significant | ||||||||||||||
Active Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
Carrying value at September 30, 2010 | Fair Value | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Impaired loans |
$ | 43,226 | $ | | $ | | $ | 43,226 | ||||||||
Foreclosed assets held for sale |
830 | | | 830 | ||||||||||||
Mortgage servicing rights |
880 | | | 880 |
Fair Value Measurements Using | ||||||||||||||||
Quotes Prices in | Significant Other | Significant | ||||||||||||||
Active Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
Carrying value at December 31, 2009 | Fair Value | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Impaired loans |
$ | 44,142 | $ | | $ | | $ | 44,142 | ||||||||
Foreclosed assets held for sale |
885 | | | 885 | ||||||||||||
Mortgage servicing rights |
1,331 | | | 1,331 | ||||||||||||
Cost method investments |
5,409 | | | 5,409 |
ASC 825, formerly Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, and FSP FAS 107-1, requires all entities to disclose the estimated
fair value of their financial instrument assets and liabilities. For the Company, as for most
financial institutions, the majority of its assets and liabilities are considered financial
instruments as defined in ASC 825. Many of the Companys financial instruments, however, lack an
available trading market as characterized by a willing buyer and willing seller engaging in an
exchange transaction. It is also the Companys general practice and intent to hold its financial
instruments to maturity and to not engage in trading or sales activities except for loans
held-for-sale and available-for-sale securities. Therefore, significant estimations and
assumptions, as well as present value calculations, were used by the Company for the purposes of
this disclosure.
Estimated fair values have been determined by the Company using the best available data and an
estimation methodology suitable for each category of financial instruments. For those loans and
deposits with floating interest rates, it is presumed that estimated fair values generally
approximate the recorded book balances.
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Table of Contents
The estimation methodologies used, the estimated fair values, and the recorded book balances at
September 30, 2010 and December 31, 2009, were as follows:
September 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Carrying | |||||||||||||||
Amount | Fair Value | Amount | Fair Value | |||||||||||||
(Restated) | ||||||||||||||||
Financial assets |
||||||||||||||||
Cash and cash equivalents |
$ | 95,094 | $ | 95,094 | $ | 121,267 | $ | 121,267 | ||||||||
Available-for-sale securities |
117,434 | 117,434 | 128,150 | 128,150 | ||||||||||||
Held-to-maturity securities |
1,481 | 1,535 | 2,334 | 2,441 | ||||||||||||
Loans held for sale |
2,871 | 2,871 | 681 | 681 | ||||||||||||
Loans, net |
675,442 | 673,401 | 757,138 | 757,721 | ||||||||||||
Federal Home Loan Bank stock |
2,884 | 2,884 | 2,900 | 2,900 | ||||||||||||
Cost method investments in common stock |
1,392 | 1,392 | 1,392 | 1,392 | ||||||||||||
Interest receivable |
3,881 | 3,881 | 3,962 | 3,962 | ||||||||||||
Financial liabilities |
||||||||||||||||
Deposits |
868,909 | 864,682 | 954,524 | 952,611 | ||||||||||||
Short-term borrowings |
10,906 | 10,906 | 30,740 | 30,740 | ||||||||||||
Long-term debt and junior subordinated
debentures |
76,858 | 46,492 | 87,030 | 56,368 | ||||||||||||
Interest payable |
6,258 | 6,258 | 4,114 | 4,114 | ||||||||||||
Unrecognized financial instruments (net
of contract amount) |
||||||||||||||||
Commitments to originate loans |
| | | | ||||||||||||
Letters of credit |
| | | | ||||||||||||
Lines of credit |
| | | |
The following methods and assumptions were used to estimate the fair value of each class of
financial instruments.
Cash and Cash Equivalents, Federal Home Loan Bank Stock, Interest Receivable, and Cost Method
Investments in Common Stock The carrying amount approximates fair value.
Held-to-Maturity Securities Fair values equal quoted market prices if available. If quoted
market prices are not available, fair value is estimated based on quoted market prices of
similar securities.
Loans Held for Sale For homogeneous categories of loans, such as mortgage loans held for sale,
fair value is estimated using the quoted market prices for securities backed by similar loans,
adjusted for differences in loan characteristics.
Loans The fair value of loans is estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers with similar credit ratings and
for the same remaining maturities. Loans with similar characteristics were aggregated for
purposes of the calculations. The carrying amount of accrued interest approximates its fair
value.
Deposits For demand deposits, savings accounts, NOW accounts, and money market deposits, the
carrying amount approximates fair value. The fair value of fixed-maturity time and brokered
time deposits is estimated using a discounted cash flow calculation that applies the rates
currently offered for deposits of similar remaining maturities.
Short-Term Borrowings and Interest Payable The carrying amount approximates fair value.
Long-Term Debt and Junior Subordinated Debentures Rates currently available to the Company for
debt with similar terms and remaining maturities are used to estimate fair value of existing
debt.
Commitments to Originate Loans, Letters of Credit, and Lines of Credit The fair value of
commitments to originate loans is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also
considers the difference between current levels of interest rates and the committed rates. The
fair value of forward sale commitments is estimated based on current market prices for loans of
similar terms and credit quality. The fair values of letters of credit and lines of credit are
based on fees currently charged for similar agreements or on the estimated cost to terminate or
otherwise settle the obligations with the counterparties at the reporting date.
14
Table of Contents
Changes in assumptions or estimation methodologies may have a material effect on these estimated
fair values.
The Companys remaining assets and liabilities, which are not considered financial instruments,
have not been valued differently than has been customary with historical cost accounting.
Fair value estimates are based on existing balance sheet financial instruments, without attempting
to estimate the value of anticipated future business and the value of assets and liabilities that
are not considered financial instruments. Significant assets and liabilities that are not
considered financial assets or liabilities include the Companys fiduciary services department,
brokerage operations, deferred taxes, and premises and equipment. In addition, the tax
ramifications related to the realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in the estimates.
Management believes that reasonable comparability between financial institutions may not be likely,
due to the wide range of permitted valuation techniques and numerous estimates that must be made,
given the absence of active secondary markets for many of the financial instruments. This lack of
uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated
fair values.
8. INCOME TAXES
A reconciliation of income tax expense (benefit) on continuing operations at the statutory rate to
the Companys actual income tax expense (benefit) is shown below:
September 30, | December 31, | |||||||
2010 | 2009 | |||||||
(Restated) | ||||||||
Computed at the statutory rate (35%) |
$ | (8,413 | ) | $ | (1,580 | ) | ||
Increase (decrease) resulting from |
||||||||
Graduated tax rates |
240 | 45 | ||||||
Tax exempt income |
(470 | ) | (136 | ) | ||||
State income taxes |
(1,192 | ) | (2 | ) | ||||
Increase in cash surrender value of life insurance |
(142 | ) | (42 | ) | ||||
Changes in the deferred tax asset valuation allowance |
20,067 | | ||||||
Other |
(13 | ) | 30 | |||||
Actual tax expense (benefit) |
$ | 10,077 | $ | (1,685 | ) | |||
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Table of Contents
The tax effects of temporary differences related to deferred taxes shown on the balance sheets
were:
September 30, | December 31, | |||||||
2010 | 2009 | |||||||
Deferred tax assets |
||||||||
Allowance for loan losses |
$ | 9,542 | $ | 6,885 | ||||
Accrued compensated absences |
122 | 115 | ||||||
Deferred compensation |
796 | 759 | ||||||
Accrued postretirement benefits |
136 | 125 | ||||||
Deferred loss on investments |
2,301 | 2,050 | ||||||
Capital loss carryforward on disposal of HNB |
3,810 | 5,773 | ||||||
Net operating loss carryforward |
10,074 | 2,395 | ||||||
Stock options |
111 | 111 | ||||||
Deferred loan fees |
55 | 80 | ||||||
Alternative minimum tax credits |
1,059 | 149 | ||||||
Other |
1,421 | 1,029 | ||||||
29,427 | 19,471 | |||||||
Deferred tax liabilities |
||||||||
Federal Home Loan Bank stock dividends |
249 | 277 | ||||||
Depreciation |
519 | 522 | ||||||
State taxes |
765 | 452 | ||||||
Mortgage servicing rights |
341 | 334 | ||||||
Deferred gain on sale of BOLI policies |
| 770 | ||||||
Unrealized gains on available-for-sale securities |
1,623 | 1,161 | ||||||
Purchase accounting adjustments |
76 | 35 | ||||||
Other |
197 | 118 | ||||||
3,770 | 3,669 | |||||||
Net deferred tax asset before valuation allowance |
25,657 | 15,802 | ||||||
Valuation allowance |
||||||||
Beginning balance |
$ | (5,590 | ) | $ | | |||
(Increase) decrease during the period |
(20,067 | ) | (5,590 | ) | ||||
Ending balance |
(25,657 | ) | (5,590 | ) | ||||
Net deferred tax asset |
$ | | $ | 10,212 | ||||
As of September 30, 2010, the Company had $29,629,000 of net operating loss carryforwards which
will expire in 15-20 years.
As of September 30, 2010, the Company had $1,059,000 of alternative minimum tax credits available
to offset future federal income taxes. The credits have no expiration date.
9. DISCONTINUED OPERATIONS
The Company completed the sale of Marine Bank & Trust (Marine Bank) and Brown County State Bank
(Brown County) to United Community Bancorp, Inc. (United), of Chatham, Illinois for
approximately $25.8 million on February 26, 2010 resulting in a pre-tax gain of approximately $4.5
million. Approximately $531 thousand of the recognized gain was due to principal payments received
by the Company in accordance with a letter agreement entered into with United at the time of the
sale regarding two specified loan participations to both Marine Bank and Brown County. The proceeds
of the sale were used to strengthen the Companys capital position and reduce its outstanding debt
obligations. This sale, announced in November 2009, was a stage in the Companys multi-tiered
recapitalization plan.
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The following table summarizes the estimated fair values of the assets and liabilities at the
date the Company sold Marine Bank and Brown County:
Cash and cash equivalents |
$ | 4,343 | ||
Available-for-sale securities |
39,306 | |||
Held-to-maturity securities |
1,027 | |||
Loans, net of allowance for loan losses of $1,183 |
206,872 | |||
Interest receivable |
2,300 | |||
Federal Home Loan Bank stock |
1,574 | |||
Premises and equipment |
3,698 | |||
Other assets |
19,465 | |||
Total assets disposed |
278,585 | |||
Deposits |
232,330 | |||
Long-term debt |
13,500 | |||
Interest payable |
559 | |||
Other liabilities |
10,469 | |||
Total liabilities released |
256,858 | |||
Net assets disposed |
$ | 21,727 | ||
Operations for 2009 have been reclassified to include all income and expense into discontinued
operations. On November 21, 2009, the Company entered into an Exchange Agreement, which provided
for the sale of HNB National Bank (HNB), one of the Companys subsidiary banks, in exchange for
the repayment of $28 million of debt. The Company realized a loss of approximately $2.4 million on
the debt exchange transaction.
The following table summarizes the income and expenses of the discontinued operations for the
periods ended September 30, 2010, including Marine Bank and Brown County, and 2009 including HNB,
Marine Bank, and Brown County:
Three Months Ended | Nine Months Ended | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Interest and dividend income |
$ | | $ | 8,261 | $ | 2,206 | $ | 24,898 | ||||||||
Interest expense |
| 2,384 | 572 | 7,973 | ||||||||||||
Net interest margin |
5,877 | 1,634 | 16,925 | |||||||||||||
Provision for loan loss |
| 250 | 48 | 1,092 | ||||||||||||
Noninterest income |
238 | 1,309 | 4,754 | 4,179 | ||||||||||||
Noninterest expense |
| 4,006 | 866 | 26,612 | ||||||||||||
Net income (loss) before taxes |
238 | 2,930 | 5,474 | (6,600 | ) | |||||||||||
Income tax expense |
19 | 609 | 2,045 | 1,874 | ||||||||||||
Net income |
$ | 219 | $ | 2,321 | $ | 3,429 | $ | (8,474 | ) | |||||||
10. OFF BALANCE SHEET CREDIT COMMITMENTS
In the normal course of business, the Company enters into various transactions, which, in
accordance with accounting principles generally accepted in the United States of America, are not
included in its consolidated balance sheets. These transactions are referred to as off
balance-sheet commitments. The Company enters into these transactions to meet the financing needs
of its customers. These transactions include commitments to extend credit and standby letters of
credit, which involve elements of credit risk in excess of the amounts recognized in the
consolidated balance sheet. The Company minimizes its exposure to loss under these commitments by
subjecting them to credit approval and monitoring procedures.
The Company enters into contractual commitments to extend credit, normally with fixed expiration
dates or termination clauses, at specified rates and for specific purposes. Customers use credit
commitments to ensure that funds will be available for working capital purposes, for capital
expenditures and to ensure access to funds at specified terms and conditions. Substantially all of
the Companys commitments to extend credit are contingent
17
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upon customers maintaining specific credit standards at the time of loan funding. Management
assesses the credit risk associated with certain commitments to extend credit in determining the
level of the allowance for loan losses. Commitments to originate loans totaled $22.8 million at
September 30, 2010 and $2.3 million at December 31, 2009. The commitments extend over varying
periods of time with the majority being disbursed within a one-year period. At September 30, 2010
and December 31, 2009, the Company had granted unused lines of credit to borrowers totaling $102.6
million and $143.2 million, respectively, for commercial lines and open-end consumer lines.
Standby letters of credit are written conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. The Companys policies generally require that
standby letters of credit arrangements contain collateral and debt covenants similar to those
contained in loan agreements. In the event the customer does not perform in accordance with the
terms of the agreement with the third party, the Company would be required to fund the commitment.
The maximum potential amount of future payments the Company could be required to make is
represented by the contractual amount of the commitment. If the commitment is funded, the Company
would be entitled to seek recovery from the customer. Standby letters of credit totaled $9 million
at September 30, 2010 and $12.8 million at December 31, 2009. At September 30, 2010, the
outstanding standby letters of credit had a weighted average term of approximately one year. As of
September 30, 2010 and December 31, 2009, no liability for the fair value of the Companys
potential obligations under these guarantees has been recorded since the amount is deemed
immaterial.
11. COMPREHENSIVE LOSS
Comprehensive loss components and related taxes were as follows:
For the Three Months | ||||||||
Ended September 30, | ||||||||
2010 | 2009 | |||||||
Net loss |
$ | (25,085 | ) | $ | (1,848 | ) | ||
Other comprehensive income (loss): |
||||||||
Unrealized appreciation (depreciation) on available-for-sale
securities: |
||||||||
Unrealized appreciation (depreciation) on
available-for-sale securities, net of tax expense (benefit)
of $(184) for 2010 and $(294) for 2009 |
(307 | ) | 538 | |||||
Less reclassification adjustment for realized gains
(losses) included in income net of tax expense (benefit) of
$14 for 2010 and $0 for 2009 |
25 | | ||||||
Less reclassification adjustment for other than temporary
losses included in income net of tax expense (benefit) of
$(0) for 2010 and $(263) for 2009 |
| (428 | ) | |||||
Total unrealized appreciation (depreciation) on
available-for-sale securities, net of tax expense (benefit)
of $(198) for 2010 and $557 for 2009 |
(332 | ) | 966 | |||||
Adjustment of ASC 715 (formerly SFAS 158) liability, net of
tax expense (benefit) of $(0) for 2010 and $0 for 2009 |
(1 | ) | | |||||
Total other comprehensive income (loss), net of tax |
(333 | ) | 966 | |||||
Comprehensive loss |
(25,418 | ) | (882 | ) | ||||
Comprehensive loss attributable to the noncontrolling interest |
(2,551 | ) | (488 | ) | ||||
Comprehensive loss attributable to Mercantile Bancorp, Inc. |
$ | (22,867 | ) | $ | (394 | ) | ||
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For the Nine Months | ||||||||
Ended September 30, | ||||||||
2010 | 2009 | |||||||
Net loss |
$ | (30,687 | ) | $ | (55,697 | ) | ||
Other comprehensive income (loss): |
||||||||
Unrealized appreciation (depreciation) on available-for-sale
securities: |
||||||||
Unrealized appreciation (depreciation) on
available-for-sale securities, net of tax expense of
$(256) for 2010 and $(169) for 2009 |
(482 | ) | (116 | ) | ||||
Less reclassification adjustment for realized gains
(losses) included in income net of tax expense (benefit)
of $14 for 2010 and $0 for 2009 |
25 | | ||||||
Less reclassification adjustment for other than temporary
losses included in income net of tax benefit of $(215) for
2010 and $(1,230) for 2009 |
(351 | ) | (2,007 | ) | ||||
Total unrealized appreciation (depreciation) on
available-for-sale securities, net of tax expense (benefit)
of $(55) for 2010 and $1,061 for 2009 |
(156 | ) | 1,891 | |||||
Adjustment of SFAS 158 liability, net of tax expense of $(10)
for 2010 and $(12) for 2009 |
17 | 20 | ||||||
Total other comprehensive income, net of tax |
(139 | ) | 1,911 | |||||
Comprehensive loss |
(30,826 | ) | (53,876 | ) | ||||
Comprehensive loss attributable to the noncontrolling interest |
(4,662 | ) | (1,415 | ) | ||||
Comprehensive loss attributable to Mercantile Bancorp, Inc. |
$ | (26,164 | ) | $ | (52,371 | ) | ||
12. OPERATING AND LIQUIDITY MATTERS
The Company generated a net loss of $26.0 million in the first nine months of 2010, as well as net
losses in each of the last two years, with $58.5 million in 2009 and $8.8 million in 2008. The
2008 and 2009 losses were largely due to the operating losses at two of its subsidiary banks, Royal
Palm Bank in Naples, Florida, and Heartland Bank in Leawood, Kansas. Both of those banks continued
to generate losses in the first nine months of 2010, as did Mercantile Bank, the Companys largest
subsidiary. Each bank has experienced significant increases in non-performing assets, impaired
loans and loan loss provisions, resulting in bank regulators imposing cease and desist orders at
Royal Palm Bank and Heartland Bank and a memorandum of understanding at Mercantile Bank. As
discussed in the Explanatory Note on page 3 of this Form 10-Q/A, the net loss in the first nine
months of 2010 was increased by additional loan loss provisions of approximately $6.2 million at
Mercantile Bank, along with an approximate $10.3 million increase in the valuation allowance
related to the Companys deferred tax assets.
Mercantile Banks net loss in 2010 is primarily due to charge-offs of purchased participations in
large commercial real estate developments in various parts of the United States. Royal Palm Banks
operating losses over the past three years (excluding goodwill impairment) were primarily
attributable to the severe decline in real estate values in its southwest Florida market, creating
both loan losses and write-downs of foreclosed assets. Heartland Banks losses were largely due to
purchased participations from a bank in Georgia that was closed by the FDIC. Although the
subsidiary banks are confident that they have identified the bulk of their asset quality issues and
expect to see improved operating performance beginning in 2011, there can be no assurance that they
wont experience results similar to the past two-plus years. The Company has projected 2011 and
2012 operating results for each bank assuming an improving economy and reduced loan losses compared
to 2008 through 2010. Those projections indicate Mercantile Bank returning to profitability in
2011. Royal Palm Bank and Heartland Bank are projected to be profitable in 2012, although not
attaining compliance with all regulatory mandates set forth in their respective cease and desist
orders. Due to the net losses incurred by the Company in 2008, 2009 and the first nine months of
2010, including the effect of restatement of its results for the three and nine months ended
September 30, 2010, equity capital has been reduced to a level that leaves the Company with very
little capacity to absorb further losses. Mercantile Bank is the Companys largest subsidiary bank,
representing approximately 71% of total consolidated assets at September 30, 2010, and although
operating under a regulatory memorandum of understanding due to elevated levels of impaired loans,
its actual loan losses over the past two-plus years have been lower than the other two subsidiary
banks and it retains significant earnings capacity. However, it is unlikely that Mercantile Bank
could generate sufficient earnings to offset continued losses at Royal Palm Bank and Heartland
Bank.
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In June 2009, the Companys Board of Directors initiated a process to identify and evaluate a broad
range of strategic alternatives to further strengthen the Companys capital base and enhance
shareholder value. These strategic alternatives have included and may include asset
sales, rationalization of non-business operations, consolidation of operations, closing of
branches, mergers of subsidiaries, capital raising and other recapitalization transactions. As
part of this process, the Board created a special committee (the Special Committee) of
independent directors to develop, evaluate and oversee any strategic alternatives that the Company
may pursue. The Special Committee has retained outside financial and legal advisors to assist it
with its evaluation and oversight.
In November 2009, as a part of a capital-raising plan developed by the Special Committee
and its advisors, the Company reached agreements to sell three of its subsidiary banks for
cash or in exchange for the cancellation of indebtedness owed by the Company. The first of these
transactions closed in December 2009, and the other two in February 2010, serving to reduce debt
and provide liquidity to support the capital requirements of its remaining subsidiaries.
The Special Committee also developed and executed a plan to raise additional equity through a
shareholder rights offering. On April 27, 2010, the Companys Board of Directors, upon the
recommendation of the Special Committee, approved an amendment to its Certificate of Incorporation
to increase the number of authorized shares of common stock of the Company from 14,000,000 to
30,000,000 (the Amendment). On May 24, 2010, at the Companys annual meeting, stockholders voted
to approve the Amendment. On July 12, 2010, the Company filed a Registration Statement on Form S-1
with the Securities and Exchange Commission (SEC), to register Units comprised of shares of the
Companys common stock and warrants to acquire the Companys common stock. Holders of the
Companys common stock would receive one subscription right for each share of Company common stock
held as of September 23, 2010, the record date. The offering period expired on October 29, 2010. On
November 3, 2010, the Company terminated the offering without acceptance of any of the
subscriptions exercised thereunder. The Companys Board of Directors determined that in light of
the Companys stock price trading substantially below the subscription price, it was not
appropriate to accept the subscriptions that were exercised.
If the Company is unsuccessful in assessing and implementing other strategic and capital-raising
options, and if a liquidity crisis would develop, the Company has various alternatives, which could
include selling or closing certain branches or subsidiary banks, packaging and selling high-quality
commercial loans, executing sale/leaseback agreements on its banking facilities, and other options.
If executed, these transactions would decrease the various banks assets and liabilities, generate
taxable income, improve capital ratios, and reduce general, administrative and other expense. In
addition, the affected subsidiary banks would dividend the funds to the Company to provide
liquidity, assuming such dividends receive the requisite regulatory approval. The Company is
continuing to explore and evaluate all strategic and capital-raising options with its financial and
legal advisors.
13. RESTATEMENT OF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Certain adjustments have been made to restate previously reported results for the three and nine
months ended September 30, 2010. The Company previously announced its intentions to file this Form
10-Q/A on Form 8-K filed on December 28, 2010. This restatement is necessary to reflect an
additional provision for loan losses of approximately $6.2 million and to increase the valuation
allowance related to its deferred tax assets by approximately $10.3 million. These increases in
the Companys net loss were partially offset by an increase in the net loss attributable to the
noncontrolling interest of approximately $1.5 million.
The increase in the provision for loan losses for the quarter ended September 30, 2010, reflected
in this restatement, is the result of a determination made by the Company to increase its provision
for loan losses after Mercantile Bank, the Companys largest subsidiary bank, received the results
of a recent, regularly scheduled safety and soundness examination conducted jointly by the Federal
Deposit Insurance Corporation (the FDIC) and the Illinois Division of Financial Institutions (the
IDFI) and completed in December 2010. Subsequent to the receipt of the results of its
examination, Mercantile Bank amended its September 30, 2010 call report on December 17, 2010, to
reflect an additional approximately $6.2 million in loan loss provision. The additional loan loss
provision was required to increase the allowance for loan losses to a level deemed appropriate by
Company management following the additional write-down of two commercial real estate loans by
Mercantile Bank. As a result of the examination, Mercantile Bank reviewed Financial Accounting
Standards Board Accounting Standards Codification (ASC) Topic 855, Subsequent Events;
reassessed its evaluation of potential impairment losses as required by ASC Topic 310,
Receivables; and reviewed information about the valuation of the underlying loan collateral and
the financial condition of the borrowers that became known to Mercantile Bank following September
30, 2010, and determined that it was appropriate to record the write-down of the two impaired
commercial real estate loans and make the additional adjustments retroactive to the third quarter
of 2010.
Due to the determination to record additional loan loss provisions in the third quarter of 2010,
the Companys capital ratios were reduced and the Company re-evaluated the adequacy of the
valuation allowance established for its deferred tax assets. Based on its analysis, the Company
determined that it was no longer more likely than not that it
20
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could generate sufficient taxable income to realize the deferred tax assets in future near-term
periods as defined by generally accepted accounting principles, and accordingly recognized an
additional valuation allowance in the third quarter of 2010 in the amount of approximately $10.3
million, representing the full remaining balance of the Companys and each of its subsidiary banks
deferred tax assets prior to the adjustment.
Included in the Companys additional approximately $10.3 million deferred tax asset valuation
allowance was approximately $3.4 million related to Mid-America Bancorp, Inc. (Mid-America). This
adjustment increased Mid-Americas net loss for the three and nine months ended September 30, 2010
by approximately $3.4 million, thereby increasing the Companys net loss attributable to the
noncontrolling interest for those same periods by approximately $1.5 million.
See the Explanatory Note on page 3 of this Form 10-Q/A for more information related to the
adjustments retroactive to the third quarter of 2010.
The effects of the restatement on the Companys condensed consolidated balance sheet, statement of
operations, and statement of cash flows are summarized as follows:
As of and for the Three Months Ended, | As of and for the Nine Months Ended, | |||||||||||||||||||||||
September 30, 2010 | September 30, 2010 | |||||||||||||||||||||||
Condensed Consolidated | As Previously | As Previously | ||||||||||||||||||||||
Statement of Operations | Reported | Adjustment | Restated | Reported | Adjustment | Restated | ||||||||||||||||||
Provision for loan losses |
$ | 5,386 | $ | 6,174 | $ | 11,560 | $ | 16,526 | $ | 6,174 | $ | 22,700 | ||||||||||||
Net interest income (expense)
after provision for loan
losses |
979 | (6,174 | ) | (5,195 | ) | 2,260 | (6,174 | ) | (3,914 | ) | ||||||||||||||
Loss from continuing
operations before income taxes |
(6,016 | ) | (6,174 | ) | (12,190 | ) | (17,865 | ) | (6,174 | ) | (24,039 | ) | ||||||||||||
Income tax expense (benefit) |
2,765 | 10,349 | 13,114 | (272 | ) | 10,349 | 10,077 | |||||||||||||||||
Loss from continuing operations |
(8,781 | ) | (16,523 | ) | (25,304 | ) | (17,593 | ) | (16,523 | ) | (34,116 | ) | ||||||||||||
Net Loss |
(8,562 | ) | (16,523 | ) | (25,085 | ) | (14,164 | ) | (16,523 | ) | (30,687 | ) | ||||||||||||
Net loss attributable to
the noncontrolling
interest |
(1,035 | ) | (1,516 | ) | (2,551 | ) | (3,146 | ) | (1,516 | ) | (4,662 | ) | ||||||||||||
Net loss attributable to
Mercantile Bancorp, Inc. |
(7,527 | ) | (15,007 | ) | (22,534 | ) | (11,018 | ) | (15,007 | ) | (26,025 | ) | ||||||||||||
Per share data |
||||||||||||||||||||||||
Basic earnings (loss) per
share from continuing
operations |
(0.89 | ) | (1.73 | ) | (2.62 | ) | (1.66 | ) | (1.72 | ) | (3.38 | ) | ||||||||||||
As of and for the Nine Months Ended, | ||||||||||||
September 30, 2010 | ||||||||||||
As Previously | ||||||||||||
Condensed Consolidated Statement of Cash Flows | Reported | Adjustment | Restated | |||||||||
Net loss before attribution of noncontrolling interest |
$ | (14,164 | ) | $ | (16,523 | ) | $ | (30,687 | ) | |||
Net loss attributable to noncontrolling interest |
(3,146 | ) | (1,516 | ) | (4,662 | ) | ||||||
Net income (loss) attributable to Mercantile Bancorp, Inc. |
(11,018 | ) | (15,007 | ) | (26,025 | ) | ||||||
Provision for loan losses |
16,574 | 6,174 | 22,748 | |||||||||
Deferred income taxes |
638 | 10,124 | 10,762 | |||||||||
Other assets |
3,047 | 225 | 3,272 | |||||||||
Noncontrolling interest in subsidiary |
(3,146 | ) | (1,516 | ) | (4,662 | ) | ||||||
As of September 30, 2010 | ||||||||||||
As Previously | ||||||||||||
Condensed Consolidated Balance Sheet | Reported | Adjustment | Restated | |||||||||
Loans, net of allowance for loan losses |
$ | 681,615 | $ | (6,173 | ) | $ | 675,442 | |||||
Deferred income taxes |
10,125 | (10,125 | ) | | ||||||||
Other assets |
14,085 | (225 | ) | 13,860 | ||||||||
Total assets |
998,573 | (16,522 | ) | 982,051 | ||||||||
Retained earnings (deficit) |
14,077 | (15,005 | ) | (928 | ) | |||||||
Total Mercantile Bancorp, Inc. stockholders equity |
30,145 | (15,005 | ) | 15,140 | ||||||||
Noncontrolling interest |
755 | (1,517 | ) | (762 | ) | |||||||
Total equity |
30,900 | (16,522 | ) | 14,378 | ||||||||
Total liabilities and equity |
998,573 | (16,522 | ) | 982,051 |
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14. SUBSEQUENT EVENTS
On November 3, 2010, the Company announced it would terminate the shareholder rights offering it
implemented on September 23, 2010 without acceptance of any of the subscriptions exercised
thereunder. The Companys Board of Directors determined that in light of the Companys stock price
trading substantially below the subscription price, it was not appropriate to accept the
subscriptions that were exercised. The Company continues to work with its financial advisors and
legal counsel in assessing its strategic and capital-raising options.
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Special Cautionary Notice Regarding Forward-looking Statements
Statements and financial discussion and analysis contained in the Form 10-Q/A that are
not historical facts are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends
such forward-looking statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995 and are including this
statement for purposes of invoking these safe harbor provisions. These forward-looking statements
include information about possible or assumed future results of the Companys operations or
performance. Use of the words believe, expect, anticipate, estimate, continue, intend,
may, will, should, or similar expressions, identifies these forward-looking statements.
Examples of forward-looking statements include, but are not limited to, estimates or projections
with respect to our future financial condition, results of operations or business, such as:
| projections of revenues, income, earnings per share, capital expenditures, assets, liabilities, dividends, capital structure, or other financial items; | ||
| descriptions of plans or objectives of management for future operations, products, or services, including pending acquisition transactions; | ||
| forecasts of future economic performance; and | ||
| descriptions of assumptions underlying or relating to any of the foregoing |
Many possible factors or events could affect the future financial results and performance of the
Company and could cause those financial results or performance to differ materially from those
expressed in the forward-looking statement. These possible events or factors include, without
limitation:
| the effects of current and future business and economic conditions in the markets the Company serves change or are less favorable than it expected; | ||
| deposit attrition, operating costs, customer loss and business disruption are greater than the Company expected; | ||
| competitive factors including product and pricing pressures among financial services organizations may increase; | ||
| the effects of changes in interest rates on the level and composition of deposits, loan demand, the values of loan collateral, securities and interest sensitive assets and liabilities may lead to a reduction in the Companys net interest margins; | ||
| changes in market rates and prices may adversely impact securities, loans, deposits, mortgage servicing rights, and other financial instruments; | ||
| the legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry, such as the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), and the extensive rule making it requires to be undertaken by various regulatory agencies may adversely affect the Companys business, financial condition and results of operations; | ||
| personal or commercial bankruptcies increase; |
22
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| the Companys ability to expand and grow its business and operations, including the establishment of additional branches and acquisition of additional banks or branches of banks may be more difficult or costly than the Company expected; | ||
| any future acquisitions may be more difficult to integrate than expected and the Company may be unable to realize any cost savings and revenue enhancements the Company may have projected in connection with such acquisitions; | ||
| changes in accounting principles, policies or guidelines; | ||
| credit risks, including credit risks resulting from the devaluation of collateral debt obligations and/or structured investment vehicles on the capital markets to which the Company currently has no direct exposure; | ||
| the failure of assumptions underlying the Companys deferred tax valuation assumptions; | ||
| the failure of assumptions underlying the establishment of the Companys allowance for loan losses; | ||
| construction and development loans are based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate, and cause the Company to be exposed to more losses on these projects than on other loans; | ||
| changes occur in the securities markets; | ||
| technology-related changes may be harder to make or more expensive than the Company anticipated; | ||
| worldwide political and social unrest, including acts of war and terrorism; and | ||
| changes occur in monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board. |
A forward-looking statement may include a statement of the assumptions or bases underlying the
forward-looking statement. The Company believes it has chosen the assumptions or bases in good
faith and that they are reasonable. However, the Company cautions you that assumptions or bases
almost always vary from actual results, and the differences between assumptions or bases and actual
results can be material. Any forward-looking statements made or incorporated by reference in this
report are made as of the date of this report, and, except as required by applicable law, the
Company assumes no obligation to update such statements or to update the reasons why actual results
could differ from those projected in such statements. You should consider these risks and
uncertainties in evaluating forward-looking statements and you should not place undue reliance on
these statements.
General
Mercantile Bancorp, Inc. is a three-bank holding company headquartered in Quincy, Illinois with 12
banking facilities (11 full service offices and 1 stand-alone drive-up facility) serving 9
communities located throughout west-central Illinois, central Indiana, western Missouri, eastern
Kansas and southwestern Florida. The Company is focused on meeting the financial needs of its
markets by offering competitive financial products, services and technologies. It is engaged in
retail, commercial and agricultural banking, and its core products include loans, deposits, trust
and investment management. The Company derives substantially all of its net income from its
subsidiary banks.
Wholly Owned Subsidiaries. As of September 30, 2010, the Company was the sole shareholder of the
following banking subsidiaries:
| Mercantile Bank (Mercantile Bank), located in Quincy, Illinois; and | ||
| Royal Palm Bancorp, Inc. (Royal Palm), the sole shareholder of Royal Palm Bank of Florida (Royal Palm Bank), located in Naples, Florida. |
Majority-Owned Subsidiary. As of September 30, 2010, the Company was the majority, but not sole,
shareholder of Mid-America Bancorp, Inc. (Mid-America), the sole shareholder of Heartland Bank
(Heartland), located in Leawood, Kansas, in which the Company owns 55.5% of the outstanding
voting stock. During the first three
quarters of 2010, there were no transactions affecting Mid-Americas outstanding shares of common
stock or the Companys ownership percentage in Mid-America.
23
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Other Investments in Financial Institutions. As of September 30, 2010, the Company had less than
majority ownership interests in several additional banking organizations located throughout the
United States. Specifically, the Company owned the following percentages of the outstanding voting
stock of these banking entities:
| 2.5% of Premier Community Bank of the Emerald Coast (Premier Community), located in Crestview, Florida; | ||
| 3.7% of Paragon National Bank (Paragon), located in Memphis, Tennessee; | ||
| 0.9% of Enterprise Financial Services Corp. (Enterprise), the sole shareholder of Enterprise Bank & Trust, based in Clayton, Missouri; | ||
| 4.1% of Solera National Bancorp, Inc. (Solera), the sole shareholder of Solera National Bank, located in Lakewood, Colorado; | ||
| 2.9% of Manhattan Bancorp, Inc. (Manhattan), the sole shareholder of Bank of Manhattan, located in Los Angeles, California; and | ||
| 4.9% of Brookhaven Bank (Brookhaven), located in Atlanta, Georgia. |
On February 27, 2009, the FDIC adopted an interim rule to impose a 20 basis point emergency special
assessment on June 30, 2009, which would be collected on September 30, 2009. The 20 basis point
assessment was originally based on the institutions assessment base of total deposits. In the
second quarter of 2009, the FDIC announced it had revised the original interim rule to impose a 20
basis point special assessment based on deposits to a 5 basis point special assessment based on the
institutions total assets minus Tier 1 Capital. The new rule provided that additional assessments
of up to 5 basis points could be imposed on September 30, 2009 and December 31, 2009 if the reserve
ratio of the Deposit Insurance Fund was not at an acceptable level. The 5 basis point additional
assessment for each quarter could not exceed an institutions calculation of 10 basis points on the
original assessment base of total deposits. On November 12, 2009, the FDIC adopted a final rule
requiring insured depository institutions to prepay their estimated quarterly risk-based
assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, on December 30,
2009, along with each institutions risk-based deposit insurance assessment for the third quarter
of 2009. The FDIC is also scheduled to increase the normal assessment rates with the intent being
to replenish the Deposit Insurance Fund to the statutory limit of 1.15% of insured deposits by
December 31, 2013. The December 30, 2009 prepayment is being amortized based on the actual
quarterly assessment invoices received from the FDIC. As of September 30, 2010, the prepaid FDIC
assessment balance is approximately $2.6 million.
On January 12, 2010, the FDICs board of directors approved an Advance Notice of Proposed
Rulemaking, or ANPR, entitled Incorporating Executive Compensation Criteria into the Risk
Assessment System. The ANPR requests comment on ways in which the FDIC can amend its risk-based
deposit insurance assessment system to account for risks posed by certain employee compensation
programs. The FDICs goal is to provide an incentive for insured depository institutions to adopt
compensation programs that align employee interest with the long-term interests of the institution
and its stakeholders, including the FDIC. In order to accomplish this goal, the FDIC would adjust a
assessment rates in a manner commensurate with the risks presented by an institutions compensation
program. Examples of compensation program features that meet the FDICs goals include: (i)
providing significant portions of performance-based compensation in the form of restricted,
non-discounted company stock to those employees whose activities present a significant risk to the
institution; (ii) vesting significant awards of company stock over multiple years and subject to
some form of claw-back mechanism to account for the outcome of risks assumed in earlier periods;
and (iii) administering the program through a board committee composed of independent directors
with input from independent compensation professionals. The Company believes its compensation
programs currently meet the FDICs goals.
In June 2009, the Company elected to defer regularly scheduled interest payments on its outstanding
junior subordinated debentures relating to its trust preferred securities. The terms of the junior
subordinated debentures and the trust documents allow the Company to defer payments of interest for
up to 20 consecutive quarterly periods without default or penalty. During the deferral period, the
respective trusts will likewise suspend the declaration and payment of dividends on the trust
preferred securities. Also during the deferral period, the Company may not, among other things and
with limited exceptions, pay cash dividends on or repurchase its common stock nor make any payment
on outstanding debt obligations that rank equally with or junior to the junior subordinated
debentures. As of September 30, 2010, the accumulated deferred interest payments totaled $4.8
million.
On July 12, 2010, the Company announced that it had implemented an early retirement option and a
limited reduction in force at the Company, Mercantile Bank, Royal Palm Bank and Heartland Bank.
The Companys Board of Directors authorized these actions on June 22, 2010, upon recommendation of
the Boards Compensation Committee, as additional steps in the Companys efforts to reduce overhead
costs in light of the sale of three of the Companys subsidiary banks in the fourth quarter of 2009
and first quarter of 2010. The early retirements and reductions in force were completed by October
31, 2010. Total expenses related to these actions (principally one-
time termination payments) were approximately $191,000. A total of 22 full-time positions were
eliminated, representing approximately 7.7% of the Companys workforce prior to implementation of
these actions.
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Table of Contents
Also on July 12, 2010, the Company filed a Registration Statement on Form S-1 with the Securities
and Exchange Commission (SEC), to register units comprised of shares of the Companys common stock
and warrants to acquire the Companys common stock. Holders of the Companys common stock would
receive one subscription right for each share of Company common stock held as of September 23,
2010, the record date. The offering period expired on October 29, 2010. On November 3, 2010, the
Company terminated the offering without acceptance of any of the subscriptions exercised
thereunder. The Companys Board of Directors determined that in light of the Companys stock price
trading substantially below the subscription price, it was not appropriate to accept the
subscriptions that were exercised.
Results of Operations
Comparison of Operating Results for the Three Months Ended September 30, 2010 and 2009
Overview. Unless otherwise indicated, discussions below regarding income and expense for the three
months ended September 30, 2010 and 2009 refer to the Companys continuing operations. Net loss for
the three months ended September 30, 2010 from both continuing and discontinued operations was
$22.5 million compared with a net loss of $1.4 million for the same period in 2009. The primary
factors contributing to the increase in net loss were an increase in provision for loan losses to
$11.6 million for the three months ended September 30, 2010 compared to $5.3 million for the same
period in 2009; income tax expense of $13.1 million for the three months ended September 30, 2010,
largely related to an increase in the valuation allowance on deferred tax assets, compared to
income tax benefit of $3.0 million for the same period in 2009; and a decrease in income from
discontinued operations of $2.1 million. These increases in net loss were partially offset by an
increase in net interest income of $661 thousand, an increase in noninterest income of $215
thousand, a decrease in noninterest expense of $293 thousand, and an increase in net loss
attributable to noncontrolling interest of $2.1 million. Basic earnings (loss) per share (EPS)
from continuing operations for the three months ended September 30, 2010 was $(2.62) compared with
($0.42) for the same period in 2009.
Total assets at September 30, 2010 were $982.1 million compared with $1.4 billion at December 31,
2009, a decrease of $408.4 million or 29.4%, primarily attributable to decreases in cash and cash
equivalents, securities, loans, and discontinued operations assets held for sale, partially offset
by an increase in foreclosed assets held for sale. Total loans, including loans held for sale, at
September 30, 2010 were $704.2 million compared with $776.7 million at December 31, 2009, a
decrease of $72.5 million or 9.3%. Total deposits at September 30, 2010 were $868.9 million
compared with $954.5 million at December 31, 2009, a decrease of $85.6 million or 9.0%. Total
Mercantile Bancorp, Inc. stockholders equity at September 30, 2010 was $15.1 million compared with
$41.3 million at December 31, 2009, a decrease of $26.2 million or 63.3%.
Discontinued Operations. As a result of the sale of two of the Companys wholly-owned
subsidiaries, Marine Bank and Trust and Brown County State Bank, to United Community Bancshares,
Inc. on February 26, 2010, the assets and liabilities of those two banks are included in the
Companys consolidated balance sheet as of December 31, 2009, but are reflected as Discontinued
operations, assets held for sale and Discontinued operations, liabilities held for sale. The
income and expenses of those two banks for the period January 1 through February 26, 2010 and the
three months ended September 30, 2009 are included in Income (loss) from discontinued operations
in the Companys consolidated statements of operations. As a result of the exchange for debt of
another of the Companys wholly-owned subsidiaries, HNB National Bank, on December 16, 2009, that
banks income and expenses for the three months ended September 30, 2009 are included in Income
(loss) from discontinued operations in the Companys consolidated statements of operations.
Net Interest Income. For the three months ended September 30, 2010, net interest income increased
$661 thousand, or 11.6%, to $6.4 million compared with $5.7 million for the same period in 2009.
The increase was primarily due to decreased volumes of savings, money market and time and brokered
time deposits, short-term borrowings and long-term debt, increased rates on loans, and decreased
rates on all deposits. For the three months ended September 30, 2010 and 2009, the net interest
margin increased by 56 basis points to 2.73% from 2.17% while the net interest spread increased by
50 basis points to 2.60% from 2.10%, respectively.
Interest and dividend income for the three months ended September 30, 2010 decreased $1.1 million,
or 8.9%, to $11.4 million compared with $12.5 million for the same period in 2009. This decrease
was due primarily to a decrease in loan interest income of $966 thousand. Average total loans from
continuing operations for the three months ended September 30, 2010 decreased $107.7 million, or
13.0%, to $717.6 million compared with $825.3 million for the same period in 2009, while the
average yield on total loans increased 27 basis points to 5.65% for the same period. Average total
investments for the three months ended September 30, 2010 increased $1.8 million, or 1.46%, to
$122.6 million compared with $120.8 million for the same period in 2009, while the average yield on
investments decreased 77 basis points to 3.49% for the same period. For the three months ended
September 30,
2010, compared to the same period in 2009, the yield on total average earning assets decreased by
13 basis points to 4.87%.
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Table of Contents
Interest expense for the three months ended September 30, 2010 decreased $1.8 million, or 26.3%, to
$5.0 million compared with $6.8 million for the same period in 2009. This decrease was due
primarily to decreases in interest expense on deposits of $1.1 million and interest expense on
short-term borrowings of $569 thousand. Average total interest-bearing deposits for the three
months ended September 30, 2010 decreased $76.6 million, or 9.0%, to $778.6 million compared with
$855.2 million for the same period in 2009, while the average cost of funds on total
interest-bearing deposits decreased 37 basis points to 1.99% for the same period. The average cost
of funds on all categories of deposits decreased in the three months ended September 30, 2010,
compared to the same period in 2009, primarily due to the Company reducing deposit rates to align
with competitors in an inelastic rate environment. Average total long-term debt for the three
months ended September 30, 2010 decreased $20.1 million, or 20.7%, to $76.9 million compared with
$96.9 million for the same period in 2009, while the average cost of funds on long-term debt
increased 56 basis points to 5.33% for the same period. For the three months ended September 30,
2010, compared to the same period in 2009, the cost of funds on total average interest-bearing
liabilities decreased by 37 basis points to 2.27%.
The following table sets forth for the periods indicated an analysis of net interest income by
each major category of interest-earning assets and interest-bearing liabilities, the average
amounts outstanding and the interest earned or paid on such amounts. The table also sets forth the
average rate earned on total interest-earning assets, the average rate paid on total
interest-bearing liabilities and the net interest margin on average total interest-earning assets
for the same periods. All average balances are daily average balances and nonaccruing loans have
been included in the table as loans carrying a zero yield.
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Table of Contents
For the three months ended September 30 | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Income/ | Income/ | |||||||||||||||||||||||
Average Balance | Expense | Yield/Rate | Average Balance | Expense | Yield/Rate | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Interest-bearing demand
deposits |
$ | 71,794 | $ | 43 | 0.24 | % | $ | 86,706 | $ | 8 | 0.04 | % | ||||||||||||
Federal funds sold |
10,679 | 6 | 0.22 | % | 8,504 | 3 | 0.14 | % | ||||||||||||||||
Securities: |
||||||||||||||||||||||||
Taxable |
||||||||||||||||||||||||
U.S. treasuries
and government
agencies |
4,079 | 24 | 2.33 | % | | 3 | 0.00 | % | ||||||||||||||||
Mortgage-backed
securities: GSE
residential |
33,052 | 244 | 2.93 | % | 24,012 | 241 | 3.98 | % | ||||||||||||||||
Other securities |
58,283 | 579 | 3.94 | % | 69,193 | 788 | 4.52 | % | ||||||||||||||||
Total taxable |
95,414 | 847 | 3.52 | % | 93,205 | 1,032 | 4.39 | % | ||||||||||||||||
Non-taxable State and
political subdivision (3) |
27,164 | 231 | 3.37 | % | 27,612 | 234 | 3.36 | % | ||||||||||||||||
Loans (net of unearned
discount ) (1)(2) |
717,608 | 10,225 | 5.65 | % | 825,305 | 11,191 | 5.38 | % | ||||||||||||||||
Federal Home Loan Bank
stock |
2,949 | 2 | 0.27 | % | 2,947 | 2 | 0.27 | % | ||||||||||||||||
Total
interest-earning
assets |
925,608 | $ | 11,354 | 4.87 | % | 1,044,279 | $ | 12,470 | 4.74 | % | ||||||||||||||
Cash and due from banks |
10,350 | 12,359 | ||||||||||||||||||||||
Interest receivable |
3,847 | 4,288 | ||||||||||||||||||||||
Foreclosed assets held
for sale, net |
25,876 | 10,401 | ||||||||||||||||||||||
Cost method investments
in common stock |
1,392 | 2,210 | ||||||||||||||||||||||
Cash surrender value of
life insurance |
15,337 | 14,783 | ||||||||||||||||||||||
Premises and equipment |
24,618 | 26,254 | ||||||||||||||||||||||
Other |
26,855 | 20,290 | ||||||||||||||||||||||
Intangible assets |
1,861 | 1,992 | ||||||||||||||||||||||
Allowance for loan loss |
(22,184 | ) | (23,271 | ) | ||||||||||||||||||||
Discontinued operations,
Assets held for sale |
| 595,767 | ||||||||||||||||||||||
Total assets |
$ | 1,013,560 | $ | 1,709,352 | ||||||||||||||||||||
Liabilities and Stockholders Equity |
||||||||||||||||||||||||
Interest-bearing
transaction deposits |
$ | 66,345 | $ | 44 | 0.26 | % | $ | 63,078 | $ | 48 | 0.30 | % | ||||||||||||
Savings deposits |
45,604 | 38 | 0.33 | % | 46,873 | 64 | 0.54 | % | ||||||||||||||||
Money-market deposits |
112,432 | 163 | 0.58 | % | 160,918 | 315 | 0.78 | % | ||||||||||||||||
Time and brokered time
deposits |
554,268 | 3,666 | 2.62 | % | 584,364 | 4,559 | 3.10 | % | ||||||||||||||||
Short-term borrowings |
14,907 | 45 | 1.20 | % | 65,039 | 614 | 3.75 | % | ||||||||||||||||
Long term debt |
15,001 | 159 | 4.21 | % | 35,052 | 347 | 3.93 | % | ||||||||||||||||
Junior subordinated
debentures |
61,858 | 874 | 5.61 | % | 61,858 | 819 | 5.25 | % | ||||||||||||||||
Total
interest-bearing
liabilities |
870,415 | $ | 4,989 | 2.27 | % | 1,017,182 | $ | 6,766 | 2.64 | % | ||||||||||||||
Demand deposits |
93,773 | 85,234 | ||||||||||||||||||||||
Interest payable |
6,063 | 3,796 | ||||||||||||||||||||||
Other liabilities |
4,594 | 4,650 | ||||||||||||||||||||||
Discontinued operations,
Liabilities held for sale |
| 544,499 | ||||||||||||||||||||||
Noncontrolling interest |
1,723 | 4,682 | ||||||||||||||||||||||
Stockholders equity |
36,992 | 49,309 | ||||||||||||||||||||||
Total
liabilities and
stockholders
equity |
$ | 1,013,560 | $ | 1,709,352 | ||||||||||||||||||||
Interest spread |
2.60 | % | 2.10 | % | ||||||||||||||||||||
Net interest income |
$ | 6,365 | $ | 5,704 | ||||||||||||||||||||
Net interest margin |
2.73 | % | 2.17 | % | ||||||||||||||||||||
Interest-earning assets
to interest-bearing
liabilities |
106.34 | % | 102.66 | % |
(1) | Non-accrual loans have been included in average loans, net of unearned discount | |
(2) | Includes loans held for sale | |
(3) | The tax exempt income for state and political subdivisions in not recorded on a tax equivalent basis. |
27
Table of Contents
The following table presents information regarding the dollar amount of changes in interest
income and interest expense for the periods indicated for the major components of interest-earning
assets and interest-bearing liabilities and distinguishes between the increase (decrease)
attributable to changes in volume and changes in interest rates. For purposes of this table,
changes attributable to both volume and rate have been allocated proportionately to the change due
to volume and rate.
For the three months ended September 30, | ||||||||||||
2010 vs. 2009 | ||||||||||||
Increase (Decrease) Due to | ||||||||||||
Change in | ||||||||||||
Volume | Rate | Total | ||||||||||
Increase (decrease) in interest income: |
||||||||||||
Interest-bearing bank deposits |
$ | (2 | ) | $ | 37 | $ | 35 | |||||
Federal funds sold |
1 | 2 | 3 | |||||||||
Investment securities: |
||||||||||||
U.S. Treasuries and Agencies |
| 21 | 21 | |||||||||
Mortgage-backed securities: GSE
residential |
77 | (74 | ) | 3 | ||||||||
States and political subdivision (1) |
(4 | ) | 1 | (3 | ) | |||||||
Other securities |
(115 | ) | (94 | ) | (209 | ) | ||||||
Loans (net of unearned discounts) |
(1,514 | ) | 548 | (966 | ) | |||||||
Federal Home Loan Bank stock |
| | | |||||||||
Change in interest income |
(1,557 | ) | 441 | (1,116 | ) | |||||||
Increase (decrease) in interest expense: |
||||||||||||
Interest-bearing transaction deposits |
2 | (6 | ) | (4 | ) | |||||||
Savings deposits |
(2 | ) | (24 | ) | (26 | ) | ||||||
Money-market deposits |
(82 | ) | (70 | ) | (152 | ) | ||||||
Time and brokered time deposits |
(226 | ) | (667 | ) | (893 | ) | ||||||
Short-term borrowings |
(302 | ) | (267 | ) | (569 | ) | ||||||
Long-term debt and junior subordinated
debentures |
(259 | ) | 126 | (133 | ) | |||||||
Change in interest expense |
(869 | ) | (908 | ) | (1,777 | ) | ||||||
Increase (decrease) in net interest income |
$ | (688 | ) | $ | 1,349 | $ | 661 | |||||
(1) | The tax exempt income for state and political subdivisions is not recorded on a tax equivalent basis. |
Provision for Loan Losses. As discussed in the Explanatory Note on page 3 of this Form 10-Q/A,
certain adjustments have been made to restate previously reported results for the three and nine
months ended September 30, 2010. These adjustments included an additional $6.2 million of
provision for loan loss, compared to the amount originally reported.
Provisions for loan losses are charged against income to bring the Companys allowance for loan
losses (ALLL) to a level deemed appropriate by management. For the three months ended September
30, 2010, the provision increased by approximately $6.2 million to $11.6 million, compared with
$5.3 million for the same period in 2009, due to Mercantile Banks write-down of two commercial
real estate loans. As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, Mercantile
Bank originally recorded these write-downs in the fourth quarter of 2010, but after receiving the
results of a recent, regularly scheduled safety and soundness examination, Mercantile Bank
reassessed the circumstances impacting the two loans as subsequent events, and determined the
write-downs should have been recognized as of September 30, 2010. On one of the loans, the
borrower unexpectedly filed for bankruptcy in October 2010, whereas the other loan involved a
lawsuit filed against the guarantors that was continued by the court in November 2010 until
February 2011. In both cases, prior to the third quarter of 2010, Mercantile Bank had relied on
the financial strength of the guarantors to service the debt. However, considering the
uncertainties associated with the bankruptcy process and the delays in the lawsuit, Mercantile Bank
concluded that both write-downs should be retroactively applied to the third quarter of 2010.
The Company continues to be negatively impacted by further declines in real estate values that
collateralize loans, both in its Florida market and in some of its purchased participations in
commercial real estate developments in other areas of the country.
The ALLL at September 30, 2010 was $25.9 million, or 3.67% of total loans, an increase of $7.0
million from $18.9 million or 2.43% of total loans at December 31, 2009. Nonperforming loans were
$49.8 million, or 7.07% of total
28
Table of Contents
loans as of September 30, 2010, compared with $50.8 million, or 6.54% of total loans as of December
31, 2009. Impaired loans decreased from $111.2 million at December 31, 2009 to $105.7 million at
September 30, 2010. Approximately $12.1 million of this decrease is attributable to foreclosures
on two loans to commercial real estate developers by Mercantile Bank and the subsequent transfer of
the properties to foreclosed assets held for sale. The remainder of the decrease was due to the
charge-offs at Mercantile Bank and Heartland, as well as payments received on impaired loans. This
decrease was partially offset by an increase in impaired loans at Mercantile Bank, Royal Palm Bank,
and Heartland throughout 2010. The Company anticipates a portion of the impaired loans will
eventually be charged off, but believes it has adequately reserved for these losses based on
circumstances existing as of September 30, 2010.
As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, due to the additional loan
write-downs and provisions for loan losses retroactive to the third quarter of 2010, the Company
re-evaluated its ALLL calculation as of September 30, 2010, including both the general and specific
reserves and incorporated into its re-evaluation the revised historical loss experience factor
created by the additional write-downs. Each of the Companys subsidiary banks performs a quarterly
ALLL calculation which the Company utilizes to evaluate the adequacy of the total ALLL on a
consolidated basis. Each of these calculations is designed to quantify an acceptable range rather
than a specific amount. The Companys re-evaluation of the consolidated ALLL as of September 30,
2010, based on the additional $6.2 million of loan write-downs at Mercantile Bank, resulted in a
determination by the Company that the difference between the calculated amount and the balance
reflected in the restated financial statements as of September 30, 2010 was within the acceptable
range.
Management has a process in place to review each subsidiary banks loan portfolio on a
quarterly basis by an independent consulting firm that reports directly to the Audit Committee of
the Board of Directors. The purpose of these quarterly reviews is to assist management in
evaluating the adequacy of the allowance for loan losses. In light of the elevated levels of
nonperforming and impaired loans over historical averages, management has increased the frequency
and scope of the reviews in areas deemed to have the greatest risk of potential losses.
Managements goal is to identify problems loans as soon as possible, with the hope that early
detection and attention to these loans will minimize the amount of the loss.
Noninterest Income. Noninterest income for the three months ended September 30, 2010 increased $215
thousand to $2.1 million compared with $1.9 million for the same period in 2009. The increase in
noninterest income was primarily due to increases in other service charges and fees, net gains on
loan sales, and other income, partially offset by decreases in brokerage fees.
The following table presents, for the periods indicated, the major categories of noninterest
income:
For the Three Months Ended | ||||||||
September 30 | ||||||||
2010 | 2009 | |||||||
Fiduciary activities |
$ | 581 | $ | 569 | ||||
Brokerage fees |
243 | 302 | ||||||
Customer service fees |
400 | 439 | ||||||
Other service charges and fees |
195 | 142 | ||||||
Net gains (losses) on sales of assets |
(3 | ) | (6 | ) | ||||
Net gains on investments in common stock |
39 | | ||||||
Net gains on loan sales |
248 | 157 | ||||||
Loan servicing fees |
126 | 122 | ||||||
Net increase in cash surrender value of life insurance |
143 | 176 | ||||||
Other |
158 | 14 | ||||||
Total noninterest income |
$ | 2,130 | $ | 1,915 | ||||
Other service charges and fees for the three months ended September 30, 2010 increased $53 thousand
to $195 thousand compared with $142 thousand for the same period in 2009, primarily due to an
expansion of the number of accounts that generate transaction and maintenance fees.
Net gains on loan sales for the three months ended September 30, 2010 increased $91 thousand to
$248 thousand compared with $157 thousand for the same period in 2009, primarily due to an increase
in residential mortgage refinancing activity.
Other noninterest income for the three months ended September 30, 2010 increased $144 thousand to
$158 thousand compared with $14 thousand for the same period in 2009, primarily due to fees for
providing data processing services to the three former subsidiaries that were sold in December 2009
and February 2010.
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Table of Contents
Brokerage fees for the three months ended September 30, 2010 decreased $59 thousand to $243
thousand compared with $302 thousand for the same period in 2009, primarily due to the volatility
of the economy and stock market, creating fluctuations in amounts and timing of performance-based
fees generated on customer brokerage accounts .
Noninterest Expense. For the three months ended September 30, 2010, noninterest expense decreased
$293 thousand to $9.1 million compared with $9.4 million for the same period in 2009, primarily due
to a decrease in other than temporary losses on available-for-sale securities and cost method
investments, partially offset by an increase in other noninterest expense.
The following table presents, for the periods indicated, the major categories of noninterest
expense:
For the Three Months Ended | ||||||||
September 30 | ||||||||
2010 | 2009 | |||||||
Salaries and employee benefits |
$ | 4,310 | $ | 4,432 | ||||
Net occupancy expense |
675 | 467 | ||||||
Equipment expense |
552 | 712 | ||||||
Deposit insurance premium |
645 | 561 | ||||||
Professional fees |
610 | 665 | ||||||
Postage and supplies |
131 | 164 | ||||||
Losses on foreclosed assets, net |
508 | 512 | ||||||
Other than temporary losses on
available-for-sale securities and cost
method investments |
| 692 | ||||||
Amortization of mortgage servicing rights |
117 | 38 | ||||||
Other |
1,577 | 1,175 | ||||||
Total noninterest expense |
$ | 9,125 | $ | 9,418 | ||||
Other than temporary losses on available-for-sale securities and cost method investments decreased
$692 thousand for the three months ended September 30, 2010 compared to the same period in 2009,
primarily due to the gradual stabilization of values associated with these securities and
investments from 2009 to 2010.
Other noninterest expense for the three months ended September 30, 2010 increased $402 thousand to
$1.6 million compared with $1.2 million for the same period in 2009, primarily due to increases in
liability insurance expense and repossession and foreclosure expenses.
Income Tax Expense (Benefit). Income tax expense from continuing operations for the three months
ended September 30, 2010 was $13.1 million compared to a benefit of $3.0 million for the same
period in 2009, primarily due to an increase in the valuation allowance related to the Companys
deferred tax assets. As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, certain
adjustments have been made to restate previously reported results for the three and nine months
ended September 30, 2010. These adjustments included an additional valuation allowance related to
deferred tax assets in the amount of approximately $10.3 million, representing the full remaining
balance of the Companys and each of its subsidiary banks deferred tax assets prior to the
adjustment. Due to the determination to record additional loan loss provisions in the third quarter
of 2010, the Companys capital ratios were reduced and the Company re-evaluated the adequacy of the
valuation allowance established for its deferred tax assets. Based on its analysis, the Company
determined that it was no longer more likely than not that it could generate sufficient taxable
income to realize the deferred tax assets in future near-term periods as defined by generally
accepted accounting principles.
The Company has recognized no increase in its liability for unrecognized tax benefits. The Company
files income tax returns in the U.S. federal jurisdiction and the states of Illinois, Missouri,
Kansas and Florida jurisdictions. With a few exceptions, the Company is no longer subject to U.S.
federal, state and local or non-U.S. income tax examinations by tax authorities for years before
2005.
Results of Operations
Comparison of Operating Results for the Nine Months Ended September 30, 2010 and 2009
Overview. Unless otherwise indicated, discussions below regarding income and expense for the nine
months ended September 30, 2010 and 2009 refer to the Companys continuing operations. Net loss for
the nine months ended September 30, 2010 from both continuing and discontinued operations was $26.0
million compared with a net loss of $54.3 million for the same period in 2009. The primary factors
contributing to the decrease in net loss were a goodwill impairment charge of $30.4 million
recognized during the second quarter of 2009, compared to none in 2010; an increase in net interest
income of $3.0 million; an increase in noninterest income of $279 thousand; a decrease in
noninterest expense of $35.3 million (including the $30.4 million decrease in goodwill impairment
30
Table of Contents
charge); an increase in income from discontinued operations of $11.9 million; and an increase in
net loss attributable to noncontrolling interest of $3.2 million. These decreases in net loss were
partially offset by an increase in provision for loan losses to $22.7 million for the nine months
ended September 30, 2010, compared to $17.6 million for the same period in 2009, and income tax
expense of $10.1 million for the nine months ended September 30, 2010, associated with an increase
in the valuation allowance on deferred tax assets, compared to an income tax benefit of $10.3
million for the same period in 2009. . Basic earnings (loss) per share (EPS) for the nine months
ended September 30, 2010 were $(3.38) compared with $(5.27) for the same period in 2009. The
Companys annualized return on average assets was (3.18)% for the nine months ended September 30,
2010, compared with (4.14)% for the same period in 2009. The annualized return on average
stockholders equity was (85.97)% for the nine months ended September 30, 2010, compared to
(88.72)% for the same period in 2009.
Discontinued Operations. As a result of the sale of two of the Companys wholly owned
subsidiaries, Marine Bank and Trust and Brown County State Bank, to United Community Bancshares,
Inc. on February 26, 2010, the assets and liabilities of those two banks are included in the
Companys consolidated balance sheet as of December 31, 2009, but are reflected as Discontinued
operations, assets held for sale and Discontinued operations, liabilities held for sale. The
income and expenses of those two banks for the period January 1 through February 26, 2010 and the
nine months ended September 30, 2009 are included in Income (loss) from discontinued operations
in the Companys consolidated statements of operations. As a result of the exchange for debt of
another of the Companys wholly owned subsidiaries, HNB National Bank, on December 16, 2009, that
banks income and expenses for the nine months ended September 30, 2009 are included in Income
(loss) from discontinued operations in the Companys consolidated statements of operations.
Net Interest Income. For the nine months ended September 30, 2010, net interest income increased
$3.0 million, or 19.2%, to $18.8 million compared with $15.8 million for the same period in 2009.
The increase was primarily due to decreased volumes of money market and time and brokered time
deposits, short-term borrowings and long-term debt, increased rates on loans, and decreased rates
on all deposits. For the nine months ended September 30, 2010 and 2009, the net interest margin
increased by 64 basis points to 2.63% from 1.99% while the net interest spread increased by 54
basis points to 2.47% from 1.93%, respectively.
Interest and dividend income for the nine months ended September 30, 2010 decreased $4.0 million,
or 10.5%, to $34.1 million compared with $38.1 million for the same period in 2009. This decrease
was due primarily to a decrease in loan interest income of $3.5 million. Average total loans for
the nine months ended September 30, 2010 decreased $97.8 million, or 11.6%, to $743.0 million
compared with $840.8 million for the same period in 2009, while the average yield on total loans
increased 9 basis points to 5.48% for the same period. Average total investments for the nine
months ended September 30, 2010 decreased $742 thousand, or 0.59%, to $125.4 million compared with
$126.2 million for the same period in 2009, while the average yield on investments decreased 68
basis points to 3.71% for the same period. For the nine months ended September 30, 2010, compared
to the same period in 2009, the yield on total average earning assets decreased by 5 basis points
to 4.77%.
Interest expense for the nine months ended September 30, 2010 decreased $7.0 million, or 31.5%, to
$15.3 million compared with $22.4 million for the same period in 2009. This decrease was due
primarily to decreases in interest expense on deposits of $5.0 million and interest expense on
short-term borrowings of $1.5 million. Average total interest-bearing deposits for the nine months
ended September 30, 2010 decreased $77.4 million, or 8.7%, to $794.3 million compared with $871.7
million for the same period in 2009, while the average cost of funds on total interest-bearing
deposits decreased 61 basis points to 2.01% for the same period. The average cost of funds on all
categories of deposits decreased in the nine months ended September 30, 2010, compared to the same
period in 2009, due to the Company reducing deposit rates to align with competitors in an inelastic
rate environment. Average total long-term debt for the nine months ended September 30, 2010
decreased $19.4 million, or 20.0%, to $77.5 million compared with $96.9 million for the same period
in 2009, primarily due to the payoff of a large note payable, while the average cost of funds on
long-term debt increased 35 basis points to 5.33% for the same period. For the nine months ended
September 30, 2010, compared to the same period in 2009, the cost of funds on total average
interest-bearing liabilities decreased by 58 basis points to 2.30%.
The following table sets forth for the periods indicated an analysis of net interest income by
each major category of interest-earning assets and interest-bearing liabilities, the average
amounts outstanding and the interest earned or paid on such amounts. The table also sets forth the
average rate earned on total interest-earning assets, the average rate paid on total
interest-bearing liabilities and the net interest margin on average total interest-earning assets
for the same periods. All average balances are daily average balances and nonaccruing loans have
been included in the table as loans carrying a zero yield.
31
Table of Contents
For the nine months ended September 30 | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Income/ | Income/ | |||||||||||||||||||||||
Average Balance | Expense | Yield/Rate | Average Balance | Expense | Yield/Rate | |||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Interest-bearing demand
deposits |
$ | 72,611 | $ | 161 | 0.30 | % | $ | 77,582 | $ | 160 | 0.28 | % | ||||||||||||
Federal funds sold |
11,892 | 21 | 0.24 | % | 12,058 | 11 | 0.12 | % | ||||||||||||||||
Securities: |
||||||||||||||||||||||||
Taxable |
||||||||||||||||||||||||
U.S. treasuries
and government
agencies |
2,328 | 49 | 2.81 | % | 1,722 | 25 | 1.94 | % | ||||||||||||||||
Mortgage-backed
securities: GSE
residential |
33,632 | 800 | 3.18 | % | 23,834 | 784 | 4.40 | % | ||||||||||||||||
Other securities |
61,739 | 1,894 | 4.10 | % | 72,509 | 2,525 | 4.66 | % | ||||||||||||||||
Total taxable |
97,699 | 2,743 | 3.75 | % | 98,065 | 3,334 | 4.55 | % | ||||||||||||||||
Non-taxable State and
political subdivision (3) |
27,727 | 737 | 3.55 | % | 28,103 | 714 | 3.40 | % | ||||||||||||||||
Loans (net of unearned
discount ) (1)(2) |
743,006 | 30,458 | 5.48 | % | 840,834 | 33,918 | 5.39 | % | ||||||||||||||||
Federal Home Loan Bank
stock |
2,899 | 9 | 0.42 | % | 3,332 | 11 | 0.44 | % | ||||||||||||||||
Total
interest-earning
assets |
955,834 | $ | 34,129 | 4.77 | % | 1,059,974 | $ | 38,148 | 4.81 | % | ||||||||||||||
Cash and due from banks |
9,334 | 12,432 | ||||||||||||||||||||||
Interest receivable |
3,797 | 4,351 | ||||||||||||||||||||||
Foreclosed assets held
for sale, net |
20,507 | 10,177 | ||||||||||||||||||||||
Cost method investments
in common stock |
1,392 | 2,874 | ||||||||||||||||||||||
Cash surrender value of
life insurance |
15,221 | 14,194 | ||||||||||||||||||||||
Premises and equipment |
24,993 | 26,664 | ||||||||||||||||||||||
Other |
24,497 | 19,269 | ||||||||||||||||||||||
Goodwill |
| 20,480 | ||||||||||||||||||||||
Intangible assets |
1,890 | 1,545 | ||||||||||||||||||||||
Allowance for loan loss |
(20,183 | ) | (19,798 | ) | ||||||||||||||||||||
Discontinued operations,
Assets held for sale |
58,130 | 602,904 | ||||||||||||||||||||||
Total assets |
$ | 1,095,412 | $ | 1,755,066 | ||||||||||||||||||||
Liabilities and Stockholders Equity |
||||||||||||||||||||||||
Interest-bearing
transaction deposits |
$ | 67,476 | $ | 137 | 0.27 | % | $ | 65,152 | $ | 158 | 0.32 | % | ||||||||||||
Savings deposits |
46,921 | 123 | 0.35 | % | 46,705 | 218 | 0.62 | % | ||||||||||||||||
Money-market deposits |
120,516 | 533 | 0.59 | % | 153,013 | 1,057 | 0.92 | % | ||||||||||||||||
Time and brokered time
deposits |
559,397 | 11,177 | 2.67 | % | 606,800 | 15,567 | 3.43 | % | ||||||||||||||||
Short-term borrowings |
20,056 | 282 | 1.88 | % | 69,195 | 1,783 | 3.45 | % | ||||||||||||||||
Long term debt |
15,687 | 538 | 4.59 | % | 35,052 | 1,085 | 4.14 | % | ||||||||||||||||
Junior subordinated
debentures |
61,858 | 2,553 | 5.52 | % | 61,858 | 2,523 | 5.45 | % | ||||||||||||||||
Total
interest-bearing
liabilities |
891,911 | $ | 15,343 | 2.30 | % | 1,037,775 | $ | 22,391 | 2.88 | % | ||||||||||||||
Demand deposits |
97,320 | 81,043 | ||||||||||||||||||||||
Interest payable |
5,239 | 3,341 | ||||||||||||||||||||||
Other liabilities |
4,190 | 4,414 | ||||||||||||||||||||||
Discontinued operations,
Liabilities held for sale |
53,479 | 541,608 | ||||||||||||||||||||||
Noncontrolling interest |
2,800 | 5,082 | ||||||||||||||||||||||
Stockholders equity |
40,473 | 81,803 | ||||||||||||||||||||||
Total
liabilities and
stockholders
equity |
$ | 1,095,412 | $ | 1,755,066 | ||||||||||||||||||||
Interest spread |
2.47 | % | 1.93 | % | ||||||||||||||||||||
Net interest income |
$ | 18,786 | $ | 15,757 | ||||||||||||||||||||
Net interest margin |
2.63 | % | 1.99 | % | ||||||||||||||||||||
Interest-earning assets
to interest-bearing
liabilities |
107.17 | % | 102.14 | % |
(1) | Non-accrual loans have been included in average loans, net of unearned discount | |
(2) | Includes loans held for sale | |
(3) | The tax exempt income for state and political subdivisions in not recorded on a tax equivalent basis. |
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Table of Contents
The following table presents information regarding the dollar amount of changes in interest
income and interest expense for the periods indicated for the major components of interest-earning
assets and interest-bearing liabilities and distinguishes between the increase (decrease)
attributable to changes in volume and changes in interest rates. For purposes of this table,
changes attributable to both volume and rate have been allocated proportionately to the change due
to volume and rate.
For the nine months ended September 30, | |||||||||||||
2010 vs. 2009 | |||||||||||||
Increase (Decrease) Due to | |||||||||||||
Change in | |||||||||||||
Volume | Rate | Total | |||||||||||
Increase (decrease) in interest income: |
|||||||||||||
Interest-bearing bank deposits |
$ | (11 | ) | $ | 12 | $ | 1 | ||||||
Federal funds sold |
| 10 | 10 | ||||||||||
Investment securities: |
|||||||||||||
U.S. Treasuries and Agencies |
11 | 13 | 24 | ||||||||||
Mortgage-backed securities: GSE residential |
269 | (253 | ) | 16 | |||||||||
States and political subdivision (1) |
(10 | ) | 33 | 23 | |||||||||
Other securities |
(350 | ) | (281 | ) | (631 | ) | |||||||
Loans (net of unearned discounts) |
(4,002 | ) | 542 | (3,460 | ) | ||||||||
Federal Home Loan Bank stock |
(1 | ) | (1 | ) | (2 | ) | |||||||
Change in interest income |
(4,094 | ) | 75 | (4,019 | ) | ||||||||
Increase (decrease) in interest expense: |
|||||||||||||
Interest-bearing transaction deposits |
5 | (26 | ) | (21 | ) | ||||||||
Savings deposits |
1 | (96 | ) | (95 | ) | ||||||||
Money-market deposits |
(195 | ) | (329 | ) | (524 | ) | |||||||
Time and brokered time deposits |
(1,146 | ) | (3,244 | ) | (4,390 | ) | |||||||
Short-term borrowings |
(915 | ) | (586 | ) | (1,501 | ) | |||||||
Long-term debt and junior subordinated debentures |
(759 | ) | 242 | (517 | ) | ||||||||
Change in interest expense |
(3,009 | ) | (4,039 | ) | (7,048 | ) | |||||||
Increase (decrease) in net interest income |
$ | (1,085 | ) | $ | 4,114 | $ | 3,029 | ||||||
(1) | The tax exempt income for state and political subdivisions is not recorded on a tax equivalent basis. |
Provision for Loan Losses. As discussed in the Explanatory Note on page 3 of this Form 10-Q/A,
certain adjustments have been made to restate previously reported results for the three and nine
months ended September 30, 2010. These adjustments included an additional approximately $6.2
million of provision for loan loss, compared to the amount originally reported.
Provisions for loan losses are charged against income to bring the Companys allowance for loan
losses to a level deemed appropriate by management. For the nine months ended September 30, 2010,
the provision increased by $5.1 million to $22.7 million, compared with $17.6 million for the same
period in 2009, primarily due to Mercantile Banks write-down of the two commercial real estate
loans discussed in the Explanatory Note on page 3 of this Form 10-Q/A. The Company continues to be
negatively impacted by further declines in real estate values that collateralize loans, both in its
Florida market and in some of its purchased participations in commercial real estate developments
in other areas of the country. Additionally, the provision for the nine months ended September 30,
2010 includes approximately $2.0 million related to a subordinated debenture at a troubled
financial institution held by both Royal Palm Bank and Heartland.
The allowance for loan losses at September 30, 2010 was $25.9 million, or 3.67% of total loans, an
increase of $7.0 million from $18.9 million or 2.43% of total loans at December 31, 2009.
Nonperforming loans were $49.8 million, or 7.07% of total loans as of September 30, 2010, compared
with $50.8 million, or 6.54% of total loans as of December 31, 2009. Impaired loans decreased from
$111.2 million at December 31, 2009 to $105.7 million at September 30, 2010. Approximately $12.1
million of this decrease is attributable to foreclosures on two loans to commercial real estate
developers by Mercantile Bank and the subsequent transfer of the properties to foreclosed assets
held for sale. The remainder of the decrease was due to the charge-offs at Mercantile Bank and
Heartland, as well as payments received on impaired loans. This decrease was partially offset by
an increase in impaired loans at Mercantile Bank, Royal Palm Bank, and Heartland throughout 2010.
The Company anticipates a portion of the
33
Table of Contents
impaired loans will eventually be charged off, but
believes it has adequately reserved for these losses based on circumstances existing as of
September 30, 2010, including the Companys re-evaluation of its ALLL calculation incorporating the
revised historical loss experience factor created by the additional write-downs discussed in the
Explanatory Note on page 3 of this Form 10-Q/A.
Management has a process in place to review each subsidiary banks loan portfolio on a quarterly
basis by an independent consulting firm that reports directly to the Audit Committee of the Board
of Directors. The purpose of these quarterly reviews is to assist management in evaluating the
adequacy of the allowance for loan losses. In light of the elevated levels of nonperforming and
impaired loans over historical averages, management has increased the frequency and scope of the
reviews in areas deemed to have the greatest risk of potential losses. Managements goal is to
identify problems loans as soon as possible, with the hope that early detection and attention to
these loans will minimize the amount of the loss.
Noninterest Income. Noninterest income for the nine months ended September 30, 2010 increased $279
thousand to $6.3 million compared with $6.0 million for the same period in 2009. The increase in
noninterest income was primarily due to increases in brokerage fees, other service charges and
fees, and other income, partially offset by decreases in net gains on loan sales.
The following table presents, for the periods indicated, the major categories of noninterest
income:
For the Nine Months Ended | ||||||||
September 30 | ||||||||
2010 | 2009 | |||||||
Fiduciary activities |
$ | 1,744 | $ | 1,705 | ||||
Brokerage fees |
899 | 742 | ||||||
Customer service fees |
1,183 | 1,221 | ||||||
Other service charges and fees |
564 | 382 | ||||||
Net gains (losses) on sales of assets |
5 | (17 | ) | |||||
Net gains on investments in common stock |
39 | | ||||||
Net gains on loan sales |
466 | 1,046 | ||||||
Loan servicing fees |
373 | 349 | ||||||
Net increase in cash surrender value of life insurance |
420 | 434 | ||||||
Other |
569 | 121 | ||||||
Total noninterest income |
$ | 6,262 | $ | 5,983 | ||||
Brokerage fees for the nine months ended September 30, 2010 increased $157 thousand to $899
thousand compared with $742 thousand for the same period in 2009, primarily due to the volatility
of the economy and stock market, creating fluctuations in amounts and timing of performance-based
fees generated on customer brokerage accounts.
Other service charges and fees for the nine months ended September 30, 2010 increased $182 thousand
to $564 thousand compared with $382 thousand for the same period in 2009, primarily due to an
expansion of the number of accounts that generate transaction and maintenance fees.
Other noninterest income for the nine months ended September 30, 2010 increased $448 thousand to
$569 thousand compared with $121 thousand for the same period in 2009, primarily due to fees for
providing data processing services to the three former subsidiaries that were sold in December 2009
and February 2010.
Net gains on loan sales for the nine months ended September 30, 2010 decreased $580 thousand to
$466 thousand compared with $1.0 million for the same period in 2009, primarily due to a slow-down
in residential mortgage refinancing activity, ultimately leading to a reduction in the amount of
loan sales from 2009 to 2010.
Noninterest Expense. For the nine months ended September 30, 2010, noninterest expense decreased
$35.3 million to $26.4 million compared with $61.6 million for the same period in 2009, primarily
due to a goodwill impairment charge of $30.4 million in 2009. The decrease was also attributable to
decreases in net losses on foreclosed assets and other than temporary losses on available-for-sale
securities and cost method investments.
34
Table of Contents
The following table presents, for the periods indicated, the major categories of noninterest
expense:
For the Nine Months Ended | ||||||||
September 30 | ||||||||
2010 | 2009 | |||||||
Salaries and employee benefits |
$ | 13,004 | $ | 13,234 | ||||
Net occupancy expense |
1,899 | 1,658 | ||||||
Equipment expense |
1,721 | 1,928 | ||||||
Deposit insurance premium |
1,717 | 2,259 | ||||||
Professional fees |
1,566 | 2,210 | ||||||
Postage and supplies |
406 | 465 | ||||||
Losses on foreclosed assets, net |
890 | 2,067 | ||||||
Other than temporary losses on available-for-sale securities and cost method investments |
566 | 3,238 | ||||||
Goodwill impairment losses |
| 30,417 | ||||||
Amortization of mortgage servicing rights |
196 | 379 | ||||||
Other |
4,422 | 3,785 | ||||||
Total noninterest expense |
$ | 26,387 | $ | 61,640 | ||||
Net losses on foreclosed assets decreased $1.2 million for the nine months ended September 30, 2010
to $890 thousand, from $2.1 million for the same period in 2009, primarily due to write-downs of
the carrying values of several foreclosed properties held by Royal Palm, based on updated
appraisals during the second quarter of 2009. The write-downs of carrying values have continued
into 2010, but are occurring at a slower pace.
Other than temporary losses on available-for-sale securities and cost method investments decreased
$2.7 million for the nine months ended September 30, 2010 to $566 thousand, from $3.2 million for
the same period in 2009, primarily due to the gradual stabilization of values associated with these
securities and investments from 2009 to 2010.
Income Tax Expense (Benefit). Income tax expense from continuing operations for the nine months
ended September 30, 2010 was $10.1 million, compared to a benefit of approximately $10.3 million
for the same period in 2009, primarily due to an increase in the valuation allowance related to the
Companys deferred tax assets. As discussed in the Explanatory Note on page 3 of this Form 10-Q/A,
certain adjustments have been made to restate previously reported results for the three and nine
months ended September 30, 2010. These adjustments included an additional valuation allowance
related to deferred tax assets in the amount of $10.3 million, representing the full remaining
balance of the Companys and each of its subsidiary banks deferred tax assets prior to the
adjustment. Due to the determination to record additional loan loss provisions in the third quarter
of 2010, the Companys capital ratios were reduced and the Company re-evaluated the adequacy of the
valuation allowance established for its deferred tax assets. Based on its analysis, the Company
determined that it was no longer more likely than not that it could generate sufficient taxable
income to realize the deferred tax assets in future near-term periods as defined by generally
accepted accounting principles.
The Company has recognized no increase in its liability for unrecognized tax benefits. The Company
files income tax returns in the U.S. federal jurisdiction and the states of Illinois, Missouri,
Kansas and Florida jurisdictions. With a few exceptions, the Company is no longer subject to U.S.
federal, state and local or non-U.S. income tax examinations by tax authorities for years before
2005.
Financial Condition
September 30, 2010 Compared to December 31, 2009
Loan Related Data. As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, certain
adjustments have been made to restate previously reported results for the three and nine months
ended September 30, 2010. These adjustments included additional loan charge-offs as of September
30, 2010. Further discussion of the loan portfolio reflects these adjustments to September 30, 2010
balances, as restated.
Loan Portfolio. Total loans from continuing operations, including loans held for sale, decreased
$72.5 million or 9.3% to $704.2 million as of September 30, 2010 from $776.7 million as of December
31, 2009. The Companys subsidiary banks experienced decreased loan balances in the first nine
months of 2010 due to charge offs, seasonal fluctuations, debt paydowns, stricter underwriting
standards, and the uncertain economy and the fear of continued recession causing potential
borrowers to reduce their spending. At September 30, 2010 and December 31, 2009, the ratio of
total loans to total deposits was 81.0% and 81.4%, respectively. For the same periods, total loans
represented 71.7% and 55.9% of total assets, respectively.
35
Table of Contents
The following table summarizes the loan portfolio of the Company by type of loan at the dates
indicated, with 2009 restated to exclude discontinued operations:
September 30, 2010 | December 31, 2009 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
Restated | (dollars in thousands) | |||||||||||||||
Commercial and financial |
$ | 152,586 | 21.67 | % | $ | 161,702 | 20.82 | % | ||||||||
Agricultural |
11,820 | 1.68 | % | 9,832 | 1.27 | % | ||||||||||
Real estate farmland |
17,201 | 2.44 | % | 19,655 | 2.53 | % | ||||||||||
Real estate construction |
106,781 | 15.16 | % | 153,578 | 19.77 | % | ||||||||||
Real estate commercial |
161,200 | 22.89 | % | 163,292 | 21.02 | % | ||||||||||
Real estate residential (1) |
190,338 | 27.04 | % | 193,818 | 24.96 | % | ||||||||||
Installment loans to individuals |
64,253 | 9.12 | % | 74,793 | 9.63 | % | ||||||||||
Total loans |
704,179 | 100.00 | % | 776,670 | 100.00 | % | ||||||||||
Allowance for loan losses |
25,866 | 18,851 | ||||||||||||||
Total loans, including loans
held for sale, net of allowance
for loan losses |
$ | 678,313 | $ | 757,819 | ||||||||||||
(1) | Includes loans held for sale |
Nonperforming Assets. Nonperforming assets consist of nonaccrual loans, loans 90 days or more past
due, restructured loans, repossessed assets and other assets acquired in satisfaction of debts
previously contracted. It is managements policy to place loans on nonaccrual status when interest
or principal is 90 days or more past due. Such loans may continue on accrual status only if they
are both well-secured and in the process of collection.
Total nonperforming loans decreased to $49.8 million as of September 30, 2010 from $50.8 million as
of December 31, 2009, while total nonperforming loans and nonperforming other assets increased to
$75.9 million as of September 30, 2010 from $67.2 million as of December 31, 2009. The Company
continues to be negatively impacted by further declines in real estate values that collateralize
loans, both in its Florida market and in some of its purchased participations in commercial real
estate developments in other areas of the country.
Impaired loans decreased from $111.2 million at December 31, 2009 to $105.7 million at September
30, 2010. Approximately $12.1 million of this decrease is attributable to foreclosures on two
loans to commercial real estate developers by Mercantile Bank and the subsequent transfer of the
properties to foreclosed assets held for sale. The remainder of the decrease was due to the
charge-offs at Mercantile Bank and Heartland, as well as payments received on impaired loans. This
decrease was partially offset by an increase in impaired loans at Mercantile Bank, Royal Palm Bank,
and Heartland throughout 2010. The Company anticipates a portion of the impaired loans will
eventually be charged off, but believes it has adequately reserved for these losses based on
circumstances existing as of September 30, 2010.
Nonperforming other assets is comprised primarily of the carrying value of several foreclosed
commercial real estate properties in the Midwest and Florida that the Company intends to sell, with
the carrying value representing managements assessment of the net realizable value in the current
market. The ratio of nonperforming loans to total loans increased to 7.07% as of September 30,
2010, from 6.54% as of December 31, 2009. The ratio of nonperforming loans and nonperforming other
assets to total loans increased to 10.78% as of September 30, 2010 from 8.66% as of December 31,
2009.
36
Table of Contents
The following table presents information regarding nonperforming assets at the dates indicated,
with 2009 restated to exclude discontinued operations:
September 30, | December 31, | |||||||
2010 | 2009 | |||||||
(Restated) | ||||||||
Nonaccrual loans |
||||||||
Commercial and financial |
$ | 2,882 | $ | 1,439 | ||||
Agricultural |
| 248 | ||||||
Real estate farmland |
715 | 62 | ||||||
Real estate construction |
24,483 | 33,946 | ||||||
Real estate commercial |
7,316 | 7,378 | ||||||
Real estate residential |
6,797 | 6,803 | ||||||
Installment loans to individuals |
164 | 154 | ||||||
Total nonaccrual loans |
42,357 | 50,030 | ||||||
Loans 90 days past due and still accruing |
3,773 | 393 | ||||||
Restructured loans |
3,622 | 397 | ||||||
Total nonperforming loans |
49,752 | 50,820 | ||||||
Repossessed assets |
26,178 | 16,409 | ||||||
Other assets acquired in satisfaction of debt previously contracted |
| | ||||||
Total nonperforming other assets |
26,178 | 16,409 | ||||||
Total nonperforming loans and nonperforming other assets |
$ | 75,930 | $ | 67,229 | ||||
Nonperforming loans to loans, before allowance for loan losses |
7.07 | % | 6.54 | % | ||||
Nonperforming loans and nonperforming other assets to loans, before allowance for loan losses |
10.78 | % | 8.66 | % | ||||
Allowance for Loan Losses. In originating loans, the Company recognizes that loan losses will be
experienced and the risk of loss will vary with, among other things, general economic conditions,
the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in
the case of a collateralized loan, the quality of the collateral for such loan. Management has
established an allowance for loan losses (ALLL), which it believes is adequate to cover probable
losses inherent in the loan portfolio. Loans are charged off against the ALLL when the loans are
deemed to be uncollectible. Although the Company believes the ALLL is adequate to cover probable
losses inherent in the loan portfolio, the amount of the allowance is based upon the judgment of
management, and future adjustments may be necessary if economic or other conditions differ from the
assumptions used by management in making the determinations. In addition, the Companys subsidiary
banks periodically undergo regulatory examinations, and future adjustments to the ALLL could occur
based on these examinations.
Based on an evaluation of the loan portfolio, management presents a quarterly review of the ALLL to
the Audit Committee of the Board of Directors, indicating any change in the allowance since the
last review and any recommendations as to adjustments in the allowance. In making its evaluation,
management considers the diversification by industry of the commercial loan portfolio, the effect
of changes in the local real estate market on collateral values, the results of recent regulatory
examinations, the effects on the loan portfolio of current economic indicators and their probable
impact on borrowers, the amount of charge-offs for the period, the amount of nonperforming loans
and related collateral security, and the present level of the ALLL.
A model is utilized to determine the specific and general portions of the ALLL. Through the loan
review process, management assigns one of six loan grades to each loan, according to payment
history, collateral values and financial condition of the borrower. The loan grades aid management
in monitoring the overall quality of the loan portfolio. Specific reserves are allocated for loans
in which management has determined that deterioration has occurred. In addition, a general
allocation is made for each loan category in an amount determined based on general economic
conditions, historical loan loss experience, and amount of past due loans. Management maintains the
ALLL based on the amounts determined using the procedures set forth above.
The allowance for loan losses increased $7.0 million to $25.9 million as of September 30, 2010 from
$18.9 million as of December 31, 2009. Provision for loan losses was $22.7 million and net
charge-offs were $15.7 million for the nine months ended September 30, 2010. The allowance for loan
losses as a percent of total loans increased to 3.67%
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as of September 30, 2010 from 2.43% as of
December 31, 2009. The increase was due to further deterioration of the commercial real estate
markets in several of the Companys locations, particularly in southwest Florida, resulting in
nonperforming and impaired loan totals at historic elevated levels, as well as additional
provisions at Heartland and Royal Palm Bank in regards to a subordinated debenture at a troubled
financial institution, and at Mercantile Bank in regards to purchased participations in
out-of-territory commercial real estate developments. The increase in allowance for loan losses was
partially offset by increases in net charge-offs at Mercantile Bank and Heartland. As a percent of
nonperforming loans, the allowance for loan losses increased to 51.99% as of September 30, 2010
from 37.09% as of December 31, 2009. The Company believes it has adequately reserved for potential
losses based on circumstances existing as of September 30, 2010.
As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, due to the additional loan
write-downs and provisions for loan losses retroactive to the third quarter of 2010, the Company
re-evaluated its allowance for loan loss (ALLL) calculation as of September 30, 2010, including
both the general and specific reserves and incorporated into its re-evaluation the revised
historical loss experience factor created by the additional write-downs. Each of the Companys
subsidiary banks performs a quarterly ALLL calculation which the Company utilizes to evaluate the
adequacy of the total ALLL on a consolidated basis. Each of these calculations is designed to
quantify an acceptable range rather than a specific amount. The Companys re-evaluation of the
consolidated ALLL as of September 30, 2010, based on the additional approximately $6.2 million of
loan write-downs at Mercantile Bank, determined that the difference between the calculated amount
and the balance reflected in the restated financial statements as of September 30, 2010 was within
the acceptable range.
The following table presents for the periods indicated an analysis of the allowance for loan losses
and other related data, with 2009 restated to exclude discontinued operations:
As of and for the | As of and for | |||||||
Nine Months Ended | the Year Ended | |||||||
September 30, | December 31, | |||||||
2010 | 2009 | |||||||
(Restated) | ||||||||
Average loans outstanding during year |
$ | 743,006 | $ | 840,834 | ||||
Allowance for loan losses: |
||||||||
Balance at beginning of year |
$ | 18,851 | $ | 19,038 | ||||
Loans charged-off: |
||||||||
Commercial and financial |
2,777 | 927 | ||||||
Agricultural |
13 | 438 | ||||||
Real estate farmland |
39 | | ||||||
Real estate construction |
10,211 | 10,938 | ||||||
Real estate commercial |
1,019 | 2,055 | ||||||
Real estate residential |
1,220 | 7,218 | ||||||
Installment loans to individuals |
627 | 899 | ||||||
Total charge-offs |
15,906 | 22,475 | ||||||
Recoveries: |
||||||||
Commercial and financial |
72 | | ||||||
Agricultural |
15 | 13 | ||||||
Real estate farmland |
| | ||||||
Real estate construction |
52 | 34 | ||||||
Real estate commercial |
1 | 7 | ||||||
Real estate residential |
20 | 8 | ||||||
Installment loans to individuals |
61 | 143 | ||||||
Total recoveries |
221 | 205 | ||||||
Net charge-offs |
15,685 | 22,270 | ||||||
Provision for loan losses |
22,700 | 22,083 | ||||||
Balance at end of year |
$ | 25,866 | $ | 18,851 | ||||
Allowance for loan losses as a percent of total loans outstanding at year end |
3.67 | % | 2.43 | % | ||||
Allowance for loan losses as a percent of total nonperforming loans |
51.99 | % | 37.09 | % | ||||
Ratio of net charge-offs to average total loans |
2.11 | % | 2.65 | % | ||||
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Concentration of Credit Risk. Included in the Companys loan portfolio at September 30, 2010 are
approximately $21.5 million of purchased participation loans to borrowers located in areas outside
the Companys normal markets. Although the Company applies the same underwriting standards to
these loans, there may be additional risk associated with those out of the Companys normal
territory.
At September 30, 2010, Heartland had approximately $3.2 million in loans with various customers
collateralized by stock in a financial institution closed by regulators in October, 2010. The
Company is currently working with these customers to increase collateral to acceptable levels and
believes there are adequate reserves placed against the loans.
Included in the loan portfolios of Heartland and Royal Palm Bank at September 30, 2010 are $3.5
million and $1.0 million, respectively, of subordinated debentures issued by a troubled financial
institution. Based on the Companys risk analysis, despite the issuer being current on all
interest payments, it was determined that additional specific allowance for loan loss should be in
place to cover potential future losses. Accordingly, the Company recorded $2.0 million of loan
loss provision in the second quarter of 2010, increasing the specific allowance for loan loss
related to these debentures to $2.25 million. No additional loan loss provision related to the
debentures was recorded in the third quarter of 2010. The Company will continue to monitor the
financial condition
of the issuer, which is attempting to raise additional capital and exploring opportunities to be
acquired by or merge with another financial institution. If these efforts are unsuccessful and the
issuer is closed by regulators, the Company would be subject to additional losses on these
debentures of up to $2.25 million.
Heartland also held, in addition to the $3.5 million of subordinated debentures issued by a
troubled financial institution, a total of $2.0 million in subordinated debentures issued by two
other financial institutions as of September 30, 2010. The Company monitors the financial
condition of these two issuers, which are current on all interest payments related to the
debentures, and has determined, based on information available as of September 30, 2010, that no
specific allowance for loan losses is required. In October 2010, Heartland received a payoff in
the amount of $1.5 million on one of these subordinated debentures. At September 30, 2010, Royal
Palm Bank holds no other debentures other than the $1.0 million issued by a troubled financial
institution.
Securities. The Company uses its securities portfolio to ensure liquidity for cash requirements, to
manage interest rate risk, to provide a source of income, to ensure collateral is available for
municipal pledging requirements and to manage asset quality. Where the Company has less than
majority ownership interests in banking organizations that are publicly traded, it continuously
adjusts its common stock investments to their current market value through the securities portfolio
as an unrealized gain or loss on available-for-sale securities.
The Company has classified securities as both available-for-sale and held-to-maturity as of
September 30, 2010. Available-for-sale securities are held with the option of their disposal in the
foreseeable future to meet investment objectives, liquidity needs or other operational needs.
Securities available-for-sale are carried at fair value. Held-to-maturity securities are those
securities for which the Company has the positive intent and ability to hold until maturity, and
are carried at historical cost adjusted for amortization of premiums and accretion of discounts.
As of September 30, 2010, the fair value of the available for-sale securities was $117.4 million
and the amortized cost was $114.3 million for an unrealized gain of $3.1 million. The after-tax
effect of this unrealized gain was $2.2 million and has been included in stockholders equity. As
of December 31, 2009, the fair value of the available-for-sale securities was $128.1 million and
the amortized cost was $124.8 million for an unrealized gain of $3.3 million. Fluctuations in net
unrealized gains and losses on available-for-sale securities are due primarily to increases or
decreases in prevailing interest rates for the types of securities held in the portfolio.
As of September 30, 2010, the amortized cost of held-to-maturity securities was $1.5 million, a
decrease of $800 thousand from the December 31, 2009 amortized cost of $2.3 million.
The Company owns approximately $1.9 million of Federal Home Loan Bank of Chicago stock included in
other assets. During the third quarter of 2007, the Federal Home Loan Bank of Chicago received a
Cease and Desist Order from their regulator, the Federal Housing Finance Board. The Federal Home
Loan Bank will continue to provide liquidity and funding through advances, however the draft order
prohibits capital stock repurchases and redemptions until a time to be determined by the Federal
Housing Finance Board. With regard to dividends, the Federal Home Loan Bank continues to assess its
dividend capacity each quarter and make appropriate request for approval. There were no dividends
paid by the Federal Home Loan Bank of Chicago during the first three quarters of 2010.
Foreclosed Assets Held for Sale. At September 30, 2010, foreclosed assets increased $9.7 million or
59.2% to $26.1 million from $16.4 million as of December 31, 2009, primarily attributable to the
foreclosure on two loans to commercial real estate developers by Mercantile Bank, partially offset
by the sale of one property by Heartland and
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additional write-downs at each subsidiary based on
updated appraisals of the carrying values of previously foreclosed properties. Included in total
foreclosed assets held for sale at September 30, 2010 were properties resulting from foreclosure on
several of Royal Palms loans in the Florida market, several of Heartlands purchased participation
loans in the Georgia and Arkansas markets, and a Mercantile purchased participation in the Iowa
market.
Deposits. Total deposits decreased $85.6 million or 9.0% to $868.9 million as of September 30, 2010
from $954.5 million as of December 31, 2009. Noninterest-bearing deposits decreased $5.7 million or
5.3% to $102.6 million as of September 30, 2010 from $108.3 million as of December 31, 2009, while
interest-bearing deposits decreased $79.9 million or 9.4% to $766.3 million as of September 30,
2010 from $846.2 million as of December 31, 2009. The decrease in noninterest-bearing deposits was
partially related to one commercial depositor at Mercantile Bank with a large balance at December
31, 2009 that was transferred out in the second quarter of 2010. The majority of the overall
decrease in deposits during the first nine months of 2010 was attributable to reduced funding
required in the loan portfolio as well as reduced liquidity required by Mercantile Bank to provide
correspondent banking services to the three subsidiary banks that were sold in December 2009 and
February 2010.
Borrowings. The Company utilizes borrowings to supplement deposits in funding its lending and
investing activities. Short-term borrowings consist of federal funds purchased, securities sold
under agreements to repurchase, US Treasury demand notes, short-term advances from the Federal Home
Loan Bank (FHLB), short term advances from the Federal Discount Borrower in Custody line
(Federal BIC line), and demand notes and a note payable with Great River Bancshares, Inc. (Great
River), owned by R. Dean Phillips, a significant shareholder of the Company. Long-term debt
consists of long-term advances from the FHLB, notes payable with Great River and junior
subordinated debentures.
Short-term borrowings were $10.9 million as of September 30, 2010, a decrease of $19.8 million from
$30.7 million as of December 31, 2009, primarily attributable to repayment of the remaining
short-term debt due to Great River following the sale of two of the Companys subsidiaries in
February 2010, partially offset by an increase in federal funds purchased.
Long-term borrowings were $15.0 million as of September 30, 2010, a decrease of $10.2 million from
$25.2 million as of December 31, 2009, primarily attributable to repayment of the remaining
long-term debt due to Great River following the sale of two of the Companys subsidiaries in
February 2010, as well as a reduction in advances from the FHLB. Included in long-term borrowings
as of September 30, 2010 were FHLB borrowings totaling $13.0 million, with maturities ranging from
the years 2011 to 2013 and interest rates ranging from 3.15% to 5.30%.
Junior subordinated debentures were $61.9 million at September 30, 2010 and December 31, 2009.
Maturities ranged from the years 2035 to 2037 (callable at the Companys option in 2011, 2015 and
2017), and interest rates ranged from 1.94% to 7.17%. In June 2009, the Company decided to defer
regularly scheduled interest payments on its outstanding $61.9 million of junior subordinated notes
relating to its trust preferred securities. The terms of the junior subordinated notes and the
trust documents allow the Company to defer payments of interest for up to 20 consecutive quarterly
periods without default or penalty. During the deferral period, the respective trusts will
likewise suspend the declaration and payment of dividends on the trust preferred securities. Also
during the deferral period, the Company may not, among other things and with limited exceptions,
pay cash dividends on or repurchase its common stock or make any payment on outstanding debt
obligations that rank equally with or junior to the junior subordinated notes. As previously
disclosed, the Company had suspended the payment of cash dividends on its outstanding common stock.
The Company believes that the deferral of interest payments on the junior subordinated notes and
the suspension of cash dividend payments on its common stock will generate approximately $5.6
million per year in additional cash flow (compared with the prior levels of interest and dividend
payments) and serve to strengthen its capital ratios and those of its subsidiary banks until those
banks return to a sufficient level of profitability. As of September 30, 2010, the accumulated
deferred interest payments totaled $4.8 million.
Liquidity
Liquidity management is the process by which the Company and its subsidiary banks ensure that
adequate liquid funds are available to meet the present and future cash flow obligations arising in
the daily operations of the business in a timely and efficient manner. These financial obligations
consist of needs for funds to meet commitments to borrowers for extensions of credit, funding
capital expenditures, withdrawals by customers, maintaining deposit reserve requirements, servicing
debt, paying dividends to shareholders, and paying operating expenses. Management believes that
adequate liquidity exists to meet all projected cash flow obligations.
The Company achieves a satisfactory degree of liquidity through actively managing both assets and
liabilities. Asset management guides the proportion of liquid assets to total assets, while
liability management monitors future funding requirements and prices liabilities accordingly.
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The Companys most liquid assets are cash and due from banks, interest-bearing demand
deposits, and federal funds sold. The balances of these assets are dependent on the Companys
operating, investing, lending, and financing activities during any given period. As of September
30, 2010, cash and cash equivalents totaled $95.1 million, a decrease of $26.2 million from $121.3
million as of December 31, 2009. This decrease was primarily attributable to reduced liquidity
required by Mercantile Bank to provide correspondent banking services to the three subsidiary banks
that were sold in December 2009 and February 2010.
The Companys primary sources of funds consist of deposits, investment maturities and sales, loan
principal repayment, sales of loans, and capital funds. Additional liquidity is provided by bank
lines of credit and term debt, repurchase agreements, junior subordinated debentures and the
ability to borrow from the Federal Reserve Bank and Federal Home Loan Bank.
Capital Resources
Other than the option of issuing common stock, the Companys primary source of capital is net
income retained by the Company. During the nine months ended September 30, 2010, the Company had a
net loss of $26.0 million and paid no dividends to stockholders. During the year ended December 31,
2009, the Company incurred a net loss of $58.5 million and paid no dividends to stockholders. As
of September 30, 2010, total Mercantile Bancorp, Inc. stockholders equity was $15.1 million, a
decrease of $26.2 million from $41.3 million as of December 31, 2009.
In recent regulatory guidance, the Board of Governors of the Federal Reserve System has emphasized
that voting common stockholders equity generally should be the dominant element within Tier One
capital for bank holding companies and that it is the most desirable element of capital from a
supervisory standpoint. The Board of Governors has reiterated that bank holding companies should
place primary reliance on common equity and has cautioned bank holding companies against
over-reliance on non-common-equity capital elements.
The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of
bank holding companies and their subsidiary banks. Risk-based capital ratios are established by
allocating assets and certain off-balance sheet commitments into four risk-weighted categories.
These balances are then multiplied by the factor appropriate for that risk-weighted category. The
guidelines require bank holding companies and their subsidiary banks to maintain a total capital to
total risk-weighted asset ratio of not less than 8.00%, of which at least one half must be Tier 1
capital, and a Tier 1 leverage ratio of not less than 4.00%. As of September 30, 2010, the
Companys total risk-based capital ratio was 3.86%, Tier 1 risk-based capital ratio was 1.93%, and
its Tier 1 leverage ratio was 1.42%. The capital ratios fell below the adequately capitalized
levels primarily due to continued loan losses as well as additional valuation allowance related to
the Companys and each of its subsidiary banks deferred tax. The Company is working with its
legal and other professional advisors on various capital-raising options in an effort to restore
its capital ratios to adequately capitalized levels. See the Regulatory Matters section of this
filing for more information on the capital adequacy of the Company and its subsidiary banks.
Without prior approval, the subsidiary banks are restricted as to the amount of dividends that they
may declare to the balance of the retained earnings account, adjusted for defined bad debts. In
addition, the FDIC has authority to prohibit or to limit the payment of dividends by a bank if, in
the banking regulators opinion, payment of a dividend would constitute an unsafe or unsound
practice in light of the financial condition of the banking organization. The Company, Mercantile
Bank, Royal Palm Bank and Heartland Bank are each prohibited from paying any dividends without
regulatory consent, pursuant to various regulatory enforcement actions taken with respect to each
entity. See further discussion in the Regulatory Matters section of this filing.
The Company generated a net loss of $26.0 million in the first nine months of 2010, as well as net
losses in each of the last two years, with $58.5 million in 2009 and $8.8 million in 2008. The 2008
and 2009 losses were largely due to the operating losses at Royal Palm Bank and Heartland Bank.
Both of those banks continued to generate losses in the first nine months of 2010, as did
Mercantile Bank, the Companys largest subsidiary. Each bank has experienced significant increases
in non-performing assets, impaired loans and loan loss provisions, resulting in bank regulators
imposing cease and desist orders at Royal Palm Bank and Heartland Bank and a memorandum of
understanding at Mercantile Bank. For further discussion of these regulatory enforcement actions,
see the Regulatory Matters section of this filing.
As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, the net loss in the first nine
months of 2010 was increased by additional loan loss provision of approximately $6.2 million at
Mercantile Bank, along with an approximately $10.3 million increase in the valuation allowance
related to the Companys deferred tax assets. Mercantile Banks net loss in 2010 is primarily due
to charge-offs of purchased participations in large commercial real estate developments in various
parts of the country. Royal Palm Banks operating losses over the past three years (excluding
goodwill impairment) were primarily attributable to the severe decline in real estate values in its
southwest Florida market, creating both loan losses and write-downs of foreclosed assets.
Heartlands losses were largely due to purchased participations from a bank in Georgia that was
closed by the FDIC. Although the subsidiary banks are confident that they have identified the bulk
of their asset quality issues and expect to see
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improved operating performance beginning in 2011,
there can be no assurance that they will not experience additional losses. The Company has
projected 2011 and 2012 operating results for each bank assuming an improving economy and reduced
loan losses compared to 2008 through 2010. Those projections indicate Mercantile Bank returning to
profitability in 2011. Royal Palm Bank and Heartland Bank are projected to be profitable in 2012,
although not attaining compliance with all regulatory mandates set forth in their respective cease
and desist orders.
Due to the net losses incurred by the Company in 2008, 2009 and the first nine months of 2010,
including the effect of the re-statement of its results for the three and nine months ended
September 30, 2010, equity capital has been reduced to a level that leaves the Company with very
little capacity to absorb further losses. Mercantile Bank is the Companys largest subsidiary bank,
representing approximately 71% of total consolidated assets at September 30, 2010, and although
operating under a regulatory memorandum of understanding due to elevated levels of impaired
loans, its actual loan losses over the past two-plus years have been lower than the other two
subsidiaries and it retains significant earnings capacity. However, it is unlikely that Mercantile
Bank could generate sufficient earnings to offset continued losses at Royal Palm Bank and Heartland
Bank.
In June 2009, the Companys Board of Directors initiated a process to identify and evaluate a broad
range of strategic alternatives to further strengthen the Companys capital base and enhance
shareholder value. These strategic alternatives have included and may include asset sales,
rationalization of non-business operations, consolidation of operations, closing of branches,
mergers of subsidiaries, capital raising and other recapitalization transactions. As part of this
process, the Board created a special committee (the Special Committee) of independent directors
to develop, evaluate and oversee any strategic alternatives that the Company may pursue. The
Special Committee retained outside financial and legal advisors to assist it with its evaluation
and oversight.
In November 2009, as a part of a capital-raising plan developed by the Special Committee and its
advisors, the Company reached agreements to sell three of its subsidiary banks for cash or in
exchange for the cancellation of indebtedness owed by the Company. The first of these transactions
closed in December 2009, and the other two in February 2010, serving to reduce debt and provide
liquidity to support the capital requirements of its remaining subsidiaries.
The Special Committee also developed and executed a plan to raise additional equity through a
shareholder rights offering. On April 27, 2010, the Companys Board of Directors, upon the
recommendation of the Special Committee, approved an amendment to its Certificate of Incorporation
to increase the number of authorized shares of common stock of the Company from 14,000,000 to
30,000,000 (the Amendment). On May 24, 2010, at the Companys annual meeting, stockholders voted
to approve the Amendment. On July 12, 2010, the Company filed a Registration Statement on Form S-1
with the Securities and Exchange Commission (SEC), to register units comprised of shares of the
Companys common stock and warrants to acquire the Companys common stock. Holders of the
Companys common stock would receive one subscription right for each share of Company common stock
held as of September 23, 2010, the record date. The offering period expired on October 29, 2010. On
November 3, 2010, the Company terminated the offering without acceptance of any of the
subscriptions exercised thereunder. The Companys Board of Directors determined that in light of
the Companys stock price trading substantially below the subscription price, it was appropriate
not to accept the subscriptions that were exercised.
If the Company is unsuccessful in assessing and implementing other strategic and capital-raising
options, and if a liquidity crisis would develop, the Company has various alternatives, which could
include selling or closing certain branches or subsidiary banks, packaging and selling high-quality
commercial loans, executing sale/leaseback agreements on its banking facilities, and other options.
If executed, these transactions would decrease the various banks assets and liabilities, generate
taxable income, improve capital ratios, and reduce general, administrative and other expense. In
addition, the affected subsidiary banks would dividend the funds to the Company to provide
liquidity, assuming such dividends receive the requisite regulatory approval. The Company is
continuing to explore and evaluate all strategic and capital-raising options with its financial and
legal advisors.
Regulatory Matters
In connection with regular examinations of the Company, Mercantile Bank, Royal Palm Bank, Royal
Palm Bancorp, Heartland Bank and Mid-America Bancorp by the Federal Reserve Bank of St. Louis
(FRB), the FDIC, the Illinois Department of Financial and Professional Regulation (IDFPR) and
Florida Office of Financial Regulation (FOFR), various actions were taken by the regulatory
agencies.
These regulatory actions fall under three categories:
1. | A cease and desist order (CDO) is a formal action by the FDIC requiring a bank to take corrective measures to address deficiencies identified by the FDIC. The bank can continue to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions. All customer deposits remain fully insured to the maximum limits set by the FDIC. |
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2. | A Memorandum of Understanding (MOU) agreement is characterized by regulatory authorities as an informal action that is neither published nor made publicly available by the agencies and is used when circumstances warrant a milder form of action than a formal supervisory action, such as a cease and desist order. | ||
3. | A Written Agreement (WA) is a formal enforcement action by the FRB, similar in nature to an MOU, but is legally binding and will be published and made public. |
The Company. On March 10, 2009, the Company received a notice from the FRB of its intent to issue
an MOU, which was signed by the Companys Board of Directors on March 17, 2009. Under the terms
of the MOU, the
Company was expected to, among other things, provide its subsidiary banks with financial and
managerial resources as needed, submit capital and cash flow plans to the FRB and provide periodic
performance updates to the FRB. In addition, the Company was prohibited from paying any special
salaries or bonuses to insiders, paying dividends, paying interest related to trust preferred
securities, or incur any additional debt, without the prior written approval of the FRB. On July
31, 2009, the Company submitted to the FRB a three-year strategic and capital plan designed to
strengthen the Companys and its subsidiaries operations and capital position going forward. The
plan reflected the challenges with respect to capital and the difficulties in projecting the impact
of the economic weakness in the Companys markets on its loan portfolio, as well as strategies to
maintain the financial strength of the Company and its subsidiaries. A significant part of the
plan was the initiative by the Company to sell one or more subsidiary banks in order to generate
liquidity to reduce debt, improve capital ratios and provide necessary capital contributions to its
remaining subsidiary banks. The result of this initiative was the exchange for debt of HNB in
December 2009 and the sale of Marine Bank and Brown County in February 2010.
On February 16, 2010, the Company executed a WA with the FRB, replacing the previously-issued MOU.
The terms of the WA are generally consistent with the MOU, with a requirement that an updated
capital and cash flow plan be submitted to the FRB. On May 19, 2010, the Company submitted to the
FRB a revised three-year strategic and capital plan that outlines the proposed strategies to
maintain its regulatory capital status of at least adequately capitalized, maintain positive cash
balances at the parent company level, ensure that each of its subsidiaries meets the capital
requirements directed by their respective regulatory orders, and meet its debt service
requirements, including distributions on its trust preferred securities. On December 15, 2010, the
Company submitted to the FRB an updated three-year strategic and capital plan that outlines the
revised proposed strategies to maintain its regulatory capital status of at least adequately
capitalized, maintain positive cash balances at the parent company level, ensure that each of its
subsidiaries meets the capital requirements directed by their respective regulatory orders, and
meet its debt service requirements, including distributions on its trust preferred securities. See
the Capital Resources section of this filing for discussion of the Companys efforts to raise
capital through a shareholder rights offering and other strategies.
Mercantile Bank. On March 8, 2010, Mercantile Bank entered into a MOU with the FDIC and the
IDFPR. Under the terms of the MOU, Mercantile Bank agreed, among other things, to provide certain
information to each supervisory authority including, but not limited to, financial performance
updates, loan performance updates, written plan for reducing classified assets and concentrations
of credit, written plan to improve liquidity and reduce dependency on volatile liabilities, written
capital plan, and written reports of progress. In addition, the bank agreed not to declare any
dividends or make any distributions of capital without the prior approval of the supervisory
authorities, and within 30 days of the date of the MOU, to maintain its Tier 1 leverage capital
ratio at no less than 8.0% and total risk based capital ratio at no less than 12.0%.
As of September 30, 2010, Mercantile Bank had a Tier 1 leverage capital ratio of 7.44% and a total
risk based capital ratio of 11.14%. These ratios fell below the level required by the MOU primarily
due to additional provisions for loan losses, and the Company elected not to inject any capital
into Mercantile Bank until it determines a course of action to raise capital at the Company level.
The FDIC has been notified of the non-compliance, and has requested the bank to provide a plan to
restore the ratios to the required levels. The Company and Mercantile Bank are working with their
legal and other professional advisors to develop a plan, which is expected to be implemented by
March 31, 2011.
Royal Palm Bank. On October 3, 2008, Royal Palm Bank entered into a MOU with the FDIC and FOFR.
Under the terms of the MOU, Royal Palm Bank agreed, among other things, to provide certain
information to each supervisory authority including, but not limited to, financial performance
updates, loan performance updates, written plan for improved earnings, written capital plan, review
and assessment of all officers who head departments of the bank, and written reports of progress.
In addition, Royal Palm Bank agreed not to declare any dividends or make any distributions of
capital without the prior approval of the supervisory authorities, and to maintain its Tier 1
leverage capital ratio at no less than 8.0%, the Tier 1 risk based capital ratio at no less than
10.0%, and total risk based capital ratio at no less than 12.0%.
In May 2009, Royal Palm Bank entered into a stipulation and consent to the issuance of a CDO with
the FDIC and FOFR. The CDO was issued and became effective May 30, 2009. Under the CDO, Royal
Palm agreed, among
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other things, to provide certain information to each supervisory authority
including, but not limited to, notification of plans to add any individual to the board of
directors or employ any individual as a senior executive officer, financial performance updates,
loan performance updates, written plan for improved earnings, written capital plan, written
contingency funding plan, written strategic plan, and written reports of progress. In addition,
Royal Palm agreed not to declare any dividends or make any distributions of capital without the
prior approval of the supervisory authorities, and to maintain its Tier 1 leverage capital ratio at
no less than 8.0%, the Tier 1 risk based capital ratio at no less than 10.0%, and total risk based
capital ratio at no less than 12.0%.
At September 30, 2009, Royal Palm Banks Tier 1 leverage ratio was 1.51% and total risk based
capital ratio was 3.61%. As specified in the CDO, Royal Palm Bank notified the supervisory
authorities within 10 days of the
determination of the ratios. As a result of these capital ratios, Royal Palm Bank was not in
compliance with the CDO requirements for capital ratios on September 30, 2009. On October 7, 2009,
Royal Palm Bank received a letter from the FDIC informing it that the FDIC has preliminarily
determined that Royal Palm Bank was critically undercapitalized and was subject to certain
mandatory requirements under the Federal Deposit Insurance Act (FDIA). The letter also required
Royal Palm Bank to submit a capital restoration plan to the FDIC by October 30, 2009, along with
certain other disclosures related to the mandatory requirements under FDIA for critically
undercapitalized banks. On October 9, 2009, the Company injected $2 million of additional capital
into Royal Palm Bank and as a result, as of that date, Royal Palm Bank had a Tier 1 leverage
capital ratio of 2.69%, a Tier 1 risk based capital ratio of 4.24% and a total risk based capital
ratio of 5.58%.
On October 23, 2009, Royal Palm Bank received a letter from the FOFR demanding that Royal Palm Bank
inject sufficient capital into Royal Palm Bank by November 30, 2009, such that as of November 30,
2009, Royal Palm Bank has a Tier 1 leverage capital ratio of at least 6%. In addition, Royal Palm
Bank was required by this FOFR letter to submit a plan to the FOFR demonstrating how Royal Palm
Bank will have a Tier 1 leverage capital ratio of at least 8% and a total risk based capital ratio
of at least 12% as of December 31, 2009.
The Company injected $11.0 million of capital into Royal Palm Bank on December 1, 2009, with the
proceeds from a short-term debt from Great River Bancshares, Inc. The Company injected an
additional $1.25 million of capital into Royal Palm Bank on March 31, 2010, with proceeds from the
sale of Marine Bank and Trust and Brown County State Bank.
As of September 30, 2010, Royal Palm Bank had a Tier 1 leverage capital ratio of 6.79%, Tier 1 risk
based capital ratio of 9.93% and a total risk based capital ratio of 11.30%. These ratios fell
below the level required by the CDO primarily due to additional provisions for loan losses, and the
Company elected not to inject any capital into Royal Palm Bank until it determines a course of
action to raise capital at the Company level. The FDIC has been notified of the non-compliance,
and has requested the bank to provide a plan to restore the ratios to the required levels. The
Company and Royal Palm Bank are working with their legal and other professional advisors to develop
a plan, which is expected to be implemented by March 31, 2011.
Royal Palm Bancorp. In September 2009, Royal Palm Bancorp entered into a MOU with the FRB. As a
one-bank holding company, this MOU primarily reflected regulatory concerns related to Royal Palm
Bancorps subsidiary (Royal Palm Bank). Under the terms of the MOU, Royal Palm Bancorp agreed,
among other things, to provide certain information to the FRB including, but not limited to,
financial performance updates and written reports of progress. In addition, Royal Palm Bancorp
agreed to assist Royal Palm Bank in addressing weaknesses identified in the bank examination, and
not to pay any salaries or bonuses to insiders, incur any debt, declare any dividends or make any
distributions of capital without the prior approval of the supervisory authorities. As of
September 30, 2010, Royal Palm Bancorp was in compliance with all requirements of the MOU.
Heartland Bank. On March 9, 2009, Heartland signed a CDO with the FDIC. Under the terms of the
CDO, Heartland agreed to, among other things, prepare and submit plans and reports to the FDIC
regarding certain matters including, but not limited to, progress reports detailing actions taken
to secure compliance with all provisions of the order, loan performance updates as well as a
written plan for the reduction of adversely classified assets, a revised comprehensive strategic
plan, and a written profit plan and comprehensive budget. In addition, Heartland agreed not to
declare any dividends without the prior consent of the FDIC and to maintain its Tier 1 leverage
capital ratio at no less than 8.0% and maintain its total risk based capital at no less than 12.0%.
As of September 30, 2010, Heartland had a Tier 1 leverage capital ratio of 5.55%, Tier 1 capital
ratio of 7.70%, and total risk based capital ratio of 9.71%. These ratios fell below the level
required by the CDO primarily due to additional provisions for loan losses, and the Company elected
not to inject any capital into Heartland until it determines a course of action to raise capital at
the Company level. The FDIC has been notified of the non-compliance, and has requested the bank to
provide a plan to restore the ratios to the required levels. The Company and Heartland are working
with their legal and other professional advisors to develop a plan, which is expected to be
implemented by March 31, 2011.
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Mid-America Bancorp. In September 2009, Mid-America Bancorp entered into a MOU with the FRB. As a
one-bank holding company, this MOU primarily reflected regulatory concerns related to Mid-Americas
subsidiary (Heartland Bank). Under the terms of the MOU, Mid-America Bancorp agreed, among other
things, to provide certain information to the FRB including, but not limited to, financial
performance updates and written reports of progress. In addition, Mid-America Bancorp agreed to
assist Heartland Bank in addressing weaknesses identified in the bank examination, and not to pay
any salaries or bonuses to insiders, incur any debt, declare any dividends or make any
distributions of capital without the prior approval of the supervisory authorities. As of September
30, 2010, Mid-America Bancorp was in compliance with all requirements of the MOU.
No fines or penalties were imposed as a result of any of the regulatory enforcement actions.
The Company, Mercantile Bank, Royal Palm Bank, Royal Palm Bancorp, Heartland Bank and Mid-America
Bancorp are committed to ensuring that future requirements of the regulatory agreements are met in
a timely manner.
Effect of Inflation and Changing Prices.
The condensed consolidated financial statements and related financial data presented herein have
been prepared in accordance with accounting procedures generally accepted in the United States of
America which require the measurement of financial position and operating results in terms of
historical dollars, without considering the change in the relative purchasing power of money over
time due to inflation. The impact of inflation is reflected in the increased cost of the Companys
operations. Unlike most industrial companies, virtually all the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates generally have a more
significant impact on a financial institutions performance than do general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same extent as the prices of
goods and services.
Critical Accounting Estimates
Critical accounting estimates are those that are critical to the portrayal and understanding
of the Companys financial condition and results of operations, and require management to make
assumptions that are difficult, subjective, or complex. These estimates involve judgments,
estimates, and uncertainties that are susceptible to change. In the event that different
assumptions of conditions were to prevail, and depending on the severity of such changes, the
possibility of materially different financial condition or results of operations is a reasonable
likelihood.
The Companys significant accounting policies are integral to understanding the results reported.
The Companys significant accounting policies are described in detail in Note 1 to its consolidated
financial statements included in its Annual Report on Form 10-K filed with the SEC on April 7,
2010. The majority of these accounting policies do not require management to make difficult,
subjective, or complex judgments or estimates, or the variability of the estimates is not material.
However, management has identified the following critical policies.
Allowance for Loan Losses. The allowance for loan losses provides coverage for probable
losses inherent in the Companys loan portfolio. Management evaluates the adequacy of the
allowance for loan losses each quarter based on changes, if any, in underwriting activities, the
loan portfolio composition (including product mix and geographic, industry or customer-specific
concentrations), trends in loan performance, regulatory guidance and economic factors. This
evaluation is inherently subjective, as it requires the use of significant management estimates.
Many factors can affect managements estimates of specific and expected losses, including
volatility of default probabilities, rating migrations, loss severity and economic and political
conditions. The allowance is increased through provisions charged to operating earnings and
reduced by net charge-offs.
The Company determines the amount of the allowance based on relative risk characteristics of the
loan portfolio. The allowance recorded for commercial loans is based on reviews of individual
credit relationships and an analysis of the migration of commercial loans and actual loss
experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan
mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical
losses, adjusted for current trends, for each homogeneous category or group of loans. The
allowance for loan losses relating to impaired loans is based on the loans observable market
price, the collateral for certain collateral-dependent loans, or the discounted cash flows using
the loans effective interest rate.
Regardless of the extent of the Companys analysis of customer performance, portfolio trends or
risk management processes, certain inherent but undetected losses are probable within the loan
portfolio. This is due to several factors including inherent delays in obtaining information
regarding a customers financial condition or changes in their unique business conditions, the
judgmental nature of individual loan evaluations, collateral assessments and the interpretation of
economic trends. Volatility of economic or customer-specific conditions affecting the
identification and estimation of losses for larger non-homogeneous credits and the sensitivity of
assumptions utilized to establish allowances for homogeneous groups of loans are among other
factors. The Company estimates a range
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of inherent losses related to the existence of the
exposures. The estimates are based upon the Companys evaluation of imprecision risk associated
with the commercial and consumer allowance levels and the estimated impact of the current economic
environment.
Deferred Taxes. Prior to September 30, 2010, the Company maintained significant net deferred tax
assets for deductible temporary differences, the largest of which related to the net operating loss
carryforward and the allowance for loan losses. For income tax return purposes, only net
charge-offs are deductible, not the provision for loan losses. Under generally accepted accounting
principles, a valuation allowance is required to be recognized if it is more likely than not that
the deferred tax asset will not be realized. The determination of the recoverability of the
deferred tax assets is highly subjective and dependent upon judgment concerning managements
evaluation of both positive and negative evidence, the forecasts of future income, applicable tax
planning strategies, and
assessments of the current and future economic and business conditions. Management considered both
positive and negative evidence regarding the ultimate recoverability of the deferred tax assets.
Positive evidence includes the existence of taxes paid in available carryback years, available tax
planning strategies and the probability that taxable income will be generated in future periods,
while negative evidence includes a cumulative loss in the current year and prior year and general
business and economic trends.
As discussed in the Explanatory Note on page 3 of this Form 10-Q/A, due to the determination to
record additional loan loss provisions in the third quarter of 2010, the Companys capital ratios
were reduced and the Company re-evaluated the adequacy of the valuation allowance established for
its deferred tax assets. Based on its analysis, the Company determined that it was no longer more
likely than not that it could generate sufficient taxable income to realize the deferred tax assets
in future near-term periods as defined by generally accepted accounting principles, and accordingly
recognized an additional valuation allowance in the third quarter of 2010 in the amount of
approximately $10.3 million, representing the full remaining balance of the Companys and each of
its subsidiary banks deferred tax assets prior to the adjustment. Managements assumptions could
change based on unanticipated changes in the current economic environment and cause management to
decrease its valuation allowance.
Regulatory Developments. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform
and Consumer Protection Act (the Dodd-Frank Act), into law. The Dodd-Frank Act will have a broad
impact on the financial services industry, including significant regulatory and compliance changes
such as, among other things, (1) enhanced resolution authority of troubled and failing banks and
their holding companies; (2) increased capital and liquidity requirements; (3) increased regulatory
examination fees; (4) changes to assessments to be paid to the FDIC for federal deposit insurance;
and (5) numerous other provisions designed to improve supervision and oversight of, and
strengthening safety and soundness for, the financial services sector. Additionally, the
Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system
to be distributed among new and existing federal regulatory agencies, including the Financial
Stability Oversight Council, the Board of Governors of the Federal Reserve System, (the Federal
Reserve), the Office of the Comptroller of the Currency, (the OCC), and the Federal Deposit
Insurance Corporation, (the FDIC).
The following items provide a brief description of the impact of the Dodd-Frank Act on the
operations and activities, both currently and prospectively, of the Company and its subsidiaries.
Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 deposit insurance
limit for insured deposits. Amendments to the Federal Deposit Insurance Act also revise the
assessment base against which an insured depository institutions deposit insurance premiums
paid to the FDICs Deposit Insurance Fund, (the DIF), will be calculated. Under the
amendments, the assessment base will no longer be the institutions deposit base, but rather
its average consolidated total assets less its average equity. Additionally, the Dodd-Frank
Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum
from 1.15 percent to 1.35 percent of the estimated amount of total insured deposits, and
eliminating the requirement that the FDIC pay dividends to depository institutions when the
reserve ratio exceeds certain thresholds. Several of these provisions could increase the
FDIC deposit insurance premiums paid by the Companys subsidiaries. The Dodd-Frank Act also
provides that, effective one year after the date of enactment, depository institutions may
pay interest on demand deposits.
Trust Preferred Securities. Under the Dodd-Frank Act, bank holding companies are
prohibited from including in their regulatory Tier 1 capital hybrid debt and equity
securities issued on or after May 19, 2010. Among the hybrid debt and equity securities
included in this prohibition are trust preferred securities, which the Company has used in
the past as a tool for raising additional Tier 1 capital and otherwise improving its
regulatory capital ratios. Although the Company is permitted to continue to include its
existing trust preferred securities as Tier 1 capital, the prohibition on the use of these
securities as Tier 1 capital going forward may limit the Companys ability to raise capital
in the future.
The Consumer Financial Protection Bureau. The Dodd-Frank Act creates a new,
independent Consumer Financial Protection Bureau, (the Bureau), within the Federal
Reserve. The Bureau is tasked with establishing and implementing rules and regulations
under certain federal consumer protection laws with
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respect to the conduct of providers of
certain consumer financial products and services. The Bureau has rulemaking authority over
many of the statutes governing products and services offered to bank consumers. In
addition, the Dodd-Frank Act permits states to adopt consumer protection laws and
regulations that are stricter than those regulations promulgated by the Bureau and state
attorneys general are permitted to enforce consumer protection rules adopted by the Bureau
against certain state-chartered institutions. Although the Companys subsidiaries do not
currently offer many of these consumer products or services, compliance with any such new
regulations would increase the cost of operations and, as a result, could limit the
Companys ability to expand into these products and services.
Increased Capital Standards and Enhanced Supervision. The federal banking agencies are
required to establish minimum leverage and risk-based capital requirements for banks and
bank holding companies.
These new standards will be no lower than existing regulatory capital and leverage standards
applicable to insured depository institutions and may, in fact, be higher when established
by the agencies. Compliance with heightened capital standards may reduce the Companys
ability to generate or originate revenue-producing assets and thereby restrict revenue
generation from banking and non-banking operations. The Dodd-Frank Act also increases
regulatory oversight, supervision and examination of banks, bank holding companies and their
respective subsidiaries by the appropriate regulatory agency. Compliance with new
regulatory requirements and expanded examination processes could increase the Companys cost
of operations.
Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain
transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including
an expansion of the definition of covered transactions and increasing the amount of time
for which collateral requirements regarding covered transactions must be maintained.
Transactions with Insiders. Insider transaction limitations are expanded through the
strengthening on loan restrictions to insiders and the expansion of the types of
transactions subject to the various limits, including derivative transactions, repurchase
agreements, reverse repurchase agreements and securities lending or borrowing transactions.
Restrictions are also placed on certain asset sales to and from an insider to an
institution, including requirements that such sales be on market terms and, in certain
circumstances, approved by the institutions board of directors.
Enhanced Lending Limits. The Dodd-Frank Act strengthens the existing limits on a
depository institutions credit exposure to one borrower. Federal banking law currently
limits a national banks ability to extend credit to one person (or group of related
persons) in an amount exceeding certain thresholds. The Dodd-Frank Act expands the scope of
these restrictions to include credit exposure arising from derivative transactions,
repurchase agreements, and securities lending and borrowing transactions. It also eventually
will prohibit state-chartered banks (such as the Companys banking subsidiaries) from
engaging in derivative transactions unless the state lending limit laws take into account
credit exposure to such transactions.
Corporate Governance. The Dodd-Frank Act addresses many corporate governance and
executive compensation matters that will affect most U.S. publicly traded companies,
including the Company. The Dodd-Frank Act (1) grants shareholders of U.S. publicly traded
companies an advisory vote on executive compensation; (2) enhances independence requirements
for compensation committee members; (3) requires companies listed on national securities
exchanges to adopt incentive-based compensation clawback policies for executive officers;
and (4) provides the SEC with authority to adopt proxy access rules that would allow
shareholders of publicly traded companies to nominate candidates for election as a director
and have those nominees included in a companys proxy materials.
Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most
will be subject to implementing regulations over the course of several years. While the Companys
current assessment is that the Dodd-Frank Act will not have a material effect on the Companys
operations, given the uncertainty associated with the manner in which the provisions of the
Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the
full extent of the impact such requirements will have on the Companys operations is unclear. The
changes resulting from the Dodd-Frank Act may impact the profitability of business activities,
require changes to certain of business practices, impose more stringent capital, liquidity and
leverage requirements or otherwise adversely affect the Companys business. These changes may also
require the Company to invest significant management attention and resources to evaluate and make
any changes necessary to comply with new statutory and regulatory requirements. Failure to comply
with the new requirements may negatively impact the Companys results of operations and financial
condition. While the Company cannot predict what effect any presently contemplated or future
changes in the laws or regulations or their interpretations would have, these changes could be
materially adverse to the Companys investors.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk. |
There have been no material changes since December 31, 2009. For more information regarding
quantitative and qualitative disclosures about market risk, please refer to the Companys Annual
Report on Form 10-K as of and for the year ended December 31, 2009, and in particular, Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations Rate
Sensitive Assets and Liabilities and Item 7A Quantitative and Qualitative Disclosures About
Market Risk.
Item 4. | Controls and Procedures. |
Evaluation of disclosure controls and procedures. The Company carried out an evaluation, under
the supervision and with the participation of management, including the Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the Companys
disclosure controls and procedures as of the end of the period covered by this report. Based on
this evaluation, the Companys Chief Executive Officer and Chief Financial Officer originally
concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) were effective to ensure
that information required to be disclosed by the Company in reports that it files or submits under
the Exchange Act is recorded, processed, summarized and reported to the Companys management within
the time periods specified in the Securities and Exchange Commissions rules and forms.
However, as discussed in the Explanatory Note on page 3 of this Form 10-Q/A, based on the need to
revise the unaudited condensed consolidated financial statements for the three and nine months
ended September 30, 2010, the Companys management and the Audit Committee of the Board of
Directors have taken steps recently to re-evaluate the Companys internal control over financial
reporting, subsequent to September 30, 2010, and have concluded there is a material weakness in
their design of such internal controls. The material weakness relates to the identification and
communication of subsequent events. The Companys Board of Directors has implemented several steps
to improve the process for timely identification and communication of subsequent events to the
Audit Committee and thus will remediate the material weakness. Included in these steps are the
following:
| Appointment of a Chief Lending Officer at Mercantile Bank, whose responsibilities will include: oversight of lending policies and procedures to ensure adequate risk management and compliance with banking regulations at each of the Companys subsidiary banks; management of loan portfolio credit quality, underwriting standards and problem resolution; evaluation of the adequacy of the ALLL; review and interpretation of banking laws and accounting guidance, along with communication of pertinent information to lending management; and, reporting and recommendations to the Audit Committee and Board of Directors of problem asset management and related processes. | ||
| Revision of the loan policy at each of the Companys subsidiary banks to clearly define what constitutes a subsequent event and to more clearly identify the procedures to follow to ensure proper accounting and reporting of the impact of such subsequent events. | ||
| Revision of the loan policy at each of the Companys subsidiary banks to address the banks participation in Shared National Credit loans, including procedures to follow upon receipt of a Shared National Credit exam report, execution of directives indicated in the report and appeal procedures with the lead bank and the FDIC in the event management disagrees with the findings in the report. |
Changes in internal controls over financial reporting. Aside from the changes implemented by
the Board of Directors, as discussed above, there were no other changes in the Companys internal
control over financial reporting that occurred during the Companys most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.
PART II
OTHER INFORMATION
Item 1. | Legal Proceedings |
None
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Item 1A. | Risk Factors |
In addition to the risk factors previously discussed in Part 1, Item 1A of the Companys Annual
Report on Form 10-K for the year ended December 31, 2009 and in Part II, Item 1A of the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, the Company also faces the risks
set forth below:
The Company and its subsidiaries are subject to regulatory agreements and orders that restrict the
Company and its subsidiaries from taking certain actions.
General. As is more fully discussed in the Regulatory Matters section in Part II, Item
7 of our Annual Report on Form 10-K for the year ended December 31, 2009, and Part I, Item 2 of our
Quarterly Reports on Form 10-Q for the
quarters ended March 31, 2010 and June 30, 2010, as well as this filing, the Company, Mercantile
Bank, Royal Palm, Royal Palm Bank, Mid-America and Heartland Bank are subject to various bank
regulatory enforcement actions. As of September 30, 2010, all regulatory requirements were met,
except as discussed in the Regulatory Matters section of this filing. The Company will continue
to work diligently to maintain compliance or become compliant with the enforcement actions. If the
Company is unable to comply with such requirements, the regulatory agencies could force a sale,
liquidation or federal conservatorship or receivership of subsidiaries.
The Company. The Company executed a Written Agreement (WA) with the Federal
Reserve Bank (FRB) in February 2010. Under the terms of the WA, the Company must, among other
requirements, provide subsidiary banks with financial and managerial resources as needed, update
capital and cash flow plans for the FRB, and provide periodic performance updates to the FRB. In
addition, the Company is prohibited from paying any special salaries or bonuses to insiders, paying
dividends, paying interest related to trust preferred securities, or incur any additional debt,
without the prior written approval of the FRB.
On May 19, 2010, the Company submitted to the FRB, and the FRB accepted, a revised three-year
strategic and capital plan that outlines the proposed strategies to maintain the regulatory capital
status of at least adequately capitalized, maintain positive cash balances at the parent company
level, ensure that each of the subsidiaries meets the capital requirements directed by their
respective regulatory orders, and meet the Companys debt service requirements, including
distributions on the trust preferred securities.
Banking Subsidiaries. Generally, the enforcement actions pertaining to the Companys
subsidiaries require that the banking subsidiaries provide certain information to each supervisory
authority including, but not limited to, financial performance updates, loan performance updates,
written plan for reducing classified assets and concentrations of credit, written plan to improve
liquidity and reduce dependency on volatile liabilities, written capital plan, and written reports
of progress. In addition, there are restrictions on the subsidiaries ability to declare any
dividends or make any distributions of capital without the prior approval of the supervisory
authorities and, with respect to the bank subsidiaries, to maintain certain Tier 1 leverage capital
and total risk based capital ratios at prescribed levels.
As of September 30, 2010, Mercantile Bank, Royal Palm, Royal Palm Bank, Mid-America and Heartland
Bank were in compliance with substantially all of the requirements of the enforcement actions
pertaining to them, with the exception of the regulatory capital ratios at Mercantile Bank, Royal
Palm Bank and Heartland Bank. The Company elected not to inject any additional capital into the
subsidiary banks until it determines a course of action to raise capital at the Company level.
The regulatory agencies have been notified of the non-compliance and have requested the banks to
provide plans to restore the ratios to required levels. The Company and its subsidiary banks are
working with their legal and other professional advisors to develop plans, which are expected to be
implemented by March 31, 2011.
Capital Injections and Ongoing Compliance. The Company and its subsidiaries ability to remain in
compliance with the enforcement actions depends on various factors, including, but not limited to,
the maintenance of adequate capital levels. A significant part of the plan presented to the FRB
was the initiative to sell one or more subsidiary banks in order to generate liquidity to reduce
debt, improve capital ratios and provide necessary capital contributions to the remaining
subsidiary banks. The result of this initiative was the exchange for debt of HNB National Bank in
December 2009 and the sale of Marine Bank & Trust and Brown County State Bank in February 2010.
The Special Committee of the Board of Directors developed and pursued a plan to raise additional
equity through a shareholder rights offering. On April 27, 2010, the Companys Board of Directors,
upon the recommendation of the Special Committee, approved an amendment to its Certificate of
Incorporation to increase the number of authorized shares of common stock of the Company from
14,000,000 to 30,000,000 (the Amendment). On May 24, 2010, at the Companys annual meeting,
stockholders voted to approve the Amendment. On July 12, 2010, the Company filed a Registration
Statement on Form S-1 with the Securities and Exchange Commission (SEC), to register units
comprised of shares of the Companys common stock and warrants to acquire the Companys common
stock. On November 3, 2010, the Company announced it would terminate the offering without
acceptance of any of the subscriptions exercised there under. The Companys Board of Directors
determined that in light of the Companys stock price trading substantially below the subscription
price, it was appropriate not to accept the subscriptions that
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were exercised. The Company
continues to work with its financial advisors and legal counsel in assessing its strategic and
capital-raising options.
If the Company is not successful in developing and implementing other strategic and capital-raising
options and the plans requested by the regulatory agencies (as described above), the ability to
become and remain compliant with the enhanced capital levels required under the enforcement actions
will be reduced. The Company could be compelled by banking regulators under those circumstances to
sell, liquidate or place in federal conservatorship or receivership one or more of its remaining
subsidiaries. Also, while these enforcement actions remain in place, the Companys ability to
address opportunities and challenges in our business, our markets and the banking industry
generally will be curtailed.
The Company may have a concentration of credit risk related to its purchased participation loans.
Included in the Companys loan portfolio at September 30, 2010 are approximately $21.5 million of
purchased participation loans to borrowers located in areas outside the Companys normal markets.
Although the Company applies the same underwriting standards to these loans, there may be
additional risk associated with those out of the Companys normal territory.
The Company may not be able to develop and implement successfully its capital plan.
The Company has developed and is continuing to develop and implement a capital-raising plan to
address its future needs for capital. The Company successfully consummated the sale of three
subsidiary banks in late 2009 and early 2010 as part of the plan. However, the Company terminated
its pending shareholder rights offering on November 3, 2010, and thus was unsuccessful in
completing that part of the plan. The Company is now assessing and developing other strategic and
capital-raising options to augment its plan. While the Company is committed to the completion and
execution of the augmented plan and is devoting necessary resources to achieve that result, the
Company may not be able to identify additional, viable options or, if identified, successfully
execute those options and the plan generally under current market conditions.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
There were no unregistered sales of equity securities.
There were the following issuer purchases of equity securities (i.e., the Companys common stock)
during the three months ended September 30, 2010:
Total Number of Shares | Maximum Approximate | |||||||||||||||
Third Quarter | Total Number of | Purchased as Part of | Dollar Value of Shares that | |||||||||||||
2010 Calendar | Shares Purchased | Average Price | Publicly Announced | May Yet Be Purchased Under | ||||||||||||
Month | (1) | Paid per Share (1) | Plans or Programs (2) | the Plans or Programs (3) | ||||||||||||
July |
0 | N/A | 0 | $ | 8,128,000 | |||||||||||
August |
0 | N/A | 0 | $ | 8,128,000 | |||||||||||
September |
0 | N/A | 0 | $ | 8,128,000 | |||||||||||
Total |
0 | N/A | 0 |
(1) | The total number of shares purchased and the average price paid per share include, in addition to other purchases, shares purchased in the open market and through privately negotiated transactions by the Companys 401(k) Profit Sharing Plan. For the months indicated, there were no shares purchased by the Plan. | |
(2) | Includes only shares subject to publicly announced stock repurchase program, i.e. the $10 million stock repurchase program approved by the Board on August 15, 2005 and announced on August 17, 2005 (the 2005 Repurchase Program). Does not include shares purchased by the Companys 401(k) Profit Sharing Plan. | |
(3) | Dollar amount of repurchase authority remaining at month-end under the 2005 Repurchase Program, the Companys only publicly announced repurchase program in effect at such dates. The 2005 Repurchase Program is limited to 883,656 shares (10% of the number of outstanding shares on the date the Board approved the program, adjusted for the three-for-one stock split in June of 2006 and the three-for-two split in December of 2007) but not to exceed $10 million in repurchases. |
Item 3. | Defaults Upon Senior Securities |
None
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Item 5. | Other Information |
On November 15, 2010, the Company received notice that Alexander J. House has resigned,
effective immediately, as a director of Mercantile Bancorp, Inc. and Mercantile Bank in order to
devote more time to his business interests.
Item 6. | Exhibits |
Exhibit | ||
Number | Identification of Exhibit | |
10.1
|
Dealer-Manager Agreement dated September 23, 2010, between Mercantile Bancorp, Inc. and McClendon, Morrison & Partners, Inc. (Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K dated September 23, 2010). | |
31.1
|
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
31.2
|
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. | |
32.1
|
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2
|
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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.
Date: February 7, 2011 | By: | /s/ Ted T. Awerkamp | ||
Ted T. Awerkamp | ||||
President and Chief Executive Officer (principal executive officer) |
||||
Date: February 7, 2011 | By: | /s/ Michael P. McGrath | ||
Michael P. McGrath | ||||
Executive Vice President, Treasurer, Secretary and
Chief Financial Officer (principal financial officer/ principal accounting officer) |
||||
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