UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
For the fiscal year ended
or
For the transition period from __________________ to __________________
Commission file number
| MERCANTILE BANK CORPORATION | ||
| (Exact name of registrant as specified in its charter) | ||
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| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
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| (Address of principal executive offices) | (Zip Code) | |
| ( | ||
| (Registrant’s telephone number, including area code) | ||
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| | | The |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐
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.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or emerging growth company (as defined in Rule 12b-2 of the Exchange Act).
| Large accelerated filer ☐ | Emerging growth company | ||
| Non-accelerated filer ☐ | Smaller reporting company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes Oxley Act (15 USC.7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. Yes ☐ No ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to Section 240.10D-1(b). Yes ☐ No ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
The aggregate value of the common equity held by non-affiliates (persons other than directors and executive officers) of the registrant, computed by reference to the closing price of the common stock as of the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company’s proxy statement for the Annual Meeting of Shareholders to be held May 25, 2023 are incorporated by reference into Part III of this report. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended December 31, 2022. Additionally, portions of the Annual Report are incorporated by reference in this Form 10-K in response to Items within Part II.
PART I
| Item 1. |
Business. |
The Company
Mercantile Bank Corporation is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). Unless the text clearly suggests otherwise, references to “us,” “we,” “our,” or “the company” include Mercantile Bank Corporation and its wholly-owned subsidiaries. As a bank holding company, we are subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). We were organized on July 15, 1997, under the laws of the State of Michigan, primarily for the purpose of holding all of the stock of Mercantile Bank (“our bank”), and of such other subsidiaries as we may acquire or establish. Our bank commenced business on December 15, 1997. During the third quarter of 2013, we filed an election to become a financial holding company, which election became effective April 14, 2014. Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank, commenced operations during 2002 to offer insurance products. Our expenses have generally been paid using cash dividends from our bank. Our principal source of future operating funds is expected to be dividends from our bank.
Our Bank
Our bank is a state banking company that operates under the laws of the State of Michigan, pursuant to a charter issued by the Michigan Department of Insurance and Financial Services. Our bank’s deposits are insured to the maximum extent permitted by law by the Federal Deposit Insurance Corporation (“FDIC”). Our bank, through its 46 office locations, provides commercial banking services primarily to small- to medium-sized businesses and retail banking services. Our bank’s main office is located in Grand Rapids, and our operations are centered around the West and Central portions of Michigan. We also have a banking office located in the metropolitan Detroit, Michigan area, as well as residential mortgage loan production offices in Midland and Petoskey, Michigan and in the Cincinnati, Ohio metropolitan area. Our bank makes secured and unsecured commercial, construction, mortgage and consumer loans, and accepts checking, savings and time deposits. Our bank owns 20 automated teller machines ("ATM") and 21 video banking machines at a majority of our office locations that participate in the ACCEL/EXCHANGE and PLUS regional network systems, as well as other ATM networks throughout the country. Our bank also enables customers to conduct certain loan and deposit transactions by personal computer and through mobile applications. Courier service is provided to certain commercial customers, and safe deposit facilities are available at a vast majority of our office locations. Our bank does not have trust powers.
Our Insurance Company
Our insurance company acquired an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent. To date, we have not provided the insurance products noted above and currently have no plans to do so.
Our Trusts
We have five business trusts that are wholly-owned subsidiaries of Mercantile Bank Corporation but are not consolidated. Each of the trusts was formed to issue preferred securities that were sold in private sales, as well as to sell common securities to Mercantile Bank Corporation. The proceeds from the preferred and common securities sales were used by the trusts to purchase floating rate notes issued by Mercantile Bank Corporation. The rates of interest, interest payment dates, call features and maturity dates of each floating rate note are identical to its respective preferred securities. The net proceeds from the issuance of the floating rate notes were used for a variety of purposes, including contributions to our bank as capital to provide support for asset growth and the funding of stock repurchase programs and certain acquisitions. The only significant assets of our trusts are the floating rate notes, and the only significant liabilities of our trusts are the preferred securities. The floating rate notes are categorized on our Consolidated Balance Sheets as subordinated debentures, and the interest expense is recorded on our Consolidated Statements of Income under interest expense on other borrowings.
Effect of Government Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States Government, its agencies, and the Federal Reserve Board. The Federal Reserve Board’s monetary policies have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order to, among other things, curb inflation, maintain or encourage employment, and mitigate economic recessions. The policies of the Federal Reserve Board have a major effect upon the levels of bank loans, investments and deposits through its open market operations in United States Government securities, and through its regulation of, among other things, the discount rate on borrowings of member banks. Our bank maintains reserves directly with the Federal Reserve Bank of Chicago to the extent required by law. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.
Regulation and Supervision
Banks and bank holding companies, like many other financial institutions, are regulated under a variety of federal and state statutes and the regulations that implement those statutes. These statutes include, among others, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”), the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, the USA PATRIOT Act, the FACT Act, the Gramm-Leach-Bliley Act, the Sarbanes Oxley Act, the Bank Secrecy Act, electronic funds transfer laws, redlining laws, predatory lending laws, antitrust laws, environmental laws, money laundering laws, privacy laws, state usury statutes, and statutes relating to fiduciaries. Our growth and earnings performance may be impacted by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. Those regulatory authorities include, but are not limited to, the Federal Reserve Board, the FDIC, the Michigan Department of Insurance and Financial Services, the Internal Revenue Service and state taxing authorities. The effect of such statutes, regulations and policies, and any changes thereto, may significantly impact our business which cannot necessarily be predicted.
As a registered bank holding company under the Bank Holding Company Act, we are required to file an annual report with the Federal Reserve Board and such additional information as the Federal Reserve Board may require. We are also subject to periodic examinations by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding companies to banking and the management of banking organizations, and to certain permitted non-banking activities. The permitted non-banking activities generally include those limited activities that the Federal Reserve Board has determined, by order or regulation as of the day prior to enactment of the Gramm-Leach-Bliley Act, to be so closely related to banking as to be a proper incident to banking. These permitted non-banking activities include, among other things: operating a mortgage company, finance company, or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, nonoperating basis; and providing discount securities brokerage services for customers. Neither we nor any of our subsidiaries engage in any of the non-banking activities listed above.
On April 14, 2014, our election to become a financial holding company, as permitted by the Bank Holding Company Act, as amended by Title I of the Gramm-Leach-Bliley Act, was accepted and made effective by the Federal Reserve Board. In order to maintain our status as a financial holding company, we and our bank must satisfy statutory requirements regarding capitalization, management and compliance with the Community Reinvestment Act. As a financial holding company, we are permitted to engage in a broader range of activities under the Bank Holding Company Act that are permitted for bank holding companies. Those expanded activities include any activity which the Federal Reserve Board (in certain instances in consultation with the Department of the Treasury) determines, by order or by regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity, and not to pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Such expanded activities that have been previously approved by the Federal Reserve Board include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent or broker for such purposes; providing financial, investment or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. While our insurance company is permitted to engage in the insurance agency activities described above by virtue of our financial holding company status, neither we nor any of our subsidiaries currently engage in these expanded activities.
Our bank is subject to restrictions imposed by federal and state laws and regulations. Among other things, these restrictions limit the transactions our bank conducts with us, our other subsidiaries or other affiliates, limit our securities borrowing or lending, derivatives, and repurchase transactions with us, our other subsidiaries or other affiliates, limit investments in stock or other securities that we issue, limit the taking of such stock or securities as collateral for loans to any borrower, and limit acquisitions of assets or services from, and sales of certain types of assets to, us, our other subsidiaries or other affiliates. Michigan banking laws place additional restrictions on various aspects of banking, including branching, payment of dividends, loan interest rates and capital and surplus requirements. Federal law restricts our ability to borrow from our bank by limiting the aggregate amount we may borrow and by requiring that all loans to us be secured in designated amounts by specified forms of collateral.
With respect to the acquisition of banking organizations, we are generally required to obtain the prior approval of the Federal Reserve Board before we can acquire all or substantially all of the assets of any bank, or acquire ownership or control of any voting shares of any bank or bank holding company, if, after the acquisition, we would own or control more than 5% of the voting shares of the bank or bank holding company. Acquisitions of banking organizations across state lines are subject to additional restrictions imposed by federal and state laws and regulations.
The scope of regulations and supervision of various aspects of our business have expanded as a result of the adoption in July, 2010 of the Dodd-Frank Act, and may continue to expand as the result of implementing regulations being adopted by federal regulators. However, on May 24, 2018, EGRRCPA amended certain provisions of the Dodd-Frank Act to tailor them to the specific circumstances of various categories of financial institutions and transactions. Many of the statutes and regulations under which we and our bank operate may change in the future, which may significantly impact our business.
Competition
We face substantial competition in all phases of our operations from a variety of different competitors. We compete for deposits, loans and other financial services with numerous Michigan-based and national and regional banks, savings banks, thrifts, credit unions and other financial institutions as well as with other entities that provide financial services. Some of the financial institutions and financial service organizations with whom we compete are not subject to the same degree of regulation as we are. Many of our primary competitors have been in business for many years, have established customer bases, are larger, have substantially higher lending limits than we do, and offer larger branch networks and other services which we do not. Most of these same entities have greater capital resources than we do, which, among other things, may allow them to price their services at levels more favorable to the customer and to provide larger credit facilities than we do. Under specified circumstances (that have been modified by the Dodd-Frank Act and EGRRCPA), securities firms and insurance companies that elect to become financial holding companies under the Bank Holding Company Act may acquire banks and other financial institutions. Federal and state banking law affects the competitive environment in which we conduct our business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. We also face new competition as a result of expansion into new markets.
Human Capital
As of December 31, 2022, we employed 601 full-time and 68 part-time persons. Our human capital is the most valuable asset we have and we believe embracing human diversity makes us a better financial institution. The collective sum of the individual differences, life experiences, knowledge, inventiveness, innovation, self-expression, unique capabilities and talent that our employees invest in their work represents a significant part of not only our culture, but our reputation and our achievements as well. We embrace and encourage our employees’ differences in age, color, disability, ethnicity, family or marital status, gender identity or expression, language, national origin, physical and mental ability, political affiliation, race, religion, sexual orientation, socio-economic status, veteran status and other characteristics that make our employees unique.
Talent Acquisition. We hire people who are able to connect, listen and deliver the best solutions to our customers and communicate with integrity every time. We are devoted to attracting and retaining the best talent in the markets we serve and have implemented HireReach’s evidence-based selection process with all branch new hires. The system utilizes a standardized, consistent process and relevant quantitative data to facilitate a multidimensional assessment of job candidates to create better matches between workers and jobs, decrease time-to-hire, reduce first-year turnover, increase workforce diversity and boost productivity. We believe in leading through example in our communities and are proud to be part of a cohort of 15 local companies that have adopted this evidence-based hiring process to help increase diversity in the workforce.
Employee Safety and Health. The prioritization of our people is reflected in the robust employee benefits and compensation packages offered to our staff, including health and wellness insurance plans and incentives, a 401(k) plan with matching contributions, dedicated internship programs for young professionals in finance and business, employee stock ownership plan participation, as well as clothing, home office and fitness equipment interest-free loans. Approximately 84% of our eligible employees participate in our medical benefit plans which include a health savings account plan in which we pay the full monthly premiums. We offer our employees generous paid time off for vacations, holidays, sick time and bereavement, along with pay-it-forward initiatives and paid volunteer time. In addition, with obstacles in maintaining balance between work responsibilities and personal time, we have enabled staff to pursue a safe and healthy work-life balance by increasing paid time off benefits for our employees.
Diversity and Inclusion. We believe in respecting, recognizing and valuing the importance of Diversity, Equity and Inclusion (“DEI”) as a natural part of our culture. Our exceptional team members are committed to maintaining an environment of personal growth and development. Our employees subscribe to a common goal: To make this financial institution the best it can possibly be. Diversity is an asset in the pursuit of this goal. Employees with dissimilar backgrounds, perspectives, opinions and lifestyles help us understand the motivations and desires of the communities we serve. We believe that each member of our workforce should be accorded the utmost respect and should be given equal opportunity and encouragement to achieve their full potential. Cooperation and teamwork are valued as much as individual growth and contribution. All employees are required to attend and complete foundational DEI training, and regular expanded learning opportunities are provided. Throughout 2022, monthly live webinars were offered to our staff as well as recorded video access to a wide variety of DEI topics along with resources such as books, group discussions and supervisor support materials.
In further support of our inclusion efforts, we have a Diversity Council comprised of members representing diverse perspectives across departments and viewpoints. The Diversity Council is designed to bring together ideas and experiences from various backgrounds to help develop respect and an appreciation for differences among employees.
Climate Change
We define sustainability as the leveraging of combined abilities to ensure our ongoing impact on people, the environment and our success is always focused on upholding long-lasting, positive results. From an efficient branch footprint to utilizing the latest technology, we are continuously focused on seeking new and better ways to be more productive with our time and energy while remaining good stewards of the resources with which we are entrusted. In each of our facilities, we follow LEED green certification guidelines wherever practical, evaluating all facilities for opportunities to incorporate energy efficient updates and space planning for new construction, renovations or expansion projects. All of our new construction and renovation projects include low-flow devices as well as LED lighting to enhance our efficiency of utility usage. Over the past four years, we have reduced our use of natural gas by 7% and electricity by 29%. All renovation and expansion projects involve the donation of former office furniture to non-profit organizations.
We continue to strive for the reduction of mail and paper usage through the promotion of customer eStatement adoption. The eStatement adoption rate continues to grow, and we were approaching 60% adoption at year-end 2022. Our online accounts payable system has also enabled us to significantly reduce paper and printing, and saves time. Every effort is made to recycle all paper, and we continue to offer community paper shredding events. Additionally, we have implemented recycling stations at all of our office locations to divert cardboard, plastic and metal items from landfills. Water bottle refill stations also aid to reduce plastic bottle usage.
Our Environmental, Social and Governance (“ESG”) Committee supports our ongoing commitment to environmental, health and safety, corporate social responsibility, corporate governance, sustainability and other public policy matters relevant to our organization. The ESG Committee is a cross-functional management committee, led by the Chief Risk Officer, that assists us in: 1) setting general strategies relating to ESG matters; 2) developing, implementing and monitoring initiatives and policies based on those strategies; 3) recommending communications with employees, investors and shareholders with respect to ESG matters; and 4) monitoring and assessing developments relating to, and improving our understanding of, ESG matters. The ESG Committee met four times during 2022. Highlights for 2022 included the enhancement of our online financial wellness tools, the rollout of the MercStart Fresh deposit program, the development of a diverse vendor database for employee use and the creation of a Vendor and Supplier Code of Conduct. The Vendor and Supplier Code of Conduct, along with our Environmental Policy, DEI Policy, Human Rights Policy, and the Supplier Diversity Program Policy, are reviewed and approved by our Board of Directors annually. These polices are available on our website, along with an application for diverse suppliers. Also during 2022, we moved Board of Director oversight of ESG matters from the Audit Committee to the Governance Committee. The meetings were well attended.
Lending Policy
As a routine part of our business, we make loans to businesses and individuals located within our market areas. Our lending policy states that the function of the lending operation is twofold: to provide a means for the investment of funds at a profitable rate of return with an acceptable degree of risk, and to meet the credit needs of the creditworthy businesses and individuals who are our customers. We recognize that in the normal business of lending, some losses on loans will be inevitable and should be considered a part of the normal cost of doing business.
Our lending policy anticipates that priorities in extending loans will be modified from time to time as interest rates, market conditions and competitive factors change. The policy sets forth guidelines on a nondiscriminatory basis for lending in accordance with applicable laws and regulations. The policy describes various criteria for granting loans, including the ability to pay; the character of the customer; evidence of financial responsibility; purpose of the loan; knowledge of collateral and its value; terms of repayment; source of repayment; payment history; and economic conditions.
The lending policy further limits the amount of funds that may be loaned against specified types of real estate collateral. For certain loans secured by real estate, the policy requires an appraisal of the property offered as collateral by a state certified independent appraiser. The policy also provides general guidelines for loan to value for other types of collateral, such as accounts receivable and machinery and equipment. In addition, the policy provides general guidelines as to environmental analysis, loans to employees, executive officers and directors, problem loan identification, maintenance of an allowance for credit losses, loan review and grading, mortgage and consumer lending, and other matters relating to our lending practices.
The Board of Directors has delegated significant lending authority to officers of our bank. The Board of Directors believes this empowerment, supported by our strong credit culture and the significant experience of our commercial lending staff, enables us to be responsive to our customers. The loan policy specifies lending authority for our lending officers with amounts based on the experience level and ability of each lender. Our loan officers and loan managers are generally able to approve loans ranging from $0.25 million and $2.5 million. We have established higher approval limits for our bank’s Chief Lending Officer, President and Chief Executive Officer ranging from $4.0 million up to $10.0 million. These lending authorities, however, are typically used only in rare circumstances where timing is of the essence. Loan requests exceeding $5.0 million require approval by the Officers Loan Committee, and loan requests exceeding $15.0 million, up to the legal lending limit of $101.4 million, require approval by our bank’s Board of Directors. We generally apply an in-house lending limit that is significantly less than our bank’s legal lending limit.
Lending Activity
Commercial Loans. Our commercial lending group originates commercial loans primarily in our market areas. Our commercial lenders have extensive commercial lending experience, with most having at least ten years’ experience. Loans are originated for general business purposes, including working capital, accounts receivable financing, machinery and equipment acquisition, and commercial real estate financing, including new construction and land development.
In most instances, commercial line of credit facilities have a term ranging from 12 to 24 months with a floating rate tied to the Wall Street Journal Prime Rate, 30-Day London Interbank Offered Rate (“Libor”) or 30-Day Secured Overnight Funding Rate (“SOFR”). Commercial term debt secured by real estate are generally at a floating rate tied to the Wall Street Journal Prime Rate, 30-Day Libor Rate or 30-Day SOFR. Since the fourth quarter of 2020, a fixed rate option for commercial term debt loans secured by real estate is generally not offered for loans over $2.5 million; instead, customers are offered participation in our back-to-back interest rate swap program to achieve a desired fixed rate. For loans under $2.5 million, we offer a rate primarily equal to the commensurate cost of funds using Federal Home Loan Bank of Indianapolis (“FHLBI”) advance rates as a proxy and a credit spread as indicated by the credit rating we assign. Commercial term debt secured by real estate generally balloon within five years, with payments based on amortizations ranging from 10 to 25 years. Commercial term debt secured by non-real estate collateral are generally at a floating rate tied to the Wall Street Journal Prime Rate, 30-Day Libor Rate or 30-Day SOFR, or a fixed rate primarily equal to the commensurate cost of funds using FHLBI advance rates as a proxy and a credit spread as indicated by the credit rating we assign, and generally mature and fully amortize within three to seven years. Effective January 1, 2022, we replaced the 30-Day Libor Rate with 30-Day SOFR for all new and renewing floating rate commercial loans and commitments. Commercial loans tied to the 30-Day Libor Rate outstanding on June 30, 2023 will convert to an equivalent fallback SOFR Rate. As of December 31, 2022, outstanding balances on loans tied to the 30-Day Libor Rate aggregated $368 million.
We evaluate many aspects of a commercial loan transaction in order to minimize credit and interest rate risk. Underwriting includes an assessment of the management, products, markets, cash flow, capital, income and collateral of the borrowing entity. This analysis includes a review of the borrower’s historical and projected financial results. Appraisals are generally required to be performed by certified independent appraisers where real estate is the primary collateral, and in some cases, where equipment is the primary collateral. In certain situations, for creditworthy customers, we may accept title reports instead of requiring lenders’ policies of title insurance.
Commercial real estate lending involves more risk than residential lending because loan balances are typically greater and repayment is dependent upon the borrower’s business operations. We attempt to minimize the risks associated with these transactions by generally limiting our commercial real estate lending to owner-operated properties and to owners of non-owner occupied properties who have an established profitable history and satisfactory tenant structure. In many cases, risk is further reduced by requiring personal guarantees, limiting the amount of credit to any one borrower to an amount considerably less than our legal lending limit and avoiding certain types of commercial real estate financings.
We have no material foreign loans, and only limited exposure to companies engaged in energy producing and agricultural-related activities.
Single-Family Residential Real Estate Loans. We originate single-family residential real estate loans in our market areas, generally according to secondary market underwriting standards. Loans not conforming to those standards are made in certain circumstances. Single-family residential real estate loans provide borrowers with a fixed or adjustable interest rate with terms up to 30 years, with the fixed interest rate loans generally sold to various investors.
Our bank has a home equity line of credit program. Home equity lines of credit are generally secured by either a first or second mortgage on the borrower’s primary residence. The program provides revolving credit at a rate tied to the Wall Street Journal Prime Rate.
Consumer Loans. We originate various types of consumer loans, including new and used automobile and boat loans, credit cards and overdraft protection lines of credit for our checking account customers. Consumer loans generally have shorter terms and higher interest rates and usually involve more credit risk than single-family residential real estate loans because of the type and nature of the collateral.
We believe our consumer loans are underwritten carefully, with a strong emphasis on the amount of the down payment, credit quality, employment stability and monthly income of the borrower. These loans are generally repaid on a monthly repayment schedule with the source of repayment tied to the borrower’s periodic income. In addition, consumer lending collections are dependent on the borrower’s continuing financial stability, and are thus likely to be adversely affected by job loss, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. We believe that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans, and that consumer loans are important to our efforts to serve the credit needs of the communities and customers that we serve.
Loan Portfolio Quality
We utilize a comprehensive grading system for our commercial loans, whereby 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 at various intervals.
Our independent loan review program is primarily responsible for the administration of the grading system and ensuring adherence to established lending policies and procedures. The loan review program is an integral part of maintaining our strong asset quality culture. The loan review function works closely with senior management, although it functionally reports to the Board of Directors. Using a risk-based approach to selecting credits for review, our loan review program covered approximately 62% of total commercial loans outstanding during 2022. In addition, a random sampling of retail loans is reviewed each quarter. Our watch list credits are reviewed monthly by our Board of Directors and our Watch List Committee, the latter of which is comprised of senior level officers from the administration, lending and loan review functions.
Loans are placed in a nonaccrual status when, in our opinion, uncertainty exists as to the ultimate collection of all principal and interest. As of December 31, 2022, loans placed in nonaccrual status totaled $7.7 million, or 0.2% of total loans, compared to $2.3 million, or 0.1% of total loans, at December 31, 2021. We had no loans past due 90 days or more and still accruing interest at year-end 2022, compared to $0.2 million in such loans as of December 31, 2021.
Additional detail and information relative to the loan portfolio is incorporated by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) and Note 3 of the Notes to Consolidated Financial Statements in this Annual Report.
Allowance for Credit Losses
The allowance is maintained at a level we believe is adequate to absorb estimated credit losses identified and inherent in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Credit losses are charged against the allowance when we believe the uncollectibility of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. The allowance is increased through a provision charged to operating expense. Uncollectible loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended by ASU 2018-19) significantly changed how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This standard replaced the “incurred loss” approach with an “expected loss” model. Referred to as the current expected credit loss (“CECL”) model, it applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expanded disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. In addition, entities need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU was effective for interim and annual reporting periods beginning after December 15, 2019.
Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continued to experience an unprecedented economic environment whereby a sizable portion of the economy had been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus was provided to businesses, individuals and state and local governments and financial institutions offered businesses and individuals payment relief options, economic forecasts were regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL until January 1, 2022, and continued to use our incurred loan loss reserve model as permitted through December 31, 2021.
We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022, are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.
Additional detail regarding the allowance is incorporated by reference to Management’s Discussion and Analysis and Note 3 of the Notes to Consolidated Financial Statements included in this Annual Report.
Investments
Bank Holding Company Investments. The principal investments of our bank holding company are the investments in the common stock of our bank and the common securities of our trusts. Other funds of our bank holding company may be invested from time to time in various debt instruments.
Subject to the limitations of the Bank Holding Company Act, we are also permitted to make portfolio investments in equity securities and to make equity investments in subsidiaries engaged in a variety of non-banking activities, which include real estate-related activities such as community development, real estate appraisals, arranging equity financing for commercial real estate, and owning and operating real estate used substantially by our bank or acquired for its future use. Our bank holding company has no plans at this time to make directly any of these equity investments at the bank holding company level. Our Board of Directors may, however, alter the investment policy at any time without shareholder approval.
Our Bank’s Investments. Our bank may invest its funds in a wide variety of debt instruments and may participate in the federal funds market with other depository institutions. Subject to certain exceptions, our bank is prohibited from investing in equity securities. Among the equity investments permitted for our bank under various conditions and subject in some instances to amount limitations, are shares of a subsidiary insurance agency, mortgage company, real estate company, or Michigan business and industrial development company, such as our insurance company. Under another such exception, in certain circumstances and with prior notice to or approval of the FDIC, our bank could invest up to 10% of its total assets in the equity securities of a subsidiary corporation engaged in the acquisition and development of real property for sale, or the improvement of real property by construction or rehabilitation of residential or commercial units for sale or lease. Our bank has no present plans to make such an investment. Real estate acquired by our bank in satisfaction of or foreclosure upon loans may be held by our bank for specified periods. Our bank is also permitted to invest in such real estate as is necessary for the convenient transaction of its business. Our bank’s Board of Directors may alter the bank’s investment policy without shareholder approval at any time.
Additional detail and information relative to the securities portfolio is incorporated by reference to Management’s Discussion and Analysis and Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report.
Available Information
We maintain an internet website at www.mercbank.com. We make available on or through our website, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practical after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We do not intend the address of our website to be an active link or to otherwise incorporate the contents of our website into this Annual Report.
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Risk Factors. |
The following risk factors could affect our business, financial condition or results of operations. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report because they could cause the actual results and conditions to differ materially from those projected in forward-looking statements. Before you buy our common stock, you should know that investing in our common stock involves risks, including the risks described below. The risks that are highlighted here are not the only ones we face. If the adverse matters referred to in any of the risks actually occur, our business, financial condition or operations could be adversely affected. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business
The Coronavirus Pandemic has impacted our business, financial condition and results of operations and will continue to have an impact, the scope and duration of which is highly uncertain and dependent on factors that are outside of our control.
For nearly the past three years, the ongoing Coronavirus Pandemic and efforts to control its spread have significantly impacted the movement of people, goods and services worldwide, including in most of or all of the regions in which we offer our services and conduct our business operations. The pandemic has resulted in, and may continue to or at a later time result in, a global slowdown of economic activity, including travel restrictions, prohibitions of non-essential activities in some cases, disruption and shutdown of businesses and greater uncertainty in global financial markets.
Overall, the ongoing Coronavirus Pandemic has caused a sustained global economic slowdown of varying durations across different industries, and it is possible that it could still cause a global recession. Deteriorating economic and political conditions caused by the ongoing Coronavirus Pandemic, such as increased unemployment, decreased capital spending, declines in consumer confidence and economic slowdowns or recessions, have caused and could continue to cause a decrease in demand for our products and services. The severity, magnitude and duration of the ongoing Coronavirus Pandemic is hard to predict due to uncertainty surrounding severity and transmission rates of new variants and rate of public acceptance and efficacy of vaccines and other treatments. We may not be able to respond to the impacts of the ongoing Coronavirus Pandemic on a timely basis to prevent near- or long-term adverse impacts on our results of operations. Although the immediate impacts of the Coronavirus Pandemic have been assessed and mitigated, the ultimate extent of the impact of this ongoing pandemic, including as a result of possible subsequent outbreaks of Coronavirus or new variants thereof and measures taken in response therein, will depend on future developments, which remain highly uncertain and cannot currently be predicted. Any negative impact on our business, financial condition, results of operations and cash flows cannot be reasonably estimated at this time, but the ongoing Coronavirus Pandemic could lead to extended disruption of economic activity and the impact on our business, financial condition, results of operations and cash flows could be material.
Although many health and safety restrictions have been lifted and vaccine distribution has increased, certain adverse consequences of the pandemic continue to impact the macroeconomic environment and may persist for some time. Given the ongoing dynamic nature of variants of the Coronavirus, it is difficult to predict the full impact of the ongoing Coronavirus Pandemic outbreak on our business. As the result of the ongoing Coronavirus Pandemic and the related adverse local and national economic consequences, we could be subject to a number of risks, any of which could have a material, adverse effect on our business, financial condition, liquidity and cash flow, results of operations, ability to execute our growth strategy and ability to pay cash dividends. These risks include, but are not limited to, the following:
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Increased loan losses or other impairments in our loan portfolios and increases in our allowance for credit losses, |
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Collateral for loans, especially real estate, may decline in value, which could cause an increase in loan losses, |
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Limitations may be placed on our ability to foreclose on properties we hold as collateral, |
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Our allowance for credit losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which would adversely affect our net income, |
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The net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us, |
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FDIC premiums may increase if the agency experiences additional resolution costs, |
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Litigation arising from our participation in the Small Business Administration’s Paycheck Protection Program, |
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Unanticipated unavailability of employees, |
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Increased cybersecurity risks as employees work remotely, |
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A triggering event leading to impairment testing on our goodwill or core deposit and customer relationships intangibles, which could result in an impairment charge, and |
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A prolonged weakness in economic conditions resulting in a reduction of future projected earnings could necessitate a valuation allowance against our current outstanding deferred tax assets. |
Changes in interest rates may reduce our net interest income, may result in higher defaults in a rising rate environment and may hurt our earnings and asset value.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Since March 2022, in response to inflation, the Federal Open Market Committee (“FOMC”) of the Federal Reserve has significantly increased the target range for the federal funds rate by hundreds of basis points. As it seeks to control inflation without creating a recession, the FOMC has indicated further increases are to be expected in 2023. If the FOMC further increases the targeted federal funds rate, overall interest rates will likely continue to rise, which will likely positively impact our net interest income but may negatively impact both the housing market by reducing refinancing activity and new home purchases and the U.S. economy. In addition, inflationary pressures may increase our operational costs and could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans which could negatively affect our financial performance.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect: (1) our ability to originate and/or sell loans and obtain deposits; (2) the fair value of our financial assets and liabilities, which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of such assets; (3) our ability to obtain and retain deposits in competition with other available investment alternatives; (4) the ability of our borrowers to repay adjustable or variable rate loans; and (5) the average duration of our investment securities portfolio and other interest-earning assets. If the interest rates paid on deposits and borrowings increase at a faster rate than the interest received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments decline more rapidly than the interest rates paid on deposits and other borrowings. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
Unfavorable global economic, geopolitical conflicts and other political conditions could adversely affect our business, financial condition or results of operations.
Our results of operations could be adversely affected by general conditions in the global economy, the global financial markets and global political conditions. The United States and global economies are facing high levels of inflation, higher interest rates and potential recession. Furthermore, a severe or prolonged economic downturn, including a recession or depression resulting from the ongoing Coronavirus Pandemic or political disruption, such as the war between Ukraine and Russia or political conflict between China and Taiwan, could result in a variety of risks to our business, including weakened demand for our products and services as well as our ability to raise additional capital if needed on acceptable terms. A weak or declining economy or political disruption, including any international trade disputes, could also strain our manufacturers or suppliers, possibly resulting in supply disruptions, or cause our customers to delay making payments for our products and services. Any of the foregoing could seriously harm our business, and we cannot anticipate all of the ways in which the political or economic climate and financial market conditions could seriously harm our business.
Significant declines in the value of commercial real estate could adversely impact us.
Approximately 62% of our total commercial loans, or about 50% of our total loans, relate to commercial real estate. Stressed economic conditions may reduce the value of commercial real estate and strain the financial condition of our commercial real estate borrowers, especially in the land development and non-owner occupied commercial real estate segments of our loan portfolio. Those difficulties could adversely affect us and could produce losses and other adverse effects on our business.
Market volatility may adversely affect us.
The capital and credit markets may experience volatility and disruption. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without apparent regard to those issuers’ underlying financial strength. Future levels of market disruption and volatility may have an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. We compete for deposits, loans and other financial services with numerous Michigan-based and national and regional banks, thrifts, credit unions and other financial institutions as well as other entities that provide financial services, including securities firms and mutual funds. Some of the financial institutions and financial service organizations with which we compete are not subject to the same degree of regulation as we are. Many of our competitors have been in business for many years, have established customer bases, are larger, have substantially higher lending limits than we do and offer larger branch networks and other services which we do not, including trust and international banking services. Most of these entities have greater capital and other resources than we do, which, among other things, may allow them to price their services at levels more favorable to the customer and to provide larger credit facilities than we do. This competition may limit our growth or earnings. Under specified circumstances (that have been modified by the Dodd-Frank Act and EGRRCPA), securities firms and insurance companies that elect to become financial holding companies under the Bank Holding Company Act may acquire banks and other financial institutions. Federal banking law affects the competitive environment in which we conduct our business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
Our risk management systems may fall short of their intended objectives.
We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review processes and other mechanisms. Our risk management process seeks to balance our ability to profit from investing or lending positions with our exposure to potential losses. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Thus, we may, in the course of our activities, incur losses.
We may not be able to successfully adapt to evolving industry standards and market pressures.
Our success depends, in part, on the ability to adapt products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. This can reduce net interest income and noninterest income from fee-based products and services. In addition, the widespread adoption of new technologies could require us to make substantial capital expenditures to modify or adapt existing products and services or develop new products and services. We may not be successful in introducing new products and services in response to industry trends or developments in technology, or those new products may not achieve market acceptance. As a result, we could lose business, be forced to price products and services on less advantageous terms to retain or attract clients, or be subject to cost increases. As a result, our business, financial condition, or results of operations may be adversely affected.
Our inability to execute or integrate potential future acquisitions successfully could impede us from realizing all of the benefits of the acquisitions, which could weaken our operations.
In addition to pursuing organic growth, we may also pursue strategic acquisition opportunities that we believe will fit our core philosophy and culture, enhance our profitability and provide appropriate risk-adjusted returns. These acquisition opportunities could be material to our business and involve a number of risks, including the following:
° intense competition from other banking organizations and other acquirers for potential merger candidates drives market pricing;
° time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions may divert human and capital resources without producing the desired returns;
° estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution or assets are inherently complex and may be inaccurate;
° potential exposure to unknown or contingent liabilities of targets; and
° regulatory timeframes for review of applications may limit the number and frequency of transactions we may be able to consummate.
If we are unable to successfully integrate potential future acquisitions, we could be impeded from realizing all of the benefits of those acquisitions and could weaken our business operations. The integration process may disrupt our business and, if implemented ineffectively, may preclude realization of the full benefits expected by us and could harm our results of operations. In addition, the overall integration of the combining companies may result in unanticipated problems, expenses, liabilities and competitive responses, and may cause our stock price to decline. The difficulties of integrating an acquisition include, among others:
° unanticipated issues in integration of information, communications and other systems;
° unanticipated incompatibility of logistics, marketing and administrative methods;
° maintaining employee morale and retaining key employees;
° integrating the business cultures of both companies;
° preserving important strategic client relationships;
° coordinating geographically diverse organizations; and
° consolidating corporate and administrative infrastructures and eliminating duplicative operations.
Finally, even if the operations of an acquisition are integrated successfully, we may not realize the full benefits of the acquisition, including the synergies, cost savings or growth opportunities we expect. These benefits may not be achieved within the anticipated time frame as well.
Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy, which, in turn, could have an adverse effect on our business, financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Even routine funding transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Our credit losses could increase and our allowance may not be adequate to cover actual loan losses.
The risk of nonpayment of loans is inherent in all lending activities, and nonpayment, when it occurs, may have a materially adverse effect on our earnings and overall financial condition as well as the value of our common stock. Our focus on commercial lending may result in a larger concentration of loans to small businesses. As a result, we may assume different or greater lending risks than other banks. We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for losses based on several factors. If our assumptions are wrong, our allowance may not be sufficient to cover our losses, which would have an adverse effect on our operating results. The actual amounts of future provisions for credit losses cannot be determined at this time and may exceed the amounts of past provisions. Additions to our allowance decrease our net income.
We rely heavily on our management and other key personnel, and the loss of any of them may adversely affect our operations.
We are and will continue to be dependent upon the services of our management team, including our executive officers and our other senior managers. The unanticipated loss of our executive officers, or any of our other senior managers, could have an adverse effect on our growth and performance.
In addition, we continue to depend on our key commercial loan officers. Several of our commercial loan officers are responsible, or share responsibility, for generating and managing a significant portion of our commercial loan portfolio. Our success can be attributed in large part to the relationships these officers as well as members of our management team have developed and are able to maintain with our customers as we continue to implement our community banking philosophy. The loss of any of these commercial loan officers could adversely affect our loan portfolio and performance, and our ability to generate new loans. Many of our key employees have signed agreements with us agreeing not to compete with us in one or more of our markets for specified time periods if they leave employment with us. However, we may not be able to effectively enforce such agreements.
Some of the other financial institutions in our markets also require their key employees to sign agreements that preclude or limit their ability to leave their employment and compete with them or solicit their customers. These agreements make it more difficult for us to hire loan officers with experience in our markets who can immediately solicit their former or new customers on our behalf.
Direct and indirect effects of climate change may adversely affect us.
Climate change presents immediate and long-term risks to us and to our customers and communities, with risks expected to increase over time. Climate change refers to risk of life and property damage occurring due to naturally occurring events induced by human behavior and can manifest in the form of physical risk and indirect risk. Physical risk refers to results of severe weather, such as floods, hurricanes, rising sea levels, fires and water availability. Indirect risk refers to how changes in regulation, conscious consumer choices, competition for sustainable products, and reduced demand for goods or services that produce significant green-house gas emissions may have on the results and operations of a company. Physical effects of climate change to our offices, branches or personnel could have an immediate adverse effect on our operations and financial condition, whereas indirect consequences may result in increased expenditures to comply with climate-related regulations.
Similarly, physical effects could have a severe impact on the business and operations of our customers and vendors. Furthermore, consumer choices and shareholder demands could require our customers to invest more in cleaner energy manufacturing and procurement and to compete with innovative new products that generate lower emissions, which may or may not be successful. If our customers are not able to keep up with evolving climate change effects, it could ultimately have an adverse effect on our business and results of operations. Lastly, like other financial institutions, we also run a reputational risk of financing businesses that are responsible for significant green-house gas emissions or are related to carbon-based energy sources. While our risk management framework monitors various types of risks and applies risk mitigation techniques including for environmental risks, and while we have been conscious of our own carbon footprint and have established an ESG Committee, introduction of new climate-related legislation and related compliance costs as well as the unpredictable effects of climate change on us or our customers could have a negative impact on our business, financial condition and results of operations, even if temporary in nature.
Failure to meet ESG expectations or standards, or achieve our ESG goals, could adversely affect our business, results of operations, financial condition or stock price.
There has been an increased focus from regulators and stockholders on ESG matters, including greenhouse gas emissions, sustainability and climate-related risks; diversity, equity and inclusion; responsible sourcing and supply chain; human rights and social responsibility; and corporate governance and oversight. Given our commitment to ESG, we actively manage these issues and have established and publicly announced certain goals, commitments and targets which we may refine or even expand further in the future. These goals, commitments and targets reflect our current plans and aspirations and are not guarantees that we will be able to achieve them. Evolving stakeholder expectations and our efforts and ability to manage these issues, provide updates on them and accomplish our goals, commitments and targets present numerous operational, regulatory, reputational, financial, legal and other risks, any of which may be outside of our control or could have a material adverse impact on our business, including on our reputation and stock price. Further, there is uncertainty around the accounting standards and climate-related disclosures associated with emerging laws and reporting requirements and the related costs to comply with the emerging regulations.
Our failure or perceived failure to achieve our ESG goals, maintain ESG practices or comply with emerging ESG regulations that meet evolving regulatory or stakeholder expectations could harm our reputation, adversely impact our ability to attract and retain customers and talent and expose us to increased scrutiny from the investment community and enforcement authorities. Our reputation also may be harmed by the perceptions that our stakeholders have about our action or inaction on ESG-related issues. Damage to our reputation and loss of brand equity may reduce demand for our products and services and thus have an adverse effect on our future financial results, as well as require additional resources to rebuild our reputation and could also reduce our stock price.
The adoption of the Secured Overnight Funding Rate may adversely affect interest income or expense, and may be more volatile than other benchmark or market interest rates.
On July 27, 2017, the United Kingdom Financial Conduct Authority (“FCA”), which oversees Libor, formally announced that it could not assure the continued existence of Libor in its current form beyond the end of 2021, and that an orderly transition process to one or more alternative benchmarks should begin. In June 2017, the Alternative Reference Rates Committee (“ARRC”), a steering committee comprised of large U.S. financial institutions organized by the Federal Reserve, announced that it had selected a modified version of the unpublished Broad Treasuries Financing Rate as the preferred alternative reference rate for U.S. dollar obligations. That rate, now referred to as SOFR, is determined based upon actual transactions in certain portions of the bi-lateral and tri-party overnight repurchase agreement markets for certain U.S. Treasury obligations. On April 3, 2018, the Federal Reserve Bank of New York (“FRBNY”) began publishing three new reference rates, including SOFR. SOFR is observed and backward-looking, which stands in contrast with Libor under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given the SOFR is a secured rate backed by government securities, it is a rate that does not take into account bank credit risk (as is the case with Libor). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions.
During 2019 and 2020, among other things, the ARRC published a white paper on ways in which market participants could use SOFR in cash markets, conducted surveys of market participants, engaged with cognizant U.S. government agencies and private sector groups regarding tax, securities, and derivatives issues presented by the transition from Libor, published sample transition provisions for a variety of types of loan and note agreements, and investigated methods by which a forward-looking term SOFR index could be established. To facilitate the development of a generally-recognized forward-looking SOFR index, on March 2, 2020 the FRBNY began publication of 30-, 90-, and 180-day SOFR Averages, as well as a SOFR Index, on each business day. The FRBNY has stated that it will consider the potential benefits of introducing calendar month-based rates and/or adding further tenors as additional reference rates.
In November 2020, the ICE Benchmark Administration announced a consultation regarding the cessation of the publication of Libor. The consultation proposed a December 31, 2021 cessation for all tenors of various foreign currencies and for the one week and two-month U.S. dollar Libor, and a June 30, 2023 cessation for the remaining overnight, one-month, three-month, six-month and twelve-month U.S. dollar Libor tenors. This represented an 18-month extension of Libor publication for the most frequently used tenors of U.S. dollar Libor from the cessation date originally proposed in 2017. The consultation period closed on January 25, 2021. The ICE Benchmark Administration concluded the consultation on its intent to cease publication of one-week and two-month U.S. dollar Libor on December 31, 2021 and to extend the publication of all remaining U.S. dollar Libor tenors until June 30, 2023 for legacy contracts.
Effective January 1, 2022, we replaced the 30-Day Libor Rate with the CME Term SOFR Rate for all new floating rate commercial loan commitments. It is expected that currently outstanding commercial loans tied to the 30-Day Libor Rate will convert to an equivalent fallback SOFR Rate on or about June 30, 2023.
The FRBNY, who originally started publishing SOFR, states that it obtains information from DTCC Solutions LLC, an affiliate of DTCC. FRBNY currently publishes SOFR daily on its website at https://apps.newyorkfed.org/markets/autorates/sofr. FRBNY states that use of SOFR is subject to important disclaimers, limitations and indemnification obligations, including that FRBNY may alter the methods of calculations, publication schedule, rate revision practices or availability of SOFR at any time without notice. The foregoing Internet website is an inactive textual reference only, meaning that the information contained on the website is not part of this filing or incorporated by reference herein.
Since the initial publication of SOFR, daily changes in the rate have, on occasion, been more volatile than daily changes in comparable benchmark or market interest rates, and SOFR over time may bear little or no relation to the historical actual or historical indicative data. In addition, the return on and value of SOFR-linked instruments may fluctuate more than floating rate securities that are linked to less volatile interest rates.
Changes in SOFR could adversely affect the amount of interest that accrues on SOFR-linked instruments.
Because SOFR is published by the FRBNY based on data received from other sources, we have no control over its determination, calculation or publication. There can be no assurance that SOFR will not be discontinued or fundamentally altered in a manner that is materially adverse to the interests of investors in SOFR-linked instruments. If the manner in which SOFR is calculated is changed, that change may result in a change in the amount of interest that accrues on the SOFR-linked instruments. In addition, the interest rate on SOFR-linked instruments may for any day not be adjusted for any modification or amendments to SOFR for that day that the FRBNY may publish if the interest rate for that day has already been determined prior to such determination. There is no assurance that changes in SOFR could not have a material adverse effect on the yield on, value of, and market for SOFR-linked instruments, which could have a material adverse effect on our business.
Further, SOFR is a relatively new interest rate, and the FRBNY or any successor, as administrator of SOFR, may make methodological or other changes that could change the value of SOFR, including changes related to the methodology by which SOFR is calculated, eligibility criteria applicable to the transactions used to calculate SOFR or timing related to the publication of SOFR. If the manner in which SOFR is calculated is changed, the change may result in a reduction of the amount of interest payable on loans we have made to customers, which could have a material adverse effect on our business. The administrator of SOFR may withdraw, modify, suspend or discontinue the calculation or dissemination of SOFR in its sole discretion and without notice, and has no obligation to consider the interests of investors in calculating, withdrawing, modifying, amending, suspending or discontinuing SOFR.
Our accounting policies and methods are the basis for how we prepare our consolidated financial statements, and they require management to make estimates about matters that are inherently uncertain.
Accounting policies and processes are fundamental to how we record and report our financial condition and results of operations. We must exercise judgment in selecting and applying many of these accounting policies and processes so they comply with U.S. GAAP. In some cases, we must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in our reporting materially different results than would have been reported under a different alternative.
We have identified certain accounting policies as being critical because they require us to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. We have established detailed policies and control procedures that are intended to ensure these critical accounting estimates and judgments are well controlled and applied consistently. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. Because of the uncertainty surrounding management’s judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust accounting policies or restate prior period financial statements. For additional information, see “Critical Accounting Estimates” beginning on page F-3 of this Annual Report and “Note 1 – Summary of Significant Accounting Policies” beginning on page F-41 of this Annual Report.
We continually encounter technological change, and we may have fewer resources than our competitors to continue to invest in technological improvements.
The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we do. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
Damage to our reputation could materially harm our business.
Our relationship with many of our clients is predicated upon our reputation as a fiduciary and a service provider that adheres to the highest standards of ethics, service quality and regulatory compliance. Adverse publicity, regulatory actions, litigation, operational failures, the failure to meet client expectations and other issues with respect to one or more of our businesses could materially and adversely affect our reputation, our ability to attract and retain clients or our sources of funding for the same or other businesses. Preserving and enhancing our reputation also depends on maintaining systems and procedures that address known risks and regulatory requirements, as well as our ability to identify and mitigate additional risks that arise due to changes in our businesses and the marketplaces in which we operate, the regulatory environment and client expectations. If any of these developments has a material effect on our reputation, our business will suffer.
Our business is subject to operational risks.
We, like most financial institutions, are exposed to many types of operational risks, including the risk of fraud by employees or outsiders, unauthorized transactions by employees or operational errors. To date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but our systems and those of our customers and third-party service providers are under constant threat, and it is possible that we could experience a significant event in the future. Operational errors may include clerical or record keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Given our volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully corrected. Our necessary dependence upon automated systems to record and process our transaction volume may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.
We may also be subject to disruptions of our operating systems arising from events that are wholly or partially beyond our control, including, for example, computer viruses or electrical or telecommunications outages, which may give rise to losses in service to customers and to loss or liability to us. We are further exposed to the risk that our external vendors may be unable to fulfill their contractual obligations to us, or will be subject to the same risk of fraud or operational errors by their respective employees as are we, and to the risk that our or our vendors’ business continuity and data security systems prove not to be adequate. We also face the risk that the design of our controls and procedures proves inadequate or is circumvented, causing delays in detection or errors in information. Although we maintain a system of controls designed to keep operational risks at appropriate levels, there can be no assurance that we will not suffer losses from operational risks in the future that may be material in amount.
We face the risk of cyber-attack to our computer systems.
In the ordinary course of business, we collect and store sensitive data, including proprietary business information and personally identifiable information of our customers and employees in systems and on networks. The secure processing, maintenance and use of this information is critical to our operations. To date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but our systems and those of our customers and third-party service providers are under constant threat, and it is possible that we could experience a significant event in the future. Cybersecurity threats include unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. Remote working of employees during the Coronavirus Pandemic introduces additional potential cybersecurity risks due to the use of home networks, video conferencing and other remote work technologies over which we do not have as much control as our internal systems. Cyber threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. We cannot assure that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses as a result of third-party failures, and insurance coverage may be inadequate to cover all losses resulting from breaches, systems failures or other disruptions. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of internet banking, mobile banking and other technology-based products and services by us and our customers. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.
As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customers’ information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased.
In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. In August 2019, the federal bank regulatory agencies issued a statement recommending that banking organizations use a standardized approach to assess and improve cybersecurity preparedness. The agencies noted that the use of standardized tools, such as the FFIEC Cybersecurity Assessment Tool, makes firms better able to track their progress over time, and to share information and best practices with other financial institutions, a behavior which the bank regulatory agencies encourage. In April 2020, the federal banking agencies issued a statement highlighting the risks presented by banking organizations’ use of cloud computing services in their business. The statement noted specific risks unique to the cloud computing environment, and the importance of ongoing controls of virtual infrastructure, care in the use of containers for data, and the sensitivity of use of managed security services, among other things. Although guidance of this nature does not have the full force and effect of law, it sets out supervisory priorities and expectations regarding safe and sound operation. Failure to observe such guidance may result in supervisory identification of unsafe or unsound practices or other deficiencies in risk management or other areas that do not constitute violations of law or regulation.
Regulatory Risks
We are subject to significant government regulation, and any regulatory changes may adversely affect us.
The banking industry is subject to extensive regulation, supervision and legal requirements under both federal and state law that govern almost all aspects of our operations. These regulations are primarily intended to protect customers, the federal deposit insurance fund, and the stability of the U.S. financial system, not our creditors or shareholders. Existing state and federal banking laws subject us to substantial limitations with respect to our activities, including the making of loans, the purchase of securities, the payment of dividends and many other aspects of our business. Some of these laws may benefit us, others may increase our costs of doing business, or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, which may be accelerated by changes in the administration of federal and state governments, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition. Federal economic and monetary policy may also affect our ability to attract deposits, make loans and achieve satisfactory interest spreads. The implementation, amendment or repeal of federal financial services laws or regulations may limit our business opportunities, impose additional costs on us, impact our revenues or the value of our assets, or otherwise adversely affect our business, financial condition or results of operations.
Minimum capital requirements may adversely affect our ability (and that of our bank) to pay cash dividends, reduce our profitability, or otherwise adversely affect our business, financial condition or results of operations.
We are subject to extensive capital regulations imposed by federal and state banking regulations. These regulations, among other things, establish minimum requirements to qualify as a “well-capitalized” institution. If our bank were to fail to maintain its status of “well-capitalized” under the applicable regulatory capital regulations, we may lose our status as a financial holding company and be subjected to a consent agreement requiring us to bring our bank back to a “well-capitalized” status. Such an agreement may impose restrictions on our activities. If we were to fail to enter into such an agreement, or fail to comply with the terms of such agreement, the Federal Reserve may impose more severe restrictions on our activities, including requiring us to cease and desist activities permitted under the Bank Holding Company Act of 1956. The regulatory environment is constantly evolving, with requirements frequently being introduced or amended. It is possible that increases in regulatory capital requirements and changes in how regulatory capital is calculated could require us to increase our capital levels by issuing additional securities that qualify as regulatory capital, thus potentially diluting our existing shareholders, or by taking other actions, such as selling assets, in order to maintain required capital ratios. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations, cash flow and financial condition.
Risks Related to Our Stock
Issuance of debt securities or sales of our common stock or other securities may dilute the value of our common stock.
We have issued both trust preferred securities and subordinated notes. In the event of our liquidation, the holders of our debt securities would receive a distribution of our available assets before distributions are made to holders of our common stock. In many situations, our Board of Directors has the authority, without any vote of our shareholders, to issue shares of our authorized but unissued preferred or common stock, including shares authorized and unissued under our equity incentive plans. In the future, we may issue additional debt or equity securities, through public or private offerings, in order to raise additional capital. Any such issuance of equity securities would dilute the percentage of ownership interest of existing shareholders and may dilute the per share book value of the common stock. In addition, option holders under our stock-based incentive plans may exercise their options at a time when we would otherwise be able to obtain additional equity capital on more favorable terms.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We may need or want to raise additional capital in the future by issuing debt or equity securities to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, particularly if our asset quality or earnings were to deteriorate significantly. Our ability to raise additional capital will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. Economic conditions and any loss of confidence in financial institutions generally may increase our cost of funding and limit access to certain customary sources of capital.
There can be no assurance that capital will be available on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decrease in our credit rating or a decline in the confidence of equity or debt purchasers, or counterparties participating in the capital markets, may adversely affect our capital costs and our ability to raise capital and, potentially, our liquidity. Also, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our business, financial condition and results of operations.
Our Articles of Incorporation and By-laws and the laws of the State of Michigan contain provisions that may discourage or prevent a takeover of our company and reduce any takeover premium.
Our Articles of Incorporation and By-laws, and the corporate laws of the State of Michigan, include provisions which are designed to provide our Board of Directors with time to consider whether a hostile takeover offer is in our and our shareholders’ best interest. These provisions, however, could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of our common stock to participate in tender offers, including tender offers at a price above the then-current market price for our common stock. These provisions could also prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interest.
The Michigan Business Corporation Act contains provisions intended to protect shareholders and prohibit or discourage various types of hostile takeover activities. In addition to these provisions and the provisions of our Articles of Incorporation and By-laws, federal law requires the Federal Reserve Board’s approval prior to acquiring “control” of a bank holding company. All of these provisions may delay or prevent a change in control without action by our shareholders and could adversely affect the price of our common stock.
There is a limited trading market for our common stock.
The price of our common stock has been, and will likely continue to be, subject to fluctuations based on, among other things, economic and market conditions for bank holding companies and the stock market in general, as well as changes in investor perceptions of our company. The issuance of new shares of our common stock also may affect the market for our common stock.
Our common stock is traded on the Nasdaq Global Select Market under the symbol “MBWM.” The development and maintenance of an active public trading market depends upon the existence of willing buyers and sellers, the presence of which is beyond our control. While we are a publicly-traded company, the volume of trading activity in our stock is still relatively limited. Even if a more active market develops, there can be no assurance that such a market will continue, or that our shareholders will be able to sell their shares at or above the price at which they acquired shares.
The value of securities in our investment securities portfolio may be negatively affected by disruptions in securities markets.
Prices and volumes of transactions in the nation’s securities markets can be affected suddenly by economic crises, or by other national or international crises, such as national disasters, acts of war or terrorism, changes in commodities markets, or instability in foreign governments. Disruptions in securities markets may detrimentally affect the value of securities that we hold in our investment portfolio, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that declines in market value associated with these disruptions will not result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
| Item 1B. |
Unresolved Staff Comments |
We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more before the end of our 2022 fiscal year and that remain unresolved.
| Item 2. |
Properties. |
Our headquarters is located in our bank’s main office facility in Grand Rapids, Michigan. Our bank operates 46 banking offices primarily concentrated throughout Western and Central Michigan, most of which are full-service facilities. We also have a banking office in Troy, Michigan, and residential mortgage loan production offices in Midland and Petoskey, Michigan and the Cincinnati, Ohio metropolitan area. We have larger banking facilities in Kalamazoo, Lansing, Mt. Pleasant and West Branch. The remaining banking offices generally range in size from 1,200 to 3,200 square feet, based on the location and number of employees located at the facility. All of our banking offices are owned by our bank except for eleven that are rented under various operating lease agreements. In several instances, the banking offices contain more usable space than what is needed for current banking operations. This excess space, totaling approximately 23,500 square feet, is generally leased to unrelated businesses. In addition, certain functions operate out of our standalone facility located in Alma, Michigan.
We consider our properties and equipment to be well maintained, in good operating condition and capable of accommodating current growth forecasts. However, we may choose to add branch locations to expand our presence in current markets and/or in new markets or, alternatively, to consolidate, close or relocate branches if we believe it would be beneficial to our overall performance.
| Item 3. |
Legal Proceedings. |
From time to time, we may be involved in various legal proceedings that are incidental to our business. In the opinion of management, we are not a party to any legal proceedings that are material to our financial condition, either individually or in the aggregate.
| Item 4. |
Mine Safety Disclosures. |
Not applicable.
PART II
| Item 5. |
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Market Information and Holders
Our common stock is traded on the Nasdaq Global Select Market under the symbol “MBWM.” At March 1, 2023, there were approximately 1,200 record holders of our common stock. In addition, we estimate that there were approximately 7,000 beneficial owners of our common stock who own their shares through brokers or banks.
Dividend Policy
The following table shows the high and low sales prices for our common stock as reported by the Nasdaq Global Select Market for the periods indicated and the quarterly cash dividends paid by us during those periods.
| High |
Low |
Dividend |
||||||||||
| 2022 |
||||||||||||
| First Quarter |
$ | 40.01 | $ | 34.93 | $ | 0.31 | ||||||
| Second Quarter |
36.04 | 30.10 | 0.31 | |||||||||
| Third Quarter |
39.03 | 29.26 | 0.32 | |||||||||
| Fourth Quarter |
36.36 | 30.02 | 0.32 | |||||||||
| 2021 |
||||||||||||
| First Quarter |
$ | 34.47 | $ | 26.75 | $ | 0.29 | ||||||
| Second Quarter |
33.41 | 29.65 | 0.29 | |||||||||
| Third Quarter |
33.18 | 28.51 | 0.30 | |||||||||
| Fourth Quarter |
37.33 | 32.13 | 0.30 | |||||||||
Holders of our common stock are entitled to receive dividends that the Board of Directors may declare from time to time. We may only pay dividends out of funds that are legally available for that purpose. We are a financial holding company and substantially all of our assets are held by our bank and its subsidiaries. Our ability to pay dividends to our shareholders depends primarily on our bank’s ability to pay dividends to us. Dividend payments and extensions of credit to us from our bank are subject to legal and regulatory limitations, generally based on capital levels and current and retained earnings, imposed by law and regulatory agencies with authority over our bank. The ability of our bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. In addition, under the terms of our subordinated debentures, we would be precluded from paying dividends on our common stock if an event of default has occurred and is continuing under the subordinated debentures, or if we exercised our right to defer payments of interest on the subordinated debentures, until the deferral ended.
We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on our financial statements. Our bank’s ability to pay cash and stock dividends or repurchase equity securities is subject to limitations under various laws and regulations and to prudent and sound banking practices.
On January 13, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $0.31 per share that was paid on March 16, 2022 to shareholders of record as of March 4, 2022. On April 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $0.31 per share that was paid on June 15, 2022 to shareholders of record as of June 3, 2022. On July 14, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $0.32 per share that was paid on September 14, 2022 to shareholders of record as of September 2, 2022. On October 13, 2022, our Board of Directors declared a cash dividend on our common stock in the amount of $0.32 per share that was paid on December 14, 2022 to shareholders of record as of December 2, 2022.
On January 14, 2021, our Board of Directors declared a cash dividend on our common stock in the amount of $0.29 per share that was paid on March 17, 2021 to shareholders of record as of March 5, 2021. On April 15, 2021, our Board of Directors declared a cash dividend on our common stock in the amount of $0.29 per share that was paid on June 16, 2021 to shareholders of record as of June 4, 2021. On July 15, 2021, our Board of Directors declared a cash dividend on our common stock in the amount of $0.30 per share that was paid on September 15, 2021 to shareholders of record as of September 3, 2021. On October 14, 2021, our Board of Directors declared a cash dividend on our common stock in the amount of $0.30 per share that was paid on December 15, 2021 to shareholders of record as of December 3, 2021.
On January 12, 2023, our Board of Directors declared a cash dividend on our common stock in the amount of $0.33 per share that will be paid on March 15, 2023 to shareholders of record as of March 3, 2023.
Issuer Purchases of Equity Securities
On May 27, 2021, we announced that our Board of Directors had authorized a program to repurchase up to $20.0 million of our common stock from time to time in open market transactions at prevailing market prices or by other means in accordance with applicable regulations. The actual timing, number and value of shares repurchased under the program will be determined by management in its discretion and will depend on a number of factors, including the market price of our stock, general market and economic conditions, our capital position, financial performance and alternative uses of capital, and applicable legal requirements. The program may be discontinued at any time. No shares were repurchased during 2022. Historically, stock repurchases have been funded from cash dividends paid to us from our bank. Additional repurchases may be made in future periods under the authorized plan or a new plan, which would also likely be funded from cash dividends paid to us from our bank. As of December 31, 2022, repurchases aggregating $6.8 million were available to be made under the current repurchase program.
Repurchases made during the fourth quarter of 2022 are detailed in the table below.
| Period |
(a) Total Number of Shares Purchased |
(b) Average Price Paid Per Share |
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
(d) Maximum Number of Shares or Approximate Dollar Value that May Yet Be Purchased Under the Plans or Programs |
||||||||||||
| October 1 – 31 |
0 | $ | NA |
0 | $ | 6,818,000 | ||||||||||
| November 1 – 30 |
0 | NA |
0 | 6,818,000 | ||||||||||||
| December 1 – 31 |
0 | NA |
0 | 6,818,000 | ||||||||||||
| Total |
0 | $ | NA |
0 | $ | 6,818,000 | ||||||||||
Shareholder Return Performance Graph
Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on our common stock (based on the last reported sales price of the respective year) with the cumulative total return of the Nasdaq Composite Index and the SNL Bank Nasdaq Index from December 31, 2017 through December 31, 2022. The following is based on an investment of $100 on December 31, 2017 in our common stock, the Nasdaq Composite Index and the SNL Bank Nasdaq Index, with dividends reinvested where applicable.
| Period Ending |
||||||||||||||||||||||||
| Index |
12/31/17 |
12/31/18 |
12/31/19 |
12/31/20 |
12/31/21 |
12/31/22 |
||||||||||||||||||
| Mercantile Bank Corporation |
100.00 | 84.26 | 112.35 | 87.59 | 117.18 | 116.19 | ||||||||||||||||||
| NASDAQ Composite Index |
100.00 | 97.16 | 132.81 | 192.47 | 235.15 | 158.65 | ||||||||||||||||||
| KBW Bank NASDAQ Index |
100.00 | 82.29 | 112.01 | 100.46 | 138.97 | 109.23 | ||||||||||||||||||
| Item 6. |
Reserved. |
| Item 7. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Management’s Discussion and Analysis included in this Annual Report is incorporated here by reference.
| Item 7A. |
Quantitative and Qualitative Disclosures About Market Risk. |
The information under the heading “Market Risk Analysis” included in this Annual Report is incorporated here by reference.
| Item 8. |
Financial Statements and Supplementary Data. |
The Consolidated Financial Statements, the Notes to Consolidated Financial Statements and the Reports of Independent Registered Public Accounting Firm included in this Annual Report are incorporated here by reference.
| Item 9. |
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. |
None
| Item 9A. |
Controls and Procedures. |
As of December 31, 2022, an evaluation was performed under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of December 31, 2022.
There have been no significant changes in our internal control over financial reporting during the year ended December 31, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2022. This evaluation was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2022. Refer to page F-32 for management’s report.
Our independent registered public accounting firm has issued an audit report on our internal control over financial reporting which is included in this Annual Report.
| Item 9B. |
Other Information. |
None
PART III
| Item 10. |
Directors, Executive Officers and Corporate Governance. |
The information presented under the captions “Election of Directors,” “Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance – Code of Ethics” in the definitive Proxy Statement of Mercantile Bank Corporation for our May 25, 2023 Annual Meeting of Shareholders (the “Proxy Statement”), a copy of which will be filed with the Securities and Exchange Commission before April 30, 2023, is incorporated here by reference.
| Item 11. |
Executive Compensation. |
The information presented under the captions “Executive Compensation,” “Corporate Governance – Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the Proxy Statement is incorporated here by reference.
| Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. |
The information presented under the caption “Stock Ownership of Certain Beneficial Owners and Management” in the Proxy Statement is incorporated here by reference.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2022, relating to compensation plans under which equity securities are authorized for issuance.
| Plan Category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights |
Weighted- average exercise price of outstanding options, warrants and rights |
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) |
|||||||||
| (a) |
(b) |
(c) |
||||||||||
| Equity compensation plans approved by security holders |
5,000 | $ | 36.22 | 66,000 | (1) | |||||||
| Equity compensation plans not approved by security holders |
0 | 0 | 0 | |||||||||
| Total |
5,000 | $ | 36.22 | 66,000 | ||||||||
(1) These securities are available under the Stock Incentive Plan of 2020. Incentive awards may include, but are not limited to, stock options, restricted stock, stock appreciation rights and stock awards.
| Item 13. |
Certain Relationships and Related Transactions, and Director Independence. |
The information presented under the captions “Transactions with Related Persons” and “Corporate Governance – Director Independence” in the Proxy Statement is incorporated here by reference.
| Item 14. |
Principal Accountant Fees and Services. |
The information presented under the caption “Principal Accountant Fees and Services” in the Proxy Statement is incorporated here by reference.
PART IV
| Item 15. |
Exhibits and Financial Statement Schedules |
(a) (1) Financial Statements. The following financial statements and reports of the independent registered public accounting firm of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets --- December 31, 2022 and 2021
Consolidated Statements of Income for each of the three years in the period ended December 31, 2022
Consolidated Statements of Comprehensive Income (Loss) for each of the three years in the period ended December 31, 2022
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2022
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2022
Notes to Consolidated Financial Statements
The Consolidated Financial Statements, the Notes to Consolidated Financial Statements, and the Reports of Independent Registered Public Accounting Firm listed above are incorporated by reference in Item 8 of this report.
| (2) |
Financial Statement Schedules |
Not applicable
| (b) |
Exhibits: |
The Exhibit Index immediately preceding the Signatures Page hereto is incorporated by reference under this item.
| (c) |
Financial Statements Not Included In Annual Report |
Not applicable
| Item 16. |
Form 10-K Summary |
None
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2022 and 2021
FINANCIAL INFORMATION
December 31, 2022 and 2021
CONTENTS
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion and other portions of this Annual Report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates, and projections about the financial services industry, the economy, and our company. Words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “is likely,” “plans,” “projects,” “indicates,” “strategy,” “future,” “likely,” “may,” “should,” “will,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“Future Factors”) that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. We undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events (whether anticipated or unanticipated), or otherwise.
Future Factors include, among others, adverse changes in interest rates and interest rate relationships; increasing rates of inflation and slower growth rates; significant declines in the value of commercial real estate; market volatility; demand for products and services; climate impacts; labor markets; the degree of competition by traditional and non-traditional financial services companies; changes in banking regulation or actions by bank regulators; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; potential cyber-attacks, information security breaches, and other criminal activities; litigation liabilities; governmental and regulatory policy changes; the outcomes of existing or future contingencies; trends in customer behavior as well as their ability to repay loans; changes in local real estate values; damage to our reputation resulting from adverse publicity, regulatory actions, litigation, operational failures, and the failure to meet client expectations and other facts; changes in the method of determining Libor and the phase-out of Libor; changes in the national and local economies, including the ongoing disruption to supply chain and financial markets caused by the Coronavirus Pandemic and unstable political and economic environments; and risk factors described in our annual report on Form 10-K for the year ended December 31, 2022. These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and a forward-looking statement.
Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
CRITICAL ACCOUNTING ESTIMATES
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“Management’s Discussion and Analysis”) is based on Mercantile Bank Corporation’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our critical accounting estimates are highly dependent upon subjective or complex judgments and assumptions, and changes in such may have a significant impact on the financial statements, just as actual results may differ. We have reviewed the application of our critical accounting estimates with the Audit Committee of our Board of Directors.
Allowance For Credit Losses (“allowance”): The allowance is maintained at a level we believe is adequate to absorb estimated credit losses identified and inherent in the loan portfolio. Our evaluation of the adequacy of the allowance is an estimate based on past loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, guidance from bank regulatory agencies, and assessments of the impact of current and anticipated economic conditions on the loan portfolio. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. Credit losses are charged against the allowance when we believe the uncollectibility of a loan is likely. The balance of the allowance represents our best estimate, but significant downturns in circumstances relating to loan quality or economic conditions could result in a requirement for an increased allowance in the future. Likewise, an upturn in loan quality or improved economic conditions may result in a decline in the required allowance in the future. In either instance, unanticipated changes could have a significant impact on the allowance and operating results. The allowance is increased through a provision charged to operating expense. Uncollectible loans are charged-off through the allowance, while recoveries of loans previously charged-off are added to the allowance.
In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended by ASU 2018-19) significantly changed how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This standard replaced the “incurred loss” approach with an “expected loss” model. Referred to as the current expected credit loss (“CECL”) model, this standard applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expanded disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. In addition, entities need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU was effective for interim and annual reporting periods beginning after December 15, 2019.
Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continued to experience an unprecedented economic environment whereby a sizable portion of the economy had been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus was provided to businesses, individuals and state and local governments and financial institutions offered businesses and individuals payment relief options, economic forecasts were regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL until January 1, 2022, and continued to use our incurred loan loss reserve model as permitted through December 31, 2021.
We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, and a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.
See Note 1 – Significant Accounting Policies in the Notes to our Consolidated Financial Statements in this Form 10-K for additional information on our estimation process and methodology related to the allowance. See also Note 3 – Loans and Allowance for Credit Losses in the Notes to our Consolidated Financial Statements in this Form 10-K for further information regarding our loan portfolio and allowance.
Mortgage Servicing Rights: Mortgage servicing rights are recognized as assets based on the allocated fair value of retained servicing rights on loans sold. Servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing income. We utilize a discounted cash flow model to determine the value of our servicing rights. The valuation model utilizes mortgage loan prepayment speeds, the remaining life of the mortgage loan pool, delinquency rates, our cost to service loans, and other factors to determine the cash flow that we will receive from servicing each grouping of loans. These cash flows are then discounted based on current interest rate assumptions to arrive at the fair value of the right to service those loans. Impairment is evaluated quarterly based on the fair value of the servicing rights, using groupings of the underlying loans classified by interest rates. Any impairment of a grouping is reported as a valuation allowance.
Goodwill: Accounting rules require us to determine the fair value of all the assets and liabilities of an acquired entity, and to record their fair value on the date of acquisition. We employ a variety of means in determining fair value, including the use of discounted cash flow analysis, market comparisons and projected future revenue streams. For those items for which we conclude that we have the appropriate expertise to determine fair value, we may choose to use our own calculation of fair value. In other cases, where the fair value is not readily determined, consultation with outside parties is used to determine fair value. Once valuations have been determined, the net difference between the price paid for the acquired entity and the fair value of the balance sheet is recorded as goodwill. Goodwill is assessed at least annually for impairment, with any such impairment recognized in the period identified. A more frequent assessment is performed if there are material changes in the market place or within the organizational structure.
INTRODUCTION
This Management’s Discussion and Analysis should be read in conjunction with the consolidated financial statements contained in this Annual Report. This discussion provides information about the consolidated financial condition and results of operations of Mercantile Bank Corporation and its consolidated subsidiary, Mercantile Bank (“our bank”), and Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank. Unless the text clearly suggests otherwise, references to “us,” “we,” “our,” or “the company” include Mercantile Bank Corporation and its wholly-owned subsidiaries referred to above.
CORONAVIRUS PANDEMIC
Although virtually all related restrictions have been terminated, impacts remain across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). Overall, the Coronavirus Pandemic has caused a sustained global economic slowdown of varying durations across different industries, and it is possible that it could still cause a global recession as a result of deteriorating economic and political conditions such as increased unemployment, decreased capital spending, declines in consumer confidence, and economic slowdowns. This uncertainty is heightened in certain geographic areas due to continued surges in Covid-19 cases, and governments at all levels continue to react to changes in circumstances, including vaccine hesitancy, booster shot efficacy, supply chain disruptions and inflationary pressures. For example, although many health and safety restrictions have been lifted and vaccine distribution has increased, certain adverse consequences of the Coronavirus Pandemic continue to impact the macroeconomic environment and may persist for some time, including labor shortages and disruptions of global supply chains, particularly in China and other parts of Asia. In addition, this uncertainty is further heightened by the possibility that new and highly infectious variants and subvariants of Covid-19 might arise which are more severe, more transmissible, and capable of evading vaccinations, booster shots and prior immunity.
The Coronavirus Pandemic has had a significant impact on our financial condition and operating results since its onset in March, 2020. Federal government stimulus programs resulted in a massive increase to the money supply, providing significant inflationary pressures that the Federal Reserve’s Federal Open Market Committee (“FOMC”) has been attempting to manage through substantial increases in the federal funds rate since March, 2022. In addition, we experienced significant growth in liquidity as federal government stimulus monies were deposited by program recipients, providing for sizable impacts to our operating performance as well as our capital and liquidity positions during 2022 and 2021.
The following section summarizes the primary Covid-19 related measures that directly impacted us and our customers.
| ● |
Paycheck Protection Program |
| The Paycheck Protection Program (“PPP”) reflected a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, and self-employed and individual contractors. The PPP provided 100% guaranteed loans to cover specific operating costs. PPP loans were eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent, and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee from the Small Business Administration. The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology. The program ended on August 8, 2020. We originated approximately 2,200 loans aggregating $554 million. As of December 31, 2022, we recorded forgiveness transactions on all but five loans aggregating $0.5 million. Net loan origination fees of less than $0.1 million were recorded during 2022.
The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in Second Draw PPP loans (“Second Draw”). This program ended on May 31, 2021. Under the Second Draw, we originated approximately 1,200 loans aggregating $209 million. As of December 31, 2022, we recorded forgiveness transactions on all but six loans aggregating $0.4 million. Net loan origination fees of $1.0 million were recorded during 2022. |
| ● |
Individual Economic Impact Payments |
| The Internal Revenue Service made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks. In general, and subject to adjusted gross income limitations, qualifying individuals received payments of $1,200 in April 2020, $600 in January 2021, and $1,400 in March 2021. |
| ● |
Troubled Debt Restructuring Relief |
| From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022. We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021. |
| ● |
Current Expected Credit Loss Methodology Delay |
| Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022. We adopted the CECL methodology effective January 1, 2022. |
We continue to monitor the situation, including cases of sickness within our workforce, and will take action to adjust office attendance policies as circumstances warrant in order to protect the health and safety of employees, contractors, and others who visit our offices. However, if the Coronavirus Pandemic worsens and shutdown orders are issued in the future, our ability to operate could be adversely impacted, depending on the language of such orders. The extent to which the Coronavirus Pandemic continues to impact us will depend on future developments, which are highly uncertain and cannot be predicted.
CLIMATE CHANGE
Increased public and investor concern about climate change will likely continue to (1) generate more regional and/or national requirements to reduce greenhouse gas emissions; (2) increase energy efficiency and reduce carbon pollution; and (3) cause a shift to cleaner and more sustainable sources of energy which may be more expensive than using fossil fuels as an energy source. The potential impact of climate changes on our operations and the needs of our customers remains uncertain. Scientists have proposed that the impacts of climate change could include changes in rainfall patterns, water shortages, changes to the water levels of lakes and other bodies of water, changing storm patterns and intensities, and changing temperature levels. These changes could be severe and vary by geographic location. Climate change may also affect the occurrence of certain natural events, the incidence and severity of which are inherently unpredictable. We could also face indirect financial risks passed through the supply chain that could result in higher prices for resources, such as energy. Additionally, climate change may adversely impact the demand, prices, and availability of property and casualty insurance that insures our loan collateral. Due to significant economic variability associated with potential future changing climate conditions, we are unable to predict the impact climate change will have on us.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE MATTERS
There has been an increased focus from regulators and stakeholders on environmental, social, and governance (“ESG”) matters, including greenhouse gas emissions, sustainability, and climate-related risks; diversity, equity and inclusion; responsible sourcing and supply chain; human rights and social responsibility; and corporate governance and oversight. Given our commitment to ESG matters, we actively manage these issues and have established and publicly announced certain goals, commitments, and targets which we may refine or even expand further in the future. These goals, commitments, and targets reflect our current plans and aspirations and are not guarantees that we will be able to achieve them. Evolving stakeholder expectations and our efforts and ability to manage these issues, provide updates on them, and accomplish our goals, commitments, and targets present numerous operational, regulatory, reputational, financial, legal, and other risks, any of which may be outside of our control or could have a material adverse impact on our business, including on our reputation and stock price. Further, there is uncertainty around the accounting standards and climate-related disclosures associated with emerging laws and reporting requirements and the related costs to comply with the emerging regulations. Our failure or perceived failure to achieve our ESG goals, maintain ESG practices, or comply with emerging ESG regulations that meet evolving regulatory or stakeholder expectations could harm our reputation, adversely impact our ability to attract and retain customers and talent, and expose us to increased scrutiny from the investment community and regulatory authorities. Our reputation also may be harmed by the perception that our stakeholders have about our action or inaction on ESG-related issues.
Our ESG Committee supports our ongoing commitment to environmental, health and safety, corporate social responsibility, corporate governance, sustainability, and other public policy matters relevant to our organization. The ESG Committee is a cross-functional management committee, led by the Chief Risk Officer, that assists us in: (1) setting general strategies relating to ESG matters; (2) developing, implementing, and monitoring initiatives and polices based on those strategies; (3) recommending communications with employees, investors, and shareholders with respect to ESG matters; and (4) monitoring and assessing developments relating to, and improving our understanding of, ESG matters. The committee met four times during 2022. Highlights for 2022 included the enhancement of our online financial wellness tools, the rollout of the MercStart Fresh deposit program, the development of a diverse vendor database for employee use, and the creation of a Vendor and Supplier Code of Conduct. The Vendor and Supplier Code of Conduct, along with our Environmental Policy, Diversity, Equity and Inclusion Policy, Human Rights Policy, and Supplier Diversity Program Policy, are reviewed and approved by our Board of Directors at least annually. These polices are available on our website, along with an application for diverse suppliers. Also during 2022, we moved Board of Director oversight of ESG matters from the Audit Committee to the Governance Committee.
FINANCIAL OVERVIEW
We recorded net income of $61.1 million, or $3.85 per basic and diluted share, for 2022, compared with net income of $59.0 million, or $3.69 per basic and diluted share, for 2021. Higher net interest income, stemming from an improved net interest margin and ongoing strong loan growth, combined with continued strength in asset quality metrics and ongoing increases in treasury management fee income, more than offset a significant decline in residential mortgage banking revenue as industry-wide originations come off of the record levels of 2020 and 2021 which were driven by low residential mortgage rates and resulting refinancing activity. Our earnings performance in 2021 also benefited from negative provisions to the allowance.
Commercial loans increased $181 million during 2022, reflecting the combined growth of commercial loans and activity under the PPP. Core commercial loans (commercial loans excluding PPP loans) increased $221 million, or almost 8%, during 2022, while PPP loans declined $39.2 million. Core commercial and industrial loans increased $86.9 million, owner-occupied commercial real estate (“CRE”) loans grew $73.4 million, multi-family and residential rental property loans increased $35.4 million, vacant land, land development, and residential construction loans increased $18.6 million, and nonowner-occupied CRE loans grew $6.3 million. As a percentage of total core commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 58.2% at December 31, 2022, compared to 57.1% at year-end 2021. The new commercial loan pipeline remains strong, and at December 31, 2022, we had $197 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase.
Residential mortgage loans, excluding home equity lines of credit, increased $275 million during 2022, representing a growth rate of approximately 62%. With the increase in residential mortgage loan interest rates during 2022, we witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in the prior two years. Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet. During 2022, approximately 35% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to about 68% during 2021. The shift in product mix impacts the timing of revenue recognition; it takes an estimated 24 months for the amount of net interest income earned on a residential mortgage loan that is retained on our balance sheet to approximate the amount of immediately recorded gain on sale of a residential mortgage loan that has been sold to a third-party investor.
The overall quality of our loan portfolio remains strong, with nonperforming loans equaling 0.20% of total loans as of December 31, 2022. Accruing loans past due 30 to 89 days remain very low, and we had no foreclosed properties throughout 2022. Gross loan charge-offs totaled $0.3 million during 2022, while recoveries of prior period loan charge-offs totaled $1.0 million, providing for net loan recoveries of $0.7 million, or 0.02% of average total loans, for the year.
We recorded a credit loss provision expense of $6.6 million during 2022, compared to a negative provision expense of $4.3 million during 2021. The provision expense recorded during 2022 was necessitated by the net increase in required reserve levels stemming from changes to several environmental factors that largely reflected enhanced inherent risk within the commercial loan and residential mortgage loan portfolios, loan growth, and increased specific reserves for certain distressed loan relationships. A higher reserve for residential mortgage loans reflecting slower principal prepayment rates, and the resulting extended average life of the portfolio also impacted provision expense in 2022. The negative provision expense recorded during 2021 primarily reflected reduced allowance allocations attributed to improvement in both current and forecasted economic conditions and net loan recoveries, which more than offset required allowance allocations necessitated by strong loan growth.
Interest-earning deposits, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During 2022, the average balance of these funds equaled $445 million, or 9.3% of average earning assets, compared to $671 million, or 14.9% of average earning assets, during 2021. Typically, we maintain our interest-earning deposits at approximately $75 million, or about 2% of average earning assets. The elevated levels during 2022 and 2021 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus programs and reduced business and consumer investing and spending. The excess level of interest-earning deposits had a negative impact on our net interest margin. The level of interest-earning deposits was on a declining trend throughout 2022, as excess monies were used to fund loan growth as well as brokered deposit and Federal Home Loan Bank of Indianapolis (“FHLBI”) advance maturities. We also experienced a net decline in local deposit balances throughout 2022. Our deposit balance at the Federal Reserve Bank of Chicago equaled $29.4 million as of December 31, 2022.
Total deposits decreased $370 million during 2022, and totaled $3.71 billion at December 31, 2022. Local deposits declined $346 million, and out-of-area deposits decreased $23.9 million. A large portion of the decline in local deposits was comprised of a single customer’s anticipated withdrawal of funds that had been deposited in late 2021 from the sale of a business; excluding the withdrawal of these monies, local deposits were down approximately $150 million in 2022. Sizable withdrawals by other customers to fund bonus and tax payments, especially during the latter part of the fourth quarter, and public unit withdrawals primarily reflecting transfers into high-yielding accounts at other banks and nonbanks, also contributed to the decrease in local deposits.
Net interest income increased $34.2 million during 2022 compared to 2021. Interest income was up $38.3 million, while interest expense increased $4.1 million. Interest income on loans increased significantly during 2022 due to a rapidly increasing interest rate environment and loan growth. Our yield on loans was 3.87% during the first quarter of 2022, growing to 5.49% during the fourth quarter of 2022, and equaling 4.50% for all of 2022. Our yield on loans during 2021 was 4.06%, which had been significantly positively impacted by PPP net fee income accretion. We also recorded growth in interest income on securities, reflecting portfolio growth as we deployed a portion of our excess liquid funds position and the higher interest rate environment. The higher interest rate environment also provided for increased interest income on our interest-earning deposits. Interest expense on deposits increased a relatively low $0.9 million in 2022, in large part reflecting generally steady deposit rates in a rapidly increasing interest rate environment during most of 2022. Interest expense on other borrowed money increased $4.2 million during 2022, reflecting interest costs associated with the $90.0 million in subordinated notes issued between December 2021 and January 2022, and higher interest rates on our floating rate subordinated debentures.
Noninterest income was $32.1 million during 2022, compared to $56.2 million during 2021. The decline mainly resulted from a $21.3 million reduction in mortgage banking income, reflecting the aforementioned increase in residential mortgage loan interest rates and corresponding substantial reduction in refinancing activity. We also recorded a $3.4 million decline in interest rate swap income, as the higher interest rate environment resulted in less transactions. We continued to record meaningful increased fee income in our treasury management products and services, with service charges on deposit and sweep accounts, credit and debit card fees, and payroll services growing $0.9 million, $0.7 million and $0.4 million, respectively.
Noninterest expense was $108 million during 2022, compared to $111 million during 2021. Excluding contributions to The Mercantile Bank Foundation, noninterest expense totaled $106 million and $107 million in 2022 and 2021, respectively. Aggregate salary and benefit costs declined $1.3 million in 2022, in large part reflecting lower residential mortgage lender commissions, reduced stock-based compensation costs, and higher residential mortgage loan deferred costs, which more than offset higher salary costs stemming from annual merit increases, market adjustments, and higher bonus accruals.
FINANCIAL CONDITION
Our total assets decreased $385 million during 2022, and totaled $4.87 billion as of December 31, 2022. Total loans increased $463 million and securities available for sale were up $10.2 million, while interest-earning deposits declined $881 million. Total deposits decreased $370 million and FHLBI advances were down $65.8 million, while net proceeds from the issuance of subordinated notes totaled $14.6 million. In large part, the excess funds maintained with the Federal Reserve Bank of Chicago at year-end 2021 were used to fund loan growth, deposit withdrawals, and FHLBI advance maturities during 2022.
Earning Assets
Average earning assets equaled 94.3% of average total assets during 2022, compared to 93.9% during 2021. The loan portfolio continued to comprise a majority of earning assets, followed by securities and interest-earning deposits. Average total loans equaled 77.8% of average earning assets during 2022, compared to 73.7% in 2021, while average securities and interest-earning deposits comprised 12.9% and 9.3% of average earning assets during 2022 and 11.4% and 14.9% of average earning assets during 2021, respectively.
Our loan portfolio has historically been primarily comprised of commercial loans. Commercial loans increased $181 million during 2022, reflecting the combined net growth of core commercial loans and net activity under the PPP. Core commercial loans increased $221 million, or almost 8%, during 2022, while PPP loans declined $39.2 million. Core commercial and industrial loans increased $86.9 million, owner-occupied CRE loans grew $73.4 million, multi-family and residential rental property loans increased $35.4 million, vacant land, land development, and residential construction loans increased $18.6 million, and nonowner-occupied CRE loans grew $6.3 million. As a percentage of total core commercial loans, commercial and industrial loans and owner-occupied CRE loans combined equaled 58.2% at December 31, 2022, compared to 57.1% at year-end 2021. The new commercial loan pipeline remains strong, and at December 31, 2022, we had $197 million in unfunded loan commitments on commercial construction and development loans that are in the construction phase. We believe our commercial loan portfolio remains well diversified.
As of December 31, 2022, availability on commercial construction and development loans that are in the construction phase totaled $197 million, with most of the funds expected to be drawn over the next 12 to 18 months. Our current pipeline reports indicate continued strong commercial loan funding opportunities in future periods, including $330 million in new lending commitments, a majority of which we expect to be accepted and funded over the next 12 to 18 months. Our commercial lenders also report additional opportunities they are currently discussing with existing borrowers and potential new customers. We remain committed to prudent underwriting standards that provide for an appropriate yield and risk relationship, as well as concentration limits we have established within our commercial loan portfolio. Usage of existing commercial lines of credit was relatively stable during 2022 at approximately 42%, compared to about 36% during the latter half of 2020 and all of 2021, and our historical average of about 47% prior to the Coronavirus Pandemic.
Residential mortgage loans totaled $755 million, or 19.3% of total loans, at December 31, 2022, compared to $443 million, or 12.8% of total loans, as of December 31, 2021. Residential mortgage loans, excluding home equity lines of credit, increased $275 million during 2022, representing a growth rate of approximately 62%. We originated $614 million in residential mortgage loans during 2022, compared to $952 million in 2021, a reduction of about 36%. The decline primarily reflected an increase in residential mortgage loan interest rates throughout 2022, resulting in a substantial reduction of refinancing activity. Production associated with refinancing activity totaled $134 million in 2022, compared to $458 million in 2021. With the increase in residential mortgage loan rates, we also witnessed a shift in borrowers primarily selecting adjustable rate residential mortgage loans compared to fixed rate residential mortgage loans in 2021. Generally, we sell fixed rate residential mortgage loans to third-party investors, while we maintain adjustable rate residential mortgage loans on our balance sheet. During 2022, approximately 35% of our residential mortgage loan production was comprised of longer-term fixed rate loans, compared to about 68% during 2021. The shift in product mix impacts the timing of revenue recognition; it takes an estimated 24 months for the amount of net interest income earned on a residential mortgage loan that is retained on our balance sheet to approximate the amount of immediately recorded gain on sale of a residential mortgage loan that has been sold to a third-party investor.
Other consumer-related loans increased $4.9 million during 2022, and at December 31, 2022 totaled $29.8 million, or 0.7% of total loans. As of December 31, 2021, the other consumer-related loan portfolio comprised 0.7% of total loans. We expect this loan portfolio segment to remain relatively steady in dollar amount but decline as a percent of total loans in future periods as commercial loans and residential mortgage loan portfolios grow.
The following table summarizes our loan portfolio:
| 12/31/22 |
12/31/21 |
12/31/20 |
12/31/19 |
12/31/18 |
||||||||||||||||
| Commercial: |
||||||||||||||||||||
| Commercial & Industrial * |
$ | 1,185,083,000 | $ | 1,137,419,000 | $ | 1,145,423,000 | $ | 846,551,000 | $ | 822,723,000 | ||||||||||
| Land Development & Construction |
61,873,000 | 43,239,000 | 55,055,000 | 56,119,000 | 44,885,000 | |||||||||||||||
| Owner Occupied Commercial Real Estate |
639,192,000 | 565,758,000 | 529,953,000 | 579,003,000 | 548,619,000 | |||||||||||||||
| Non-Owner Occupied Commercial Real Estate |
1,033,734,000 | 1,027,415,000 | 917,436,000 | 835,346,000 | 816,282,000 | |||||||||||||||
| Multi-Family & Residential Rental |
211,948,000 | 176,593,000 | 146,095,000 | 124,525,000 | 127,597,000 | |||||||||||||||
| Total Commercial |
3,131,830,000 | 2,950,424,000 | 2,793,962,000 | 2,441,544,000 | 2,360,106,000 | |||||||||||||||
| Retail: |
||||||||||||||||||||
| 1-4 Family Mortgages |
755,036,000 | 442,547,000 | 337,888,000 | 334,771,000 | 307,540,000 | |||||||||||||||
| Other Consumer Loans (**) |
29,753,000 | 60,488,000 | 61,620,000 | 75,374,000 | 85,439,000 | |||||||||||||||
| Total Retail |
784,789,000 | 503,035,000 | 399,508,000 | 410,145,000 | 392,979,000 | |||||||||||||||
| Total Loans |
$ | 3,916,619,000 | $ | 3,453,459,000 | $ | 3,193,470,000 | $ | 2,851,689,000 | $ | 2,753,085,000 | ||||||||||
(*) For December 31, 2022, December 31, 2021, and December 31, 2020, includes $0.9 million, $40.1 million, and $365 million in loans originated under the Paycheck Protection Program, respectively.
(**) In conjunction with the adoption of the CECL methodology effective January 1, 2022, home equity lines of credit were reclassified to 1-4 family mortgage loans from consumer loans. Home equity lines of credit totaled $37.4 million, $29.5 million, $32.6 million, $37.7 million, and $41.6 million as of December 31, 2022, December 31, 2021, December 31, 2020, December 31, 2019, and December 31, 2018, respectively.
The following table presents total loans outstanding as of December 31, 2022, according to scheduled repayments of principal on fixed rate loans and repricing frequency on variable rate loans. Floating rate commercial loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency.
| Less Than |
One Through |
Five Through |
||||||||||||||
| One Year |
Five Years |
Fifteen Years |
Total |
|||||||||||||
| Construction and land development |
$ | 243,660,000 | $ | 58,870,000 | $ | 68,387,000 | $ | 370,917,000 | ||||||||
| Real estate - residential properties |
67,086,000 | 157,904,000 | 474,846,000 | 699,836,000 | ||||||||||||
| Real estate - multi-family properties |
92,105,000 | 66,017,000 | 3,418,000 | 161,540,000 | ||||||||||||
| Real estate - commercial properties |
790,993,000 | 603,002,000 | 93,719,000 | 1,487,714,000 | ||||||||||||
| Commercial and industrial |
966,786,000 | 175,781,000 | 40,521,000 | 1,183,088,000 | ||||||||||||
| Consumer |
3,497,000 | 9,299,000 | 728,000 | 13,524,000 | ||||||||||||
| Total loans |
$ | 2,164,127,000 | $ | 1,070,873,000 | $ | 681,619,000 | $ | 3,916,619,000 | ||||||||
| Fixed rate loans |
$ | 126,669,000 | $ | 911,168,000 | $ | 281,563,000 | $ | 1,319,400,000 | ||||||||
| Floating rate loans |
2,037,458,000 | 159,705,000 | 400,056,000 | 2,597,219,000 | ||||||||||||
| Total loans |
$ | 2,164,127,000 | $ | 1,070,873,000 | $ | 681,619,000 | $ | 3,916,619,000 | ||||||||
Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to provide effective loan portfolio administration. The credit policies and procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, we must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these items could occur quickly because of changing economic conditions or other factors. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on the internal loan watch list. Senior management and the Board of Directors review this list regularly. Market value estimates of collateral on nonperforming loans, as well as on foreclosed and repossessed assets, are reviewed periodically. We have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices, and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions.
Nonaccrual loans totaled $7.7 million, or 0.2% of total loans, as of December 31, 2022, compared to $2.3 million, or 0.1% of total loans, as of December 31, 2021. Nonperforming assets, comprised of nonaccrual loans, loans past due 90 days or more and accruing interest and foreclosed properties, totaled $7.7 million (0.2% of total assets) as of December 31, 2022, compared to $2.5 million (0.1% of total assets) as of December 31, 2021. The volume of nonperforming assets has remained under 0.3% of total assets since year-end 2015, and has averaged 0.1% over the past four years. Given the low level of nonperforming loans and accruing loans 30 to 89 days delinquent, combined with what we believe are strong credit administration practices, we are pleased with the overall quality of the loan portfolio.
The following tables provide a breakdown of nonperforming assets by property type:
| NONPERFORMING LOANS |
||||||||||||||||||||
| 12/31/22 |
12/31/21 |
12/31/20 |
12/31/19 |
12/31/18 |
||||||||||||||||
| Residential Real Estate: |
||||||||||||||||||||
| Land Development |
$ | 29,000 | $ | 32,000 | $ | 35,000 | $ | 34,000 | $ | 0 | ||||||||||
| Construction |
124,000 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied / Rental |
1,304,000 | 1,768,000 | 2,519,000 | 2,104,000 | 3,157,000 | |||||||||||||||
| 1,457,000 | 1,800,000 | 2,554,000 | 2,138,000 | 3,157,000 | ||||||||||||||||
| Commercial Real Estate: |
||||||||||||||||||||
| Land Development |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Construction |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied |
248,000 | 0 | 619,000 | 134,000 | 950,000 | |||||||||||||||
| Non-Owner Occupied |
0 | 0 | 22,000 | 0 | 0 | |||||||||||||||
| 248,000 | 0 | 641,000 | 134,000 | 950,000 | ||||||||||||||||
| Non-Real Estate: |
||||||||||||||||||||
| Commercial Assets |
6,023,000 | 662,000 | 172,000 | 0 | 17,000 | |||||||||||||||
| Consumer Assets |
0 | 6,000 | 17,000 | 12,000 | 17,000 | |||||||||||||||
| 6,023,000 | 668,000 | 189,000 | 12,000 | 34,000 | ||||||||||||||||
| Total |
$ | 7,728,000 | $ | 2,468,000 | $ | 3,384,000 | $ | 2,284,000 | $ | 4,141,000 | ||||||||||
| OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS |
||||||||||||||||||||
| 12/31/22 |
12/31/21 |
12/31/20 |
12/31/19 |
12/31/18 |
||||||||||||||||
| Residential Real Estate: |
||||||||||||||||||||
| Land Development |
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
| Construction |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied / Rental |
0 | 0 | 88,000 | 260,000 | 398,000 | |||||||||||||||
| 0 | 0 | 88,000 | 260,000 | 398,000 | ||||||||||||||||
| Commercial Real Estate: |
||||||||||||||||||||
| Land Development |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Construction |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Owner Occupied |
0 | 0 | 613,000 | 192,000 | 413,000 | |||||||||||||||
| Non-Owner Occupied |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| 0 | 0 | 613,000 | 192,000 | 413,000 | ||||||||||||||||
| Non-Real Estate: |
||||||||||||||||||||
| Commercial Assets |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| Consumer Assets |
0 | 0 | 0 | 0 | 0 | |||||||||||||||
| 0 | 0 | 0 | 0 | 0 | ||||||||||||||||
| Total |
$ | 0 | $ | 0 | $ | 701,000 | $ | 452,000 | $ | 811,000 | ||||||||||
The following tables provide a reconciliation of nonperforming assets:
| NONPERFORMING LOANS RECONCILIATION |
||||||||||||||||||||
| 2022 |
2021 |
2020 |
2019 |
2018 |
||||||||||||||||
| Beginning balance |
$ | 2,468,000 | $ | 3,384,000 | $ | 2,284,000 | $ | 4,141,000 | $ | 7,143,000 | ||||||||||
| Additions |
6,770,000 | 1,187,000 | 3,361,000 | 698,000 | 2,909,000 | |||||||||||||||
| Returns to performing status |
(373,000 | ) |
(165,000 | ) |
(105,000 | ) |
(126,000 | ) |
(175,000 | ) |
||||||||||
| Principal payments |
(1,042,000 | ) |
(1,711,000 | ) |
(1,701,000 | ) |
(2,140,000 | ) |
(5,028,000 | ) |
||||||||||
| Loan charge-offs |
(95,000 | ) |
(227,000 | ) |
(455,000 | ) |
(289,000 | ) |
(708,000 | ) |
||||||||||
| Total |
$ | 7,728,000 | $ | 2,468,000 | $ | 3,384,000 | $ | 2,284,000 | $ | 4,141,000 | ||||||||||
| OTHER REAL ESTATE OWNED & REPOSSESSED ASSETS RECONCILIATION | ||||||||||||||||||||
| 2022 |
2021 |
2020 |
2019 |
2018 |
||||||||||||||||
| Beginning balance |
$ | 0 | $ | 701,000 | $ | 452,000 | $ | 811,000 | $ | 2,260,000 | ||||||||||
| Additions |
0 | 30,000 | 758,000 | 462,000 | 1,114,000 | |||||||||||||||
| Sale proceeds |
0 | (397,000 | ) |
(485,000 | ) |
(792,000 | ) |
(2,380,000 | ) |
|||||||||||
| Valuation write-downs |
0 | (334,000 | ) |
(24,000 | ) |
(29,000 | ) |
(183,000 | ) |
|||||||||||
| Total |
$ | 0 | $ | 0 | $ | 701,000 | $ | 452,000 | $ | 811,000 | ||||||||||
During 2022, loan charge-offs totaled $0.3 million, while recoveries of prior period loan charge-offs equaled $1.0 million, providing for net loan recoveries of $0.7 million, or 0.02% of average total loans. During 2021, loan charge-offs totaled $1.0 million, while recoveries of prior period loan charge-offs equaled $2.7 million, providing for net loan recoveries of $1.7 million, or 0.05% of average total loans. We continue our collection efforts on charged-off loans, and we expect to record recoveries in future periods; however, given the nature of these efforts, it is not practical to forecast the dollar amount and timing of the recoveries.
The following table illustrates the breakdown of the allowance for credit losses by loan type (dollars in thousands) and of the total loan portfolio (in percentages). For the years 2019 and 2018, presented loan and allowance data are reflective of only originated loans and the allowance for originated loans. We terminated the application of purchase accounting associated with our merger with Firstbank effective January 1, 2020.
| 12/31/22 |
12/31/21 |
12/31/20 |
12/31/19 |
12/31/18 |
||||||||||||||||||||||||||||||||||||
| Loan | Loan | Loan | Loan | Loan | ||||||||||||||||||||||||||||||||||||
| Amount |
Portfolio |
Amount |
Portfolio |
Amount |
Portfolio |
Amount |
Portfolio |
Amount |
Portfolio |
|||||||||||||||||||||||||||||||
| Commercial, financial and agricultural |
$ | 27,550 | 72.3 | % |
$ | 30,224 | 77.3 | % |
$ | 33,235 | 79.6 | % |
$ | 20,599 | 76.0 | % |
$ | 19,228 | 86.7 | % |
||||||||||||||||||||
| Construction and land development |
490 | 9.5 | 2,324 | 8.9 | 813 | 7.2 | 340 | 9.0 | 270 | 2.0 | ||||||||||||||||||||||||||||||
| Residential real estate |
14,027 | 17.9 | 2,524 | 13.4 | 3,595 | 12.7 | 1,863 | 14.2 | 1,778 | 10.0 | ||||||||||||||||||||||||||||||
| Instalment loans to individuals |
160 | 0.3 | 246 | 0.4 | 265 | 0.5 | 294 | 0.8 | 234 | 1.3 | ||||||||||||||||||||||||||||||
| Unallocated |
19 | 0.0 | 45 | 0.0 | 59 | 0.0 | 70 | 0.0 | 44 | 0.0 | ||||||||||||||||||||||||||||||
| Total |
$ | 42,246 | 100.0 | % |
$ | 35,363 | 100.0 | % |
$ | 37,967 | 100.0 | % |
$ | 23,166 | 100.0 | % |
$ | 21,554 | 100.0 | % |
||||||||||||||||||||
The following table depicts the ratio of our allowance to nonperforming loans:
| 12/31/22 |
12/31/21 |
12/31/20 |
12/31/19 |
12/31/18 |
||||||||||||||||
| Ratio of allowance to nonperforming loans |
546.7 | % | 1,432.9 | % | 1,122.0 | % | 1,045.9 | % | 540.4 | % | ||||||||||
We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $0.4 million, which included a $0.3 million increase to the retained earnings account to reflect the cumulative effect of adopting CECL on our Consolidated Balance Sheet, with the $0.1 million tax impact portion being recorded as part of the deferred tax asset in other assets on our Consolidated Balance Sheet.
The allowance for loan loss accounting in effect at December 31, 2021 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date (“incurred loss” methodology). Under the CECL methodology, our allowance is based on the total amount of credit losses that are expected over the remaining life of the loan portfolio. Our estimate of credit losses under CECL is determined using a complex model that relies on historical loss information, reasonable and supportable economic forecasts, and various qualitative factors.
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 we have a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to each residential mortgage 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 creditors’ rights in order to preserve our collateral position.
See Note 1 - Significant Accounting Policies in this Form 10-K for further detailed descriptions of our estimation process and methodology related to the allowance. See also Note 3 - Loans and Allowance for Credit Losses in this Form 10-K for further information regarding our loan portfolio and allowance.
The allowance equaled $42.2 million, or 1.08% of total loans, and over 500% of nonperforming loans, as of December 31, 2022. As of December 31, 2022, the allowance was comprised of $39.6 million in general reserves relating to performing loans and $2.6 million in specific reserves on other loans, primarily nonperforming loans. Troubled debt restructurings totaled $11.6 million at December 31, 2022, consisting of $6.1 million that are on nonaccrual status and $5.5 million that are on accrual status. The latter are not included in our nonperforming loan totals. Loans with an aggregate carrying value of $0.4 million as of December 31, 2022 had been subject to previous partial charge-offs aggregating $0.3 million over the past several years. As of December 31, 2022, there were no specific reserves allocated to loans that had been subject to a previous partial charge-off.
The following table provides a breakdown of our loans categorized as troubled debt restructurings:
| 12/31/22 |
12/31/21 |
12/31/20 |
12/31/19 |
12/31/18 |
||||||||||||||||
| Performing |
$ | 5,470,000 | $ | 16,728,000 | $ | 23,133,000 | $ | 11,788,000 | $ | 19,223,000 | ||||||||||
| Nonperforming |
6,113,000 | 746,000 | 510,000 | 353,000 | 229,000 | |||||||||||||||
| Total |
$ | 11,583,000 | $ | 17,474,000 | $ | 23,643,000 | $ | 12,141,000 | $ | 19,452,000 | ||||||||||
Although we believe the allowance is adequate to absorb loan losses in our originated loan portfolio as they arise, there can be no assurance that we will not sustain loan losses in any given period that could be substantial in relation to, or greater than, the size of the allowance.
Securities available for sale increased $10.2 million during 2022, totaling $603 million as of December 31, 2022. Purchases of U.S. Government agency bonds totaled $54.5 million during 2022, while purchases of U.S. Government agency guaranteed mortgage-backed securities totaled $2.1 million. There were no U.S. Government agency bond maturities or calls during 2022, while principal paydowns on U.S. Government agency guaranteed mortgage-backed securities totaled $5.8 million. Purchases of municipal bonds totaled $50.4 million during 2022; proceeds from matured and called municipal bonds totaled $12.1 million. At December 31, 2022, the portfolio was primarily comprised of U.S. Government agency bonds (65%), municipal bonds (30%), and U.S. Government agency guaranteed mortgage-backed securities (5%). All of our securities are currently designated as available for sale and are therefore stated at fair value. The fair value of securities designated as available for sale at December 31, 2022 totaled $603 million, including a net unrealized loss of $82.7 million. After we considered whether the securities were issued by the federal government or its agencies and whether downgrades by bond rating agencies had occurred, we determined that the unrealized losses were due to changing interest rate environments. As we do not intend to sell our debt securities before recovery of their cost basis, and we believe it is more likely than not that we will not be required to sell our debt securities before recovery of the cost basis, no unrealized losses are deemed to be other-than-temporary. We maintain the securities portfolio at levels to provide adequate pledging and secondary liquidity for our daily operations. In addition, the securities portfolio serves a primary interest rate risk management function. We expect upcoming purchases to generally consist of municipal bonds, with the securities portfolio maintained at about 12% of total assets.
The following table reflects the composition of the securities portfolio:
| 12/31/22 |
12/31/21 |
12/31/20 |
||||||||||||||||||||||
| Carrying |
Carrying |
Carrying |
||||||||||||||||||||||
| Value |
Percent |
Value |
Percent |
Value |
Percent |
|||||||||||||||||||
| U.S. Government agency debt obligations |
$ | 388,744,000 | 64.5 | % |
$ | 390,371,000 | 65.9 | % |
$ | 242,141,000 | 62.5 | % |
||||||||||||
| Mortgage-backed securities |
31,953,000 | 5.3 | 41,803,000 | 7.0 | 24,890,000 | 6.4 | ||||||||||||||||||
| Municipal general obligations |
154,433,000 | 25.6 | 137,594,000 | 23.2 | 107,824,000 | 27.9 | ||||||||||||||||||
| Municipal revenue bonds |
27,306,000 | 4.5 | 22,475,000 | 3.8 | 11,992,000 | 3.1 | ||||||||||||||||||
| Other investments |
500,000 | 0.1 | 500,000 | 0.1 | 500,000 | 0.1 | ||||||||||||||||||
| Totals |
$ | 602,936,000 | 100.0 | % |
$ | 592,743,000 | 100.0 | % |
$ | 387,347,000 | 100.0 | % |
||||||||||||
Market values on our U.S. Government agency bonds, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal bonds are generally determined on a monthly basis with the assistance of a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer quotes, and issuer spreads. The market value of certain non-rated securities issued by relatively small municipalities generally located within our markets is estimated at carrying value. We believe our valuation methodology provides for a reasonable estimation of market value, and that it is consistent with the requirements of accounting guidelines.
FHLBI stock totaled $17.7 million as of December 31, 2022, compared to $18.0 million as of December 31, 2021. The reduction reflects the FHLBI’s repurchase of excess stock. Our investment in FHLBI stock is necessary to engage in their advance and other financing programs. We have regularly received quarterly cash dividends, and we expect a cash dividend will continue to be paid in future quarterly periods.
The following table shows by class of maturities as of December 31, 2022 the amounts and weighted average yields (on a fully taxable-equivalent basis) of investment securities:
| Carrying |
Average |
|||||||
| Value |
Yield |
|||||||
| Obligations of U.S. Government agencies: |
||||||||
| One year or less |
$ | 11,531,000 | 0.29 | % |
||||
| Over one through five years |
174,389,000 | 0.90 | ||||||
| Over five through ten years |
189,149,000 | 1.60 | ||||||
| Over ten years |
13,675,000 | 1.95 | ||||||
| 388,744,000 | 1.26 | |||||||
| Obligations of states and political subdivisions: |
||||||||
| One year or less |
9,200,000 | 1.36 | ||||||
| Over one through five years |
52,968,000 | 2.39 | ||||||
| Over five through ten years |
82,503,000 | 2.65 | ||||||
| Over ten years |
37,068,000 | 3.51 | ||||||
| 181,739,000 | 2.68 | |||||||
| Mortgage-backed securities |
31,953,000 | 2.10 | ||||||
| Other investments |
500,000 | 4.94 | ||||||
| Totals |
$ | 602,936,000 | 1.72 | % |
||||
Interest-earning deposits, primarily consisting of funds deposited at the Federal Reserve Bank of Chicago, are used to manage daily liquidity needs and interest rate risk sensitivity. During 2022, the average balance of these funds equaled $445 million, or 9.3% of average earning assets, compared to $671 million, or 14.9% of average earning assets, during 2021. Typically, we maintain our interest-earning deposits at approximately $75 million, or about 2% of average earning assets. The elevated levels during 2022 and 2021 primarily reflected increased local deposits stemming from Covid-19-related federal government stimulus programs and reduced business and consumer investing and spending. The excess level of interest-earning deposits had a negative impact on our net interest margin. The level of interest-earning deposits was on a declining trend throughout 2022, as excess monies were used to fund loan growth as well as brokered deposit and FHLBI advance maturities. We also experienced a net decline in local deposit balances throughout 2022. Our deposit balance at the Federal Reserve Bank of Chicago equaled $29.4 million as of December 31, 2022.
Non-Earning Assets
Cash and due from bank balances averaged 1.5% of total assets during 2022, similar to the average level during 2021, and no significant changes are expected in future periods. Net premises and equipment equaled $51.5 million at December 31, 2022, representing a decrease of $5.8 million during 2022. The decline primarily reflected the sale of a branch facility located in Lansing, Michigan as part of a branch relocation project whereby we are moving our operations to a leased facility that better aligns with our operations in the greater Lansing area and provides for lower operating costs, along with depreciation expense. We had no foreclosed or repossessed assets as of December 31, 2022, unchanged from December 31, 2021.
Other assets equaled $95.0 million at December 31, 2022, reflecting an increase of $40.7 million during 2022. The increase is primarily associated with $21.1 million of growth in the fair value of interest rates swaps and a $16.6 million increase in a deferred tax benefit related to unrealized losses on available for sale securities.
Source of Funds
Total deposits decreased $370 million during 2022, totaling $3.71 billion as of December 31, 2022. Local deposits declined $346 million and out-of-area deposits decreased $23.9 million. We had no out-of-area deposits as of December 31, 2022, compared to $23.9 million, or 0.6% of total deposits, as of December 31, 2021. FHLBI advances decreased $65.7 million during 2022, totaling $308 million as of December 31, 2022.
Noninterest-bearing checking accounts declined $73.2 million during 2022, in large part during the fourth quarter due primarily from commercial customers withdrawing funds for the payment of taxes and bonuses. Interest-bearing checking accounts increased $36.2 million, while savings deposits declined $12.7 million. Money market deposit accounts decreased $263 million during 2022, primarily reflecting a single customer’s anticipated withdrawal of funds that had been deposited in late 2021 from the sale of a business. Local time deposits decreased $33.3 million during 2022. The $23.9 million reduction in out-of-area time deposits during 2022 reflects maturities that were not replaced as the funds were no longer needed.
Total local deposits had increased an aggregate $1.50 billion during 2020 and 2021. Noninterest-bearing checking accounts grew $753 million during this time period, while interest-bearing checking accounts and money market deposit accounts were up $206 million and $531 million, respectively. The increases in these transactional deposit products largely reflected federal government stimulus programs, especially the PPP, as well as lower business investing and spending. Deposit growth associated with new commercial lending relationships was also notable. Savings deposits were up $125 million, primarily reflecting the impact of federal government stimulus programs and lower consumer investing and spending.
Securities sold under agreements to repurchase (“sweep accounts”) decreased $3.1 million during 2022, totaling $194 million as of December 31, 2022. The aggregate balance of this funding type can be subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that many of the customers maintain. The average balance of sweep accounts equaled $200 million during 2022, with a high balance of $236 million and a low balance of $173 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.
FHLBI advances declined $65.7 million during 2022, totaling $308 million as of December 31, 2022. Advance maturities aggregating $94.0 million were not replaced as the funds were no longer needed, while advances totaling $28.3 million were obtained to match-fund fixed rate longer term commercial lending relationships. FHLBI advances are primarily used to assist in funding loan demand, as well as playing an integral role in our interest rate risk management program. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. Our borrowing line of credit at year-end 2022 totaled $1.03 billion, with remaining availability based on collateral of $713 million.
On December 15, 2021, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $75.0 million in aggregate principal amount of its 3.25% fixed-to-floating rate subordinated notes (“Notes”). The Notes have a stated maturity of January 30, 2032, are redeemable by us at our option, in whole or in part, on or after January 30, 2027 on any interest payment date at a redemption price of 100% of the principal amount of the Notes being redeemed. The Notes are not subject to redemption at the option of the holder. The Notes will bear interest at a fixed rate of 3.25% per year until January 29, 2027. Commencing on January 30, 2027 and through the stated maturity date of January 30, 2032, the interest rate will reset quarterly at a variable rate equal to the then-current Three-Month Term SOFR plus 212 basis points. On December 15, 2021, we injected $70.0 million of the issuance proceeds to our bank as an increase to equity capital.
On January 14, 2022, we issued an additional $15.0 million of its Notes to certain institutional accredited investors, reflecting an expansion of the $75.0 million issuance completed on December 15, 2021. The additional $15.0 million issuance was completed on the same terms as the prior offering and under the existing indenture. On January 14, 2022, we injected $15.0 million of the issuance proceeds to our bank as an increase to equity capital.
Shareholders’ equity declined $15.2 million during 2022, totaling $441 million as of December 31, 2022. Positively impacting shareholders’ equity was net income of $61.1 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $19.6 million. Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by a total of $4.7 million. Negatively impacting shareholders’ equity during 2022 was a $61.6 million increase in the after-tax net unrealized loss on available for sale securities.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2022 and 2021
Summary
We recorded net income of $61.1 million, or $3.85 per basic and diluted share, for 2022, compared to net income of $59.0 million, or $3.69 per basic and diluted share, for 2021. Diluted earnings per share increased $0.16, or 4.3%, during 2022 compared to 2021.
The higher level of net income during 2022 compared to 2021 reflected improved net interest income and lower noninterest expense, which more than offset decreased noninterest income and an increased provision for credit losses. The increase in net interest income resulted from a higher net interest margin and earning asset growth. Overhead costs declined in 2022 primarily due to reduced contributions to The Mercantile Bank Foundation and compensation-related costs. The reduction in noninterest income during 2022 mainly reflected decreased mortgage banking income and interest rate swap income, which outweighed increases in treasury management fee income. The provision expense recorded during 2022 was necessitated by the net increase in required reserve levels stemming from changes to several environmental factors that largely reflected enhanced inherent risk within the commercial loan and residential mortgage loan portfolios, loan growth, and increased specific reserves for certain distressed loan relationships. A higher reserve for residential mortgage loans reflecting slower principal prepayment rates and the associated extended average life of the portfolio also impacted provision expense during 2022. A negative loan loss provision expense was recorded in 2021, primarily reflecting reduced allocations attributable to improvement in both current and forecasted economic conditions and a net loan recovery.
Net Interest Income
Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings. Interest income (adjusted for tax-exempt income) and interest expense totaled $182 million and $23.6 million, respectively, during 2022, providing for net interest income of $158 million. During 2021, interest income and interest expense equaled $144 million and $19.4 million, respectively, providing for net interest income of $124 million. In comparing 2022 with 2021, interest income increased 26.7%, interest expense was up 21.4%, and net interest income increased 27.5%. The level of net interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types and levels of assets and liabilities, the interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact net interest income as well as the net interest margin.
The $34.2 million increase in net interest income in 2022 compared to 2021 resulted from an improved net interest margin and a higher level of average earning assets. During 2022, the net interest margin equaled 3.33%, up from 2.76% during 2021 due to a higher yield on average earning assets, which more than offset an increase in the cost of funds. The increased yield on average earning assets mainly resulted from a higher yield on loans and a change in earning asset mix, reflecting a decrease in low-yielding interest-earning deposits. The increased yield on loans primarily resulted from higher interest rates on variable-rate commercial loans stemming from the FOMC significantly raising the targeted federal funds rate in an effort to curb elevated inflation levels. The FOMC increased the targeted federal funds rate by 425 basis points during the period of March 2022 through December 2022. As of December 31, 2022, approximately 65% of the commercial loan portfolio consisted of variable-rate loans. Higher yields on other interest-earning assets and securities, reflecting the increased interest rate environment, also contributed to the improved yield on earning assets. During 2022, earning assets averaged $4.77 billion, representing an increase of $256 million, or 5.7%, from the $4.51 billion average during 2021. Average loans increased $382 million, average interest-earning deposits were down $226 million, and average securities were up $99.9 million. The cost of funds increased from 0.43% in 2021 to 0.50% in 2022 mainly due to higher costs of non-time deposits and trust preferred securities, reflecting the increased interest rate environment, and the issuance of subordinated notes totaling $90 million in December of 2021 and January of 2022. Subordinated note issuance proceeds of $85.0 million were injected into Mercantile Bank as an increase to equity capital to support expected loan growth.
A significant volume of excess on-balance sheet liquidity, which initially surfaced in the second quarter of 2020 in large part due to government stimulus programs related to the Covid-19 environment, negatively impacted the yield on average earning assets by 24 basis points and 46 basis points during 2022 and 2021, respectively, and the net interest margin by 19 basis points and 39 basis points during the respective periods. The excess funds, consisting almost entirely of low-yielding deposits with the Federal Reserve Bank of Chicago, were mainly a product of local deposit growth and PPP loan forgiveness activities.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets, liabilities and shareholders’ equity during 2022, 2021, and 2020. The subsequent table also depicts the dollar amount of change in interest income and interest expense of interest-earning assets and interest-bearing liabilities, respectively, segregated between change due to volume and change due to rate. Tax-exempt securities interest income and yield for 2022, 2021, and 2020 have been computed on a tax equivalent basis using a marginal tax rate of 21.0%. Securities interest income was increased by $0.2 million in 2022, 2021, and 2020 for this non-GAAP, but industry standard, adjustment. These adjustments equated to increases in our net interest margin of less than one basis point during all three years.
| (Dollars in thousands) |
Years ended December 31, |
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| 2 0 2 2 |
2 0 2 1 |
2 0 2 0 |
||||||||||||||||||||||||||||||||||
| Average Balance |
Interest |
Average Rate |
Average Balance |
Interest |
Average Rate |
Average Balance |
Interest |
Average Rate |
||||||||||||||||||||||||||||
| Taxable securities |
$ | 486,093 | $ | 7,603 | 1.56 | % |
$ | 390,720 | $ | 5,127 | 1.31 | % |
$ | 236,097 | $ | 7,740 | 3.28 | % |
||||||||||||||||||
| Tax-exempt securities |
127,272 | 2,974 | 2.34 | 122,748 | 2,626 | 2.14 | 106,935 | 2,538 | 2.37 | |||||||||||||||||||||||||||
| Total securities |
613,365 | 10,577 | 1.72 | 513,468 | 7,753 | 1.51 | 343,032 | 10,278 | 3.00 | |||||||||||||||||||||||||||
| Loans |
3,706,505 | 166,848 | 4.50 | 3,324,611 | 135,048 | 4.06 | 3,167,065 | 137,399 | 4.34 | |||||||||||||||||||||||||||
| Interest-earning deposits |
445,236 | 4,654 | 1.05 | 671,351 | 933 | 0.14 | 356,501 | 876 | 0.25 | |||||||||||||||||||||||||||
| Total earning assets |
4,765,106 | 182,079 | 3.82 | 4,509,430 | 143,734 | 3.19 | 3,866,598 | 148,553 | 3.84 | |||||||||||||||||||||||||||
| Allowance for credit losses |
(36,993 | ) |
(38,003 | ) |
(30,164 | ) |
||||||||||||||||||||||||||||||
| Cash and due from banks |
75,213 | 69,084 | 58,345 | |||||||||||||||||||||||||||||||||
| Other non-earning assets |
251,466 | 260,623 | 238,789 | |||||||||||||||||||||||||||||||||
| Total assets |
$ | 5,054,792 | $ | 4,801,134 | $ | 4,133,568 | ||||||||||||||||||||||||||||||
| Interest-bearing checking accounts |
$ | 518,357 | $ | 1,926 | 0.37 | % |
$ | 498,119 | $ | 1,469 | 0.29 | % |
$ | 392,053 | $ | 1,263 | 0.32 | % |
||||||||||||||||||
| Savings deposits |
404,284 | 105 | 0.03 | 378,312 | 146 | 0.04 | 297,825 | 185 | 0.06 | |||||||||||||||||||||||||||
| Money market accounts |
888,047 | 4,071 | 0.46 | 756,715 | 1,617 | 0.21 | 542,967 | 1,968 | 0.36 | |||||||||||||||||||||||||||
| Time deposits |
385,338 | 3,935 | 1.02 | 472,925 | 5,882 | 1.24 | 590,421 | 11,568 | 1.96 | |||||||||||||||||||||||||||
| Total interest-bearing deposits |
2,196,026 | 10,037 | 0.46 | 2,106,071 | 9,114 | 0.43 | 1,823,266 | 14,984 | 0.82 | |||||||||||||||||||||||||||
| Short-term borrowings |
200,561 | 294 | 0.15 | 158,855 | 170 | 0.11 | 137,658 | 173 | 0.13 | |||||||||||||||||||||||||||
| Federal Home Loan Bank advances |
354,136 | 7,125 | 2.01 | 392,575 | 8,177 | 2.08 | 386,896 | 8,571 | 2.22 | |||||||||||||||||||||||||||
| Other borrowings |
137,737 | 6,139 | 4.46 | 52,984 | 1,971 | 3.72 | 49,792 | 2,339 | 4.70 | |||||||||||||||||||||||||||
| Total interest-bearing liabilities |
2,888,460 | 23,595 | 0.82 | 2,710,485 | 19,432 | 0.72 | 2,397,612 | 26,067 | 1.09 | |||||||||||||||||||||||||||
| Checking accounts |
1,694,857 | 1,620,480 | 1,291,542 | |||||||||||||||||||||||||||||||||
| Other liabilities |
37,617 | 19,998 | 16,909 | |||||||||||||||||||||||||||||||||
| Total liabilities |
4,620,934 | 4,350,963 | 3,706,063 | |||||||||||||||||||||||||||||||||
| Average equity |
433,858 | 450,171 | 427,505 | |||||||||||||||||||||||||||||||||
| Total liabilities and equity |
$ | 5,054,792 | $ | 4,801,134 | $ | 4,133,568 | ||||||||||||||||||||||||||||||
| Net interest income |
$ | 158,484 | $ | 124,302 | $ | 122,486 | ||||||||||||||||||||||||||||||
| Rate spread |
3.00 | % |
2.47 | % |
2.75 | % |
||||||||||||||||||||||||||||||
| Net interest margin |
3.33 | % |
2.76 | % |
3.17 | % |
||||||||||||||||||||||||||||||
| Years ended December 31, |
||||||||||||||||||||||||
| 2022 over 2021 |
2021 over 2020 |
|||||||||||||||||||||||
| Total |
Volume |
Rate |
Total |
Volume |
Rate |
|||||||||||||||||||
| Increase (decrease) in interest income |
||||||||||||||||||||||||
| Taxable securities |
$ | 2,716,000 | $ | 1,400,000 | $ | 1,316,000 | $ | (2,613,000 | ) |
$ | 3,482,000 | $ | (6,095,000 | ) |
||||||||||
| Tax exempt securities |
108,000 | 97,000 | 11,000 | 88,000 | 353,000 | (265,000 | ) |
|||||||||||||||||
| Loans |
31,800,000 | 16,377,000 | 15,423,000 | (2,351,000 | ) |
6,644,000 | (8,995,000 | ) |
||||||||||||||||
| Interest-earning deposit balances |
3,721,000 | (415,000 | ) |
4,136,000 | 57,000 | 548,000 | (491,000 | ) |
||||||||||||||||
| Net change in tax-equivalent interest income |
38,345,000 | 17,459,000 | 20,886,000 | (4,819,000 | ) |
11,027,000 | (15,846,000 | ) |
||||||||||||||||
| Increase (decrease) in interest expense |
||||||||||||||||||||||||
| Interest-bearing demand deposits |
457,000 | 62,000 | 395,000 | 206,000 | 320,000 | (114,000 | ) |
|||||||||||||||||
| Savings deposits |
(41,000 | ) |
9,000 | (50,000 | ) |
(39,000 | ) |
42,000 | (81,000 | ) |
||||||||||||||
| Money market accounts |
2,454,000 | 323,000 | 2,131,000 | (351,000 | ) |
619,000 | (970,000 | ) |
||||||||||||||||
| Time deposits |
(1,947,000 | ) |
(990,000 | ) |
(957,000 | ) |
(5,686,000 | ) |
(2,006,000 | ) |
(3,680,000 | ) |
||||||||||||
| Short-term borrowings |
124,000 | 51,000 | 73,000 | (3,000 | ) |
25,000 | (28,000 | ) |
||||||||||||||||
| Federal Home Loan Bank advances |
(1,052,000 | ) |
(780,000 | ) |
(272,000 | ) |
(394,000 | ) |
124,000 | (518,000 | ) |
|||||||||||||
| Other borrowings |
4,168,000 | 3,709,000 | 459,000 | (368,000 | ) |
143,000 | (511,000 | ) |
||||||||||||||||
| Net change in interest expense |
4,163,000 | 2,384,000 | 1,779,000 | (6,635,000 | ) |
(733,000 | ) |
(5,902,000 | ) |
|||||||||||||||
| Net change in tax-equivalent net interest income |
$ | 34,182,000 | $ | 15,075,000 | $ | 19,107,000 | $ | 1,816,000 | $ | 11,760,000 | $ | (9,944,000 | ) |
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Interest income is primarily generated from the loan portfolio, and to a significantly lesser degree, from securities and other interest-earning assets. Interest income increased $38.3 million during 2022 from that earned in 2021, totaling $182 million in 2022 compared to $144 million in 2021. The increase in interest income is attributable to a higher yield on average earning assets and the positive impact of an increased level of average earning assets. During 2022 and 2021, earning assets had an average yield (tax equivalent-adjusted basis) of 3.82% and 3.19%, respectively. The higher yield on average earning assets mainly resulted from an increased yield on loans and a change in earning asset mix. The increased yield on loans primarily reflected higher interest rates on variable-rate commercial loans stemming from the previously mentioned FOMC rate hikes. On average, lower-yielding interest-earning deposits represented 9.3% of earning assets during 2022, down from 14.9% during 2021, while higher-yielding loans represented 77.8% of earning assets during 2022, up from 73.7% during 2021. Interest-earning deposits decreased $881 million during 2022 as excess overnight funds were used to fund loan growth, brokered deposit and FHLBI advance maturities, and securities purchases. In addition, a customer’s withdrawal of a majority of funds that were deposited in late 2021 following the sale of a business, as well as other fund withdrawals by customers to make customary tax and bonus payments, contributed to the lower level of interest-earning deposits. Improved yields on other interest-earning assets and securities, reflecting the increased interest rate environment, also contributed to the higher yield on average earning assets.
Interest income generated from the loan portfolio increased $31.8 million in 2022 compared to the level earned in 2021. Growth in the loan portfolio during 2022 resulted in a $16.4 million increase in interest income, while an upturn in loan yield from 4.06% in 2021 to 4.50% in 2022 resulted in a $15.4 million increase in interest income. The improved yield on loans mainly resulted from a higher yield on commercial loans, which increased from 4.09% during 2021 to 4.72% during 2022 primarily due to the aforementioned FOMC rate increases. The increase in loan yield during 2022 was achieved despite a significant reduction in PPP net loan fee accretion, which totaled $1.0 million and $10.8 million in 2022 and 2021, respectively.
Interest income generated from the securities portfolio increased $2.8 million in 2022 compared to the level earned in 2021. Growth in the average balance of the securities portfolio during 2022 resulted in an increase in interest income of $1.5 million, while an increase in the yield on securities from 1.51% during 2021 to 1.72% during 2022 resulted in a $1.3 million increase in interest income. Interest income on interest-earning deposits increased $3.7 million in 2022 from the level earned in 2021; a higher yield on these balances resulted in an increase in interest income of $4.1 million, while a reduction in the average balance of these balances resulted in a decrease in interest income of $0.4 million.
Interest expense is generated from interest-bearing deposits and borrowed funds. Interest expense increased $4.2 million during 2022 from that expensed in 2021, totaling $23.6 million in 2022 compared to $19.4 million in 2021. Growth in the average balance of interest-bearing liabilities during 2022 resulted in an increase in interest expense of $2.4 million, while an increase in the cost of these liabilities resulted in a $1.8 million increase in interest expense. During 2022, interest-bearing liabilities averaged $2.89 billion, representing an increase of $178 million, or 6.6%, from the $2.71 billion average during 2021; average interest-bearing deposits and borrowings were up $90.0 million and $88.0 million, respectively. During 2022 and 2021, interest-bearing liabilities had a weighted average rate of 0.82% and 0.72%, respectively. The higher average cost of interest-bearing liabilities mainly resulted from increased costs of non-time deposit accounts and borrowings, which more than offset a decreased cost of time deposits.
The cost of interest-bearing non-time deposit accounts increased from 0.20% during 2021 to 0.34% during 2022, primarily reflecting higher interest rates paid on money market accounts; the higher interest rates mainly reflected the increased interest rate environment. The cost of borrowed funds increased from 1.71% during 2021 to 1.96% during 2022, primarily reflecting a higher cost of subordinated debentures and the issuance of subordinated notes. The cost of subordinated debentures was 5.89% during 2022, up from 3.80% during 2021, reflecting the increased interest rate environment. Subordinated notes totaling $90 million were issued in December of 2021 and January of 2022, with $85.0 million of the proceeds being injected into Mercantile Bank as an increase to equity capital to support expected loan growth. The cost of time deposits declined from 1.24% during 2021 to 1.02% during 2022 primarily due to lower rates paid on local time deposits.
A higher average rate paid on interest-bearing non-time deposits during 2022 resulted in a $2.5 million increase in interest expense, while $178 million of growth in the average balance of these deposits equated to a $0.4 million increase in interest expense. An $87.6 million decrease in the average balance of time deposits equated to a $1.0 million reduction in interest expense during 2022, while a lower average rate paid on time deposits also resulted in a $1.0 million decrease in interest expense. Interest expense related to short-term borrowings, which are comprised entirely of sweep accounts, increased slightly during 2022 due to a higher rate paid on, along with growth in the average balance of, these funds. A $38.4 million decline in the average balance of FHLBI advances during 2022 resulted in a $0.8 million reduction in interest expense, while a lower average rate paid on these borrowings resulted in a $0.3 million reduction in interest expense. An $84.8 million increase in the average balance of other borrowings, mainly reflecting the previously mentioned issuance of subordinated notes, during 2022 equated to a $3.7 million increase in interest expense, while an increased average rate paid on these borrowings resulted in a $0.5 million increase in interest expense.
Provision for Credit Losses
A provision for credit losses of $6.6 million was recorded during 2022, compared to a negative provision expense of $4.3 million during 2021. The provision expense recorded during 2022 primarily reflected the net increase in required reserve levels resulting from changes to several environmental factors that were implemented mainly in response to heightened inherent risk within the commercial loan and residential mortgage loan portfolios, loan growth, and increased specific reserves for certain distressed loan relationships. A higher reserve for residential mortgage loans stemming from slower principal prepayment rates and the associated extended average life of the portfolio also impacted provision expense during 2022. The negative provision expense recorded during 2021 primarily reflected diminished allocations attributable to improvement in both current and forecasted economic conditions and a net loan recovery, which more than offset required reserve allocations necessitated by loan growth.
During 2022, loan charge-offs totaled $0.3 million, while recoveries of prior period loan charge-offs equaled $1.0 million, providing for net loan recoveries of $0.7 million, or 0.02% of average total loans. During 2021, loan charge-offs totaled $1.0 million, while recoveries of prior period loan charge-offs equaled $2.7 million, providing for net loan recoveries of $1.7 million, or 0.05% of average total loans. The allowance for credit losses, as a percentage of total loans, was 1.1% and 1.0% as of December 31, 2022 and December 31, 2021, respectively.
Noninterest Income
Noninterest income during 2022 was $32.1 million, compared to $56.2 million during 2021. Noninterest income during 2022 included a $0.5 million bank owned life insurance death benefit claim, while noninterest income during 2021 included a $1.1 million gain on the sale of a branch facility, a $0.6 million recovery of loan collection costs, and $0.5 million in gains on the sales of former branch facilities. Excluding these transactions, noninterest income decreased $22.6 million in 2022 compared to 2021.
The lower level of noninterest income during 2022 primarily stemmed from decreased mortgage banking income, which more than offset growth in several key fee income sources, including service charges on accounts, credit and debit card income, and payroll servicing fees. Reduced interest rate swap income, reflecting lower transaction volume, contributed to the decreased level of noninterest income during 2022. Higher interest rates, lower refinancing activity, a reduced sold percentage, and a decreased gain on sale rate negatively impacted mortgage banking income during 2022. Sustained strength in purchase mortgage originations during 2022 partially mitigated the impact of these factors. The residential mortgage loan sold percentage declined from approximately 68% during 2021 to approximately 35% during 2022. The decreased sold percentage in large part reflects customers’ preferences for adjustable-rate loans in the current interest rate environment and construction loans representing an increased percentage of overall loan production. In aggregate, service charges on accounts, credit and debit card income, and payroll servicing fees were up approximately 13% during 2022 compared to 2021.
Noninterest Expense
Noninterest expense totaled $108 million during 2022, compared to $111 million during 2021. Overhead costs during 2022 included $1.5 million in charitable contributions to The Mercantile Bank Foundation (the “Foundation”) and a $0.3 million net loss on the sale of a former branch facility, while overhead costs during the prior year included $4.0 million in expenses and contributions associated with the formation and initial funding of the Foundation and $0.6 million in net losses on sales and write-downs of former branch facilities. Excluding these transactions, noninterest expense decreased nominally during 2022 compared to 2021.
Compensation-related costs, in large part reflecting higher residential mortgage loan deferred salary costs, reduced residential mortgage lender commissions and associated incentives, and lower stock-based compensation costs, declined in 2022 compared to 2021. The increased residential mortgage loan deferred salary costs reflected the outcome of an updated loan origination cost study and resulting higher allocated cost per loan, while the decreased residential mortgage lender commissions and associated incentives resulted from reduced loan production, in large part reflecting lower refinancing activity. Regular salary costs, primarily reflecting annual merit pay increases and market adjustments, and a bonus accrual were up in 2022. Data processing costs, mainly depicting higher transaction volume and software support costs, and other employee costs, consisting mainly of meals, training, travel, and mileage, also increased in 2022. The higher level of other employee costs primarily reflected the easing of Covid-19 pandemic-related restrictions.
Federal Income Tax Expense
During 2022, we recorded income before federal income tax of $75.8 million and a federal income tax expense of $14.7 million, compared to income before federal income tax of $73.7 million and a federal income tax expense of $14.7 million during 2021. The less than $0.1 million increase in federal income tax expense in 2022 compared to 2021 resulted from the slightly higher level of income before federal income tax. Our effective tax rate was 19.4% during 2022, compared to 19.9% during 2021. The aforementioned bank owned life insurance death benefit claim, substantially all of which was nontaxable, positively impacted the effective tax rate in 2022.
Future changes in tax laws could have a material effect on our business, cash flows, financial condition, results of operations, tax liability, and effective tax rate. On August 16, 2022, the Inflation Reduction Act of 2022 (the “IR Act”) was signed into federal law. The IR Act provides for a new U.S. federal 1% excise tax on certain repurchases of stock by publicly traded U.S. domestic corporations and certain U.S. domestic subsidiaries of publicly traded foreign corporations occurring on or after January 1, 2023. The excise tax is imposed on the repurchasing corporation itself, not its shareholders from which shares are repurchased. The amount of the excise tax is generally 1% of the fair market value of the shares repurchased at the time of the repurchase. However, for purposes of calculating the excise tax, repurchasing corporations are permitted to net the fair market value of certain new stock issuances against the fair market value of stock repurchases during the same taxable year. In addition, certain exceptions apply to the excise tax, such as repurchases under $1 million.
Any redemption or other repurchase that occurs after December 31, 2022, in connection with a business combination, extension vote, or otherwise, may be subject to the excise tax. Whether and to what extent we would be subject to the excise tax in connection with a business combination, extension vote, or otherwise would depend on a number of factors, including: (i) the fair market value of the redemptions and repurchases in connection with the business combination, extension, or otherwise; (ii) the structure of a business combination; (iii) the nature and amount of any equity issuances in connection with a business combination (or otherwise issued not in connection with a business combination but issued within the same taxable year of a business combination); and (iv) the content of regulations and other guidance from the U.S. Department of the Treasury.
The IR Act also included a new 15% Corporate Alternative Minimum Tax (“CAMT”) that acts as a new book minimum tax of at least 15% of consolidated GAAP pre-tax income for corporations with average book income in excess of $1 billion. Any increase in our effective tax rate will depend on a number of factors, including any offsets for general business credits or changes in book income following business combinations. The CAMT is effective for tax years beginning on or after January 1, 2023. Lastly, the IR Act also creates a number of potentially beneficial tax credits to incentivize investments in certain technologies and industries.
We are in the process of evaluating the potential impacts of the IR Act. While we do not believe the IR Act will have a material negative impact on our business or our financial performance, the effects of the measures are unknown at this time. Our analysis is ongoing and incomplete, and it is possible that the IR Act could ultimately have a material adverse effect on our tax liability. We continue to monitor the IR Act and related regulatory developments to evaluate their potential impact on our business, tax rate, and financial results.
CAPITAL RESOURCES
Shareholders’ equity declined $15.2 million during 2022, totaling $441 million as of December 31, 2022. Positively impacting shareholders’ equity was net income of $61.1 million, while negatively affecting shareholders’ equity were cash dividends on our common stock totaling $19.6 million. Activity relating to the issuance and sale of common stock through various stock-based compensation programs and our dividend reinvestment plan positively impacted shareholders’ equity by a total of $4.7 million. Negatively impacting shareholders’ equity during 2022 was a $61.6 million increase in the after-tax net unrealized loss on available for sale securities.
We and our bank are subject to regulatory capital requirements administered by state and federal banking agencies. Failure to meet the various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. As of December 31, 2022, our bank’s total risk-based capital ratio was 13.7%, compared to 13.6% at December 31, 2021. Our bank’s total regulatory capital increased $66.9 million during 2022, primarily reflecting the net impact of net income totaling $70.2 million, a $15.0 million equity capital injection from us in association with the $15.0 million issuance of subordinated notes in January 2022, and cash dividends paid to us aggregating $26.0 million. Our bank’s total risk-based capital ratio was also impacted by a $482 million increase in total risk-weighted assets, in large part reflecting growth in commercial loans and residential mortgage loans. As of December 31, 2022, our bank’s total regulatory capital equaled $619 million, or approximately $166 million in excess of the amount necessary to attain the 10.0% minimum total risk-based capital ratio, which is among the requirements to be categorized as “well capitalized.”
We maintain a stock repurchase program, which is discussed in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in this Annual Report.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment of loans and securities. These funds are used to fund loans, meet deposit withdrawals, maintain reserve requirements and operate our company. Liquidity is essential to our business. An inability to maintain sufficient funds through deposits, borrowings, the sale of assets, and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Liquidity is primarily achieved through local and out-of-area deposits and liquid assets such as securities available for sale, matured and called securities, federal funds sold, and interest-earning deposit balances. Asset and liability management is the process of managing the balance sheet to achieve a mix of earning assets and liabilities that maximizes profitability, while providing adequate liquidity.
To assist in providing needed funds, we have regularly obtained monies from wholesale funding sources. Wholesale funds, comprised of deposits from customers outside of our market areas and advances from the FHLBI, totaled $308 million, or 7.3% of combined deposits and borrowed funds as of December 31, 2022, compared to $398 million, or 8.5% of combined deposits and borrowed funds, as of December 31, 2021. We had no out-of-area deposits as of December 31, 2022, compared to $23.9 million as of December 31, 2021.
Sweep accounts decreased $3.1 million during 2022, totaling $194 million as of December 31, 2022. The aggregate balance of this funding type can be subject to relatively large daily fluctuations given the nature of the customers utilizing this product and the sizable balances that many of the customers maintain. The average balance of sweep accounts equaled $200 million during 2022, with a high balance of $236 million and a low balance of $173 million. Our sweep account program entails transferring collected funds from certain business noninterest-bearing checking accounts to overnight interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts and are not afforded federal deposit insurance. All of our repurchase agreements are accounted for as secured borrowings.
Information regarding our repurchase agreements as of December 31, 2022 and during 2022 is as follows:
| Outstanding balance at December 31, 2022 |
$ | 194,340,000 | ||
| Weighted average interest rate at December 31, 2022 |
0.75 | % |
||
| Maximum daily balance twelve months ended December 31, 2022 |
$ | 235,577,000 | ||
| Average daily balance for twelve months ended December 31, 2022 |
$ | 200,499,000 | ||
| Weighted average interest rate for twelve months ended December 31, 2022 |
0.15 | % |
FHLBI advances declined $65.7 million during 2022, totaling $308 million as of December 31, 2022. Advance maturities aggregating $94.0 million were not replaced as the funds were no longer needed, while advances totaling $28.3 million were obtained to match-fund fixed rate longer term commercial lending relationships. FHLBI advances are primarily used to assist in funding loan demand, as well as playing an integral role in our interest rate risk management program. FHLBI advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on certain commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. Based on collateral, our aggregate borrowing capacity at year-end 2022 totaled $1.03 billion, with availability of $713 million.
We also have the ability to borrow up to $70.0 million on a daily basis through correspondent banks using established unsecured federal funds purchased lines of credit, with an average balance of less than $0.1 million during 2022. In contrast, our interest-earning deposit account at the Federal Reserve Bank of Chicago averaged $439 million during 2022. We have a line of credit through the Discount Window of the Federal Reserve Bank of Chicago. Based on pledged municipal bonds, we could have borrowed up to $27.2 million at December 31, 2022. We have not utilized this line of credit in over ten years, and we do not plan to access this line of credit in future periods.
The following table reflects, as of December 31, 2022, significant fixed and determinable contractual obligations to third parties by payment date, excluding accrued interest:
| One Year |
One to |
Three to |
Over |
|||||||||||||||||
| or Less |
Three Years |
Five Years |
Five Years |
Total |
||||||||||||||||
| Deposits without a stated maturity |
$ | 3,338,103,000 | $ | 0 | $ | 0 | $ | 0 | $ | 3,338,103,000 | ||||||||||
| Certificates of deposit |
188,887,000 | 90,487,000 | 95,334,000 | 0 | 374,708,000 | |||||||||||||||
| Short-term borrowings |
194,340,000 | 0 | 0 | 0 | 194,340,000 | |||||||||||||||
| Federal Home Loan Bank advances |
80,353,000 | 131,688,000 | 71,837,000 | 24,385,000 | 308,263,000 | |||||||||||||||
| Subordinated debentures |
0 | 0 | 0 | 48,958,000 | 48,958,000 | |||||||||||||||
| Subordinated notes |
0 | 0 | 0 | 88,628,000 | 88,628,000 | |||||||||||||||
| Other borrowed money |
0 | 0 | 0 | 1,106,000 | 1,106,000 | |||||||||||||||
| Property leases |
1,091,000 | 1,326,000 | 627,000 | 1,589,000 | 4,633,000 | |||||||||||||||
In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain unfunded loan commitments and standby letters of credit. At December 31, 2022, we had a total of $1.88 billion in unfunded loan commitments and $23.5 million in unfunded standby letters of credit. Of the total unfunded loan commitments, $1.56 billion were commitments available as lines of credit to be drawn at any time as customers’ cash needs vary, and $330 million were for loan commitments generally expected to be accepted and become funded within the next 12 to 18 months. We regularly monitor fluctuations in loan balances and commitment levels, and include such data in our liquidity management.
The following table depicts our loan commitments at the end of the past three years:
| 12/31/22 |
12/31/21 |
12/31/20 |
||||||||||
| Commercial unused lines of credit |
$ | 1,283,703,000 | $ | 1,098,951,000 | $ | 1,019,496,000 | ||||||
| Unused lines of credit secured by 1-4 family residential properties |
71,972,000 | 64,313,000 | 59,396,000 | |||||||||
| Credit card unused lines of credit |
123,687,000 | 92,146,000 | 72,495,000 | |||||||||
| Other consumer unused lines of credit |
75,747,000 | 64,876,000 | 30,707,000 | |||||||||
| Commitments to make loans |
329,646,000 | 212,476,000 | 227,558,000 | |||||||||
| Standby letters of credit |
23,539,000 | 33,109,000 | 20,543,000 | |||||||||
| Total |
$ | 1,908,294,000 | $ | 1,565,871,000 | $ | 1,430,195,000 | ||||||
We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events, economic or market conditions, reductions in earnings performance, declining capital levels, or situations beyond our control could cause liquidity challenges. While we believe it is unlikely that a funding crisis of any significant degree is likely to materialize, we have developed a comprehensive contingency funding plan that provides a framework for meeting liquidity disruptions.
MARKET RISK ANALYSIS
Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and inflation risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. We have only limited agricultural-related loan assets and therefore have no significant exposure to changes in commodity prices. Any impact that changes in foreign exchange rates and commodity prices would have on interest rates is assumed to be insignificant. Interest rate risk is the exposure of our financial condition to adverse movements in interest rates.
Inflation risk is the risk that the values of assets or income from investments will be worth less in the future as inflation decreases the value of money. Recently, there has been a pronounced rise in inflation. As a result, the FOMC has significantly increased interest rates and has indicated its intention to continue doing so in an effort to combat inflation. As inflation increases, the value of our investment securities, particularly those with fixed rates and longer maturities, declines. In addition, inflation increases salary and benefit costs, as well as the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our noninterest expenses. Furthermore, our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.
We derive our income primarily from the excess of interest collected on interest-earning assets over the interest paid on interest-bearing liabilities. The rates of interest we earn on our assets and owe on our liabilities generally are established contractually for a period of time. Since market interest rates change over time, we are exposed to lower profitability if we cannot adapt to interest rate changes. Accepting interest rate risk can be an important source of profitability and shareholder value; however, excessive levels of interest rate risk could pose a significant threat to our earnings and capital base. Accordingly, effective risk management that maintains interest rate risk at prudent levels is essential to our safety and soundness.
Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure. Our interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems, and internal controls are in place to maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk, we assess the existing and potential future effects of changes in interest rates on our financial condition, including capital adequacy, earnings, liquidity, and asset quality.
We use two interest rate risk measurement techniques. The first, which is commonly referred to as GAP analysis, measures the difference between the dollar amounts of interest-sensitive assets and liabilities that will be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to the net interest margin during periods of changing market interest rates.
The following table depicts our GAP position as of December 31, 2022:
| Within |
Three to |
One to |
After |
|||||||||||||||||
| Three |
Twelve |
Five |
Five |
|||||||||||||||||
| Months |
Months |
Years |
Years |
Total |
||||||||||||||||
| Assets: |
||||||||||||||||||||
| Commercial loans (1) |
$ | 1,993,191,000 | $ | 100,353,000 | $ | 903,670,000 | $ | 206,045,000 | $ | 3,203,259,000 | ||||||||||
| Residential real estate loans |
49,666,000 | 17,420,000 | 157,904,000 | 474,846,000 | 699,836,000 | |||||||||||||||
| Consumer loans |
3,079,000 | 418,000 | 9,299,000 | 728,000 | 13,524,000 | |||||||||||||||
| Securities (2) |
20,430,000 | 18,858,000 | 230,791,000 | 350,578,000 | 620,657,000 | |||||||||||||||
| Interest-earning deposits |
31,128,000 | 1,500,000 | 2,250,000 | 0 | 34,878,000 | |||||||||||||||
| Mortgage loans held for sale |
3,565,000 | 0 | 0 | 0 | 3,565,000 | |||||||||||||||
| Allowance for credit losses |
0 | 0 | 0 | 0 | (42,246,000 | ) |
||||||||||||||
| Other assets |
0 | 0 | 0 | 0 | 339,146,000 | |||||||||||||||
| Total assets |
2,101,059,000 | 138,549,000 | 1,303,914,000 | 1,032,197,000 | $ | 4,872,619,000 | ||||||||||||||
| Liabilities: |
||||||||||||||||||||
| Interest-bearing checking |
575,028,000 | 0 | 0 | 0 | 575,028,000 | |||||||||||||||
| Savings deposits |
381,602,000 | 0 | 0 | 0 | 381,602,000 | |||||||||||||||
| Money market accounts |
776,723,000 | 0 | 0 | 0 | 776,723,000 | |||||||||||||||
| Time deposits under $100,000 |
17,184,000 | 51,630,000 | 44,285,000 | 0 | 113,099,000 | |||||||||||||||
| Time deposits $100,000 & over |
40,538,000 | 79,535,000 | 141,536,000 | 0 | 261,609,000 | |||||||||||||||
| Short-term borrowings |
194,340,000 | 0 | 0 | 0 | 194,340,000 | |||||||||||||||
| Federal Home Loan Bank advances |
10,353,000 | 70,000,000 | 203,525,000 | 24,385,000 | 308,263,000 | |||||||||||||||
| Other borrowed money |
50,064,000 | 0 | 88,628,000 | 0 | 138,692,000 | |||||||||||||||
| Noninterest-bearing checking |
0 | 0 | 0 | 0 | 1,604,750,000 | |||||||||||||||
| Other liabilities |
0 | 0 | 0 | 0 | 77,105,000 | |||||||||||||||
| Total liabilities |
2,045,832,000 | 201,165,000 | 477,974,000 | 24,385,000 | 4,431,211,000 | |||||||||||||||
| Shareholders' equity |
0 | 0 | 0 | 0 | 441,408,000 | |||||||||||||||
| Total liabilities & shareholders' equity |
2,045,832,000 | 201,165,000 | 477,974,000 | 24,385,000 | $ | 4,872,619,000 | ||||||||||||||
| Net asset (liability) GAP |
$ | 55,227,000 | $ | (62,616,000 | ) |
$ | 825,940,000 | $ | 1,007,812,000 | |||||||||||
| Cumulative GAP |
$ | 55,227,000 | $ | (7,389,000 | ) |
$ | 818,551,000 | $ | 1,826,363,000 | |||||||||||
| Percent of cumulative GAP to total assets |
1.1 | % | (0.2 | %) |
16.8 | % | 37.5 | % | ||||||||||||
| (1) |
Floating rate loans that are currently at interest rate floors are treated as fixed rate loans and are reflected using maturity date and not repricing frequency. |
| (2) |
Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2022. |
The second interest rate risk measurement used is commonly referred to as net interest income simulation analysis. We believe that this methodology provides a more accurate measurement of interest rate risk than the GAP analysis, and therefore, it serves as our primary interest rate risk measurement technique. The simulation model assesses the direction and magnitude of variations in net interest income resulting from potential changes in market interest rates.
Key assumptions in the model include prepayment speeds on various loan and investment assets; cash flows and maturities of interest-sensitive assets and liabilities; and changes in market conditions impacting loan and deposit volume and pricing. These assumptions are inherently uncertain and subject to fluctuation and revision in a dynamic environment; therefore, the model cannot precisely estimate net interest income or exactly predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions and our strategies, among other factors.
We conducted multiple simulations as of December 31, 2022, in which it was assumed that changes in market interest rates occurred ranging from up 300 basis points to down 300 basis points in equal quarterly instalments over the next twelve months. The following table reflects the suggested dollar and percentage changes in net interest income over the next twelve months in comparison to the $185 million in net interest income projected using our balance sheet amounts and anticipated replacement rates as of December 31, 2022. The resulting estimates are generally within our policy parameters established to manage and monitor interest rate risk.
| Dollar Change |
Percent Change |
|||||||
| In Net |
In Net |
|||||||
| Interest Rate Scenario |
Interest Income |
Interest Income |
||||||
| Interest rates down 300 basis points |
$ | (12,400,000 | ) |
(6.7 | %) | |||
| Interest rates down 200 basis points |
(11,400,000 | ) |
(6.2 | ) | ||||
| Interest rates down 100 basis points |
(4,900,000 | ) |
(2.6 | ) | ||||
| Interest rates up 100 basis points |
5,400,000 | 2.9 | ||||||
| Interest rates up 200 basis points |
11,300,000 | 6.1 | ||||||
| Interest rates up 300 basis points |
17,100,000 | 9.3 | ||||||
In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition, and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; level of nonperforming assets; economic and competitive conditions; potential changes in lending, investing, and deposit gathering strategies; client preferences; and other factors.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
Mercantile Bank Corporation
Grand Rapids, Michigan
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 3, 2023 expressed an unqualified opinion thereon.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2022 due to the adoption of ASC Topic 326, Financial Instruments – Credit Losses. Our opinion is not modified with respect to this matter.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements, and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses – General Reserve
As described in Notes 1 and 3 to the Company’s consolidated financial statements, the Company has a gross loan balance of $3,916,619,000 and related allowance for credit losses balance of $42,246,000 at December 31, 2022. The allowance for credit losses consists of quantitative and qualitative components. The Company considers historical loss experience, current economic and business conditions, as well as reasonable and supportable forecasts to develop the quantitative component. This quantitative component is then adjusted for qualitative environmental factors that involve significant assumptions that require a high degree of management’s judgment.
We identified management’s selection of reasonable and supportable forecasts that represents market conditions in which the Company operates, as well as significant assumptions used in the determination of certain qualitative environmental factors of the allowance for credit losses as a critical audit matter. Management’s selection of a reasonable and supportable forecast and assumptions related to certain qualitative environmental factors, which are used to adjust the quantitative historical losses (both upwards and downwards), are highly subjective and could have a significant impact on the allowance for credit losses. Auditing these complex judgments and assumptions involved especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill and knowledge needed.
The primary procedures we performed to address this critical audit matter included:
| ● | Testing the design and operating effectiveness of internal controls over management’s review of the reasonable and supportable forecasts. As well as their review of certain qualitative environmental factors. |
| ● | Utilizing personnel with specialized skill and knowledge to assist with evaluating the reliability of the reasonable and supportable forecasts used by management by comparing to other external forecast sources, including considerations of contradictory evidence, and evaluating the reasonableness of management’s conclusions that the forecasts used represent geographic areas for which the Company services. |
| ● | Evaluating the reliability of the data and assumptions used by management to support their assessment of certain qualitative environmental factors by vouching to internal and external sources, including considerations of contradictory evidence. |
| ● | Evaluating the reasonableness of management’s conclusion on the qualitative assessment and the resulting adjustment to the allowance. |
/s/
BDO USA, LLP
We have served as the Company’s auditor since 2006.
March 3, 2023
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
Mercantile Bank Corporation
Grand Rapids, Michigan
Opinion on Internal Control over Financial Reporting
We have audited Mercantile Bank Corporation’s (the “Company’s”) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and our report dated March 3, 2023 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report by Mercantile Bank Corporation’s Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of internal control over financial reporting in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ BDO USA, LLP
BDO USA, LLP
Grand Rapids, Michigan
March 3, 2023
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Management assessed the Company’s system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles as of December 31, 2022. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2022, Mercantile Bank Corporation maintained an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles based on those criteria.
The Company’s independent auditors have issued an audit report on the effectiveness of the Company’s internal control over financial reporting as found on page F-31.
Mercantile Bank Corporation
/s/ Robert B. Kaminski, Jr.
Robert B. Kaminski, Jr.
President and Chief Executive Officer
/s/ Charles E. Christmas
Charles E. Christmas
Executive Vice President, Chief Financial Officer and Treasurer
CONSOLIDATED BALANCE SHEETS
December 31, 2022 and 2021
| 2022 | 2021 | |||||||
| ASSETS | ||||||||
| Cash and due from banks | $ | $ | ||||||
| Interest-earning deposits | ||||||||
| Total cash and cash equivalents | ||||||||
| Securities available for sale | ||||||||
| Federal Home Loan Bank stock | ||||||||
| Mortgage loans held for sale | ||||||||
| Loans | ||||||||
| Allowance for credit losses | ( | ) | ( | ) | ||||
| Loans, net | ||||||||
| Premises and equipment, net | ||||||||
| Bank owned life insurance | ||||||||
| Goodwill | ||||||||
| Core deposit intangible, net | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Deposits | ||||||||
| Noninterest-bearing | $ | $ | ||||||
| Interest-bearing | ||||||||
| Total deposits | ||||||||
| Securities sold under agreements to repurchase | ||||||||
| Federal Home Loan Bank advances | ||||||||
| Subordinated debentures | ||||||||
| Subordinated notes | ||||||||
| Accrued interest and other liabilities | ||||||||
| Total liabilities | ||||||||
| Commitments and contingent liabilities (Note 13) | ||||||||
| Shareholders' equity | ||||||||
| Preferred stock, par value; shares authorized; shares outstanding at December 31, 2022 and December 31, 2021 | ||||||||
| Common stock, par value; shares authorized; shares outstanding at December 31, 2022 and shares outstanding at December 31, 2021 | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive gain/(loss) | ( | ) | ( | ) | ||||
| Total shareholders’ equity | ||||||||
| Total liabilities and shareholders’ equity | $ | $ | ||||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2022, 2021 and 2020
| 2022 |
2021 |
2020 |
||||||||||
| Interest income |
||||||||||||
| Loans, including fees |
$ | $ | $ | |||||||||
| Securities, taxable |
||||||||||||
| Securities, tax-exempt |
||||||||||||
| Other interest-earning assets |
||||||||||||
| Total interest income |
||||||||||||
| Interest expense |
||||||||||||
| Deposits |
||||||||||||
| Short-term borrowings |
||||||||||||
| Federal Home Loan Bank advances |
||||||||||||
| Subordinated debentures and other borrowings |
||||||||||||
| Total interest expense |
||||||||||||
| Net interest income |
||||||||||||
| Provision (benefit) for credit losses |
( |
) |
||||||||||
| Net interest income after provision for credit losses |
||||||||||||
| Noninterest income |
||||||||||||
| Service charges on deposit and sweep accounts |
||||||||||||
| Mortgage banking activities |
||||||||||||
| Credit and debit card fees |
||||||||||||
| Interest rate swap program fees |
||||||||||||
| Payroll processing |
||||||||||||
| Earnings on bank owned life insurance |
||||||||||||
| Gain on sale of branch |
||||||||||||
| Other income |
||||||||||||
| Total noninterest income |
||||||||||||
| Noninterest expense |
||||||||||||
| Salaries and benefits |
||||||||||||
| Occupancy |
||||||||||||
| Furniture and equipment rent, depreciation and maintenance |
||||||||||||
| Data processing |
||||||||||||
| Advertising |
||||||||||||
| FDIC insurance costs |
||||||||||||
| Charitable foundation contributions |
||||||||||||
| Other expense |
||||||||||||
| Total noninterest expenses |
||||||||||||
| Income before federal income tax expense |
||||||||||||
| Federal income tax expense |
||||||||||||
| Net income |
$ | $ | $ | |||||||||
| Earnings per common share: |
||||||||||||
| Basic |
$ | $ | $ | |||||||||
| Diluted |
$ | $ | $ | |||||||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2022, 2021 and 2020
| 2022 |
2021 |
2020 |
||||||||||
| Net income |
$ | $ | $ | |||||||||
| Other comprehensive income (loss): |
||||||||||||
| Unrealized holding gains (losses) on securities available for sale |
( |
) |
( |
) |
||||||||
| Total other comprehensive income (loss) |
( |
) |
( |
) |
||||||||
| Tax effect of unrealized holding gains (losses) on securities available for sale |
( |
) |
||||||||||
| Total tax effect of other comprehensive income (loss) |
( |
) |
||||||||||
| Other comprehensive income (loss), net of tax effect |
( |
) |
( |
) |
||||||||
| Comprehensive income (loss) |
$ | ( |
) |
$ | $ | |||||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years ended December 31, 2022, 2021 and 2020
| Accumulated | ||||||||||||||||||||
| Other | Total | |||||||||||||||||||
| Preferred | Common | Retained | Comprehensive | Shareholders’ | ||||||||||||||||
| ($ in thousands except per share amounts) | Stock | Stock | Earnings | Income/(Loss) | Equity | |||||||||||||||
| Balances, January 1, 2020 | $ | | $ | | $ | | $ | | $ | | ||||||||||
| Employee stock purchase plan ( shares) | | | ||||||||||||||||||
| Dividend reinvestment plan ( shares) | | | ||||||||||||||||||
| Stock option exercises, net ( shares) | | | ||||||||||||||||||
| Stock grants to directors for retainer fees ( shares) | | | ||||||||||||||||||
| Stock-based compensation expense | | | ||||||||||||||||||
| Share repurchase program ( shares) | ( | ) | ( | ) | ||||||||||||||||
| Cash dividends ($ per common share) | ( | ) | ( | ) | ||||||||||||||||
| Net income for 2020 | | | ||||||||||||||||||
| Change in net unrealized gain/(loss) on securities available for sale, net of tax effect | | | ||||||||||||||||||
| Balances, December 31, 2020 | $ | | $ | | $ | | $ | | $ | | ||||||||||
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2022, 2021 and 2020
| Accumulated | ||||||||||||||||||||
| Other | Total | |||||||||||||||||||
| Preferred | Common | Retained | Comprehensive | Shareholders’ | ||||||||||||||||
| ($ in thousands except per share amounts) | Stock | Stock | Earnings | Income/(Loss) | Equity | |||||||||||||||
| Balances, January 1, 2021 | $ | $ | $ | $ | $ | |||||||||||||||
| Employee stock purchase plan ( shares) | ||||||||||||||||||||
| Dividend reinvestment plan ( shares) | ||||||||||||||||||||
| Stock option exercises, net ( shares) | ||||||||||||||||||||
| Stock grants to directors for retainer fees ( shares) | ||||||||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Share repurchase program ( shares) | ( | ) | ( | ) | ||||||||||||||||
| Cash dividends ($ per common share) | ( | ) | ( | ) | ||||||||||||||||
| Net income for 2021 | ||||||||||||||||||||
| Change in net unrealized gain/(loss) on securities available for sale, net of tax effect | ( | ) | ( | ) | ||||||||||||||||
| Balances, December 31, 2021 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2022, 2021 and 2020
| Accumulated | ||||||||||||||||||||
| Other | Total | |||||||||||||||||||
| Preferred | Common | Retained | Comprehensive | Shareholders’ | ||||||||||||||||
| ($ in thousands except per share amounts) | Stock | Stock | Earnings | Income/(Loss) | Equity | |||||||||||||||
| Balances, January 1, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Adoption of ASU 2016-13 | ||||||||||||||||||||
| Employee stock purchase plan ( shares) | ||||||||||||||||||||
| Dividend reinvestment plan ( shares) | ||||||||||||||||||||
| Stock option exercises, net ( shares) | ||||||||||||||||||||
| Stock grants to directors for retainer fees ( shares) | ||||||||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||
| Cash dividends ($ per common share) | ( | ) | ( | ) | ||||||||||||||||
| Net income for 2022 | ||||||||||||||||||||
| Change in net unrealized gain/(loss) on securities available for sale, net of tax effect | ( | ) | ( | ) | ||||||||||||||||
| Balances, December 31, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2022, 2021 and 2020
| 2022 |
2021 |
2020 |
||||||||||
| Cash flows from operating activities |
||||||||||||
| Net income |
$ | $ | $ | |||||||||
| Adjustments to reconcile net income to net cash from operating activities: |
||||||||||||
| Depreciation and amortization |
||||||||||||
| Accretion of acquired loans |
( |
) |
( |
) |
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| Provision for credit losses |
( |
) |
||||||||||
| Deferred income tax expense (benefit) |
( |
) |
( |
) |
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| Stock-based compensation expense |
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| Stock grants to directors for retainer fee |
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| Proceeds from sales of mortgage loans held for sale |
||||||||||||
| Origination of mortgage loans held for sale |
( |
) |
( |
) |
( |
) |
||||||
| Net gain on sales of mortgage loans held for sale |
( |
) |
( |
) |
( |
) |
||||||
| Net gain from sales and valuation write-downs of foreclosed assets |
( |
) |
( |
) |
( |
) |
||||||
| Net (gain) loss from sale and write-downs on former bank premises |
( |
) |
( |
) |
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| Net (gain) loss from sales and disposals of premises and equipment |
( |
) |
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| Earnings on bank owned life insurance |
( |
) |
( |
) |
( |
) |
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| Gain on sale of branch |
( |
) |
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| Net (gain) loss on instruments designated at fair value and related derivatives |
( |
) |
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| Net change in: |
||||||||||||
| Accrued interest receivable |
( |
) |
( |
) |
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| Other assets |
( |
) |
( |
) |
( |
) |
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| Accrued interest and other liabilities |
( |
) |
||||||||||
| Net cash from operating activities |
||||||||||||
| Cash flows from investing activities |
||||||||||||
| Purchases of securities available for sale |
( |
) |
( |
) |
( |
) |
||||||
| Proceeds from maturities, calls and repayments of securities available for sale |
||||||||||||
| Loan originations and payments, net |
( |
) |
( |
) |
( |
) |
||||||
| Proceeds from Federal Home Loan Bank stock redemption |
||||||||||||
| Purchases of bank owned life insurance |
( |
) |
( |
) |
( |
) |
||||||
| Proceeds from bank owned life insurance death benefits claim |
||||||||||||
| Net cash transferred in branch sale |
( |
) |
||||||||||
| Purchases of premises and equipment and lease activity |
( |
) |
( |
) |
( |
) |
||||||
| Proceeds from sales of former bank premises |
||||||||||||
| Proceeds from sales of foreclosed assets |
||||||||||||
| Net cash for investing activities |
( |
) |
( |
) |
( |
) |
||||||
| Cash flows from financing activities |
||||||||||||
| Net decrease in time deposits |
( |
) |
( |
) |
( |
) |
||||||
| Net (decrease) increase in all other deposits |
( |
) |
||||||||||
| Net (decrease) increase in securities sold under agreements to repurchase |
( |
) |
||||||||||
| Proceeds from Federal Home Loan Bank advances |
||||||||||||
| Maturities of Federal Home Loan Bank advances |
( |
) |
( |
) |
( |
) |
||||||
| Net proceeds from subordinated notes issuance |
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| Proceeds from stock option exercises, net of cashless exercises |
||||||||||||
| Employee stock purchase plan |
||||||||||||
| Dividend reinvestment plan |
||||||||||||
| Repurchases of common stock |
( |
) |
( |
) |
||||||||
| Payment of cash dividends to common shareholders |
( |
) |
( |
) |
( |
) |
||||||
| Net cash (for) from financing activities |
( |
) |
||||||||||
See accompanying notes to consolidated financial statements.
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 2022, 2021 and 2020
| 2022 |
2021 |
2020 |
||||||||||
| Net change in cash and cash equivalents |
( |
) |
||||||||||
| Cash and cash equivalents at beginning of period |
||||||||||||
| Cash and cash equivalents at end of period |
$ | $ | $ | |||||||||
| Supplemental disclosures of cash flows information |
||||||||||||
| Cash paid during the year for: |
||||||||||||
| Interest |
$ | $ | $ | |||||||||
| Federal income taxes |
||||||||||||
| Noncash financing and investing activities: |
||||||||||||
| Transfers from loans to foreclosed assets |
||||||||||||
| Transfers from bank premises to other real estate owned |
||||||||||||
| Transfers from premises and equipment to other assets |
||||||||||||
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the accounts of Mercantile Bank Corporation (“Mercantile”) and its subsidiary, Mercantile Bank (“our bank”), and of Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank, after elimination of significant intercompany transactions and accounts.
Mercantile has
Nature of Operations: Mercantile was incorporated on July 15, 1997 to establish and own the bank based in Grand Rapids, Michigan. Our bank began operations on December 15, 1997. We completed the merger of Firstbank Corporation (“Firstbank”), a Michigan corporation with approximately $
Our bank is a community-based financial institution. Our bank’s primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial loans, residential mortgage loans, and instalment loans. Substantially all loans are secured by specific items of collateral including business assets, real estate or consumer assets. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by commercial or residential real estate. We have no material foreign loans or significant overdraft balances. Our bank’s loan accounts and retail deposits are primarily with customers located in the communities in which we have bank office locations. As an alternative source of funds, our bank has also issued certificates of deposit to depositors outside of its primary market areas. Substantially all revenues are derived from banking products and services and investment securities. While we monitor the revenue streams of the various products and services offered, we manage our business on the basis of one operating segment, banking.
Our insurance company acquired an existing shelf insurance agency effective April 15, 2002. An Agency and Institution Agreement was entered into among our insurance company, our bank and Hub International for the purpose of providing programs of mass marketed personal lines of insurance. Insurance product offerings include private passenger automobile, homeowners, personal inland marine, boat owners, recreational vehicle, dwelling fire, umbrella policies, small business and life insurance products, all of which are provided by and written through companies that have appointed Hub International as their agent. To date, we have not provided the insurance products noted above and currently have no plans to do so.
We have evaluated subsequent events for potential recognition and/or disclosure through the date these financial statements were issued.
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for credit losses and the fair values of financial instruments are particularly subject to change.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Coronavirus Pandemic: Although virtually all related restrictions have been terminated, impacts remain across national and global economies due to the pandemic of coronavirus disease 2019 (“Covid-19”) caused by severe acute respiratory syndrome coronavirus 2 (the “Coronavirus Pandemic”). Overall, The Coronavirus Pandemic has caused a sustained global economic slowdown of varying durations across different industries, and it is possible that it could still cause a global recession as a result of deteriorating economic and political conditions such as increased unemployment, decreased capital spending, declines in consumer confidence, and economic slowdowns. This uncertainty is heightened in certain geographic areas due to continued surges in Covid-19 cases, and governments at all levels continue to react to changes in circumstances, including vaccine hesitancy, booster shot efficacy, supply chain disruptions and inflationary pressures. For example, although many health and safety restrictions have been lifted and vaccine distribution has increased, certain adverse consequences of the Coronavirus Pandemic continue to impact the macroeconomic environment and may persist for some time, including labor shortages and disruptions of global supply chains, particularly in China and other parts of Asia. In addition, this uncertainty is further heightened by the possibility that new and highly infectious variants and subvariants of Covid-19 might arise which are more severe, more transmissible, and capable of evading vaccinations, booster shots and prior immunity.
The Coronavirus Pandemic has had a significant impact on our financial condition and operating results since its onset in March, 2020. Federal government stimulus programs resulted in a massive increase to the money supply, providing significant inflationary pressures that the Federal Reserve’s Federal Open Market Committee (“FOMC”) has been attempting to manage through substantial increases in the federal funds rate since March, 2022. In addition, we experienced significant growth in liquidity as federal government stimulus monies were deposited by program recipients, providing for sizable impacts to our operating performance as well as our capital and liquidity positions during 2022 and 2021.
The following section summarizes the primary Covid-19 related measures that directly impacted us and our customers.
| ● | Paycheck Protection Program |
|
| The Paycheck Protection Program (“PPP”) reflected a substantial expansion of the Small Business Administration’s 100% guaranteed 7(a) loan program. The CARES Act authorized up to $350 billion in loans to businesses with fewer than 500 employees, including non-profit organizations, tribal business concerns, and self-employed and individual contractors. The PPP provided 100% guaranteed loans to cover specific operating costs. PPP loans were eligible to be forgiven based upon certain criteria. In general, the amount of the loan that is forgivable is the sum of the payroll costs, interest payments on mortgages, rent, and utilities incurred or paid by the business during a prescribed period beginning on the loan origination date. Any remaining balance after forgiveness is maintained at the 100% guarantee for the duration of the loan. The interest rate on the loan is fixed at 1.00%, with the financial institution receiving a loan origination fee from the Small Business Administration. The loan origination fees, net of the direct origination costs, are accreted into interest income on loans using the level yield methodology. The program ended on August 8, 2020. We originated approximately
The Consolidated Appropriations Act, 2021 authorized an additional $284 billion in Second Draw PPP loans (“Second Draw”). This program ended on May 31, 2021. Under the Second Draw, we originated approximately |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
| ● | Individual Economic Impact Payments |
|
| The Internal Revenue Service made three rounds of Individual Economic Impact Payments via direct deposit or mailed checks. In general, and subject to adjusted gross income limitations, qualifying individuals received payments of $1,200 in April 2020, $600 in January 2021, and $1,400 in March 2021. |
| ● | Troubled Debt Restructuring Relief |
|
| From March 1, 2020 through 60 days after the end of the National Emergency (or December 31, 2020 if earlier), a financial institution may elect to suspend GAAP principles and regulatory determinations with respect to loan modifications related to Covid-19 that would otherwise be categorized as troubled debt restructurings. Banking agencies must defer to the financial institution’s election. The Consolidated Appropriations Act, 2021 extended the suspension date to January 1, 2022. We elected to suspend GAAP principles and regulatory determinations as permitted up to December 31, 2021. |
| ● | Current Expected Credit Loss Methodology Delay |
|
| Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the National Emergency or December 31, 2020. We elected to postpone CECL adoption as permitted. The Consolidated Appropriations Act, 2021 extended the adoption deferral date to January 1, 2022. We adopted the CECL methodology effective January 1, 2022. |
We continue to monitor the situation, including cases of sickness within our workforce, and will take action to adjust office attendance policies as circumstances warrant in order to protect the health and safety of employees, contractors, and others who visit our offices. However, if the Coronavirus Pandemic worsens and shutdown orders are issued in the future, our ability to operate could be adversely impacted, depending on the language of such orders. The extent to which the Coronavirus Pandemic continues to impact us will depend on future developments, which are highly uncertain and cannot be predicted.
Cash and Cash Equivalents and Cash Flow Reporting: Cash and cash equivalents include cash on hand, demand deposits with other financial institutions, short-term investments and federal funds sold. Cash flows are reported net for customer loan and deposit transactions, interest-earning deposits invested with other financial institutions and short-term borrowings with maturities of 90 days or less.
Debt Securities: Debt securities classified as held to maturity are carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities available for sale consist of bonds which might be sold prior to maturity due to a number of factors, including changes in interest rates, prepayment risks, yield, availability of alternative investments or liquidity needs. Debt securities classified as available for sale are reported at their fair value. For available for sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the debt security’s amortized cost basis is written down to fair value through income with the establishment of an allowance. For debt securities available for sale that do not meet the aforementioned criteria, we evaluate whether any decline in fair value is due to credit loss factors. In making this assessment, we consider any changes to the rating of the security by a rating agency and adverse conditions specifically related to the issuer of the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance is recognized in other comprehensive income.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Changes in the allowance under CECL are recorded as provisions for (or reversal of) credit loss expense. Losses are charged against the allowance when the collectability of an available for sale debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At December 31, 2022, there was allowance related to the available for sale debt securities portfolio.
Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized or accreted on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
It is not practical to determine the fair value of FHLBI stock due to transferability restrictions; therefore, its fair value is estimated at carrying value.
Loans: Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. Net unamortized deferred loan fees/(costs) amounted to ($
Interest income on commercial loans and mortgage loans is discontinued at the time the loan is
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Commercial Loan Participations: As part of our credit risk administration practices and to manage exposure limits, we engage in commercial loan participations with other financial institutions from time-to-time. In all instances, the commercial loans are participated at par with no loan yield adjustments; therefore, no gain or loss on sale, or servicing right, is recorded. We retain a large portion of the loan exposure and continue to service the lending relationship. Commercial loan participations aggregated $
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related mortgage loan sold, which is reduced by the cost allocated to the servicing right. We generally lock in the sale price to the purchaser of the mortgage loan at the same time we make an interest rate commitment to the borrower.
Year-end mortgage loans held for sale, included in total loans in the Consolidated Balance Sheets, were as follows:
| 2022 | 2021 | |||||||
| Mortgage loans held for sale | $ | $ | ||||||
| Less: Allowance to adjust to lower of cost or market | ||||||||
| Mortgage loans held for sale, net | $ | $ | ||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Mortgage Loan Derivatives: We enter into forward contracts and interest rate lock commitments in the ordinary course of business, which are accounted for as derivatives. The derivatives are not designated as hedges and are carried at fair value. The net gain or loss on derivatives is included in mortgage banking activities in the Consolidated Statements of Income. The balance of mortgage loan derivatives aggregated less than $
Mortgage Banking Activities: Mortgage loan servicing rights are recognized as assets based on the allocated value of retained servicing rights on mortgage loans sold. Mortgage loan servicing rights are carried at the lower of amortized cost or fair value and are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying mortgage loans as to interest rates. Any impairment of a grouping is reported as a valuation allowance.
Servicing fee income is recorded for fees earned for servicing mortgage loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Amortization of mortgage loan servicing rights is netted against mortgage loan servicing income and recorded in mortgage banking activities in the Consolidated Statements of Income.
Troubled Debt Restructurings: A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.
The federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” on March 22, 2020, which was subsequently revised on April 7, 2020. This guidance encourages financial institutions to work prudently with borrowers that are or may be unable to meet their contractual obligations because of the effects of the Coronavirus Pandemic. Pursuant to the guidance, the federal banking agencies concluded, in consultation with FASB staff, that short-term modifications (e.g., six months) made on a good faith basis to borrowers who were current prior to any relief are not troubled debt restructurings. This guidance complements Section 4013 of the CARES Act, which specified that Coronavirus-related modifications made on loans that were current as of December 31, 2019 and that occur between March 1, 2020 and the earlier of 60 days after the date of termination of the National Emergency declared by President Trump on March 13, 2020 (the “National Emergency”) or December 31, 2020, as applicable, are not troubled debt restructurings. As part of the Consolidated Appropriations Act that was enacted in late 2020, this guidance was extended to January 1, 2022.
Allowance for Credit Losses (“Allowance”): In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU (as subsequently amended) significantly changed how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard replaced the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the CECL model, applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. The standard also expanded the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance. In addition, entities need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. This ASU was effective for interim and annual reporting periods beginning after December 15, 2019.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Financial institutions were not required to comply with the CECL methodology requirements from the enactment date of the CARES Act until the earlier of the end of the President’s declaration of a National Emergency or December 31, 2020. The Consolidated Appropriations Act, 2021, that was enacted in December 2020, provided for a further extension of the required CECL adoption date to January 1, 2022. An economic forecast is a key component of the CECL methodology. As we continued to experience an unprecedented economic environment whereby a sizable portion of the economy had been significantly impacted by government-imposed activity limitations and similar reactions by businesses and individuals, substantial government stimulus was provided to businesses, individuals and state and local governments and financial institutions offered businesses and individuals payment relief options, economic forecasts were regularly revised with no economic forecast consensus. Given the high degree of uncertainty surrounding economic forecasting, we elected to postpone the adoption of CECL until January 1, 2022, and continued to use our incurred loan loss reserve model as permitted through December 31, 2021.
We adopted CECL effective January 1, 2022 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the incurred loss accounting standards. The transition adjustment of the CECL adoption included a decrease in the allowance of $
Accrued interest receivable for loans is included in other assets on our Consolidated Balance Sheet. We elected not to measure an allowance for accrued interest receivable and instead elected to reverse interest income on loans that are placed on nonaccrual status, which is generally when the loan becomes 90 days past due, or earlier if we believe the collection of interest is doubtful. We believe this policy results in the timely reversal of uncollectible interest.
The allowance is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged-off against the allowance when we believe the uncollectibility of a loan balance is confirmed.
The allowance is measured on a collective pool basis when similar risk characteristics exist. Loans with similar risk characteristics are grouped into homogenous segments, or pools, for analysis. Commercial loans are divided among five segments based primarily on collateral type, risk characteristics, and primary and secondary sources of repayment. These segments are then further stratified based on the commercial loan grade that is assigned using our standard loan grading paradigm. Retail loans are divided into one of two groups based on if the loan is secured by residential real estate or not.
Our loan portfolio segments as of December 31, 2022 were as follows:
| o | Commercial Loans |
| ■ | Commercial and Industrial: Risks to this loan category include industry concentration and the practical limitations associated with monitoring the condition of the collateral which often consists of inventory, accounts receivable, and other non-real estate assets. Equipment and inventory obsolescence can also pose a risk. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. |
| ■ | Owner Occupied Commercial Real Estate: Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category. |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
| ■ | Non-Owner Occupied Commercial Real Estate: Loans in this category are susceptible to declines in occupancy rates, business failure, and general economic conditions. Also, declines in real estate values and lack of suitable alternative use for the properties are risks for loans in this category. |
| ■ | Multi-Family and Residential Rental: Risks to this loan category include industry concentration and the inability to monitor the condition of the collateral. Loans in this category are susceptible to weakening general economic conditions and increases in unemployment rates, as well as market demand and supply of similar property and the resulting impact on occupancy rates, market rents, cash flow, and income-based real estate values. Also, the lack of a suitable alternative use for the properties is a risk for loans in this category. |
| ■ | Vacant Land, Land Development and Residential Construction: Risks common to commercial construction loans are cost overruns, changes in market demand for property, inadequate long-term financing arrangements, and declines in real estate values. Residential construction loans are susceptible to those same risks as well as those associated with residential mortgage loans. Changes in market demand for property could lead to longer marketing times resulting in higher carrying costs, declining values, and higher interest rates. |
| o | Retail Loans |
| ■ | 1-4 Family Mortgages: Residential mortgage loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values. |
| ■ | Other Consumer Loans: Risks common to these loans include regulatory risks, unemployment, and changes in local economic conditions as well as the inability to monitor collateral consisting of personal property. |
The “remaining life methodology” is utilized for substantially all loan pools. This non-discounted cash flow approach projects an estimated future amortized cost basis based on current loan balance and repayment terms. Our historical loss rate is then applied to future loan balances at the instrument level based on remaining contractual life adjusted for amortization, prepayment and default to develop a baseline lifetime loss. The baseline lifetime loss is adjusted for changes in macroeconomic conditions over the reasonable and supportable forecast and reversion periods via a series of macroeconomic forecast inputs, such as gross domestic product, unemployment rates, interest rates, credit spreads, stock market volatility and property price indices, to quantify the impact of current and forecasted economic conditions on expected loan performance.
We use migration to determine historical loss rates for commercial loans given the comprehensive loan grading process employed by the bank for over two decades, while an open pool approach is best suited for retail loans given the smaller dollar size of the segments. A baseline loss rate is produced at each reporting date for each loan portfolio segment using bank-specific loan charge-off and recovery data over a defined historical look-back period. The look-back period represents the number of data periods that will be used to calculate a baseline loss rate for each loan portfolio segment. We determined that the look-back period commencing on January 1, 2011 through the current reporting date was reasonable and appropriate.
Reasonable and supportable economic forecasts have to be incorporated in determining expected credit losses. The forecast period represents the time frame from the current period end through the point in time that we can reasonably forecast and support entity and environmental factors that are expected to impact the performance of our loan portfolio. Ideally, the economic forecast period would encompass the contractual terms of all loans; however, the ability to produce a forecast that is considered reasonable and supportable becomes more difficult or may not be possible in later periods.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Subsequent to the end of the forecast period, we revert to historical loan data based on an ongoing evaluation of each economic forecast in relation to then current economic conditions as well as any developing loan loss activity and resulting historical data. As of December 31, 2022, we used a one-year reasonable and supportable economic forecast period, with a six-month straight-line reversion period for all loan segments.
We are not required to develop and use our own economic forecast model, and elected to utilize economic forecasts from third-party providers that analyze and develop forecasts of the economy for the entire United States at least quarterly. The economic forecasts used for our December 31, 2022 allowance calculation reflected a $
During each reporting period, we also consider the need to adjust the historical loss rates as determined by our migration calculations to reflect the extent to which we expect current conditions and reasonable and supportable economic forecasts to differ from the conditions that existed for the period over which the migration-based historical loss information was determined. These qualitative adjustments may increase or decrease our estimate of expected future credit losses.
Traditional qualitative factors include:
| o | Changes in lending policies and procedures |
| o | Changes in the nature and volume of the loan portfolio and in the terms of loans |
| o | Changes in the experience, ability and depth of lending management and other relevant staff |
| o | Changes in the volume and severity of past due loans, nonaccrual loans and adversely classified loans |
| o | Changes in the quality of the loan review program |
| o | Changes in the value of underlying collateral dependent loans |
| o | Existence and effect of any concentrations of credit and any changes in such |
| o | Effect of other factors such as competition and legal and regulatory requirements |
The estimation of future credit losses should reflect consideration of all significant factors that affect the collectibility of the loan portfolio at each evaluation date. While our methodology considers both the historical loss rates as well as the traditional qualitative factors, there may be instances or situations where additional qualitative factors need to be considered. Effective January 1, 2022, we established a historical loss information factor to address the relatively low level of loan losses during the look-back period.
Expected credit losses are estimated over the contractual terms of the loans, adjusted for expected prepayments when appropriate. The contractual term generally excludes potential extensions, renewals and modifications.
We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via other noninterest expense on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from our bank and put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) our bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Our transfers of financial assets are generally limited to commercial loan participations sold and residential mortgage loans sold in the secondary market.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 33 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur and major improvements are capitalized. Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable based on future undiscounted cash flows. If impaired, the assets are recorded at the lower of carrying value or fair value.
Foreclosed Assets: Assets acquired through or in lieu of foreclosure are initially recorded at their estimated fair value net of estimated selling costs, establishing a new cost basis. If fair value subsequently declines, a valuation allowance is recorded through noninterest expense, as are collection and operating costs after acquisition. Foreclosed assets, included in other assets in the Consolidated Balance Sheets, totaled $
Bank Owned Life Insurance: Our bank has purchased life insurance policies on certain key officers. Bank owned life insurance is recorded at its cash surrender value, or the amount that can be realized. Increases in the net cash surrender value of the policies, as well as insurance proceeds received, are recorded as noninterest income on the Consolidated Statements of Income and are not subject to income taxes.
Goodwill and Core Deposit Intangible: GAAP requires us to determine the fair value of all the assets and liabilities of an acquired entity, and record their fair value on the date of acquisition. We employ a variety of means in determination of the fair value, including the use of discounted cash flow analysis, market comparisons and projected future revenue streams. For certain items we concluded to have the appropriate expertise to determine the fair value, we may choose to use our own calculation of fair value. In other cases, where the fair value is not readily determined, consultation with outside parties is used to determine fair value. Once valuations have been determined, the net difference between the price paid for the acquired company and the fair value of the balance sheet is recorded as goodwill. Goodwill is assessed at least annually for impairment, with any such impairment recognized in the period identified. A more frequent assessment is performed if there are material changes in the market place or within the organizational structure. We conducted an annual test during 2022 using step zero, with no impairment identified.
The core deposit intangible that arose from the merger with Firstbank was initially measured at fair value and is being amortized into noninterest expense over a -year period using the sum-of-the-years-digits methodology.
Repurchase Agreements: Our bank sells certain securities under agreements to repurchase. The agreements are treated as collateralized financing transactions, with the obligations to repurchase the securities sold reflected as liabilities and the securities underlying the agreements remaining in assets in the Consolidated Balance Sheets.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Financial Instruments and Loan Commitments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit, that are considered financial guarantees are recorded at fair value. Reserves for unfunded commitments are recorded as an other liability on our Consolidated Balance Sheets.
Stock-Based Compensation: Compensation cost for equity-based awards is measured on the grant date based on the fair value of the award at that date, and is recognized over the requisite service period, net of estimated forfeitures. Fair value of stock option awards is estimated using a closed option valuation (Black-Scholes) model. Fair value of restricted stock awards is based upon the quoted market price of the common stock on the date of grant.
Revenue from Contracts with Customers: We record revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
Our primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of our contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary.
We generally satisfy our performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
The following table depicts our sources of noninterest income presented in the Consolidated Statements of Income for the years ended December 31, 2022, 2021 and 2020 that are scoped within Topic 606:
| 2022 | 2021 | 2020 | ||||||||||
| Service charges on deposit and sweep accounts | $ | $ | $ | |||||||||
| Credit and debit card fees | ||||||||||||
| Payroll processing | ||||||||||||
| Customer service fees | ||||||||||||
Service Charges on Deposit and Sweep Accounts: We earn fees from deposit and sweep customers for account maintenance, transaction-based and overdraft services. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of the month reflecting the period over which we satisfy the performance obligation. Transaction-based fees, which includes services such as stop payment and returned item charges, are recognized at the time the transaction is executed as that is the point in time we fulfill the customer request. Service charges on deposit and sweep accounts are withdrawn from the customer account balance.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Credit and Debit Card Fees: We earn interchange income on our cardholder debit and credit card usage. Interchange income is primarily comprised of fees whenever our debit and credit cards are processed through card payment networks such as Visa. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.
Payroll Processing Fees: We earn fees from providing payroll processing services for our commercial clients. Fees are assessed for processing weekly or bi-weekly payroll files, reports and documents, as well as year-end tax-related files, reports and documents. Fees are recognized and collected as payroll processing services are completed for each payroll run and year-end processing activities.
Customer Service Fees: We earn fees by providing a variety of other services to our customers, such as wire transfers, check ordering, sales of cashier checks and money orders, and rentals of safe deposit boxes. Generally, fees are recognized and collected daily, concurrently with the point in time we fulfill the customer request. Safe deposit box rentals are on annual contracts, with fees generally earned at the time of the contract signing or renewal. Customer service fees are recorded as other noninterest income on our Consolidated Statements of Income.
Advertising Costs: Advertising costs are expensed as incurred.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable, the change in deferred income tax assets and liabilities, and any adjustments related to unrecognized tax benefits. Deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates applicable to future years. A valuation allowance, if needed, reduces deferred income tax assets to the amount expected to be realized.
Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments.
Earnings Per Share: Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans using the treasury stock method. Our unvested stock awards, which contain non-forfeitable rights to dividends whether paid or unpaid (i.e., participating securities), are included in the number of shares outstanding for both basic and diluted earnings per share calculations. In the event of a net loss, our unvested stock awards are excluded from the calculations of both basic and diluted earnings per share.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale.
Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for hedge accounting. Used as part of our asset and liability management to help manage interest rate risk, our derivatives have historically generally consisted of interest rate swap agreements that qualified for hedge accounting. We do not use derivatives for trading purposes.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Changes in the fair value of derivatives that are designated, for accounting purposes, as a hedge of the variability of cash flows to be received on various assets and liabilities and are effective are reported in other comprehensive income. They are later reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair value of derivatives are recognized immediately in current earnings as interest income or expense. We had no derivative instruments designated as hedges as of December 31, 2022 and 2021.
Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. We do not believe there are any such matters outstanding that would have a material effect on the financial statements
Newly Issued Not Yet Effective Standards: ASU No. 2022-02 Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU eliminates the accounting guidance for troubled debt restructurings (“TDRs”) by creditors in Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors, while adding disclosures for certain loan restructurings by creditors when a borrower is experiencing financial difficulty. This guidance requires an entity to determine whether the modification results in a new loan or a continuation of an existing loan. Additionally, the ASU requires disclosures of current period gross charge-offs by year of origination for financing receivables. This ASU is effective for fiscal years beginning after December 15, 2022. We do not believe the adoption of this ASU will have a material impact on our financial results. The required disclosures for gross charge-offs on our financial statements will be added upon adoption of this new standard.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 2 – SECURITIES
The amortized cost and fair value of available for sale securities and the related pre-tax gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows at year-end 2022 and 2021:
| Gross | Gross | |||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| 2022 | ||||||||||||||||
| U.S. Government agency debt obligations | $ | $ | $ | ( | ) | $ | ||||||||||
| Mortgage-backed securities | ( | ) | ||||||||||||||
| Municipal general obligation bonds | ( | ) | ||||||||||||||
| Municipal revenue bonds | ( | ) | ||||||||||||||
| Other investments | ||||||||||||||||
| $ | $ | $ | ( | ) | $ | |||||||||||
| 2021 | ||||||||||||||||
| U.S. Government agency debt obligations | $ | $ | $ | ( | ) | $ | ||||||||||
| Mortgage-backed securities | ( | ) | ||||||||||||||
| Municipal general obligation bonds | ( | ) | ||||||||||||||
| Municipal revenue bonds | ( | ) | ||||||||||||||
| Other investments | ||||||||||||||||
| $ | $ | $ | ( | ) | $ | |||||||||||
Securities with unrealized losses at year-end 2022 and 2021, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:
| Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Description of Securities | Value | Loss | Value | Loss | Value | Loss | ||||||||||||||||||
| 2022 | ||||||||||||||||||||||||
| U.S. Government agency debt obligations | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||
| Municipal general obligation bonds | ||||||||||||||||||||||||
| Municipal revenue bonds | ||||||||||||||||||||||||
| Other investments | ||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| 2021 | ||||||||||||||||||||||||
| U.S. Government agency debt obligations | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||
| Municipal general obligation bonds | ||||||||||||||||||||||||
| Municipal revenue bonds | ||||||||||||||||||||||||
| Other investments | ||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 2 – SECURITIES (Continued)
We evaluate securities in an unrealized loss position at least quarterly. Consideration is given to the financial condition of the issuer, and the intent and ability we have to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. For those debt securities whose fair value is less than their amortized cost basis, we also consider our intent to sell the security, whether it is more likely than not that we will be required to sell the security before recovery and if we do not expect to recover the entire amortized cost basis of the security. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.
At December 31, 2022,
The amortized cost and fair values of debt securities at December 31, 2022, by maturity, are shown in the following table. The contractual maturity is utilized for U.S. Government agency debt obligations and municipal bonds. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. Weighted average yields are also reflected, with yields for municipal securities shown at their tax equivalent yield.
| Weighted | Amortized | Fair | ||||||||||
| Average Yield | Cost | Value | ||||||||||
| Due in one year or less | | $ | | $ | | |||||||
| Due from one to five years | | | | |||||||||
| Due from five to ten years | | | | |||||||||
| Due after ten years | | | | |||||||||
| Mortgage-backed securities | | | | |||||||||
| Other investments | | | | |||||||||
| | $ | | $ | | ||||||||
Securities issued by the State of Michigan and all its political subdivisions had a combined amortized cost of $
The carrying value of U.S. Government agency debt obligations and mortgage-backed securities that are pledged to secure repurchase agreements was $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT 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 included in other assets in the Consolidated Balance Sheets. 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.
Year-end loans disaggregated by class of loan within the loan portfolio segments were as follows:
| December 31, 2022 | December 31, 2021 | Percent Increase | ||||||||||||||||||
| Balance | % | Balance | % | (Decrease) | ||||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial and industrial (1) | $ | % | $ | % | % | |||||||||||||||
| Vacant land, land development, and residential construction | ||||||||||||||||||||
| Real estate – owner occupied | ||||||||||||||||||||
| Real estate – non-owner occupied | ||||||||||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||||||||||
| Total commercial | ||||||||||||||||||||
| Retail: | ||||||||||||||||||||
| 1-4 family mortgages | ||||||||||||||||||||
| Other consumer loans (2) | ( | ) | ||||||||||||||||||
| Total retail | ||||||||||||||||||||
| Total loans | $ | % | $ | % | % | |||||||||||||||
| (1) | For December 31, 2022, and December 31, 2021, includes $ |
| (2) | In conjunction with the adoption of the CECL methodology effective January 1, 2022, home equity lines of credit were reclassified to 1-4 family mortgage loans from other consumer loans. Home equity lines of credit totaled $ |
Concentrations within the loan portfolio were as follows at year-end:
| 2022 | 2021 | |||||||||||||||
| Percentage | Percentage | |||||||||||||||
| of | of | |||||||||||||||
| Loan | Loan | |||||||||||||||
| Balance | Portfolio | Balance | Portfolio | |||||||||||||
| Commercial real estate loans to lessors of non-residential buildings | $ | % | $ | % | ||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Year-end nonperforming loans were as follows:
| 2022 | 2021 | |||||||
| Loans past due 90 days or more still accruing interest | $ | $ | ||||||
| Nonaccrual loans | ||||||||
| Total nonperforming loans | $ | $ | ||||||
The recorded principal balance of nonperforming loans was as follows:
| December 31, 2022 | December 31, 2021 | |||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | $ | ||||||
| Vacant land, land development, and residential construction | ||||||||
| Real estate – owner occupied | ||||||||
| Real estate – non-owner occupied | ||||||||
| Real estate – multi-family and residential rental | ||||||||
| Total commercial | ||||||||
| Retail: | ||||||||
| 1-4 family mortgages | ||||||||
| Other consumer loans | ||||||||
| Total retail | ||||||||
| Total nonperforming loans | $ | $ | ||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
An age analysis of past due loans is as follows as of December 31, 2022:
| Recorded | ||||||||||||||||||||||||||||
| Greater | Balance > | |||||||||||||||||||||||||||
| 30 – 59 | 60 – 89 | Than 89 | 89 | |||||||||||||||||||||||||
| Days | Days | Days | Total | Total | Days and | |||||||||||||||||||||||
| Past Due | Past Due | Past Due | Past Due | Current | Loans | Accruing | ||||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||
| Commercial and industrial | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Vacant land, land development, and residential construction | ||||||||||||||||||||||||||||
| Real estate – owner occupied | ||||||||||||||||||||||||||||
| Real estate – non-owner occupied | ||||||||||||||||||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||||||||||||||||||
| Total commercial | ||||||||||||||||||||||||||||
| Retail: | ||||||||||||||||||||||||||||
| 1-4 family mortgages | ||||||||||||||||||||||||||||
| Other consumer loans | ||||||||||||||||||||||||||||
| Total retail | ||||||||||||||||||||||||||||
| Total past due loans | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
An age analysis of past due loans is as follows as of December 31, 2021:
| Recorded | ||||||||||||||||||||||||||||
| Greater | Balance > | |||||||||||||||||||||||||||
| 30 – 59 | 60 – 89 | Than 89 | 89 | |||||||||||||||||||||||||
| Days | Days | Days | Total | Total | Days and | |||||||||||||||||||||||
| Past Due | Past Due | Past Due | Past Due | Current | Loans | Accruing | ||||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||
| Commercial and industrial | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Vacant land, land development, and residential construction | ||||||||||||||||||||||||||||
| Real estate – owner occupied | ||||||||||||||||||||||||||||
| Real estate – non-owner occupied | ||||||||||||||||||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||||||||||||||||||
| Total commercial | ||||||||||||||||||||||||||||
| Retail: | ||||||||||||||||||||||||||||
| Home equity and other | ||||||||||||||||||||||||||||
| 1- 4 family mortgages | ||||||||||||||||||||||||||||
| Total retail | ||||||||||||||||||||||||||||
| Total past due loans | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. Identified problem loans, which exhibit characteristics (financial or otherwise) that could cause the loans to become nonperforming or require restructuring in the future, are included on an internal watch list. Senior management and the Board of Directors review this list regularly. Fair value estimates of collateral on distressed lending relationships, as well as on foreclosed and repossessed assets, are reviewed periodically. We also have a process in place to monitor whether value estimates at each quarter-end are reflective of current market conditions. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside and internal valuations based on identifiable trends within our markets, such as recent sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address distressed market conditions. Under CECL for collateral dependent loans in instances where the borrower is experiencing financial difficulties, we adopted the practical expedient to measure the allowance based on the fair value of collateral. The allowance is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral and the recorded principal balance. If the fair value of the collateral exceeds the recorded principal balance, no allowance is required. Collateral dependent loans, representing the entire amount of loans on nonaccrual, totaled $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Nonaccrual loans as of December 31, 2022 were as follows:
| Recorded | ||||||||
| Principal | Related | |||||||
| Balance | Allowance | |||||||
| With no allowance recorded: | ||||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | $ | 0 | |||||
| Vacant land, land development and residential construction | 0 | |||||||
| Real estate – owner occupied | 0 | |||||||
| Real estate – non-owner occupied | 0 | |||||||
| Real estate – multi-family and residential rental | 0 | |||||||
| Total commercial | 0 | |||||||
| Retail: | ||||||||
| 1-4 family mortgages | 0 | |||||||
| Other consumer loans | 0 | |||||||
| Total retail | 0 | |||||||
| Total with no allowance recorded | $ | $ | 0 | |||||
| With an allowance recorded: | ||||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | $ | ||||||
| Vacant land, land development and residential construction | ||||||||
| Real estate – owner occupied | ||||||||
| Real estate – non-owner occupied | ||||||||
| Real estate – multi-family and residential rental | ||||||||
| Total commercial | ||||||||
| Retail: | ||||||||
| 1-4 family mortgages | ||||||||
| Other consumer loans | ||||||||
| Total retail | ||||||||
| Total with an allowance recorded | $ | $ | ||||||
| Total nonaccrual loans: | ||||||||
| Commercial | $ | $ | ||||||
| Retail | ||||||||
| Total nonaccrual loans | $ | $ | ||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Impaired loans with no related allowance recorded were as follows as of December 31, 2021:
| Unpaid Contractual Principal Balance | Recorded Principal Balance | Related Allowance | Year-To-Date Average Recorded Principal Balance | |||||||||||||
| With no related allowance recorded: | ||||||||||||||||
| Commercial: | ||||||||||||||||
| Commercial and industrial | $ | $ | $ | |||||||||||||
| Vacant land, land development and residential construction | ||||||||||||||||
| Real estate – owner occupied | ||||||||||||||||
| Real estate – non-owner occupied | ||||||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||||||
| Total commercial | ||||||||||||||||
| Retail: | ||||||||||||||||
| Home equity and other | ||||||||||||||||
| 1-4 family mortgages | ||||||||||||||||
| Total retail | ||||||||||||||||
| Total with no related allowance recorded | $ | $ | $ | |||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Impaired loans with an allowance recorded and total impaired loans were as follows as of December 31, 2021:
| Unpaid Contractual Principal Balance | Recorded Principal Balance | Related Allowance | Year-To-Date Average Recorded Principal Balance | |||||||||||||
| With an allowance recorded: | ||||||||||||||||
| Commercial: | ||||||||||||||||
| Commercial and industrial | $ | $ | $ | $ | ||||||||||||
| Vacant land, land development and residential construction | ||||||||||||||||
| Real estate – owner occupied | ||||||||||||||||
| Real estate – non-owner occupied | ||||||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||||||
| Total commercial | ||||||||||||||||
| Retail: | ||||||||||||||||
| Home equity and other | ||||||||||||||||
| 1-4 family mortgages | ||||||||||||||||
| Total retail | ||||||||||||||||
| Total with an allowance recorded | $ | $ | $ | $ | ||||||||||||
| Total impaired loans: | ||||||||||||||||
| Commercial | $ | $ | $ | $ | ||||||||||||
| Retail | ||||||||||||||||
| Total impaired loans | $ | $ | $ | $ | ||||||||||||
Impaired commercial loans for which no allocation of the allowance has been made in large part consist of performing troubled debt restructurings where the estimated collateral fair value exceeds the recorded principal balance, while impaired retail loans with no allowance allocation generally reflect situations whereby the recorded principal balances have been charged-down to estimated collateral fair value. Interest income recognized on accruing troubled debt restructurings totaled $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
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.
Loans by credit quality indicators were as follows as of December 31, 2022:
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 (1) | $ | $ | $ | $ | $ | |||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||
| Total commercial | $ | $ | $ | $ | $ | |||||||||||||||
Retail credit exposure – credit risk profiled by collateral type:
| Retail 1-4 Family Mortgages | Retail Other Consumer Loans | |||||||
| Performing | $ | $ | ||||||
| Nonperforming | ||||||||
| Total retail | $ | $ | ||||||
| (1) | Included in Commercial and Industrial Loans Grades 1 – 4 are $ |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Loans by credit quality indicators were as follows as of December 31, 2021:
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 (1) | $ | $ | $ | $ | $ | |||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||
| Total commercial | $ | $ | $ | $ | $ | |||||||||||||||
Retail credit exposure – credit risk profiled by collateral type:
| Retail Home Equity and Other | Retail 1-4 Family Mortgages | |||||||
| Performing | $ | $ | ||||||
| Nonperforming | ||||||||
| Total retail | $ | $ | ||||||
| (1) | Included in Commercial and Industrial Loans Grades 1 – 4 are $ |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
All commercial loans are graded using the following criteria:
| Grade 1. | “Exceptional” Loans with this rating contain very little, if any, risk. |
| Grade 2. | “Outstanding” Loans with this rating have excellent and stable sources of repayment and conform to bank policy and regulatory requirements. |
| Grade 3. | “Very Good” Loans with this rating have strong sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are acceptable. |
| Grade 4. | “Good” Loans with this rating have solid sources of repayment and conform to bank policy and regulatory requirements. These are loans for which repayment risks are modest. |
| Grade 5. | “Acceptable” Loans with this rating exhibit acceptable sources of repayment and conform with most bank policies and all regulatory requirements. These are loans for which repayment risks are satisfactory. |
| Grade 6. | “Monitor” Loans with this rating are considered to have emerging weaknesses which may include negative current cash flow, high leverage, or operating losses. Generally, if further deterioration is observed, these credits will be downgraded to the criticized asset report. |
| Grade 7. | “Special Mention” Loans with this rating have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date. |
| Grade 8. | “Substandard” Loans with this rating are inadequately protected by current sound net worth, paying capacity of the obligor, or of the pledged collateral, if any. A Substandard loan normally has one or more well-defined weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility of loss if the deficiencies are not corrected. |
| Grade 9. | “Doubtful” Loans with this rating exhibit all the weaknesses inherent in the Substandard classification and where collection or liquidation in full is highly questionable and improbable. |
| Grade 10. | “Loss” Loans with this rating are considered uncollectable, and of such little value that continuance as an active 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; loans 90 days or more past due are considered nonperforming. We have a reporting system that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
The following table reflects loan balances as of December 31, 2022 based on year of origination (dollars in thousands):
| 2022 | 2021 | 2020 | 2019 | 2018 | Prior | Term Total | Revolving Loans | Grand Total | ||||||||||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||||||||||
| Commercial and Industrial: | ||||||||||||||||||||||||||||||||||||
| Grades 1 – 4 | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Vacant Land, Land Development and Residential Construction: | ||||||||||||||||||||||||||||||||||||
| Grades 1 – 4 | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Real Estate – Owner Occupied: | ||||||||||||||||||||||||||||||||||||
| Grades 1 – 4 | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Real Estate – Non-Owner Occupied: | ||||||||||||||||||||||||||||||||||||
| Grades 1 – 4 | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Real Estate – Multi-Family and Residential Rental: | ||||||||||||||||||||||||||||||||||||
| Grades 1 – 4 | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Grades 5 – 7 | ||||||||||||||||||||||||||||||||||||
| Grades 8 – 9 | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Total Commercial | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
| 2022 | 2021 | 2020 | 2019 | 2018 | Prior | Term Total | Revolving Loans | Grand Total | ||||||||||||||||||||||||||||
| Retail: | ||||||||||||||||||||||||||||||||||||
| 1-4 Family Mortgages: | ||||||||||||||||||||||||||||||||||||
| Performing | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Nonperforming | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Other Consumer Loans: | ||||||||||||||||||||||||||||||||||||
| Performing | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Nonperforming | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Total Retail | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Grand Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
The allowance for credit losses for the year-ended December 31, 2022 is as follows (dollars in thousands):
| 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 | 1-4 family mortgages | Other consumer loans | Unallocated | Total | ||||||||||||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Adoption of ASU 2016-13 | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||
| Provision for credit losses | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2021 are as follows (dollars in thousands):
| 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 | Home equity and other | 1 – 4 family mortgages | Unallocated | Total | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Provision for loan losses | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Ending balance: individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Ending balance: collectively evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Total loans (*): | ||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Ending balance: individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Ending balance: collectively evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
(*) Excludes $40.1 million in loans originated under the Paycheck Protection Program.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
The allowance for loan losses and recorded investments in loans for the year-ended December 31, 2020 are as follows (dollars in thousands):
| 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 | Home equity and other | 1 – 4 family mortgages | Unallocated | Total | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Provision for loan losses | ( | ) | ||||||||||||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Ending balance: individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Ending balance: collectively evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Total loans (*): | ||||||||||||||||||||||||||||||||||||
| Ending balance | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Ending balance: individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Ending balance: collectively evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||
(*) Excludes $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Loans modified as troubled debt restructurings generally reflect payment extensions and below market interest rates.
Loans modified as troubled debt restructurings during the year-ended December 31, 2022 were as follows:
| Pre- | Post- | |||||||||||
| Modification | Modification | |||||||||||
| Recorded | Recorded | |||||||||||
| Number of | Principal | Principal | ||||||||||
| Contracts | Balance | Balance | ||||||||||
| Commercial: | ||||||||||||
| Commercial and industrial | $ | $ | ||||||||||
| Vacant land, land development and residential construction | ||||||||||||
| Real estate – owner occupied | ||||||||||||
| Real estate – non-owner occupied | ||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||
| Total commercial | ||||||||||||
| Retail: | ||||||||||||
| Home equity and other | ||||||||||||
| 1-4 family mortgages | ||||||||||||
| Total retail | ||||||||||||
| Total | $ | $ | ||||||||||
Loans modified as troubled debt restructurings during the year-ended December 31, 2021 were as follows:
| Pre- | Post- | |||||||||||
| Modification | Modification | |||||||||||
| Recorded | Recorded | |||||||||||
| Number of | Principal | Principal | ||||||||||
| Contracts | Balance | Balance | ||||||||||
| Commercial: | ||||||||||||
| Commercial and industrial | $ | $ | ||||||||||
| Vacant land, land development and residential construction | ||||||||||||
| Real estate – owner occupied | ||||||||||||
| Real estate – non-owner occupied | ||||||||||||
| Real estate – multi-family and residential rental | ||||||||||||
| Total commercial | ||||||||||||
| Retail: | ||||||||||||
| Home equity and other | ||||||||||||
| 1-4 family mortgages | ||||||||||||
| Total retail | ||||||||||||
| Total | $ | $ | ||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2022 (amounts as of period end):
| Number of Contracts | Recorded Principal Balance | |||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | |||||||
| Vacant land, land development and residential construction | ||||||||
| Real estate – owner occupied | ||||||||
| Real estate – non-owner occupied | ||||||||
| Real estate – multi-family and residential rental | ||||||||
| Total commercial | ||||||||
| Retail: | ||||||||
| Home equity and other | ||||||||
| 1-4 family mortgages | ||||||||
| Total retail | ||||||||
| Total | $ | |||||||
The following loans, modified as troubled debt restructurings within the previous twelve months, became over 30 days past due during the year-ended December 31, 2021 (amounts as of period end):
| Number of Contracts | Recorded Principal Balance | |||||||
| Commercial: | ||||||||
| Commercial and industrial | $ | |||||||
| Vacant land, land development and residential construction | ||||||||
| Real estate – owner occupied | ||||||||
| Real estate – non-owner occupied | ||||||||
| Real estate – multi-family and residential rental | ||||||||
| Total commercial | ||||||||
| Retail: | ||||||||
| Home equity and other | ||||||||
| 1-4 family mortgages | ||||||||
| Total retail | ||||||||
| Total | $ | |||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2022 is as follows:
| Commercial and | Commercial Vacant Land, Land Development, and Residential | Commercial Real Estate - Owner | Commercial Real Estate - Non-Owner | Commercial Real Estate - Multi-Family and Residential | ||||||||||||||||
| Industrial | Construction | Occupied | Occupied | Rental | ||||||||||||||||
| Commercial Loan Portfolio: | ||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | |||||||||||||||
| Charge-Offs | ( | ) | ( | ) | ||||||||||||||||
| Payments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
| Transfers to ORE | ||||||||||||||||||||
| Net Additions/Deletions | ( | ) | ||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | |||||||||||||||
| Retail Home Equity and Other | Retail 1-4 Family Mortgages | |||||||
| Retail Loan Portfolio: | ||||||||
| Beginning Balance | $ | $ | ||||||
| Charge-Offs | ||||||||
| Payments | ( | ) | ( | ) | ||||
| Transfers to ORE | ||||||||
| Net Additions/Deletions (1) | ( | ) | ||||||
| Ending Balance | $ | $ | ||||||
| (1) | Includes $ |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2021 is as follows:
| Commercial and | Commercial Vacant Land, Land Development, and Residential | Commercial Real Estate - Owner | Commercial Real Estate - Non-Owner | Commercial Real Estate - Multi-Family and Residential | ||||||||||||||||
| Industrial | Construction | Occupied | Occupied | Rental | ||||||||||||||||
| Commercial Loan Portfolio: | ||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | |||||||||||||||
| Charge-Offs | ( | ) | ||||||||||||||||||
| Payments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
| Transfers to ORE | ||||||||||||||||||||
| Net Additions/Deletions | ||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | |||||||||||||||
| Retail Home Equity and Other | Retail 1-4 Family Mortgages | |||||||
| Retail Loan Portfolio: | ||||||||
| Beginning Balance | $ | $ | ||||||
| Charge-Offs | ||||||||
| Payments | ( | ) | ( | ) | ||||
| Transfers to ORE | ||||||||
| Net Additions/Deletions | ||||||||
| Ending Balance | $ | $ | ||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)
Activity for loans categorized as troubled debt restructurings during the year-ended December 31, 2020 is as follows:
| Commercial and | Commercial Vacant Land, Land Development, and Residential | Commercial Real Estate - Owner | Commercial Real Estate - Non-Owner | Commercial Real Estate - Multi-Family and Residential | ||||||||||||||||
| Industrial | Construction | Occupied | Occupied | Rental | ||||||||||||||||
| Commercial Loan Portfolio: | ||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | |||||||||||||||
| Charge-Offs | ||||||||||||||||||||
| Payments | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
| Transfers to ORE | ||||||||||||||||||||
| Net Additions/Deletions | ||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | |||||||||||||||
| Retail Home Equity and Other | Retail 1-4 Family Mortgages | |||||||
| Retail Loan Portfolio: | ||||||||
| Beginning Balance | $ | $ | ||||||
| Charge-Offs | ||||||||
| Payments | ( | ) | ( | ) | ||||
| Transfers to ORE | ||||||||
| Net Additions/Deletions | ||||||||
| Ending Balance | $ | $ | ||||||
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment were as follows:
| 2022 | 2021 | |||||||
| Land and improvements | $ | $ | ||||||
| Buildings | ||||||||
| Furniture and equipment | ||||||||
| Less: accumulated depreciation | ||||||||
| Total premises and equipment | $ | $ | ||||||
Depreciation expense totaled $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 4 - PREMISES AND EQUIPMENT, NET (Continued)
We enter into facility leases in the normal course of business. As of December 31, 2022, we were under lease contracts for eleven of our branch facilities. The leases have maturity dates ranging from June, 2023 through December, 2029, with a weighted average life of
Leases are classified as either operating or finance leases at the lease commencement date, with all of our current leases determined to be operating leases. Lease expense for operating leases is recognized on a straight-line basis over the lease term. Right-of-use assets represent our right to use an underlying asset for the lease term, while lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the lease commencement date at the estimated present value of lease payments over the lease term. We use our incremental borrowing rate, on a collateralized basis, at lease commencement to calculate the present value of lease payments. The weighted average discount rate for leases was
The right-of-use assets, included in premises and equipment, net on our Consolidated Balance Sheets, and the lease liabilities, included in other liabilities on our Consolidated Balance Sheets, totaled $
Future lease payments were as follows as of December 31, 2022:
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| Thereafter | ||||
| Total undiscounted lease payments | ||||
| Less effect of discounting | ( | ) | ||
| Present value of future lease payments (lease liability) |
NOTE 5 – MORTGAGE LOAN SERVICING
Mortgage loans serviced for others are not reported as assets on the Consolidated Balance Sheets. The year-end aggregate unpaid principal balances of mortgage loans serviced for others were as follows:
| 2022 | 2021 | |||||||
| Mortgage loan portfolios serviced for: | ||||||||
| Federal Home Loan Mortgage Corporation | $ | $ | ||||||
| Federal Home Loan Bank | ||||||||
| Total mortgage loans serviced for others | $ | $ | ||||||
Custodial escrow balances, which are reported as deposits on the Consolidated Balance Sheets, maintained in connection with serviced loans were $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 5 – MORTGAGE LOAN SERVICING (Continued)
Activity for capitalized mortgage loan servicing rights, which are reported as other assets on the Consolidated Balance Sheets, during 2022 and 2021 was as follows:
| 2022 | 2021 | |||||||
| Balance at beginning of year | $ | $ | ||||||
| Additions | ||||||||
| Amortized to expense | ( | ) | ( | ) | ||||
| Balance at end of year | $ | $ | ||||||
Mortgage servicing rights result from our mortgage loan origination activities. Late and ancillary fees, included as part of mortgage banking income and reported as noninterest income in the Consolidated Statements of Income, aggregated less than $
Accounting for mortgage servicing rights is based on the class of mortgage servicing rights. We have identified four classes of mortgage servicing rights based on the initial term of the underlying mortgage loans: 10 years, 15 years, 20 years and 30 years. We distinguish between these classes based on the differing sensitivities to the change in value from changes in mortgage interest rates. Mortgage servicing rights are initially recorded at fair value, and then are accounted for using the amortization method. Netted against mortgage banking income, mortgage servicing rights amortization expense is reported as noninterest income in the Consolidated Statements of Income. Mortgage servicing rights amortization is determined by amortizing the mortgage servicing rights balance in proportion to, and over the period of the estimated future net servicing income, of the underlying mortgage loans.
Interest rate risk, prepayment risk and default risk are inherent in mortgage servicing rights valuation. Interest rate changes largely drive prepayment rates. Refinance activity generally increases as interest rates decline. A significant decrease in interest rates beyond expectation could cause a decline in the value of mortgage servicing rights. On the contrary, borrowers are less likely to refinance or prepay their mortgage loans if interest rates increase, which would extend the duration of the underlying mortgage loans and the associated mortgage servicing rights would likely rise. Because of these risks, discount rates and prepayment speeds are used to estimate the fair value of mortgage servicing rights.
We determined that
The weighted average amortization period was
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| Thereafter |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 6 – CORE DEPOSIT INTANGIBLE ASSET, NET
The gross carrying amount of core deposit intangible assets, included in other assets on our Consolidated Balance Sheets, totaled $ million as of December 31, 2022 and December 31, 2021. As of December 31, 2022, the accumulated amortization on core deposit intangible assets was $
The scheduled amortization expense on core deposit intangible assets in future periods is:
| 2023 | $ | |||
| 2024 |
NOTE 7 – DEPOSITS
Deposits at year-end are summarized as follows:
| December 31, 2022 | December 31, 2021 | Percent Increase | ||||||||||||||||||
| Balance | % | Balance | % | (Decrease) | ||||||||||||||||
| Noninterest-bearing checking | $ | % | $ | % | ( | %) | ||||||||||||||
| Interest-bearing checking | ||||||||||||||||||||
| Money market | ( | ) | ||||||||||||||||||
| Savings | ( | ) | ||||||||||||||||||
| Time, under $100,000 | ( | ) | ||||||||||||||||||
| Time, $100,000 and over | ( | ) | ||||||||||||||||||
| Total local deposits | ( | ) | ||||||||||||||||||
| Out-of-area time, $100,000 and over | ( | ) | ||||||||||||||||||
| Total deposits | $ | % | $ | % | ( | %) | ||||||||||||||
Out-of-area time deposits consist of deposits obtained from depositors outside of our primary market areas exclusively through deposit brokers.
The following table depicts the maturity distribution for time deposits at year-end:
| 2022 | 2021 | |||||||
| In one year or less | $ | $ | ||||||
| In one to two years | ||||||||
| In two to three years | ||||||||
| In three to four years | ||||||||
| In four to five years | ||||||||
| Total certificates of deposit | $ | $ | ||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 7 – DEPOSITS (Continued)
The following table depicts the maturity distribution for time deposits with balances of $100,000 or more at year-end:
| 2022 | 2021 | |||||||
| Up to three months | $ | $ | ||||||
| Three months to six months | ||||||||
| Six months to twelve months | ||||||||
| Over twelve months | ||||||||
| Total certificates of deposit | $ | $ | ||||||
Total time deposits of more than $250,000 totaled $
Deposit overdrafts, which are reported as loans on the Consolidated Balance Sheets, totaled $
NOTE 8 – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Information regarding securities sold under agreements to repurchase at year-end is summarized below:
| 2022 |
2021 |
|||||||
| Outstanding balance at year-end |
$ | $ | ||||||
| Weighted average interest rate at year-end |
% |
% |
||||||
| Average daily balance during the year |
$ | $ | ||||||
| Weighted average interest rate during the year |
% |
% |
||||||
| Maximum daily balance during the year |
$ | $ | ||||||
Securities sold under agreements to repurchase (“repurchase agreements”) generally have original maturities of less than year. Repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as liabilities on our Consolidated Balance Sheets. Repurchase agreements are secured by securities with an aggregate fair value equal to the aggregate outstanding balance of the repurchase agreements. The securities, which are included in securities available for sale on our Consolidated Balance Sheets, are held in safekeeping by a correspondent bank. Repurchase agreements are offered principally to certain large deposit customers.
NOTE 9 - FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES
Federal Home Loan Bank of Indianapolis (“FHLBI”) bullet advances totaled $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 9 - FEDERAL HOME LOAN BANK OF INDIANAPOLIS ADVANCES (Continued)
Maturities of FHLBI bullet advances as of December 31, 2022 were as follows:
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 |
FHLBI amortizing advances totaled $
Scheduled principal payments on FHLBI amortizing advances as of December 31, 2022 were as follows:
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| Thereafter |
Each advance is payable at its maturity date, and is subject to a prepayment fee if paid prior to the maturity date. The advances are collateralized by residential mortgage loans, first mortgage liens on multi-family residential property loans, first mortgage liens on commercial real estate property loans, and substantially all other assets of our bank under a blanket lien arrangement. Our borrowing line of credit as of December 31, 2022 totaled $
NOTE 10 - FEDERAL INCOME TAXES
The consolidated income tax expense is as follows:
| 2022 | 2021 | 2020 | ||||||||||
| Current expense | $ | $ | $ | |||||||||
| Deferred expense | ( | ) | ( | ) | ||||||||
| Change in valuation allowance | ( | ) | ||||||||||
| Tax expense | $ | $ | $ | |||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 10 - FEDERAL INCOME TAXES (Continued)
A reconciliation of the differences between the federal income tax expense recorded and the amount computed by applying the federal statutory rate to income before income taxes is as follows:
| 2022 | 2021 | 2020 | ||||||||||
| Tax at statutory rate | $ | $ | $ | |||||||||
| Increase (decrease) from | ||||||||||||
| Tax-exempt interest | ( | ) | ( | ) | ( | ) | ||||||
| Bank owned life insurance | ( | ) | ( | ) | ( | ) | ||||||
| Change in valuation allowance | ( | ) | ||||||||||
| Other | ( | ) | ||||||||||
| Tax expense | $ | $ | $ | |||||||||
The statutory tax rate was
Significant components of deferred tax assets and liabilities, included in other assets on our Consolidated Balance Sheets, as of December 31, 2022 and 2021 are as follows:
| 2022 | 2021 | |||||||
| Deferred income tax assets | ||||||||
| Allowance for credit losses | $ | $ | ||||||
| Deferred compensation | ||||||||
| Stock compensation | ||||||||
| Nonaccrual loan interest income | ||||||||
| Unrealized loss on securities | ||||||||
| Lease liability | ||||||||
| Deferred loan fees and costs | ||||||||
| Other | ||||||||
| Deferred tax asset | ||||||||
| Deferred income tax liabilities | ||||||||
| Depreciation | ||||||||
| Prepaid expenses | ||||||||
| Core deposit intangible | ||||||||
| Mortgage loan servicing rights | ||||||||
| Deferred loan fees and costs | ||||||||
| Right of use lease asset | ||||||||
| Business combination adjustments | ||||||||
| Other | ||||||||
| Deferred tax liability | ||||||||
| Total net deferred tax asset | $ | $ | ||||||
A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefits related to such assets will not be realized. We determined that no valuation allowance was required at year-end 2022 or 2021. We had
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 11 – 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 2015, stock option grants were provided to certain employees from the Stock Incentive Plan of 2006. Stock option grants were provided to certain employees during 2016 from the Stock Incentive Plan of 2016. During the years 2016 through 2019, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2016. During the years 2020 through 2022, restricted stock grants were provided to certain employees from the Stock Incentive Plan of 2020. Stock grants to directors as retainer payments during the years 2016 through 2019 were from the Stock Incentive Plan of 2016, while stock grants to directors as retainer payments during the years 2020 through 2022 were from the Stock Incentive Plan of 2020.
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. The Stock Incentive Plan of 2016 was effectively replaced with the Stock Incentive Plan of 2020 that was approved by shareholders in May, 2020.
Under the Stock Incentive Plan of 2006, the Stock Incentive Plan of 2016 and the Stock Incentive Plan of 2020, 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. No payments are required from employees for restricted stock awards. The restricted stock awards granted during the years 2016 through 2022 fully vest after years and, in the case of performance-based restricted stock issued to executive officers in 2018 through 2022, are subject to the attainment of pre-determined performance goals. The stock options granted during 2014, which were at
A summary of restricted stock activity from grants issued during the past three years is as follows:
| 2022 | 2021 | 2020 | ||||||||||||||||||||||
| Shares | Weighted Average Fair Value | Shares | Weighted Average Fair Value | Shares | Weighted Average Fair Value | |||||||||||||||||||
| Nonvested at beginning of year | $ | $ | $ | |||||||||||||||||||||
| Granted | ||||||||||||||||||||||||
| Vested | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Forfeited | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Nonvested at end of year | $ | $ | $ | |||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 11 – STOCK-BASED COMPENSATION (Continued)
Of the restricted stock shares granted in 2022, 2021 and 2020, a total of
A summary of stock option activity during the past three years is as follows:
| 2022 | 2021 | 2020 | ||||||||||||||||||||||
| Shares | Weighted Average Exercise Price | Shares | Weighted Average Exercise Price | Shares | Weighted Average Exercise Price | |||||||||||||||||||
| Outstanding at beginning of year | $ | $ | $ | |||||||||||||||||||||
| Granted |
| NA |
| NA |
| NA | ||||||||||||||||||
| Exercised | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Forfeited or expired |
| NA |
| NA |
| NA | ||||||||||||||||||
| Outstanding at end of year | $ | $ | $ | |||||||||||||||||||||
| Options exercisable at year-end | $ | $ | $ | |||||||||||||||||||||
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.
Options at year-end 2022 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 | |||||||||||||||||
| $36.00 | $ | $ | $ | |||||||||||||||||||
| Outstanding at year end | $ | $ | ||||||||||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 11– STOCK-BASED COMPENSATION (Continued)
Information related to options outstanding at year-end 2022, 2021 and 2020 is as follows:
| 2022 | 2021 | 2020 | ||||||||||
| Minimum exercise price | $ | $ | $ | |||||||||
| Maximum exercise price | ||||||||||||
| Average remaining option term (years) | ||||||||||||
Information related to stock option grants and exercises during 2022, 2021 and 2020 is as follows:
| 2022 | 2021 | 2020 | ||||||||||
| Aggregate intrinsic value of stock options exercised | $ | $ | $ | |||||||||
| Cash received from stock option exercises | ||||||||||||
| Tax benefit realized from stock option exercises | ||||||||||||
| Weighted average per share fair value of stock options granted |
| NA |
| NA |
| NA | ||||||
No stock option awards outstanding and exercisable at December 31, 2022 were in-the-money. Shares issued as a result of the exercise of stock option grants have been authorized and were previously unissued shares.
On May 23, 2019, we granted about
Stock-based compensation, reported as noninterest expense in the Consolidated Statements of Income, totaled $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 12 – RELATED PARTIES
Certain directors and executive officers of our bank, including their immediate families and companies in which they are principal owners, were loan customers of our bank. At year-end 2022 and 2021, our bank had $
| 2022 |
2021 |
|||||||
| Beginning balance |
$ | $ | ||||||
| New loans |
||||||||
| Repayments |
( |
) |
( |
) |
||||
| Ending balance |
$ | $ | ||||||
Related party deposits and repurchase agreements totaled $
NOTE 13 – COMMITMENTS AND OFF-BALANCE-SHEET RISK
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by our bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in the balance sheet. Our maximum exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory, and property and equipment, is generally obtained based on management’s credit assessment of the borrower.
We are required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via other noninterest expense on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.
For commercial lines of credit, retail lines of credit and credit card average outstanding balances, we determined allowance requirements by calculating the difference between the average percent outstanding of the funded commitments over the past several years to actual percent outstanding as of December 31, 2022 and applying the respective expected loss allocation factors to the difference as this difference represents the average of unfunded commitments we expect to eventually be drawn upon. The calculated allowance aggregated $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 13 – COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
At year-end 2022 and 2021, the rates on existing off-balance sheet instruments were substantially equivalent to current market rates, considering the underlying credit standing of the counterparties.
Our maximum exposure to credit losses for loan commitments and standby letters of credit outstanding at year-end was as follows:
| 2022 | 2021 | |||||||
| Commercial unused lines of credit | $ | $ | ||||||
| Unused lines of credit secured by 1 – 4 family residential properties | ||||||||
| Credit card unused lines of credit | ||||||||
| Other consumer unused lines of credit | ||||||||
| Commitments to make loans | ||||||||
| Standby letters of credit | ||||||||
| Total commitments | $ | $ | ||||||
Commitments to make commercial loans generally reflect our binding obligations to existing and prospective customers to extend credit, including line of credit facilities secured by accounts receivable and inventory, and term debt secured by either real estate or equipment.
In most instances, commercial line of credit facilities have a term ranging from
The following standby letters of credit are considered financial guarantees under current accounting guidance. These instruments are carried at fair value as an other liability on our Consolidated Balance Sheets. Standby letters of credit are generally cross collateralized with the borrowers’ other loans with us, and are included in our borrower collateral analyses.
| 2022 | 2021 | |||||||||||||||
| Contract | Carrying | Contract | Carrying | |||||||||||||
| Amount | Value | Amount | Value | |||||||||||||
| Standby letters of credit | $ | $ | $ | $ | ||||||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 14 – BENEFIT PLANS
We have a 401(k) benefit plan that covers substantially all of our employees. The percent of our matching contributions to the 401(k) benefit plan is determined annually by the Board of Directors. The matching contribution has been
We have a deferred compensation plan in which all persons serving on the Board of Directors may defer all or portions of their annual retainer and meeting fees, with distributions to be paid upon termination of service as a director or specific dates selected by the director. We also have a non-qualified deferred compensation program in which selected officers may defer all or portions of salary and bonus payments. The deferred amounts, totaling $
The Mercantile Bank Corporation Employee Stock Purchase Plan of 2014 is a non-compensatory plan intended to encourage full- and part-time employees of Mercantile and its subsidiaries to promote our best interests and to align employees’ interests with the interests of our shareholders by permitting employees to purchase shares of our common stock through regular payroll deductions. Shares are purchased on the last business day of each calendar quarter at a price equal to the consolidated closing bid price of our common stock reported on The Nasdaq Stock Market. A total of
NOTE 15 – DERIVATIVES AND HEDGING ACTIVITIES
We are exposed to certain risks arising from both business operations and economic conditions. We principally manage the exposure to a wide variety of operational risks through core business activities. Economic risks, including interest rate, liquidity and credit risk, are primarily administered via the amount, sources and duration of assets and liabilities. Derivative financial instruments may also be used to assist in managing economic risks.
Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers. We execute interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with correspondent banks to offset the impact of the interest rate swaps with the commercial banking customers. The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions.
As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent banks are recognized directly to earnings. Fees paid to us by the correspondent banks are recognized as noninterest income on our Consolidated Statements of Income on the settlement date.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 15 – DERIVATIVES AND HEDGING ACTIVITIES (Continued)
The fair values of derivative instruments as of December 31, 2022, are reflected in the following table.
| Notional Amount |
Balance Sheet Location |
Fair Value |
||||||||
| Derivative Assets | ||||||||||
| Interest rate swaps |
$ | Other Assets |
$ | |||||||
| Derivative Liabilities | ||||||||||
| Interest rate swaps |
Other Liabilities |
|||||||||
The effect of interest rate swaps that are not designated as hedging instruments resulted in income of less than $
The fair values of derivative instruments as of December 31, 2021, are reflected in the following table.
| Notional Amount |
Balance Sheet Location |
Fair Value |
||||||||
| Derivative Assets | ||||||||||
| Interest rate swaps |
$ | Other Assets |
$ | |||||||
| Derivative Liabilities | ||||||||||
| Interest rate swaps |
Other Liabilities |
|||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 15 – DERIVATIVES AND HEDGING ACTIVITIES (Continued)
The effect of interest rate swaps that are not designated as hedging instruments resulted in expense of $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 16 – FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount, estimated fair value and level within the fair value hierarchy of financial instruments were as follows at year-end (dollars in thousands):
| Level in | 2022 | 2021 | |||||||||||||||
| Fair Value | Carrying | Fair | Carrying | Fair | |||||||||||||
| Hierarchy | Amount | Value | Amount | Value | |||||||||||||
| Financial assets | |||||||||||||||||
| Cash and cash equivalents | Level 1 | $ | $ | $ | $ | ||||||||||||
| Securities available for sale | (1) | ||||||||||||||||
| Federal Home Loan Bank stock | (2) | ||||||||||||||||
| Loans, net | Level 3 | ||||||||||||||||
| Mortgage loans held for sale | Level 2 | ||||||||||||||||
| Mortgage servicing rights | Level 3 | ||||||||||||||||
| Accrued interest receivable | Level 2 | ||||||||||||||||
| Interest rate swaps | Level 2 | ||||||||||||||||
| Financial liabilities | |||||||||||||||||
| Deposits | Level 2 | ||||||||||||||||
| Securities sold under agreements to repurchase | Level 2 | ||||||||||||||||
| Federal Home Loan Bank advances | Level 2 | ||||||||||||||||
| Subordinated debentures | Level 2 | ||||||||||||||||
| Subordinated notes | Level 2 | ||||||||||||||||
| Accrued interest payable | Level 2 | ||||||||||||||||
| Interest rate swaps | Level 2 | ||||||||||||||||
| (1) |
See Note 17 for a description of the fair value hierarchy as well as a disclosure of levels for classes of financial assets and liabilities. |
| (2) |
It is not practical to determine the fair value of FHLBI stock due to transferability restrictions; therefore, fair value is estimated at carrying amount. |
Carrying amount is the estimated fair value for cash and cash equivalents, FHLBI stock, accrued interest receivable and payable, noninterest-bearing checking accounts and securities sold under agreements to repurchase. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. Fair value for loans is based on an exit price model as required by ASU 2016-01, taking into account inputs such as discounted cash flows, probability of default and loss given default assumptions. Fair value for deposit accounts other than noninterest-bearing checking accounts is based on discounted cash flows using current market rates applied to the estimated life. The fair value of mortgage servicing rights is estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. The fair values of subordinated debentures, subordinated notes, and FHLBI advances are based on current rates for similar financing. The fair values of interest rate swaps are based on discounted cash flows using forecasted yield curves, along with insignificant unobservable inputs, such as borrower credit spreads. The fair value of other off-balance sheet items is estimated to be nominal.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 17 – FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market, the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
We are required to use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect our own estimates about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances. In that regard, we utilize a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.
Level 3: Significant unobservable inputs that reflect our own estimates about the assumptions that market participants would use in pricing an asset or liability.
The following is a description of our valuation methodologies used to measure and disclose the fair values of our financial assets and liabilities on a recurring or nonrecurring basis:
Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. Government agency debt obligations, mortgage-backed securities issued or guaranteed by U.S. Government agencies, and municipal general obligation and revenue bonds. Level 3 securities include bonds issued by certain relatively small municipalities located within our markets that have very limited marketability due to their size and lack of ratings from a recognized rating service. We carry these bonds at historical cost, which we believe approximates fair value, unless our periodic financial analysis or other information that becomes known to us necessitates an impairment. There was
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 17 – FAIR VALUE MEASUREMENTS (Continued)
Derivatives. We measure fair value utilizing models that use primarily market observable inputs, such as forecasted yield curves. Insignificant unobservable inputs, such as borrower credit spreads, are also utilized.
Mortgage loans held for sale. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors, and are measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the prices for other mortgage whole loans with similar characteristics. As of December 31, 2022 and 2021, we determined the fair value of our mortgage loans held for sale to be $
Loans. We do not record loans at fair value on a recurring basis. However, from time to time, we record nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current estimated value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of significant borrower distress and on an ongoing basis until recovery or charge-off. The fair values of distressed loans are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.
Foreclosed assets. At time of foreclosure or repossession, foreclosed and repossessed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed and repossessed assets, establishing a new cost basis. We subsequently adjust estimated fair value of foreclosed assets on a nonrecurring basis to reflect write-downs based on revised fair value estimates. The fair values of parcels of other real estate owned are determined using either the sales comparison approach or income approach; respective unobservable inputs for the approaches consist of adjustments for differences between comparable sales and the utilization of appropriate capitalization rates.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 17 – FAIR VALUE MEASUREMENTS (Continued)
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2022 are as follows:
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
| Available for sale securities | ||||||||||||||||
| U.S. Government agency debt obligations | $ | $ | $ | $ | ||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Municipal general obligation bonds | ||||||||||||||||
| Municipal revenue bonds | ||||||||||||||||
| Other investments | ||||||||||||||||
| Interest rate swaps | ||||||||||||||||
| Total assets | $ | $ | $ | $ | ||||||||||||
| Interest rate swaps | ||||||||||||||||
| Total liabilities | $ | $ | $ | $ |
There were no sales, purchases or transfers in or out of Level 3 during 2022. The $
The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2021 are as follows:
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
| Available for sale securities | ||||||||||||||||
| U.S. Government agency debt obligations | $ | $ | $ | $ | ||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Municipal general obligation bonds | ||||||||||||||||
| Municipal revenue bonds | ||||||||||||||||
| Other investments | ||||||||||||||||
| Interest rate swaps | ||||||||||||||||
| Total assets | $ | $ | $ | $ | ||||||||||||
| Interest rate swaps | ||||||||||||||||
| Total liabilities | $ | $ | $ | $ |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 17 – FAIR VALUE MEASUREMENTS (Continued)
There were no sales, purchases or transfers in or out of Level 3 during 2021. The less than $
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2022 are as follows:
| Quoted Prices | ||||||||||||||||
| in Active | Significant | |||||||||||||||
| Markets for | Other | Significant | ||||||||||||||
| Identical | Observable | Unobservable | ||||||||||||||
| Assets | Inputs | Inputs | ||||||||||||||
| Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
| Collateral dependent loans | $ | $ | $ | $ | ||||||||||||
| Foreclosed assets | ||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2021 are as follows:
| Quoted Prices | ||||||||||||||||
| in Active | Significant | |||||||||||||||
| Markets for | Other | Significant | ||||||||||||||
| Identical | Observable | Unobservable | ||||||||||||||
| Assets | Inputs | Inputs | ||||||||||||||
| Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
| Impaired loans | $ | $ | $ | $ | ||||||||||||
| Foreclosed assets | ||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
The carrying values are based on the estimated value of the property or other assets. Fair value estimates of collateral on impaired loans and foreclosed assets are reviewed periodically. Our credit policies establish criteria for obtaining appraisals and determining internal value estimates. We may also adjust outside appraisals and internal evaluations based on identifiable trends within our markets, such as sales of similar properties or assets, listing prices and offers received. In addition, we may discount certain appraised and internal value estimates to address current distressed market conditions. For real estate dependent loans and foreclosed assets, we assign a discount factor range of
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 18 – EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share include the dilutive effect of additional potential common shares issuable under our stock-based compensation plans and are determined using the treasury stock method. Our unvested restricted shares, which contain non-forfeitable rights to dividends whether paid or accrued (i.e., participating securities), are included in the number of shares outstanding for both basic and diluted earnings per share calculations. In the event of a net loss, our unvested restricted shares are excluded from the calculation of both basic and diluted earnings per share. Stock options for approximately
The factors used in the earnings per share computation follow:
| 2022 |
2021 |
2020 |
||||||||||
| Basic |
||||||||||||
| Net income attributable to common shares |
$ | $ | $ | |||||||||
| Weighted average common shares outstanding |
||||||||||||
| Basic earnings per common share |
$ | $ | $ | |||||||||
| Diluted |
||||||||||||
| Net income attributable to common shares |
$ | $ | $ | |||||||||
| Weighted average common shares outstanding for basic earnings per common share |
||||||||||||
| Add: Dilutive effects of share-based awards |
||||||||||||
| Average shares and dilutive potential common shares |
||||||||||||
| Diluted earnings per common share |
$ | $ | $ | |||||||||
NOTE 19 – VARIABLE INTEREST ENTITIES
Variable interest entities are entities that either have a total equity investment that is insufficient to permit the entity to finance its activities without additional subordinated financial support or whose equity investors lack the characteristics of a controlling financial interest (i.e., ability to make significant decisions, through voting rights, right to receive the expected residual returns of the entity, and obligations to absorb the expected losses of the entity). Variable interest entities can be structured as corporations, trusts, partnerships, or other legal entities. We have relationships with certain variable interest entities related to the issuance of trust preferred securities.
We have
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 19 – VARIABLE INTEREST ENTITIES (Continued)
The assets, liabilities, operations and cash flows of each trust are solely related to the issuance, administration and repayment of the preferred securities held by third-party investors. We fully and unconditionally guarantee the obligations of each trust and are obligated to redeem the junior subordinated debentures upon maturity. We do not consolidate the trusts as we are not the primary beneficiary of these entities because our wholly-owned and indirect wholly-owned statutory subsidiaries do not have the power to direct the activities of the variable interest entity that most significantly impact the variable interest entity’s economic performance and do not have an obligation to absorb losses or the right to receive benefits that could potentially be significant to the variable interest entity. As such, we do not have a controlling financial interest in the variable interest entities.
The only significant assets of our trusts are the Floating Rate Notes, and the only significant liabilities of our trusts are the Preferred Securities. The Floating Rate Notes are categorized on our Consolidated Balance Sheets as subordinated debentures and the interest expense is recorded on our Consolidated Statements of Income under interest expense on other borrowings.
On January 26, 2016, we closed on a repurchase of trust preferred securities that were auctioned as part of a pooled collateralized debt obligation (“Fund”). The Fund owned $
The following table depicts our five business trusts as of December 31, 2022:
| Preferred Securities | |||||||
| Trust Name | Outstanding | Interest Rate | Maturity Date | ||||
| Mercantile Bank Capital Trust I | $ |
| September 16, 2034 | ||||
| Firstbank Capital Trust I | $ |
| October 18, 2034 | ||||
| Firstbank Capital Trust II | $ |
| April 7, 2036 | ||||
| Firstbank Capital Trust III | $ |
| July 30, 2037 | ||||
| Firstbank Capital Trust IV | $ |
| July 30, 2037 | ||||
The following table summarizes quantitative information about our involvement in unconsolidated variable interest entities as of December 31, 2022 and December 31, 2021:
| Aggregate Assets | Aggregate Liabilities | Risk of Loss | ||||||||||
| Trust preferred securities | $ | $ | $ | |||||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 20 – SUBORDINATED NOTES
On December 15, 2021, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant to which we issued and sold $
On January 14, 2022, we issued an additional $
NOTE 21 - REGULATORY MATTERS
We are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If an institution is not well capitalized, regulatory approval is required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if, after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to close monitoring by its principal federal regulator, its asset growth and expansion are restricted, and plans for capital restoration are required. In addition, further specific types of restrictions may be imposed on the institution at the discretion of the federal regulator. At year-end 2022 and 2021, our bank was in the well capitalized category under the regulatory framework for prompt corrective action. There are no conditions or events since December 31, 2022 that we believe have changed our bank’s categorization.
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 21 - REGULATORY MATTERS (Continued)
Our actual capital levels (dollars in thousands) and minimum required levels at year-end 2022 and 2021 were:
| Actual | Minimum Required for Capital Adequacy Purposes | Minimum Required to be Well Capitalized Under Prompt Corrective Action Regulations | ||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| 2022 | ||||||||||||||||||||||||
| Total capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | $ | % | $ | % | $ | NA | NA | |||||||||||||||||
| Bank | % | |||||||||||||||||||||||
| Tier 1 capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | NA | NA | ||||||||||||||||||||||
| Bank | ||||||||||||||||||||||||
| Common equity (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | NA | NA | ||||||||||||||||||||||
| Bank | ||||||||||||||||||||||||
| Tier 1 capital (to average assets) | ||||||||||||||||||||||||
| Consolidated | NA | NA | ||||||||||||||||||||||
| Bank | ||||||||||||||||||||||||
| 2021 | ||||||||||||||||||||||||
| Total capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | $ | % | $ | % | $ | NA | NA | |||||||||||||||||
| Bank | % | |||||||||||||||||||||||
| Tier 1 capital (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | NA | NA | ||||||||||||||||||||||
| Bank | ||||||||||||||||||||||||
| Common equity (to risk weighted assets) | ||||||||||||||||||||||||
| Consolidated | NA | NA | ||||||||||||||||||||||
| Bank | ||||||||||||||||||||||||
| Tier 1 capital (to average assets) | ||||||||||||||||||||||||
| Consolidated | NA | NA | ||||||||||||||||||||||
| Bank |
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 21 – REGULATORY MATTERS (Continued)
Under the final BASEL III capital rules that became effective on January 1, 2015, there is a requirement for a common equity Tier 1 capital conservation buffer of
Federal and state banking laws and regulations place certain restrictions on the amount of dividends our bank can transfer to Mercantile and on the capital levels that must be maintained. At year-end 2022, under the most restrictive of these regulations, our bank could distribute $
As of December 31, 2022, we had the ability to repurchase up to $
Our consolidated capital levels as of December 31, 2022 and 2021 include $
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 22 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
| 2022 | 2021 | |||||||
| ASSETS | ||||||||
| Cash and cash equivalents | $ | $ | ||||||
| Investment in bank subsidiary | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
| Liabilities | $ | $ | ||||||
| Subordinated debentures | ||||||||
| Subordinated notes | ||||||||
| Shareholders’ equity | ||||||||
| Total liabilities and shareholders’ equity | $ | $ | ||||||
CONDENSED STATEMENTS OF INCOME
| 2022 | 2021 | 2020 | ||||||||||
| Income | ||||||||||||
| Interest and dividends from subsidiaries | $ | $ | $ | |||||||||
| Total income | ||||||||||||
| Expenses | ||||||||||||
| Interest expense | ||||||||||||
| Other operating expenses | ||||||||||||
| Total expenses | ||||||||||||
| Income before income tax benefit and equity in undistributed net income of subsidiary | ||||||||||||
| Federal income tax benefit | ( | ) | ( | ) | ( | ) | ||||||
| Equity in undistributed net income of subsidiary | ||||||||||||
| Net income | $ | $ | $ | |||||||||
| Comprehensive income (loss) | $ | ( | ) | $ | $ | |||||||
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022
NOTE 22 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
| 2022 | 2021 | 2020 | ||||||||||
| Cash flows from operating activities | ||||||||||||
| Net income | $ | $ | $ | |||||||||
| Adjustments to reconcile net income to net cash from operating activities: | ||||||||||||
| Equity in undistributed net income of subsidiary | ( | ) | ( | ) | ( | ) | ||||||
| Stock-based compensation expense | ||||||||||||
| Stock grants to directors for retainer fees | ||||||||||||
| Change in other assets | ( | ) | ||||||||||
| Change in other liabilities | ( | ) | ||||||||||
| Net cash from operating activities | ||||||||||||
| Cash flows from investing activities | ||||||||||||
| Net capital investment into subsidiaries | ( | ) | ( | ) | ||||||||
| Net cash for investing activities | ( | ) | ( | ) | ||||||||
| Cash flows from financing activities | ||||||||||||
| Stock option exercises, net of cashless exercises | ||||||||||||
| Employee stock purchase plan | ||||||||||||
| Dividend reinvestment plan | ||||||||||||
| Net proceeds from subordinated notes issuance | ||||||||||||
| Repurchase of common shares | ( | ) | ( | ) | ||||||||
| Cash dividends on common stock | ( | ) | ( | ) | ( | ) | ||||||
| Net cash (for) from financing activities | ( | ) | ( | ) | ||||||||
| Net change in cash and cash equivalents | ||||||||||||
| Cash and cash equivalents at beginning of period | ||||||||||||
| Cash and cash equivalents at end of period | $ | $ | $ | |||||||||
NOTE 23 – SUBSEQUENT EVENTS
On January 12, 2023, our Board of Directors declared a cash dividend on our common stock in the amount of $
EXHIBIT INDEX
| EXHIBIT NO. |
EXHIBIT DESCRIPTION |
| 3.1 |
|
| 3.2 |
|
| 4.1 |
|
| 4.2 |
|
| 4.3 |
|
| 4.4 |
|
| 4.5 |
|
| 4.6 |
|
| 10.1 |
|
| 10.2 |
|
|
|
|
| 10.3 |
|
| 10.4 |
|
| 10.5 |
|
| 10.6 |
| EXHIBIT NO. |
EXHIBIT DESCRIPTION |
| 10.7 |
|
| 10.8 |
|
| 10.9 |
|
| 10.10 |
|
| 10.11 |
|
| 10.12 |
|
| 10.13 |
|
| 10.14 |
|
| 10.15 |
|
| 10.16 |
|
| 10.17 |
|
| 10.18 |
|
| 10.19 |
|
| 10.20 |
|
| 21 |
|
| 23 |
|
| 31 |
|
| 32.1 |
|
| 32.2 |
| EXHIBIT NO. |
EXHIBIT DESCRIPTION |
| 101 |
The following information from Mercantile’s Annual Report on Form 10-K for the year ended December 31, 2022, formatted in Inline XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income (Loss), (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements |
| 104 |
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
* Management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 3, 2023.
| MERCANTILE BANK CORPORATION |
||
| /s/ Robert B. Kaminski, Jr. |
||
| Robert B. Kaminski, Jr. |
||
| President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 3, 2023.
| /s/ David M. Cassard David M. Cassard, Director |
/s/ Michael H. Price Michael H. Price, Chairman of the Board |
| /s/ Michael S. Davenport Michael S. Davenport, Director |
/s/ David B. Ramaker David B. Ramaker, Director |
| /s/ Michelle L. Eldridge Michelle L. Eldridge, Director
/s/ Jeff A. Gardner Jeff A. Gardner, Director |
/s/ Charles E. Christmas Charles E. Christmas, Executive Vice President, Chief Financial Officer and Treasurer (principal financial and accounting officer) |
| /s/ Robert B. Kaminski, Jr. Robert B. Kaminski, Jr. Director, President and Chief Executive Officer (principal executive officer) |