LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans originated for investment are stated at their principal amount outstanding adjusted for partial charge-offs, the allowance, and net deferred loan fees and costs. Interest income on loans is accrued over the term of the loans primarily using the simple interest method based on the principal balance outstanding. Interest is not accrued on loans where collectability is uncertain. Accrued interest is presented separately in the consolidated balance sheet. Loan origination fees and certain direct costs incurred to extend credit are deferred and amortized over the term of the loan or loan commitment period as an adjustment to the related loan yield.

Acquired loans are those purchased in the Firstbank merger. These loans were recorded at estimated fair value at the merger date with no carryover of the related allowance. The acquired loans were segregated between those considered to be performing (“acquired non-impaired loans”) and those with evidence of credit deterioration (“acquired impaired loans”). Acquired loans are considered impaired if there is evidence of credit deterioration and if it is probable, at acquisition, all contractually required payments will not be collected. Acquired loans restructured after acquisition are not considered or reported as troubled debt restructurings if the loans evidenced credit deterioration as of the merger date and are accounted for in pools.

The fair value estimates for acquired loans are based on expected prepayments and the amount and timing of discounted expected principal, interest and other cash flows. Credit discounts representing the principal losses expected over the life of the loan are also a component of the initial fair value. In determining the merger date fair value of acquired impaired loans, and in subsequent accounting, we have generally aggregated acquired commercial and consumer loans into pools of loans with common risk characteristics.

The difference between the fair value of an acquired non-impaired loan and contractual amounts due at the merger date is accreted into income over the estimated life of the loan. Contractually required payments represent the total undiscounted amount of all uncollected principal and interest payments. Acquired non-impaired loans are placed on nonaccrual status and reported as nonperforming or past due using the same criteria applied to the originated loan portfolio.

The excess of an acquired impaired loan’s undiscounted contractually required payments over the amount of its undiscounted cash flows expected to be collected is referred to as the non-accretable difference. The non-accretable difference, which is neither accreted into income nor recorded on the consolidated balance sheet, reflects estimated future credit losses and uncollectible contractual interest expected to be incurred over the life of the acquired impaired loan. The excess cash flows expected to be collected over the carrying amount of the acquired loan is referred to as the accretable yield. This amount is accreted into interest income over the remaining life of the acquired loans or pools using the level yield method. The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment speed assumptions and changes in expected principal and interest payments over the estimated lives of the acquired impaired loans.

We evaluate quarterly the remaining contractual required payments receivable and estimate cash flows expected to be collected over the lives of the impaired loans. Contractually required payments receivable may increase or decrease for a variety of reasons, for example, when the contractual terms of the loan agreement are modified, when interest rates on variable rate loans change, or when principal and/or interest payments are received. Cash flows expected to be collected on acquired impaired loans are estimated by incorporating several key assumptions similar to the initial estimate of fair value. These key assumptions include probability of default, loss given default, and the amount of actual prepayments after the merger date. Prepayments affect the estimated lives of loans and could change the amount of interest income, and possibly principal, expected to be collected. In re-forecasting future estimated cash flows, credit loss expectations are adjusted as necessary. The adjustments are based, in part, on actual loss severities recognized for each loan type, as well as changes in the probability of default. For periods in which estimated cash flows are not re-forecasted, the prior reporting period’s estimated cash flows are adjusted to reflect the actual cash received and credit events that transpired during the current reporting period.

Increases in expected cash flows of acquired impaired loans subsequent to the merger date are recognized prospectively through adjustments of the yield on the loans or pools over their remaining lives, while decreases in expected cash flows are recognized as impairment through a provision for loan losses and an increase in the allowance.

Our total loans at June 30, 2016 were $2.38 billion compared to $2.28 billion at December 31, 2015, an increase of $102 million, or 4.5%. The components of our loan portfolio disaggregated by class of loan within the loan portfolio segments at June 30, 2016 and December 31, 2015, and the percentage change in loans from the end of 2015 to the end of the second quarter of 2016, are as follows:

											Percent
	June 30, 2016					December 31, 2015					Increase
	Balance		%			Balance		%			(Decrease)
Originated loans
Commercial:
Commercial and industrial	$	653,135,000		36.3	%	$	577,872,000		35.7	%		13.0	%
Vacant land, land development, and residential construction		30,232,000		1.7			30,138,000		1.9			0.3
Real estate – owner occupied		338,909,000		18.8			330,798,000		20.5			2.5
Real estate – non-owner occupied		603,236,000		33.5			520,754,000		32.2			15.8
Real estate – multi-family and residential rental		39,233,000		2.2			33,954,000		2.1			15.5
Total commercial		1,664,745,000		92.5			1,493,516,000		92.4			11.5

Retail:
Home equity and other		69,396,000		3.9			67,816,000		4.2			2.3
1-4 family mortgages		65,813,000		3.6			55,255,000		3.4			19.1
Total retail		135,209,000		7.5			123,071,000		7.6			9.9

Total originated loans	$	1,799,954,000		100.0	%	$	1,616,587,000		100.0	%		11.3	%

											Percent
	June 30, 2016					December 31, 2015					Increase
	Balance		%			Balance		%			(Decrease)
Acquired loans
Commercial:
Commercial and industrial	$	97,001,000		16.7	%	$	118,431,000		17.9	%		(18.1	)%
Vacant land, land development, and residential construction		10,297,000		1.8			14,982,000		2.3			(31.3	)
Real estate – owner occupied		99,889,000		17.2			115,121,000		17.4			(13.2	)
Real estate – non-owner occupied		113,694,000		19.6			123,597,000		18.7			(8.0	)
Real estate – multi-family and residential rental		74,129,000		12.8			81,049,000		12.3			(8.5	)
Total commercial		395,010,000		68.1			453,180,000		68.6			(12.8	)

Retail:
Home equity and other		61,671,000		10.6			72,830,000		11.0			(15.3	)
1-4 family mortgages		123,305,000		21.3			135,130,000		20.4			(8.7	)
Total retail		184,976,000		31.9			207,960,000		31.4			(11.1	)

Total acquired loans	$	579,986,000		100.0	%	$	661,140,000		100.0	%		(12.3%	)

											Percent
	June 30, 2016					December 31, 2015					Increase
	Balance		%			Balance		%			(Decrease)
Total loans
Commercial:
Commercial and industrial	$	750,136,000		31.5	%	$	696,303,000		30.6	%		7.7	%
Vacant land, land development, and residential construction		40,529,000		1.7			45,120,000		2.0			(10.2	)
Real estate – owner occupied		438,798,000		18.4			445,919,000		19.6			(1.6	)
Real estate – non-owner occupied		716,930,000		30.1			644,351,000		28.3			11.3
Real estate – multi-family and residential rental		113,362,000		4.8			115,003,000		5.0			(1.4	)
Total commercial		2,059,755,000		86.5			1,946,696,000		85.5			5.8

Retail:
Home equity and other		131,067,000		5.5			140,646,000		6.2			(6.8	)
1-4 family mortgages		189,118,000		8.0			190,385,000		8.3			(0.7	)
Total retail		320,185,000		13.5			331,031,000		14.5			(3.3	)

Total loans	$	2,379,940,000		100.0	%	$	2,277,727,000		100.0	%		4.5	%

The total contractually required payments due on and carrying value of acquired impaired loans were $19.2 million and $8.8 million, respectively, as of June 30, 2016. The total contractually required payments due on and carrying value of acquired impaired loans were $24.6 million and $13.1 million, respectively, as of December 31, 2015. Changes in the accretable yield for acquired impaired loans for the three and six months ended June 30, 2016 and June 30, 2015 were as follows:

Balance at March 31, 2016	$	6,319,000
Additions		0
Accretion income		(674,000	)
Net reclassification from nonaccretable to accretable		1,193,000
Reductions (1)		(236,000	)

Balance at June 30, 2016	$	6,602,000


Balance at December 31, 2015	$	5,193,000
Additions		21,000
Accretion income		(1,354,000	)
Net reclassification from nonaccretable to accretable		3,565,000
Reductions (1)		(823,000	)

Balance at June 30, 2016	$	6,602,000


Balance at March 31, 2015	$	5,241,000
Additions		0
Accretion income		(681,000	)
Net reclassification from nonaccretable to accretable		708,000
Reductions (1)		(153,000	)

Balance at June 30, 2015	$	5,115,000


Balance at December 31, 2014	$	4,998,000
Additions		0
Accretion income		(1,327,000	)
Net reclassification from nonaccretable to accretable		1,649,000
Reductions (1)		(205,000	)

Balance at June 30, 2015	$	5,115,000

(1) Reductions primarily reflect the result of exit events, including loan payoffs and charge-offs.

Nonperforming originated loans as of June 30, 2016 and December 31, 2015 were as follows:

	June 30, 2016		December 31, 2015

Loans past due 90 days or more still accruing interest	$	0	$	0
Nonaccrual loans		2,042,000		1,954,000

Total nonperforming originated loans	$	2,042,000	$	1,954,000

Nonperforming acquired loans as of June 30, 2016 and December 31, 2015 were as follows:

	June 30, 2016		December 31, 2015

Loans past due 90 days or more still accruing interest	$	0	$	5,000
Nonaccrual loans		3,126,000		3,485,000

Total nonperforming acquired loans	$	3,126,000	$	3,490,000

The recorded principal balance of nonperforming loans was as follows:

	June 30, 2016		December 31, 2015
Commercial:
Commercial and industrial	$	819,000	$	458,000
Vacant land, land development, and residential construction		125,000		155,000
Real estate – owner occupied		1,465,000		1,797,000
Real estate – non-owner occupied		51,000		79,000
Real estate – multi-family and residential rental		114,000		157,000
Total commercial		2,574,000		2,646,000

Retail:
Home equity and other		616,000		771,000
1-4 family mortgages		1,978,000		2,027,000
Total retail		2,594,000		2,798,000

Total nonperforming loans	$	5,168,000	$	5,444,000

Acquired impaired loans are not reported as nonperforming loans based on acquired impaired loan accounting. Acquired non-impaired loans are placed on nonaccrual status and reported as nonperforming or past due using the same criteria applied to the originated loan portfolio.

An age analysis of past due loans is as follows as of June 30, 2016:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing
Originated loans
Commercial:
Commercial and industrial	$	1,000	$	0	$	0	$	1,000	$	653,134,000	$	653,135,000	$	0
Vacant land, land development, and residential construction		0		0		0		0		30,232,000		30,232,000		0
Real estate – owner occupied		0		197,000		0		197,000		338,712,000		338,909,000		0
Real estate – non-owner occupied		0		0		0		0		603,236,000		603,236,000		0
Real estate – multi-family and residential rental		0		0		0		0		39,233,000		39,233,000		0
Total commercial		1,000		197,000		0		198,000		1,664,547,000		1,664,745,000		0

Retail:
Home equity and other		129,000		21,000		11,000		161,000		69,235,000		69,396,000		0
1-4 family mortgages		97,000		0		403,000		500,000		65,313,000		65,813,000		0
Total retail		226,000		21,000		414,000		661,000		134,548,000		135,209,000		0

Total past due loans	$	227,000	$	218,000	$	414,000	$	859,000	$	1,799,095,000	$	1,799,954,000	$	0

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing
Acquired loans
Commercial:
Commercial and industrial	$	14,000	$	0	$	350,000	$	364,000	$	96,637,000	$	97,001,000	$	0
Vacant land, land development, and residential construction		29,000		0		0		29,000		10,268,000		10,297,000		0
Real estate – owner occupied		243,000		50,000		398,000		691,000		99,198,000		99,889,000		0
Real estate – non-owner occupied		159,000		0		419,000		578,000		113,116,000		113,694,000		0
Real estate – multi-family and residential rental		164,000		42,000		80,000		286,000		73,843,000		74,129,000		0
Total commercial		609,000		92,000		1,247,000		1,948,000		393,062,000		395,010,000		0

Retail:
Home equity and other		568,000		43,000		11,000		622,000		61,049,000		61,671,000		0
1-4 family mortgages		1,188,000		261,000		344,000		1,793,000		121,512,000		123,305,000		0
Total retail		1,756,000		304,000		355,000		2,415,000		182,561,000		184,976,000		0

Total past due loans	$	2,365,000	$	396,000	$	1,602,000	$	4,363,000	$	575,623,000	$	579,986,000	$	0

An age analysis of past due loans is as follows as of December 31, 2015:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing
Originated loans
Commercial:
Commercial and industrial	$	0	$	0	$	0	$	0	$	577,872,000	$	577,872,000	$	0
Vacant land, land development, and residential construction		0		0		0		0		30,138,000		30,138,000		0
Real estate – owner occupied		432,000		0		9,000		441,000		330,357,000		330,798,000		0
Real estate – non-owner occupied		0		0		0		0		520,754,000		520,754,000		0
Real estate – multi-family and residential rental		0		0		0		0		33,954,000		33,954,000		0
Total commercial		432,000		0		9,000		441,000		1,493,075,000		1,493,516,000		0

Retail:
Home equity and other		186,000		108,000		0		294,000		67,522,000		67,816,000		0
1-4 family mortgages		107,000		95,000		356,000		558,000		54,697,000		55,255,000		0
Total retail		293,000		203,000		356,000		852,000		122,219,000		123,071,000		0

Total past due loans	$	725,000	$	203,000	$	365,000	$	1,293,000	$	1,615,294,000	$	1,616,587,000	$	0

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 89 Days Past Due		Total Past Due		Current		Total Loans		Recorded Balance > 89 Days and Accruing
Acquired Loans
Commercial:
Commercial and industrial	$	0	$	5,000	$	541,000	$	546,000	$	117,885,000	$	118,431,000	$	0
Vacant land, land development, and residential construction		27,000		0		0		27,000		14,955,000		14,982,000		0
Real estate – owner occupied		323,000		425,000		1,142,000		1,890,000		113,231,000		115,121,000		0
Real estate – non-owner occupied		53,000		703,000		79,000		835,000		122,762,000		123,597,000		0
Real estate – multi-family and residential rental		223,000		54,000		0		277,000		80,772,000		81,049,000		0
Total commercial		626,000		1,187,000		1,762,000		3,575,000		449,605,000		453,180,000		0

Retail:
Home equity and other		395,000		44,000		28,000		467,000		72,363,000		72,830,000		5,000
1-4 family mortgages		960,000		354,000		416,000		1,730,000		133,400,000		135,130,000		0
Total retail		1,355,000		398,000		444,000		2,197,000		205,763,000		207,960,000		5,000

Total past due loans	$	1,981,000	$	1,585,000	$	2,206,000	$	5,772,000	$	655,368,000	$	661,140,000	$	5,000

(Continued)

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

LOANS AND ALLOWANCE FOR LOAN LOSSES

(Continued)

Impaired originated loans as of June 30, 2016, and average originated impaired loans for the three and six months ended June 30, 2016, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	2,147,000	$	2,146,000		$	2,017,000	$	1,845,000
Vacant land, land development and residential construction		0		0			0		0
Real estate – owner occupied		348,000		251,000			160,000		275,000
Real estate – non-owner occupied		5,623,000		5,623,000			5,641,000		5,660,000
Real estate – multi-family and residential rental		0		0			0		0
Total commercial		8,118,000		8,020,000			7,818,000		7,780,000
Retail:
Home equity and other		129,000		120,000			65,000		45,000
1-4 family mortgages		1,324,000		668,000			621,000		633,000
Total retail		1,453,000		788,000			686,000		678,000

Total with no related allowance recorded	$	9,571,000	$	8,808,000		$	8,504,000	$	8,458,000

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	249,000	$	199,000	$	47,000	$	217,000	$	246,000
Vacant land, land development and residential construction		2,002,000		1,625,000		72,000		1,633,000		1,640,000
Real estate – owner occupied		5,930,000		1,378,000		235,000		1,339,000		1,331,000
Real estate – non-owner occupied		4,704,000		4,704,000		180,000		4,729,000		4,766,000
Real estate – multi-family and residential rental		979,000		979,000		293,000		993,000		1,004,000
Total commercial		13,864,000		8,885,000		827,000		8,911,000		8,987,000
Retail:
Home equity and other		550,000		512,000		137,000		491,000		515,000
1-4 family mortgages		205,000		163,000		72,000		145,000		139,000
Total retail		755,000		675,000		209,000		636,000		654,000

Total with an allowance recorded	$	14,619,000	$	9,560,000	$	1,036,000	$	9,547,000	$	9,641,000

Total impaired loans:
Commercial	$	21,982,000	$	16,905,000	$	827,000	$	16,729,000	$	16,767,000
Retail		2,208,000		1,463,000		209,000		1,322,000		1,332,000
Total impaired loans	$	24,190,000	$	18,368,000	$	1,036,000	$	18,051,000	$	18,099,000

Impaired acquired loans as of June 30, 2016, and average impaired acquired loans for the three and six months ended June 30, 2016, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	1,694,000	$	1,681,000		$	1,556,000	$	1,535,000
Vacant land, land development and residential construction		0		0			0		0
Real estate – owner occupied		1,314,000		1,300,000			1,485,000		1,640,000
Real estate – non-owner occupied		811,000		811,000			792,000		821,000
Real estate – multi-family and residential rental		295,000		295,000			289,000		327,000
Total commercial		4,114,000		4,087,000			4,122,000		4,323,000
Retail:
Home equity and other		367,000		365,000			321,000		317,000
1-4 family mortgages		1,305,000		1,305,000			1,290,000		1,376,000
Total retail		1,672,000		1,670,000			1,611,000		1,693,000

Total with no related allowance recorded	$	5,786,000	$	5,757,000		$	5,733,000	$	6,016,000

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	356,000	$	356,000	$	101,000	$	367,000	$	370,000
Vacant land, land development and residential construction		0		0		0		0		0
Real estate – owner occupied		49,000		49,000		4,000		50,000		50,000
Real estate – non-owner occupied		0		0		0		0		0
Real estate – multi-family and residential rental		20,000		20,000		1,000		20,000		21,000
Total commercial		425,000		425,000		106,000		437,000		441,000
Retail:
Home equity and other		0		0		0		0		0
1-4 family mortgages		174,000		174,000		5,000		87,000		116,000
Total retail		174,000		174,000		5,000		87,000		116,000

Total with an allowance recorded	$	599,000	$	599,000	$	111,000	$	524,000	$	557,000

Total impaired loans:
Commercial	$	4,539,000	$	4,512,000	$	106,000	$	4,559,000	$	4,764,000
Retail		1,846,000		1,844,000		5,000		1,698,000		1,809,000
Total impaired loans	$	6,385,000	$	6,356,000	$	111,000	$	6,257,000	$	6,573,000

Impaired originated loans as of December 31, 2015, and average impaired originated loans for the three and six months ended June 30, 2015, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	1,509,000	$	1,501,000		$	1,930,000	$	1,674,000
Vacant land, land development and residential construction		0		0			98,000		135,000
Real estate – owner occupied		712,000		505,000			1,062,000		1,342,000
Real estate – non-owner occupied		5,696,000		5,696,000			2,937,000		2,362,000
Real estate – multi-family and residential rental		0		0			306,000		309,000
Total commercial		7,917,000		7,702,000			6,333,000		5,822,000
Retail:
Home equity and other		14,000		5,000			189,000		190,000
1-4 family mortgages		1,328,000		657,000			615,000		597,000
Total retail		1,342,000		662,000			804,000		787,000

Total with no related allowance recorded	$	9,259,000	$	8,364,000		$	7,137,000	$	6,609,000

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	352,000	$	305,000	$	165,000	$	2,812,000	$	3,617,000
Vacant land, land development and residential construction		2,017,000		1,655,000		245,000		2,092,000		2,061,000
Real estate – owner occupied		5,867,000		1,314,000		242,000		8,806,000		11,095,000
Real estate – non-owner occupied		4,841,000		4,841,000		201,000		10,319,000		12,195,000
Real estate – multi-family and residential rental		1,028,000		1,028,000		365,000		1,321,000		1,338,000
Total commercial		14,105,000		9,143,000		1,218,000		25,350,000		30,306,000
Retail:
Home equity and other		600,000		562,000		209,000		165,000		138,000
1-4 family mortgages		165,000		128,000		47,000		217,000		811,000
Total retail		765,000		690,000		256,000		382,000		949,000

Total with an allowance recorded	$	14,870,000	$	9,833,000	$	1,474,000	$	25,732,000	$	31,255,000

Total impaired loans:
Commercial	$	22,022,000	$	16,845,000	$	1,218,000	$	31,683,000	$	36,128,000
Retail		2,107,000		1,352,000		256,000		1,186,000		1,736,000
Total impaired loans	$	24,129,000	$	18,197,000	$	1,474,000	$	32,869,000	$	37,864,000

Impaired acquired loans as of December 31, 2015, and average impaired acquired loans for the three and six months ended June 30, 2015, were as follows:

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance	Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance

With no related allowance recorded
Commercial:
Commercial and industrial	$	1,528,000	$	1,494,000		$	1,244,000	$	1,356,000
Vacant land, land development and residential construction		0		0			0		0
Real estate – owner occupied		2,233,000		1,952,000			317,000		249,000
Real estate – non-owner occupied		880,000		880,000			427,000		393,000
Real estate – multi-family and residential rental		452,000		404,000			2,037,000		1,520,000
Total commercial		5,093,000		4,730,000			4,025,000		3,518,000
Retail:
Home equity and other		471,000		310,000			365,000		456,000
1-4 family mortgages		1,804,000		1,548,000			801,000		823,000
Total retail		2,275,000		1,858,000			1,166,000		1,279,000

Total with no related allowance recorded	$	7,368,000	$	6,588,000		$	5,191,000	$	4,797,000

	Unpaid Contractual Principal Balance		Recorded Principal Balance		Related Allowance		Second Quarter Average Recorded Principal Balance		Year-To-Date Average Recorded Principal Balance
With an allowance recorded
Commercial:
Commercial and industrial	$	383,000	$	376,000	$	102,000	$	97,000	$	65,000
Vacant land, land development and residential construction		0		0		0		0		0
Real estate – owner occupied		51,000		51,000		4,000		1,256,000		1,338,000
Real estate – non-owner occupied		0		0		0		0		0
Real estate – multi-family and residential rental		23,000		23,000		0		28,000		19,000
Total commercial		457,000		450,000		106,000		1,381,000		1,422,000
Retail:
Home equity and other		0		0		0		0		0
1-4 family mortgages		175,000		175,000		6,000		283,000		189,000
Total retail		175,000		175,000		6,000		283,000		189,000

Total with an allowance recorded	$	632,000	$	625,000	$	112,000	$	1,664,000	$	1,611,000

Total impaired loans:
Commercial	$	5,550,000	$	5,180,000	$	106,000	$	5,406,000	$	4,940,000
Retail		2,450,000		2,033,000		6,000		1,449,000		1,468,000
Total impaired loans	$	8,000,000	$	7,213,000	$	112,000	$	6,855,000	$	6,408,000

Impaired loans for which no allocation of the allowance for loan losses has been made generally reflect situations whereby the loans have been charged-down to estimated collateral value. Interest income recognized on accruing troubled debt restructurings totaled $0.2 million and $0.4 million during the second quarter of 2016 and 2015, respectively, and $0.5 million and $0.8 million during the first six months of 2016 and 2015, respectively. No interest income was recognized on nonaccrual loans during the second quarter and first six months of 2016 or during the respective 2015 periods.

Credit Quality Indicators.

We utilize a comprehensive grading system for our commercial loans. All commercial loans are graded on a ten grade rating system. The rating system utilizes standardized grade paradigms that analyze several critical factors such as cash flow, operating performance, financial condition, collateral, industry condition and management. All commercial loans are graded at inception and reviewed and, if appropriate, re-graded at various intervals thereafter. The risk assessment for retail loans is primarily based on the type of collateral and payment activity.

Credit quality indicators were as follows as of June 30, 2016:

Originated loans

Commercial credit exposure – credit risk profiled by internal credit risk grades:

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	455,134,000	$	19,014,000	$	237,652,000	$	491,928,000	$	20,438,000
Grades 5 – 7		197,701,000		11,093,000		99,961,000		111,308,000		17,816,000
Grades 8 – 9		300,000		125,000		1,296,000		0		979,000
Total commercial	$	653,135,000	$	30,232,000	$	338,909,000	$	603,236,000	$	39,233,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages

Total retail	$	69,396,000	$	65,813,000

Acquired loans

Commercial credit exposure – credit risk profiled by internal credit risk grades:

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	50,716,000	$	2,322,000	$	41,217,000	$	70,569,000	$	42,729,000
Grades 5 – 7		43,819,000		7,648,000		55,364,000		41,431,000		30,692,000
Grades 8 – 9		2,466,000		327,000		3,308,000		1,694,000		708,000
Total commercial	$	97,001,000	$	10,297,000	$	99,889,000	$	113,694,000	$	74,129,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages

Total retail	$	61,671,000	$	123,305,000

Credit quality indicators were as follows as of December 31, 2015:

Originated loans

Commercial credit exposure – credit risk profiled by internal credit risk grades:

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	417,120,000	$	18,118,000	$	230,629,000	$	400,350,000	$	19,121,000
Grades 5 – 7		160,454,000		10,365,000		98,332,000		120,404,000		13,806,000
Grades 8 – 9		298,000		1,655,000		1,837,000		0		1,027,000
Total commercial	$	577,872,000	$	30,138,000	$	330,798,000	$	520,754,000	$	33,954,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages

Total retail	$	67,816,000	$	55,255,000

Acquired

loans

Commercial credit exposure – credit risk profiled by internal credit risk grades:

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied		Commercial Real Estate - Non-Owner Occupied		Commercial Real Estate - Multi-Family and Residential Rental

Internal credit risk grade groupings:
Grades 1 – 4	$	67,978,000	$	3,095,000	$	45,807,000	$	71,197,000	$	44,763,000
Grades 5 – 7		47,589,000		11,364,000		63,563,000		50,066,000		35,288,000
Grades 8 – 9		2,864,000		523,000		5,751,000		2,334,000		998,000
Total commercial	$	118,431,000	$	14,982,000	$	115,121,000	$	123,597,000	$	81,049,000

Retail credit exposure – credit risk profiled by collateral type:

	Retail Home Equity and Other		Retail 1-4 Family Mortgages

Total retail	$	72,830,000	$	135,130,000

All commercial loans are graded using the following criteria:

Grade 1.

Excellent credit rating that contain very little, if any, risk of loss.

Grade 2.

Strong sources of repayment and have low repayment risk.

Grade 3.

Good sources of repayment and have limited repayment risk.

Grade 4.

Adequate sources of repayment and acceptable repayment risk; however, characteristics are present that render the credit more vulnerable to a negative event.

Grade 5.

Marginally acceptable sources of repayment and exhibit defined weaknesses and negative characteristics.

Grade 6.

Well defined weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if the credit does not stabilize or if further deterioration is observed in the near term, the loan will likely be downgraded and placed on the Watch List (i.e., list of lending relationships that receive increased scrutiny and review by the Board of Directors and senior management).

Grade 7.

Defined weaknesses or negative trends that merit close monitoring through Watch List status.

Grade 8.

Inadequately protected by current sound net worth, paying capacity of the obligor, or pledged collateral, resulting in a distinct possibility of loss requiring close monitoring through Watch List status.

Grade 9.

Vital weaknesses exist where collection of principal is highly questionable.

Grade 10.

Considered uncollectable and of such little value that continuance as an asset is not warranted.

The primary risk elements with respect to commercial loans are the financial condition of the borrower, the sufficiency of collateral, and timeliness of scheduled payments. We have a policy of requesting and reviewing periodic financial statements from commercial loan customers and employ a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential real estate loan and consumer loan is the timeliness of scheduled payments. We have a reporting system that monitors past due loans and have adopted policies to pursue creditor’s rights in order to preserve our collateral position.

Activity in the allowance for loan losses and the recorded investments in originated loans as of and during the three and six months ended June 30, 2016 are as follows:

	Commercial Loans			Retail Loans			Unallocated		Total

Allowance for loan losses:
Balance at March 31, 2016	$	13,924,000		$	1,834,000		$	214,000	$	15,972,000
Provision for loan losses		842,000			296,000			20,000		1,158,000
Charge-offs		(166,000	)		(231,000	)		0		(397,000	)
Recoveries		129,000			14,000			0		143,000
Ending balance	$	14,729,000		$	1,913,000		$	234,000	$	16,876,000


Allowance for loan losses:
Balance at December 31, 2015	$	13,672,000		$	1,421,000		$	140,000	$	15,233,000
Provision for loan losses		936,000			799,000			94,000		1,829,000
Charge-offs		(255,000	)		(617,000	)		0		(872,000	)
Recoveries		376,000			310,000			0		686,000
Ending balance	$	14,729,000		$	1,913,000		$	234,000	$	16,876,000

Ending balance: individually evaluated for impairment	$	827,000		$	209,000		$	0	$	1,036,000

Ending balance: collectively evaluated for impairment	$	13,902,000		$	1,704,000		$	234,000	$	15,840,000


Total loans:
Ending balance	$	1,664,745,000		$	135,209,000				$	1,799,954,000

Ending balance: individually evaluated for impairment	$	16,905,000		$	1,463,000				$	18,368,000

Ending balance: collectively evaluated for impairment	$	1,647,840,000		$	133,746,000				$	1,781,586,000

Activity in the allowance for loan losses for acquired loans during the three and six months ended June 30, 2016 is as follows:

	Commercial Loans			Retail Loans			Unallocated		Total

Allowance for loan losses:
Balance at March 31, 2016	$	266,000		$	24,000		$	0	$	290,000
Provision for loan losses		(57,000	)		(1,000	)		0		(58,000	)
Charge-offs		0			0			0		0
Recoveries		2,000			0			0		2,000
Ending balance	$	211,000		$	23,000		$	0	$	234,000


Allowance for loan losses:
Balance at December 31, 2015	$	420,000		$	28,000		$	0	$	448,000
Provision for loan losses		(167,000	)		38,000			0		(129,000	)
Charge-offs		0			0			0		0
Recoveries		(42,000	)		(43,000	)		0		(85,000	)
Ending balance	$	211,000		$	23,000		$	0	$	234,000

The negative loan recoveries reflected for acquired loans during the first six months of 2016 resulted from reversals of prior-period recoveries associated with certain purchased credit impaired (“PCI”) loans that were subject to pre-acquisition charge-offs. Post-acquisition payments received on these PCI loans were previously reported as loan loss recoveries in prior periods; during the first quarter of 2016, these recoveries were reversed and reported as recovery income if associated with specifically reviewed PCI loans or retained gains if associated with PCI-pooled loans.

Activity in the allowance for loan losses and the recorded investments in originated loans as of and during the three and six months ended June 30, 2015 are as follows:

	Commercial Loans			Retail Loans			Unallocated			Total

Allowance for loan losses:
Balance at March 31, 2015	$	18,977,000		$	1,235,000		$	39,000		$	20,251,000
Provision for loan losses		(1,151,000	)		513,000			(5,000	)		(643,000	)
Charge-offs		(4,199,000	)		(154,000	)		0			(4,353,000	)
Recoveries		365,000			120,000			0			485,000
Ending balance	$	13,992,000		$	1,714,000		$	34,000		$	15,740,000


Allowance for loan losses:
Balance at December 31, 2014	$	17,736,000		$	1,487,000		$	76,000		$	19,299,000
Provision for loan losses		(1,651,000	)		592,000			(42,000	)		(1,101,000	)
Charge-offs		(4,277,000	)		(517,000	)		0			(4,794,000	)
Recoveries		2,184,000			152,000			0			2,336,000
Ending balance	$	13,992,000		$	1,714,000		$	34,000		$	15,740,000

Ending balance: individually evaluated for impairment	$	2,146,000		$	178,000		$	0		$	2,324,000

Ending balance: collectively evaluated for impairment	$	11,846,000		$	1,536,000		$	34,000		$	13,416,000


Total loans:
Ending balance	$	1,322,388,000		$	107,235,000					$	1,429,623,000

Ending balance: individually evaluated for impairment	$	19,108,000		$	1,180,000					$	20,288,000

Ending balance: collectively evaluated for impairment	$	1,303,280,000		$	106,055,000					$	1,409,335,000

Activity in the allowance for loan losses for acquired loans during the three and six months ended June 30, 2015 is as follows:

	Commercial Loans			Retail Loans			Unallocated		Total

Allowance for loan losses:
Balance at March 31, 2015	$	622,000		$	177,000		$	0	$	799,000
Provision for loan losses		(31,000	)		74,000			0		43,000
Charge-offs		(30,000	)		0			0		(30,000	)
Recoveries		0			9,000			0		9,000
Ending balance	$	561,000		$	260,000		$	0	$	821,000


Allowance for loan losses:
Balance at December 31, 2014	$	681,000		$	61,000		$	0	$	742,000
Provision for loan losses		(90,000	)		191,000			0		101,000
Charge-offs		(31,000	)		(7,000	)		0		(38,000	)
Recoveries		1,000			15,000			0		16,000
Ending balance	$	561,000		$	260,000		$	0	$	821,000

In accordance with acquisition accounting rules, acquired loans were recorded at fair value at the merger date and the prior allowance was eliminated.

Loans modified as troubled debt restructurings during the three months ended June 30, 2016 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Originated loans
Commercial:
Commercial and industrial		0	$	0	$	0
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		1		167,000		167,000
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		0		0		0
Total originated commercial		1		167,000		167,000

Retail:
Home equity and other		2		184,000		184,000
1-4 family mortgages		1		33,000		40,000
Total originated retail		3		217,000		224,000

Total originated loans		4	$	384,000	$	391,000

Acquired loans
Commercial:
Commercial and industrial		0	$	0	$	0
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		1		60,000		60,000
Real estate – multi-family and residential rental		1		7,000		7,000
Total acquired commercial		2		67,000		67,000

Retail:
Home equity and other		1		25,000		25,000
1-4 family mortgages		0		0		0
Total acquired retail		1		25,000		25,000

Total acquired loans		3	$	92,000	$	92,000

Loans modified as troubled debt restructurings during the six months ended June 30, 2016 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Originated loans
Commercial:
Commercial and industrial		1	$	20,000	$	20,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		1		167,000		167,000
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		0		0		0
Total originated commercial		2		187,000		187,000

Retail:
Home equity and other		2		184,000		184,000
1-4 family mortgages		1		33,000		40,000
Total originated retail		3		217,000		224,000

Total originated loans		5	$	404,000	$	411,000

Acquired loans
Commercial:
Commercial and industrial		0	$	0	$	0
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		1		60,000		60,000
Real estate – multi-family and residential rental		1		7,000		7,000
Total acquired commercial		2		67,000		67,000

Retail:
Home equity and other		2		51,000		51,000
1-4 family mortgages		1		19,000		19,000
Total acquired retail		3		70,000		70,000

Total acquired loans		5	$	137,000	$	137,000

Loans modified as troubled debt restructurings during the three months ended June 30, 2015 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Originated loans
Commercial:
Commercial and industrial		4	$	1,308,000	$	1,308,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		0		0		0
Total originated commercial		4		1,308,000		1,308,000

Retail:
Home equity and other		0		0		0
1-4 family mortgages		0		0		0
Total originated retail		0		0		0

Total originated loans		4	$	1,308,000	$	1,308,000

Acquired loans
Commercial:
Commercial and industrial		2	$	286,000	$	286,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		3		119,000		119,000
Real estate – non-owner occupied		1		302,000		302,000
Real estate – multi-family and residential rental		3		265,000		265,000
Total acquired commercial		9		972,000		972,000

Retail:
Home equity and other		1		161,000		161,000
1-4 family mortgages		0		0		0
Total acquired retail		1		161,000		161,000

Total acquired loans		10	$	1,133,000	$	1,133,000

Loans modified as troubled debt restructurings during the six months ended June 30, 2015 were as follows:

	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Originated loans
Commercial:
Commercial and industrial		10	$	1,876,000	$	1,901,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		0		0		0
Real estate – non-owner occupied		0		0		0
Real estate – multi-family and residential rental		0		0		0
Total originated commercial		10		1,876,000		1,901,000

Retail:
Home equity and other		0		0		0
1-4 family mortgages		0		0		0
Total originated retail		0		0		0

Total originated loans		10	$	1,876,000	$	1,901,000

Acquired loans
Commercial:
Commercial and industrial		2	$	286,000	$	286,000
Vacant land, land development and residential construction		0		0		0
Real estate – owner occupied		5		169,000		169,000
Real estate – non-owner occupied		1		302,000		302,000
Real estate – multi-family and residential rental		3		265,000		265,000
Total acquired commercial		11		1,022,000		1,022,000

Retail:
Home equity and other		1		161,000		161,000
1-4 family mortgages		0		0		0
Total acquired retail		1		161,000		161,000

Total acquired loans		12	$	1,183,000	$	1,183,000

The following originated loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended June 30, 2016 (amounts as of period end):

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		0		0
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		0		0

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		0	$	0

The following originated loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the six months ended June 30, 2016 (amounts as of period end):

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		0		0
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		0		0

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		0	$	0

The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the three months ended June 30, 2016 (amounts as of period end):

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		0		0
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		1		22,000
Total commercial		1		22,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	22,000

The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the six months ended June 30, 2016 (amounts as of period end):

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		0		0
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		1		22,000
Total commercial		1		22,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	22,000

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		1		1,182,000
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		1		1,182,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	1,182,000

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		1		1,182,000
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		1		1,182,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	1,182,000

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		1		18,000
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		1		18,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	18,000

The following acquired loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due within the six months ended June 30, 2015 (amounts as of period end):

	Number of Contracts		Recorded Principal Balance
Commercial:
Commercial and industrial		0	$	0
Vacant land, land development and residential construction		0		0
Real estate – owner occupied		1		18,000
Real estate – non-owner occupied		0		0
Real estate – multi-family and residential rental		0		0
Total commercial		1		18,000

Retail:
Home equity and other		0		0
1-4 family mortgages		0		0
Total retail		0		0

Total		1	$	18,000

Activity for originated loans categorized as troubled debt restructurings during the three months ended June 30, 2016 is as follows:

	Commercial and Industrial		Commercial Vacant Land, Land Development, and Residential Construction			Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	1,946,000	$	2,062,000		$	1,369,000		$	10,529,000		$	469,000
Charge-Offs		0		0			0			0			0
Payments		0		(26,000	)		(35,000	)		(94,000	)		(8,000	)
Transfers to ORE		0		0			0			0			0
Net Additions/Deletions		157,000		0			97,000			0			0
Ending Balance	$	2,103,000	$	2,036,000		$	1,431,000		$	10,435,000		$	461,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	146,000		$	126,000
Charge-Offs		0			0
Payments		(1,000	)		(3,000	)
Transfers to ORE		0			0
Net Additions/Deletions		184,000			40,000
Ending Balance	$	329,000		$	163,000

Activity for acquired loans categorized as troubled debt restructurings during the three months ended June 30, 2016 is as follows:

	Commercial and Industrial			Commercial Vacant Land, Land Development, and Residential Construction		Commercial Real Estate - Owner Occupied			Commercial Real Estate - Non-Owner Occupied			Commercial Real Estate - Multi-Family and Residential Rental

Commercial Loan Portfolio:
Beginning Balance	$	1,687,000		$	0	$	1,455,000		$	637,000		$	278,000
Charge-Offs		0			0		0			0			0
Payments		(43,000	)		0		(172,000	)		(12,000	)		(11,000	)
Transfers to ORE		0			0		0			0			0
Net Additions/Deletions		0			0		0			56,000			7,000
Ending Balance	$	1,644,000		$	0	$	1,283,000		$	681,000		$	274,000

	Retail Home Equity and Other			Retail 1-4 Family Mortgages
Retail Loan Portfolio:
Beginning Balance	$	161,000		$	335,000
Charge-Offs		0			0
Payments		(7,000	)		(2,000	)
Transfers to ORE		0			0
Net Additions/Deletions		26,000			0
Ending Balance	$	180,000		$	333,000

MERCANTILE BANK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)