Note 2 - Business Combination

9 Months Ended

Sep. 30, 2014

Business Combinations [Abstract]

Business Combination Disclosure [Text Block]

2. BUSINESS COMBINATION

We completed the merger of Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $1.5 billion in total assets and 46 branch locations, into Mercantile Bank Corporation as of June 1, 2014 (“Merger Date”). The results of operations due to the Firstbank transaction have been included in Mercantile’s financial results since the Merger Date. All of Firstbank’s common stock was converted into the right to receive one share of Mercantile common stock for each share of Firstbank common stock. The conversion of Firstbank’s common stock into Mercantile’s common stock resulted in Mercantile issuing 8,087,272 shares of its common stock. The merger provided an expanded geographic footprint for the Company and increased the size of the balance sheet. In conjunction with the completion of the merger, Mercantile assumed the obligations of Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III and Firstbank Capital Trust IV.

The Firstbank transaction was accounted for using the acquisition method of accounting and accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the Merger Date. Preliminary goodwill of $50.9 million was calculated as the purchase premium after adjusting for the fair value of net assets acquired and represents the value expected from the synergies created from combining the two banking organizations as well as the economies of scale expected from combining the operations of the two companies. None of the goodwill is deductible for income tax purposes as the merger is accounted for as a tax-free exchange.

The following table provides the purchase price calculation as of the Merger Date and the identifiable assets purchased and the liabilities assumed at their estimated fair values. These fair value measurements are provisional based on third-party valuations that are currently under review and are subject to refinement for up to one year after the Merger Date based on additional information that may be obtained by us that existed as of the Merger Date.

Mercantile common shares issued for Firstbank common shares		8,087,272
Price per share, based on Mercantile closing price on May 30, 2014	$	21.43
Value of common stock issued		173,310,000
Replacement stock options		1,664,000
Total purchase price	$	174,974,000

Assets
Cash and cash equivalents	$	91,806,000
Securities		358,599,000
Total loans		943,662,000
Premises and equipment		24,049,000
Core deposit intangible		17,478,000
Mortgage servicing rights		7,389,000
Other assets		8,500,000
Total Assets	$	1,451,483,000
Liabilities
Deposits	$	1,229,609,000
Borrowings		87,615,000
Other liabilities		10,155,000
Total Liabilities	$	1,327,379,000
Net Identifiable Assets Acquired			$	124,104,000
Goodwill			$	50,870,000

The fair value of mortgage servicing rights was $7.4 million at the Merger Date. During the four months ended September 30, 2014, new servicing rights of $0.2 million and amortization expense of $0.6 million were recorded.

Firstbank’s results of operations prior to the Merger Date are not included in our consolidated statements of income or consolidated statements of comprehensive income. We recorded merger-related expenses of $1.3 million and $5.1 million during the three month and nine month periods ended September 30, 2014, respectively. We recorded merger-related expenses of $0.7 million and $0.8 million during the three month and nine month periods ended September 30, 2013, respectively. Such expenses were generally for professional services, costs related to termination of existing contractual arrangements for various services, retention and severance compensation costs, marketing and promotional expenses, travel costs, and printing and supplies costs.

The following table provides the unaudited pro forma information for the results of operations for the three and nine month periods ended September 30, 2014 and 2013, as if the acquisition had occurred on January 1 of each year. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily comprised of Firstbank’s loan and deposit portfolios. In addition, the $5.1 million in merger-related expenses noted earlier are included in each period presented. We expect to achieve further operating cost savings and other business synergies as a result of the merger which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes only and are not intended to represent or be indicative of the actual results of operations of the combined banking organization that would have been achieved had the merger occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.

	Three months ended Sept 30,				Nine months ended Sept 30,
	2014		2013		2014		2013
Net interest income	$	25,989,000	$	11,994,000	$	54,924,000	$	37,080,000
Noninterest expense		24,572,000		14,284,000		47,338,000		32,944,000
Net income		3,281,000		693,000		11,711,000		9,617,000
Net income per diluted share		0.19		0.04		0.69		0.57

In most instances, determining the fair value of the acquired assets and assumed liabilities required us to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations relates to the valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no carry-over of Firstbank’s previously established allowance for loan losses.

The acquired loans were divided into loans with evidence of credit quality deterioration, which are accounted for under ASC 310-30 (“acquired impaired”), and loans that do not meet this criteria, which are accounted for under ASC 310-20 (“acquired non-impaired”). In addition, the loans are further categorized into different loan pools based primarily on the type and purpose of the loan.

The provisional fair value of loans at the Merger Date is presented in the following table:

	Acquired		Acquired		Acquired
	Impaired		Non-Impaired		Total Loans
Commercial Loans:
Commercial & industrial	$	878,000	$	163,316,000	$	164,194,000
Commercial real estate		12,973,000		378,016,000		390,989,000
Construction & development		1,289,000		33,726,000		35,015,000
Total Commercial Loans	$	15,140,000	$	575,058,000	$	590,198,000
Consumer Loans:
Residential mortgages	$	9,694,000	$	216,653,000	$	226,347,000
Instalment		167,000		61,657,000		61,824,000
Home equity lines		288,000		52,054,000		52,342,000
Construction		76,000		12,875,000		12,951,000
Total Consumer Loans	$	10,225,000	$	343,239,000	$	353,464,000
Total Loans	$	25,365,000	$	918,297,000	$	943,662,000

The following table presents data on acquired impaired loans at the Merger Date:

	Acquired
	Impaired
Contractual required payments	$	44,936,000
Nonaccretable difference		17,057,000
Expected cash flows		27,879,000
Accretable yield		2,514,000
Carrying balance	$	25,365,000

The nonaccretable difference includes $10.4 million in principal cash flows not expected to be collected, $2.8 million of pre-acquisition charge-offs and $3.9 million of future interest not expected to be collected. The unpaid principal balance of acquired performing loans was $926.4 million at the Merger Date, and the unaccreted discount on such loans was $8.1 million.

We also assumed obligations under junior subordinated debentures with an aggregate balance of $36.1 million and an aggregate fair value of $21.1 million as of the Merger Date, payable to four unconsolidated trusts (Firstbank Capital Trust I, Firstbank Capital Trust II, Firstbank Capital Trust III, and Firstbank Capital Trust IV) that have issued trust preferred securities. The junior subordinated debentures are the sole assets of each trust. Interest rates on all trust preferred securities issued by the trusts are tied to the 90 Day Libor rate with spreads ranging from 127 basis points to 199 basis points, and reset quarterly. The trust preferred securities have maturity dates ranging from October, 2034 to July, 2037, and are callable by us in whole or in part quarterly. The junior subordinated debentures are unsecured obligations of Mercantile, who has guaranteed that interest payments on the junior subordinated debentures made to the trust will be distributed by the trust to the holders of the trust preferred securities. The trust preferred securities currently fully qualify as Tier 1 Capital, and under current risk-based capital guidelines, will remain fully qualified as Tier 1 Capital until maturity unless called by us at an earlier date.

In conjunction with the Merger, all of our outstanding restricted stock awards, which were schedule to cliff vest in full in November, 2014, became fully vested as of June 1, 2014, resulting in the recognition of compensation expense of $0.2 million in the second quarter of 2014 to reflect the accelerated vesting of the restricted stock awards.

Also in conjunction with the Merger, we assumed, and issued Mercantile stock options in replacement of, all outstanding stock option grants that had been issued to Firstbank employees under the Firstbank Corporation Stock Option and Restricted Stock Plan of 1997 and the Firstbank Corporation 2006 Stock Compensation Plan. There were approximately 282,200 Mercantile stock options issued as a result of the Merger, with about 258,400 of the stock option grants fully vested and exercisable, on the Merger Date. The remaining 23,800 stock options vest over the next six to 18 months. Unrecognized compensation cost related to the unvested stock options was less than $100,000 as of September 30, 2014, which is expected to be fully recognized by November, 2015.

The aggregate intrinsic value of all stock options issued as a result of the Merger outstanding and exercisable at September 30, 2014 was $2.0 million.