NOTE

– STOCK-BASED COMPENSATION

Stock-based compensation plans are used to provide directors and employees with an increased incentive to contribute to our long-term performance and growth, to align the interests of directors and employees with the interests of our shareholders through the opportunity for increased stock ownership and to attract and retain directors and employees. During

2014

and

2015,

stock option and restricted stock grants were provided to certain employees through the Stock Incentive Plan of

2006.

During

2016,

2017

and

2018,

restricted stock grants were provided to certain employees through the Stock Incentive Plan of

2016.

Stock option grants were also provided to certain employees during

2016

through the Stock Incentive Plan of

2016.

Stock grants were provided to directors as retainer payments during

2014

and

2015

through the Stock Incentive Plan of

2006,

and during

2016,

2017

and

2018

through the Stock Incentive Plan of

2016.

The Stock Incentive Plan of

2006

expired on

January 18, 2016,

and was effectively replaced with the Stock Incentive Plan of

2016

that was approved by shareholders in

May, 2016.

Under the Stock Incentive Plan of

2006

and the Stock Incentive Plan of

2016,

incentive awards

may

include, but are

not

limited to, stock options, restricted stock, stock appreciation rights and stock awards. Incentive awards that are stock options or stock appreciation rights are granted with an exercise price

not

less than the closing price of our common stock on the date of grant. Price, vesting and expiration date parameters are determined by Mercantile’s Compensation Committee on a grant-by-grant basis.

payments are required from employees for restricted stock awards. The restricted stock awards granted during

2014,

2015,

2016,

2017

and

2018

fully vest after

three

years and, in the case of performance-based restricted stock issued to executive officers in

2018,

is subject to the attainment of pre-determined performance goals. The stock options granted during

2014,

2015

and

2016,

which were at

110%

of the market price on the date of grant, fully vest after

two

years and expire after

seven

years. At year-end

2018,

there were approximately

197,000

shares authorized for future incentive awards.

In conjunction with the Firstbank merger, all of our outstanding restricted stock awards, which were scheduled to vest in full in

November, 2014,

became fully vested on

June 1, 2014.

The unrecognized compensation cost related to restricted stock grants was

$5.8

million as of

December 31, 2018,

which will be recognized as expense over the next

three

years.

Also in conjunction with the Firstbank merger, we issued Mercantile stock options in replacement of all outstanding Firstbank stock option grants that had been previously issued to Firstbank employees under the Firstbank Corporation Stock Option and Restricted Stock Plan of

1997

and the Firstbank Corporation

2006

Stock Compensation Plan. In general, stock option grants for

shares or less fully vested after

one

year from date of grant, while stock option grants for more than

shares vested over a

five

-year period at

20%

of the grant per annum starting

one

year from date of grant. The stock option grants expire

ten

years from date of grant. 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 date of merger. The remaining

23,800

stock option grants vested during

2015.

A summary of restricted stock activity from grants issued under Mercantile plans during the past

three

years is as follows:

	2018					2017					2016
	Shares			Weighted Average Fair Value		Shares			Weighted Average Fair Value		Shares			Weighted Average Fair Value

Nonvested at beginning of year		239,637		$	32.37		228,343		$	26.09		155,501		$	22.25
Granted		91,400			31.82		94,592			37.11		86,250			32.19
Vested		(55,792	)		25.14		(74,979	)		20.17		(7,622	)		20.23
Forfeited		(12,278	)		31.62		(8,319	)		23.75		(5,786	)		21.90
Nonvested at end of year		262,967		$	33.97		239,637		$	32.37		228,343		$	26.09

Of the restricted stock shares granted in

2018,

a total of

24,633

(at the target level) are performance based awards made to our Named Executive Officers and are subject to the attainment of pre-determined performance goals.

A summary of stock option activity from grants issued under Mercantile plans during the past

three

years is as follows:

	2018					2017					2016
	Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price

Outstanding at beginning of year		15,808		$	29.62		16,808		$	29.17		11,308		$	24.50
Granted		0		NA			0		NA			6,500			36.22
Exercised		(2,108	)		23.77		(1,000	)		22.15		(1,000	)		22.15
Forfeited or expired		0		NA			0		NA			0		NA
Outstanding at end of year		13,700		$	30.51		15,808		$	29.62		16,808		$	29.17
Options exercisable at year-end		13,700		$	30.51		9,308		$	25.00		5,488		$	22.15

The fair value of each stock option award is estimated on the date of grant using a closed option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities on our common stock. Historical data is used to estimate stock option expense and post-vesting termination behavior. The expected term of stock options granted is based on historical data and represents the period of time that stock options granted are expected to be outstanding, which takes into account that the stock options are

not

transferable. The risk-free interest rate for the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of the stock option grant.

The fair value of stock options granted during

2016

was determined using the following weighted-average assumptions as of the grant date.

stock options were granted in

2017

2018.

	2016

Risk-free interest rate		1.78	%
Expected option life (years)		5
Expected stock price volatility		26	%
Dividend yield		2.5	%

Options issued under Mercantile plans outstanding at year-end

2018

were as follows:

			Outstanding						Exercisable
					Weighted Average		Weighted				Weighted
Range of					Remaining		Average				Average
Exercise					Contractual		Exercise				Exercise
Prices			Number		Life (Years)		Price		Number		Price

$22.00	-	$23.00		3,000		2.9	$	22.15		3,000		22.15
$24.01	-	$28.00		4,200		3.9		27.66		4,200		27.66
$36.00	-	$40.00		6,500		4.9		36.22		6,500		36.22
Outstanding at year end				13,700		4.1	$	30.51		13,700		30.51

Information related to options issued under various Mercantile plans outstanding at year-end

2018,

2017

and

2016

is as follows:

	2018		2017		2016

Minimum exercise price	$	22.15	$	22.15	$	22.15
Maximum exercise price		36.22		36.22		36.22
Average remaining option term (years)		4.1		5.0		6.7

Information related to stock option grants and exercises issued under various Mercantile plans during

2018,

2017

and

2016

is as follows:

	2018		2017		2016

Aggregate intrinsic value of stock options exercised	$	17,000	$	15,000	$	6,000
Cash received from stock option exercises		33,000		0		22,000
Tax benefit realized from stock option exercises		0		0		0
Weighted average per share fair value of stock options granted	NA		NA			5.25

The aggregate intrinsic value of in-the-money stock options issued under Mercantile plans outstanding and exercisable at

December 31, 2018

was less than

$0.1

million. Shares issued as a result of the exercise of stock option grants have been authorized and were previously unissued shares.

A summary of stock option activity from grants issued under Firstbank plans that became part of Mercantile’s plans upon consummation of the merger on

June 1, 2014

is as follows:

	2018					2017					2016
	Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price

Outstanding at beginning of year		15,100		$	7.20		44,275		$	9.86		123,887		$	12.64
Granted		0		NA			0		NA			0		NA
Exercised		(9,900	)		7.53		(27,675	)		11.50		(71,711	)		13.33
Forfeited or expired		0		NA			(1,500	)		6.33		(7,901	)		22.00
Outstanding at end of year		5,200		$	6.57		15,100		$	7.20		44,275		$	9.86
Options exercisable at year-end		5,200		$	6.57		15,100		$	7.20		44,275		$	9.86

Options issued under Firstbank plans outstanding at year-end

2018

were as follows:

			Outstanding						Exercisable
					Weighted Average		Weighted				Weighted
Range of					Remaining		Average				Average
Exercise					Contractual		Exercise				Exercise
Prices			Number		Life (Years)		Price		Number		Price

$ 5.00	-	$ 6.00		3,100		1.9	$	5.19		3,100	$	5.19
$ 8.01	-	$ 9.00		2,100		0.9		8.60		2,100		8.60
Outstanding at year end				5,200		1.5	$	6.57		5,200	$	6.57

Information related to options issued under Firstbank plans outstanding at year-end

2018,

2017

and

2016

is as follows:

	2018		2017		2016

Minimum exercise price	$	5.19	$	5.19	$	5.19
Maximum exercise price		8.60		8.60		16.00
Average remaining option term (years)		1.5		1.7		1.8

Information related to stock option grants and exercises issued under Firstbank plans during

2018,

2017

and

2016

is as follows:

	2018		2017		2016

Aggregate intrinsic value of stock options exercised	$	300,000	$	594,000	$	1,945,000
Cash received from stock option exercises		108,000		318,000		956,000
Tax benefit realized from stock option exercises		0		208,000		681,000
Weighted average per share fair value of stock options granted	NA		NA		NA

The aggregate intrinsic value of all stock options issued under various Firstbank plans outstanding and exercisable at

December 31, 2018

was

$0.1

million. Shares issued as a result of the exercise of stock option grants have been authorized and previously unissued shares.

May 28, 2015,

we granted about

14,000

shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of

June 1, 2015

through

May 31, 2016.

The associated

$0.3

million cost was expensed on a straightline basis over the respective

twelve

month period. On

June 6, 2016,

we granted about

13,000

shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of

June 1, 2016

through

May 31, 2017.

The associated

$0.3

million cost was expensed on a straightline basis over the respective

twelve

month period. On

May 25, 2017,

we granted about

12,000

shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of

June 1, 2017

through

May 31, 2018.

The associated

$0.4

million cost was expensed on a straightline basis over the respective

twelve

month period. On

May 24, 2018,

we granted about

11,000

shares of common stock to our Corporate, Bank and Regional Advisory Boards of Directors for retainer payments for the period of

June 1, 2018

through

May 31, 2019.

The associated

$0.4

million cost is being expensed on a straightline basis over the respective

twelve

month period. On

October 25, 2018,

we granted about

1,000

shares of common stock to newly appointed Bank Board members for retainer payments for the period of

October 1, 2018

through

May 31, 2019.

The associated less than

$0.1

million cost is being expensed over the respective

eight

month period.