U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________.
Commission File No. 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan 38-3360865
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
310 LEONARD STREET, NW, GRAND RAPIDS, MI 49504
(Address of principal executive offices) (Zip Code)
(616) 406-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large Accelerated filer Accelerated filer X Non-Accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
At August 8, 2006, there were 8,014,194 shares of Common Stock outstanding.
MERCANTILE BANK CORPORATION
INDEX
Page No.
--------
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2006 (Unaudited) and December 31, 2005.......... 3
Consolidated Statements of Income and Comprehensive
Income - Three and Six Months Ended June 30, 2006
(Unaudited) and June 30, 2005 (Unaudited)................ 4
Consolidated Statements of Changes in Shareholders'
Equity - Six Months Ended June 30, 2006 (Unaudited)
and June 30, 2005 (Unaudited)............................ 5
Consolidated Statements of Cash Flows -
Three and Six Months Ended June 30, 2006 (Unaudited)
and June 30, 2005 (Unaudited)............................ 7
Notes to Consolidated Financial Statements (Unaudited)...... 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 22
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.............................................. 31
Item 4. Controls and Procedures............................. 33
PART II. Other Information
Item 1. Legal Proceedings................................... 34
Item 1A. Risk Factors....................................... 34
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds................................................. 34
Item 3. Defaults upon Senior Securities..................... 35
Item 4. Submission of Matters to a Vote of Security
Holders.................................................. 35
Item 5. Other Information................................... 35
Item 6. Exhibits............................................ 35
Signatures
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2006 2005
-------------- --------------
(Unaudited)
ASSETS
Cash and due from banks $ 47,142,000 $ 36,208,000
Short-term investments 271,000 545,000
-------------- --------------
Total cash and cash equivalents 47,413,000 36,753,000
Securities available for sale 119,023,000 112,961,000
Securities held to maturity (fair value of $62,826,000
at June 30, 2006 and $62,850,000 at December 31, 2005) 61,759,000 60,766,000
Federal Home Loan Bank stock 7,887,000 7,887,000
Total loans and leases 1,670,471,000 1,561,812,000
Allowance for loan and lease losses (21,507,000) (20,527,000)
-------------- --------------
Total loans and leases, net 1,648,964,000 1,541,285,000
Premises and equipment, net 30,824,000 30,206,000
Bank owned life insurance policies 29,852,000 28,071,000
Accrued interest receivable 9,047,000 8,274,000
Other assets 14,660,000 12,007,000
-------------- --------------
Total assets $1,969,429,000 $1,838,210,000
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing $ 129,483,000 $ 120,828,000
Interest-bearing 1,418,429,000 1,298,524,000
-------------- --------------
Total deposits 1,547,912,000 1,419,352,000
Securities sold under agreements to repurchase 64,431,000 72,201,000
Federal funds purchased 11,400,000 9,600,000
Federal Home Loan Bank advances 130,000,000 130,000,000
Subordinated debentures 32,990,000 32,990,000
Other borrowed money 2,957,000 2,347,000
Accrued expenses and other liabilities 18,079,000 16,595,000
-------------- --------------
Total liabilities 1,807,769,000 1,683,085,000
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued 0 0
Common stock, no par value: 20,000,000 shares authorized;
8,014,044 shares outstanding at June 30, 2006 and 7,590,526
shares outstanding at December 31, 2005 160,872,000 148,533,000
Retained earnings 4,070,000 8,000,000
Accumulated other comprehensive income (loss) (3,282,000) (1,408,000)
-------------- --------------
Total shareholders' equity 161,660,000 155,125,000
-------------- --------------
Total liabilities and shareholders' equity $1,969,429,000 $1,838,210,000
============== ==============
See accompanying notes to consolidated financial statements.
3
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Interest income
Loans and leases, including fees $31,304,000 $22,250,000 $60,031,000 $42,022,000
Investment securities 2,299,000 2,036,000 4,536,000 3,923,000
Federal funds sold 139,000 56,000 271,000 100,000
Short-term investments 4,000 4,000 7,000 6,000
----------- ----------- ----------- -----------
Total interest income 33,746,000 24,346,000 64,845,000 46,051,000
Interest expense
Deposits 15,358,000 8,892,000 28,843,000 16,332,000
Short-term borrowings 720,000 375,000 1,321,000 713,000
Federal Home Loan Bank advances 1,369,000 1,006,000 2,684,000 1,863,000
Long-term borrowings 653,000 465,000 1,252,000 880,000
----------- ----------- ----------- -----------
Total interest expense 18,100,000 10,738,000 34,100,000 19,788,000
----------- ----------- ----------- -----------
NET INTEREST INCOME 15,646,000 13,608,000 30,745,000 26,263,000
Provision for loan and lease losses 1,500,000 900,000 2,725,000 1,625,000
----------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 14,146,000 12,708,000 28,020,000 24,638,000
Noninterest income
Services charges on accounts 329,000 341,000 645,000 679,000
Net gain on sales of commercial loans 0 28,000 29,000 28,000
Other income 946,000 849,000 1,844,000 1,721,000
----------- ----------- ----------- -----------
Total noninterest income 1,275,000 1,218,000 2,518,000 2,428,000
Noninterest expense
Salaries and benefits 4,683,000 4,405,000 9,448,000 8,564,000
Occupancy 772,000 566,000 1,602,000 1,084,000
Furniture and equipment 515,000 362,000 1,037,000 650,000
Other expense 2,061,000 1,812,000 3,950,000 3,697,000
----------- ----------- ----------- -----------
Total noninterest expenses 8,031,000 7,145,000 16,037,000 13,995,000
----------- ----------- ----------- -----------
INCOME BEFORE FEDERAL INCOME
TAX EXPENSE 7,390,000 6,781,000 14,501,000 13,071,000
Federal income tax expense 2,279,000 2,091,000 4,461,000 4,019,000
----------- ----------- ----------- -----------
NET INCOME $ 5,111,000 $ 4,690,000 $10,040,000 $ 9,052,000
=========== =========== =========== ===========
COMPREHENSIVE INCOME $ 3,567,000 $ 5,424,000 $ 8,166,000 $ 8,926,000
=========== =========== =========== ===========
Basic earnings per share $ 0.64 $ 0.59 $ 1.26 $ 1.14
=========== =========== =========== ===========
Diluted earnings per share $ 0.63 $ 0.58 $ 1.24 $ 1.12
=========== =========== =========== ===========
Cash dividends per share $ 0.13 $ 0.11 $ 0.25 $ 0.21
=========== =========== =========== ===========
Average basic shares outstanding 8,000,998 7,958,408 7,987,616 7,951,726
=========== =========== =========== ===========
Average diluted shares outstanding 8,119,820 8,099,740 8,111,449 8,094,716
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
4
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income/(Loss) Equity
------------ ------------ ------------- -------------
BALANCE, JANUARY 1, 2005 $131,010,000 $ 10,475,000 $ 132,000 $141,617,000
Payment of 5% stock dividend, 379,216 shares 17,187,000 (17,191,000) (4,000)
Employee stock purchase plan, 1,012 shares 39,000 39,000
Dividend reinvestment plan, 2,255 shares 84,000 84,000
Stock option exercises, 35,387 shares 319,000 319,000
Stock tendered for stock option exercises,
6,836 shares (266,000) (266,000)
Cash dividends ($0.21 per share) (1,515,000) (1,515,000)
Comprehensive income:
Net income for the period from
January 1, 2005 through June 30, 2005 9,052,000 9,052,000
Change in net unrealized gain
(loss) on securities available for sale,
net of reclassifications and tax effect (126,000) (126,000)
------------
Total comprehensive income 8,926,000
------------ ------------ --------- ------------
BALANCE, JUNE 30, 2005 $148,373,000 $ 821,000 $ 6,000 $149,200,000
============ ============ ========= ============
See accompanying notes to consolidated financial statements.
5
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Accumulated
Other Total
Common Retained Comprehensive Shareholders'
Stock Earnings Income/(Loss) Equity
------------ ------------ ------------- -------------
BALANCE, JANUARY 1, 2006 148,533,000 8,000,000 (1,408,000) 155,125,000
Payment of 5% stock dividend, 379,432 shares 12,014,000 (12,018,000) (4,000)
Employee stock purchase plan, 1,448 shares 55,000 55,000
Dividend reinvestment plan, 1,181 shares 45,000 45,000
Stock option exercises, 55,757 shares 683,000 683,000
Stock tendered for stock option exercises,
14,300 shares (560,000) (560,000)
Stock option expense 102,000 102,000
Cash dividends ($0.25 per share) (1,952,000) (1,952,000)
Comprehensive income:
Net income for the period from
January 1, 2006 through June 30, 2006 10,040,000 10,040,000
Change in net unrealized gain
(loss) on securities available for sale,
net of reclassifications and tax effect (1,874,000) (1,874,000)
------------
Total comprehensive income 8,166,000
------------ ------------ ----------- ------------
BALANCE, JUNE 30, 2006 $160,872,000 $ 4,070,000 $(3,282,000) $161,660,000
============ ============ =========== ============
See accompanying notes to consolidated financial statements.
6
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,111,000 $ 4,690,000 $ 10,040,000 $ 9,052,000
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization 794,000 584,000 1,579,000 1,074,000
Provision for loan and lease losses 1,500,000 900,000 2,725,000 1,625,000
Net gain on sales of commercial loans 0 (28,000) (29,000) (28,000)
Stock option expense 51,000 0 102,000 0
Net change in:
Accrued interest receivable 327,000 333,000 (773,000) (906,000)
Bank owned life insurance policies (285,000) (243,000) (574,000) (479,000)
Other assets (2,774,000) (1,503,000) (1,907,000) (2,632,000)
Accrued expenses and other liabilities 2,571,000 1,772,000 1,484,000 2,611,000
------------ ------------ ------------- -------------
Net cash from operating activities 7,295,000 6,505,000 12,647,000 10,317,000
CASH FLOWS FROM INVESTING ACTIVITIES
Loan and leases originations and payments, net (59,108,000) (49,999,000) (110,375,000) (107,899,000)
Purchases of:
Securities available for sale (4,880,000) (8,044,000) (13,013,000) (23,800,000)
Securities held to maturity (327,000) (2,580,000) (1,755,000) (7,475,000)
Federal Home Loan Bank stock 0 (403,000) 0 (627,000)
Proceeds from:
Maturities, calls and repayments of
available for sale securities 1,599,000 4,006,000 4,087,000 9,516,000
Maturities, calls and repayments of
held to maturity securities 730,000 735,000 730,000 936,000
Purchases of premises and equipment, net (1,591,000) (2,999,000) (1,921,000) (5,377,000)
Purchases of bank owned life insurance policies (1,207,000) (440,000) (1,207,000) (440,000)
------------ ------------ ------------- -------------
Net cash from investing activities (64,784,000) (59,724,000) (123,454,000) (135,166,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits 65,693,000 31,827,000 128,560,000 162,663,000
Net increase (decrease) in securities sold under
agreements to repurchase (3,525,000) (4,174,000) (7,770,000) (283,000)
Net increase (decrease) in federal funds purchased 4,800,000 0 1,800,000 (15,000,000)
Proceeds from new FHLB advances 35,000,000 20,000,000 50,000,000 40,000,000
Maturities of FHLB advances (35,000,000) (10,000,000) (50,000,000) (25,000,000)
Net increase in other borrowed money 166,000 153,000 610,000 460,000
Employee stock purchase plan 26,000 22,000 55,000 39,000
Dividend reinvestment plan 24,000 51,000 45,000 84,000
Stock option exercises, net 123,000 0 123,000 53,000
Payment of cash dividends (1,041,000) (794,000) (1,952,000) (1,515,000)
Cash paid in lieu of fractional shares on
stock dividend 0 (4,000) (4,000) (4,000)
------------ ------------ ------------- -------------
Net cash from financing activities 66,266,000 37,081,000 121,467,000 161,497,000
------------ ------------ ------------- -------------
See accompanying notes to consolidated financial statements.
7
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net change in cash and cash equivalents 8,777,000 (16,138,000) 10,660,000 36,648,000
Cash and cash equivalents at beginning of period 38,636,000 73,597,000 36,753,000 20,811,000
----------- ------------ ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $47,413,000 $ 57,459,000 $47,413,000 $57,459,000
=========== ============ =========== ===========
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $15,876,000 $ 9,070,000 $30,177,000 $16,796,000
Federal income tax 4,875,000 4,150,000 5,875,000 4,475,000
See accompanying notes to consolidated financial statements.
8
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The unaudited financial statements for the three and
six months ended June 30, 2006 include the consolidated results of
operations of Mercantile Bank Corporation and its consolidated
subsidiaries. These subsidiaries include Mercantile Bank of Michigan ("our
bank"), our bank's three subsidiaries, Mercantile Bank Mortgage Company,
LLC ("our mortgage company"), Mercantile Bank Real Estate Co., LLC ("our
real estate company"), and Mercantile Insurance Center, Inc. ("our
insurance center"). These consolidated financial statements have been
prepared in accordance with the instructions for Form 10-Q and Item 303(b)
of Regulation S-K and do not include all disclosures required by accounting
principles generally accepted in the United States of America for a
complete presentation of our financial condition and results of operations.
In the opinion of management, the information reflects all adjustments
(consisting only of normal recurring adjustments) which are necessary in
order to make the financial statements not misleading and for a fair
presentation of the results of operations for such periods. The results for
the periods ended June 30, 2006 should not be considered as indicative of
results for a full year. For further information, refer to the consolidated
financial statements and footnotes included in our annual report on Form
10-K for the year ended December 31, 2005.
Mercantile Bank Capital Trust I ("the trust"), a business trust formed by
Mercantile Bank Corporation, sold 16,000 trust preferred securities at
$1,000.00 per trust preferred security in a September 2004 offering. The
trust sold an additional 16,000 trust preferred securities at $1,000.00 per
trust preferred security in a December 2004 offering. Mercantile Bank
Corporation issued subordinated debentures to the trust in exchange for the
proceeds of the offerings. The debentures and related debt issuance costs
represent the sole assets of the trust. Under current accounting guidance,
FASB Interpretation No. 46, as revised in December 2003, the trust is not
consolidated. Accordingly, Mercantile Bank Corporation does not report the
securities issued by the trust as liabilities, and instead reports as
liabilities the subordinated debentures issued by Mercantile Bank
Corporation and held by the trust, as these are not eliminated in
consolidation. The effect of not consolidating the trust does not
significantly change the amounts reported as Mercantile Bank Corporation's
assets, liabilities, equity or interest expense.
Earnings Per Share: Basic earnings per share is based on weighted average
common shares outstanding during the period. Diluted earnings per share
include the dilutive effect of additional potential common shares issuable
under stock options. Options for 7,163 shares were antidilutive and were
not included in determining diluted earnings per share for the three and
six month periods ended June 30, 2006.
Stock Dividend: Per share amounts and average shares outstanding have been
adjusted for all periods presented to reflect the 5% stock dividend
distributed on May 16, 2006. The Statement of Changes in Shareholders'
Equity reflects a transfer from retained earnings to common stock for the
value of the shares distributed to the extent of available retained
earnings.
9
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan and Lease Losses: The allowance for loan and lease
losses ("allowance") is a valuation allowance for probable incurred credit
losses, increased by the provision for loan and lease losses and
recoveries, and decreased by charge-offs. Management estimates the
allowance balance required based on past loan loss experience, the nature
and volume of the portfolio, information about specific borrower situations
and estimated collateral values, and economic conditions. Allocations of
the allowance may be made for specific loans and leases, but the entire
allowance is available for any loan or lease that, in management's
judgment, should be charged-off. Loan and lease losses are charged against
the allowance when management believes the uncollectibility of a loan or
lease balance is confirmed.
A loan or lease is impaired when full payment under the loan or lease terms
is not expected. Impairment is evaluated in aggregate for smaller-balance
loans of similar nature such as residential mortgage, consumer and credit
card loans, and on an individual loan basis for other loans. If a loan or
lease is impaired, a portion of the allowance is allocated so that the loan
or lease is reported, net, at the present value of estimated future cash
flows using the loan's or lease's existing rate or at the fair value of
collateral if repayment is expected solely from the collateral. Loans and
leases are evaluated for impairment when payments are delayed, typically 30
days or more, or when serious deficiencies are identified within the credit
relationship.
Stock Options: Stock option plans are used to reward directors and
employees and provide them with additional equity interest. Stock options
granted to non-employee directors are at 125% of the market price on the
date of grant, fully vest after five years and expire ten years from the
date of grant. Stock options granted to employees are granted at the market
price on the date of grant, generally fully vest after one year and expire
ten years from the date of grant. Stock options granted to non-executive
employees during 2005 vested about three weeks after being granted.
The Stock Incentive Plan of 2006 ("Incentive Plan") was approved by
shareholders at the annual meeting held on April 27, 2006. The Incentive
Plan provides for the grant of equity-based incentives to eligible
participants. The forms of long-term incentive compensation include stock
options, stock appreciation rights, restricted stock units, restricted
stock, stock awards and other awards based on or related to shares of
Mercantile Bank Corporation common stock. The Incentive Plan provides for
350,000 shares of Mercantile Bank Corporation common stock to be available
for incentive awards under the Incentive Plan, combined with the 245,769
shares available for issuance under previously authorized stock option
plans, for a total of 595,769.
Prior to January 1, 2006, the Company accounted for stock-based
compensation expense using the intrinsic value method as required by APB
Opinion No. 25 "Accounting for Stock Issued to Employees" and as permitted
by SFAS No. 123 "Accounting for Stock-Based Compensation." No compensation
cost for stock options was reflected in net income for 2005, as all options
granted had an exercise price equal to the market price of the underlying
common stock at date of grant.
10
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
On January 1, 2006, the Company adopted SFAS No. 123(R), which requires
measurement of compensation cost for all stock-based awards be based on the
grant-date fair value and recognition of compensation cost over the service
period of stock-based awards, which is usually the same as the vesting
period. The fair value of stock options is determined using the
Black-Scholes valuation model, which is consistent with the Company's
valuation methodology previously utilized for options in the footnote
disclosures required under SFAS No. 123. The Company has adopted SFAS No.
123(R) using the modified prospective method, which provides for no
retroactive application to prior periods and no cumulative adjustment to
equity accounts. As amended, this applies to awards granted or modified
beginning with the first quarter of 2006. Compensation cost is also
recorded for prior option grants that vest after the date of adoption. SFAS
No. 123(R) also amends SFAS No. 95 "Statement of Cash Flows," and requires
tax benefits relating to excess stock-based compensation deductions be
presented in the consolidated statements of cash flows as financing cash
inflows.
On March 29, 2005, the Securities and Exchange Commission ("SEC") published
Staff Accounting Bulletin ("SAB") No. 107, which expressed the views of the
Staff regarding interaction between SFAS No. 123(R) and certain SEC rules
and regulations and provided the Staff's views regarding the valuation of
stock-based payment arrangements for public companies. SAB No. 107 requires
that stock-based compensation be classified in the same expense category as
cash compensation. Accordingly, the Company has included stock-based
compensation expense in salaries and employee benefits in the consolidated
statements of income and comprehensive income.
The adoption of SFAS No. 123(R) had the following impact on reported
amounts compared with amounts that would have been reported using the
intrinsic value method under previous accounting.
Three Months Ended June 30, 2006
-------------------------------------
Using SFAS
Previous 123(R) As
Accounting Adjustments Reported
---------- ----------- ----------
Income before taxes $7,441,000 $(51,000) $7,390,000
Income taxes 2,279,000 0 2,279,000
---------- -------- ----------
Net income $5,162,000 $(51,000) $5,111,000
========== ======== ==========
Basic earnings per share $ 0.65 $ (0.01) $ 0.64
Diluted earnings per share $ 0.64 $ (0.01) $ 0.63
11
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Six Months Ended June 30, 2006
---------------------------------------
Using SFAS
Previous 123(R)
Accounting Adjustments As Reported
----------- ----------- -----------
Income before taxes $14,603,000 $(102,000) $14,501,000
Income taxes 4,461,000 0 4,461,000
----------- --------- -----------
Net income $10,142,000 $(102,000) $10,040,000
=========== ========= ===========
Basic earnings per share $ 1.27 $ (0.01) $ 1.26
Diluted earnings per share $ 1.25 $ (0.01) $ 1.24
The following table illustrates the effect on net income and earnings per share
if expense had been measured using the fair value recognition provisions of SFAS
No. 123(R).
Three Months Ended June 30, 2005
----------------------------------------
Pro Forma As
As Pro Forma If Under
Reported Adjustments SFAS 123(R)
---------- ------------ ------------
Income before taxes $6,781,000 $(94,000) $6,687,000
Income taxes 2,091,000 0 2,091,000
---------- -------- ----------
Net income $4,690,000 $(94,000) $4,596,000
========== ======== ==========
Basic earnings per share $ 0.59 $ (0.01) $ 0.58
Diluted earnings per share $ 0.58 $ (0.01) $ 0.57
12
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Six Months Ended June 30, 2005
----------------------------------------
Pro Forma As
Pro Forma If Under
As Reported Adjustments SFAS 123(R)
----------- ----------- ------------
Income before taxes $13,071,000 $(187,000) $12,884,000
Income taxes 4,019,000 0 4,019,000
----------- --------- -----------
Net income $ 9,052,000 $(187,000) $ 8,865,000
=========== ========= ===========
Basic earnings per share $ 1.14 $ (0.03) $ 1.11
Diluted earnings per share $ 1.12 $ (0.02) $ 1.10
The following is activity under the stock option plans:
Six Months Ended June 30, 2006
------------------------------
Weighted
Average
Exercise
Shares Price
-------- --------
Outstanding at beginning of period $315,302 $21.83
Granted 0 NA
Exercised 55,757 12.25
Forfeited 2,204 33.55
-------- ------
Outstanding at end of period $257,341 $23.81
======== ======
Exercisable at end of period $214,689 $22.31
======== ======
The aggregate intrinsic value of all options outstanding at June 30, 2006 was
$4.1 million.
The aggregate intrinsic value of all options that were exercisable at June 30,
2006 was $3.8 million.
The aggregate intrinsic value of stock options exercised during the first six
months of 2006 was $1.5 million.
The weighted average fair value of the 2,479 stock options that vested during
the first six months of 2006 was $10.90.
13
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock options outstanding as of June 30, 2006:
Outstanding
-------------------------------- Exercisable
Weighted ------------------
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Shares Life Price Shares Price
------- ----------- -------- ------- --------
$4.00 - $8.00 8,952 1.1 Years $ 7.46 8,952 $ 7.46
$8.01 - $12.00 43,208 3.6 Years 9.19 43,208 9.19
$12.01 - $16.00 29,306 5.3 Years 13.07 29,306 13.07
$16.01 - $20.00 40,695 6.1 Years 16.83 33,063 16.94
$20.01 - $24.00 7,272 6.3 Years 21.19 0 NA
$24.01 - $28.00 31,748 7.3 Years 27.94 31,748 27.94
$32.01 - $36.00 42,664 8.2 Years 35.29 35,728 35.36
$36.01 - $40.00 46,333 9.4 Years 37.68 32,684 37.68
$40.01 - $44.00 7,163 8.3 Years 42.29 0 NA
------- -------
Outstanding at end of period 257,341 6.6 Years $23.81 214,689 $22.31
======= =======
The compensation cost yet to be recognized for stock option grants that
have been awarded but not vested is $100,000 for the remainder of 2006, and
$27,000, $17,000 and $8,000 for 2007, 2008, and 2009, respectively.
Newly Issued but Not Yet Effective Accounting Standards: In June 2006, the
FASB issued Interpretation No. 48, Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109 ("FIN 48"), which
clarifies the accounting for uncertainty in income taxes recognized in a
company's financial statements in accordance with SFAS 109, Accounting for
Income Taxes. FIN 48 prescribes a recognition and measurement threshold for
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Company
has not completed its evaluation of the impact of the adoption of FIN 48.
14
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2. LOANS AND LEASES
Our total loans and leases at June 30, 2006 were $1,670.5 million compared
to $1,561.8 million at December 31, 2005, an increase of $108.7 million, or
7.0%. The components of our outstanding balances at June 30, 2006 and
December 31, 2005, and the percentage change in loans and leases from the
end of 2005 to the end of the second quarter 2006 are as follows:
June 30, 2006 December 31, 2005 Percent
---------------------- ---------------------- Increase/
Balance % Balance % (Decrease)
-------------- ----- -------------- ----- ----------
Real Estate:
Construction and land
development $ 265,139,000 15.9% $ 226,544,000 14.5% 17.0%
Secured by 1-4 family
properties 122,944,000 7.4 128,111,000 8.2 (4.0)
Secured by multi-family
properties 35,397,000 2.1 30,114,000 2.0 17.5
Secured by nonresidential
properties 776,542,000 46.5 714,963,000 45.8 8.6
Commercial 461,892,000 27.6 454,911,000 29.1 1.5
Leases 1,198,000 0.1 1,786,000 0.1 (32.9)
Consumer 7,359,000 0.4 5,383,000 0.3 36.7
-------------- ----- -------------- ----- -----
Total loans and leases $1,670,471,000 100.0% $1,561,812,000 100.0% 7.0%
============== ===== ============== ===== =====
3. ALLOWANCE FOR LOAN AND LEASE LOSSES
The following is a summary of the change in our allowance for loan and
lease losses account for the three and six months ended June 30:
Three months ended Six months ended
------------------------- -------------------------
June 30, June 30, June 30, June 30,
2006 2005 2006 2005
----------- ----------- ----------- -----------
Beginning balance $20,995,000 $18,097,000 $20,527,000 $17,819,000
Charge-offs (1,083,000) (211,000) (1,863,000) (704,000)
Recoveries 95,000 70,000 118,000 116,000
Provision for loan and
lease losses 1,500,000 900,000 2,725,000 1,625,000
----------- ----------- ----------- -----------
Balance at June 30 $21,507,000 $18,856,000 $21,507,000 $18,856,000
=========== =========== =========== ===========
15
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
4. PREMISES AND EQUIPMENT - NET
Premises and equipment are comprised of the following:
June 30, December 31,
2006 2005
----------- ------------
Land and improvements $ 8,442,000 $ 7,135,000
Buildings and leasehold improvements 18,870,000 18,450,000
Furniture and equipment 10,545,000 10,351,000
----------- -----------
37,857,000 35,936,000
Less: accumulated depreciation 7,033,000 5,730,000
----------- -----------
Premises and equipment, net $30,824,000 $30,206,000
=========== ===========
Depreciation expense amounted to $0.7 million during the second quarter of
2006, compared to $0.5 million in the second quarter of 2005. Depreciation
expense amounted to $1.3 million during the first six months of 2006,
compared to $0.8 million during the first six months of 2005.
5. DEPOSITS
Our total deposits at June 30, 2006 were $1,547.9 million compared to
$1,419.4 million at December 31, 2005, an increase of $128.6 million, or
9.1%. The components of our outstanding balances at June 30, 2006 and
December 31, 2005, and percentage change in deposits from the end of 2005
to the end of the second quarter 2006 are as follows:
June 30, 2006 December 31, 2005 Percent
---------------------- ---------------------- Increase/
Balance % Balance % (Decrease)
-------------- ----- -------------- ----- ----------
Noninterest-bearing demand $ 129,483,000 8.4% $ 120,828,000 8.5% 7.2%
Interest-bearing checking 33,643,000 2.2 39,792,000 2.8 (15.5)
Money market 10,762,000 0.7 10,344,000 0.7 4.0
Savings 87,048,000 5.6 106,247,000 7.5 (18.1)
Time, under $100,000 36,259,000 2.3 23,906,000 1.7 51.7
Time, $100,000 and over 247,889,000 16.0 155,401,000 11.0 59.5
-------------- ----- -------------- ----- -----
545,084,000 35.2 456,518,000 32.2 19.4
Out-of-area time,
under $100,000 69,185,000 4.5 80,048,000 5.6 (13.6)
Out-of-area time,
$100,000 and over 933,643,000 60.3 882,786,000 62.2 5.8
-------------- ----- -------------- ----- -----
1,002,828,000 64.8 962,834,000 67.8 4.1
-------------- ----- -------------- ----- -----
Total deposits $1,547,912,000 100.0% $1,419,352,000 100.0% 9.1%
============== ===== ============== ===== =====
16
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. SHORT-TERM BORROWINGS
Information relating to our securities sold under agreements to repurchase
follows:
June 30, December 31,
2006 2005
----------- ------------
Outstanding balance at end of period $64,431,000 $72,201,000
Average interest rate at end of period 3.69% 3.31%
Average balance during the period $69,315,000 $60,743,000
Average interest rate during the period 3.52% 2.63%
Maximum month end balance during the period $76,113,000 $74,639,000
Securities sold under agreements to repurchase ("repurchase agreements")
generally have original maturities of less than one year. Repurchase
agreements are treated as financings and the obligations to repurchase
securities sold are reflected as liabilities. Securities involved with the
agreements are recorded as assets of our bank and are primarily held in
safekeeping by correspondent banks. Repurchase agreements are offered
principally to certain large deposit customers as deposit equivalent
investments.
7. FEDERAL HOME LOAN BANK ADVANCES
Our outstanding balances at June 30, 2006 and December 31, 2005 were as
follows.
June 30, December 31,
2006 2005
------------ ------------
Maturities July 2006 through May 2008,
fixed rates from 2.64 to 5.69%, averaging 4.45% $130,000,000 $ 0
Maturities January 2006 through May 2008,
fixed rates from 2.13% to 4.92%, averaging 3.68% 0 120,000,000
Maturities in May 2006, floating rates tied to Libor
indices, averaging 4.42% 0 10,000,000
------------ ------------
Total Federal Home Loan Bank advances $130,000,000 $130,000,000
============ ============
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,
17
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
and substantially all other assets of our bank, under a blanket lien
arrangement. Our borrowing line of credit as of June 30, 2006 totaled
$295.9 million, with availability approximating $154.0 million.
7. FEDERAL HOME LOAN BANK ADVANCES (Continued)
Maturities of FHLB advances currently outstanding during the next five
years are:
2006 $65,000,000
2007 50,000,000
2008 15,000,000
2009 0
2010 0
8. COMMITMENTS AND OFF-BALANCE-SHEET RISK
Our bank is 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 bank's
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. Our bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments. Collateral, such as accounts receivable, securities,
inventory, property and equipment, is generally obtained based on
management's credit assessment of the borrower. If required, estimated loss
exposure resulting from these instruments is expensed and recorded as a
liability. The balance of the liability account was $0.5 million as of June
30, 2006 and December 31, 2005.
A summary of the contractual amounts of our financial instruments with
off-balance-sheet risk at June 30, 2006 and December 31, 2005 follows:
June 30, December 31,
2006 2005
------------ ------------
Commercial unused lines of credit $327,509,000 $303,115,000
Unused lines of credit secured by 1-4 family
residential properties 29,301,000 27,830,000
18
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Credit card unused lines of credit 8,223,000 7,971,000
Other consumer unused lines of credit 7,719,000 10,791,000
Commitments to make loans 63,429,000 83,280,000
Standby letters of credit 66,586,000 59,058,000
------------ ------------
Total loan and leases commitments $502,767,000 $492,045,000
============ ============
9. 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 our 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 not
well capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are required.
Our actual capital levels and minimum required levels were (dollars in
thousands):
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
---------------- ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- --------- ----- ------- --------
June 30, 2006
Total capital (to risk
weighted assets)
Consolidated $218,449 11.7% $149,831 8.0% $NA NA
Bank 214,900 11.5 149,685 8.0 187,106 10.0%
Tier 1 capital (to risk
weighted assets)
Consolidated 196,942 10.5 74,916 4.0 NA NA
Bank 193,393 10.3 74,843 4.0 112,264 6.0
Tier 1 capital (to
average assets)
Consolidated 196,942 10.2 77,577 4.0 NA NA
Bank 193,393 10.0 77,510 4.0 96,887 5.0
19
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
9. REGULATORY MATTERS (Continued)
Minimum Required
to be Well
Minimum Required Capitalized Under
for Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
---------------- ----------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ----- -------- ----- -------- -----
December 31, 2005
Total capital (to risk
weighted assets)
Consolidated $209,060 12.0% $139,337 8.0% $ NA NA
Bank 205,642 11.8 139,158 8.0 173,947 10.0%
Tier 1 capital (to risk
weighted assets)
Consolidated 188,533 10.8 69,669 4.0 NA NA
Bank 185,115 10.6 69,579 4.0 104,368 6.0
Tier 1 capital (to
average assets)
Consolidated 188,533 10.5 72,163 4.0 NA NA
Bank 185,115 10.3 72,100 4.0 90,124 5.0
The consolidated capital levels as of June 30, 2006 and December 31, 2005
include the $32.0 million in trust preferred securities issued by the trust
subject to certain limitations. Federal Reserve guidelines limit the amount
of trust preferred securities which can be included in our Tier 1 capital
to 25% of total Tier 1 capital. As of June 30, 2006 and December 31, 2005,
all $32.0 million of the trust preferred securities were included as Tier 1
capital.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound
banking practices. We declared a 5% stock dividend on April 11, 2006, that
was distributed on May 16, 2006 to record holders as of April 24, 2006. All
earnings per share and dividend per share information have been adjusted
for the 5% stock dividend. We have also paid two cash dividends on our
common stock during 2006. On January 10, 2006, we declared a $0.12 per
share cash dividend on our common stock, which was paid on March 10, 2006
to record holders as of February 10, 2006. On April 11, 2006, we declared a
$0.13 per share cash dividend on our common stock, which was paid on June
9, 2006 to record holders as of May 17, 2006. On July 11, 2006, we declared
a $0.13 per share cash dividend on our common stock, which is payable on
September 8, 2006 to record holders as of August 10, 2006.
20
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
10. BENEFIT PLANS
We sponsor an employee stock purchase plan which allows employees to defer
after-tax payroll dollars and purchase our common stock on a quarterly
basis. We have registered 30,387 shares of common stock to be issued and
purchased under the plan; however, the plan allows for shares to be
purchased directly from us or on the open market. During the six months
ended June 30, 2006, we issued 1,448 shares under the plan.
21
MERCANTILE BANK CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that are based on management's
beliefs, assumptions, current expectations, estimates and projections about the
financial services industry, the economy, and about our company. Words such as
"anticipates", "believes", "estimates", "expects", "forecasts", "intends", "is
likely", "plans", "projects", 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 changes in interest rates and interest rate
relationships; demand for products and services; the degree of competition by
traditional and non-traditional competitors; changes in banking regulation;
changes in tax laws; changes in prices, levies, and assessments; the impact of
technological advances; governmental and regulatory policy changes; the outcomes
of contingencies; trends in customer behavior as well as their ability to repay
loans; changes in the national and local economies; and risk factors described
in our annual report on Form 10-K for the year ended December 31, 2005. These
are representative of the Future Factors that could cause a difference between
an ultimate actual outcome and a preceding forward-looking statement.
INTRODUCTION
The following discussion compares the financial condition of Mercantile Bank
Corporation and its consolidated subsidiaries, Mercantile Bank of Michigan ("our
bank"), our bank's three subsidiaries Mercantile Bank Mortgage Company ("our
mortgage company"), Mercantile Bank Real Estate Co., LLC ("our real estate
company") and Mercantile Insurance Center, Inc. ("our insurance center"), at
June 30, 2006 to December 31, 2005 and the results of operations for the three
and six months ended June 30, 2006 and June 30, 2005. This discussion should be
read in conjunction with the interim consolidated financial statements and
footnotes included in this report. Unless the text clearly suggests otherwise,
references in this report to "us," "we," "our," or "the company" include
Mercantile Bank Corporation and its consolidated subsidiaries referred to above.
CRITICAL ACCOUNTING POLICIES
Generally accepted accounting principles are complex and require management to
apply significant judgment to various accounting, reporting and disclosure
matters. Management must use assumptions and estimates to apply these principles
where actual measurements are not possible or practical. The Management's
Discussion and Analysis of Financial Condition and Results of Operations should
be read in conjunction with our unaudited financial statements included in this
report. For a complete discussion of our significant accounting policies, see
footnotes to our Consolidated Financial Statements included on pages F-35
through F-40 in our Form 10-K for the fiscal year ended December 31, 2005
(Commission file number 000-26719). Below is a discussion of our Allowance for
Loan and Lease Losses policy. This policy is critical because it is highly
dependent upon subjective or complex judgments, assumptions and estimates.
Changes in such estimates may have a significant impact on the financial
statements, and actual results may differ from those estimates. Management has
reviewed the application of this policy with the Audit Committee of the
Company's Board of Directors.
22
MERCANTILE BANK CORPORATION
Allowance for Loan and Lease Losses: The allowance for loan and lease losses
("allowance") is a valuation allowance for probable incurred credit losses,
increased by the provision for loan and lease losses and recoveries, and
decreased by charge-offs. Management estimates the allowance balance required
based on past loan loss experience, the nature and volume of the portfolio,
information about specific borrower situations and estimated collateral values,
and economic conditions. Allocations of the allowance may be made for specific
loans and leases, but the entire allowance is available for any loan or lease
that, in management's judgment, should be charged-off. Loan and lease losses are
charged against the allowance when management believes the uncollectibility of a
loan or lease balance is confirmed.
A loan or lease is impaired when full payment under the loan or lease terms is
not expected. Impairment is evaluated in aggregate for smaller-balance loans of
similar nature such as residential mortgage, consumer and credit card loans, and
on an individual loan basis for other loans. If a loan or lease is impaired, a
portion of the allowance is allocated so that the loan or lease is reported,
net, at the present value of estimated future cash flows using the loan's or
lease's existing rate or at the fair value of collateral if repayment is
expected solely from the collateral. Loans and leases are evaluated for
impairment when payments are delayed, typically 30 days or more, or when serious
deficiencies are identified within the credit relationship.
FINANCIAL CONDITION
During the first six months of 2006, our assets increased from $1,838.2 million
on December 31, 2005, to $1,969.4 million on June 30, 2006. This represents a
total increase in assets of $131.2 million, or 7.1%. The asset growth was
comprised primarily of a $107.7 million increase in net loans, a $10.6 million
increase in cash and cash equivalents and a $7.1 million increase in securities.
The growth in total assets was primarily funded by a $128.6 million increase in
deposits, partially offset by a $7.8 million decrease in securities sold under
agreements to repurchase ("repurchase agreements").
Commercial loans and leases increased by $111.9 million during the first six
months of 2006, and at June 30, 2006 totaled $1,540.2 million, or 92.2% of the
total loan and lease portfolio. The continued significant concentration of the
loan and lease portfolio in commercial loans and leases and the rapid growth of
this portion of our lending business is consistent with our stated strategy of
focusing a substantial amount of efforts on "wholesale" banking. Corporate and
business lending continues to be an area of expertise of our senior management
team, and our commercial lenders have extensive commercial lending experience,
with most having at least 10 years experience. Of each of the loan categories
that we originate, commercial loans and leases are most efficiently originated
and managed; thus limiting overhead costs by necessitating the attention of
fewer full-time employees. Our commercial lending business generates the
greatest amount of local deposits, and is our primary source of demand deposits.
Residential mortgage loans decreased by $5.2 million during the first six months
of 2006, while the balance of our consumer loan portfolio increased by $2.0
million. As of June 30, 2006, residential mortgage and consumer loans totaled a
combined $130.3 million, or 7.8% of the total loan and lease portfolio. Although
we plan to increase our non-commercial loan portfolios in future periods, given
our wholesale banking strategy, we expect the commercial sector of our lending
efforts and resultant assets to remain the dominant loan portfolio category.
23
MERCANTILE BANK CORPORATION
Management believes the quality of our loan and lease portfolio remains strong.
Net loan and lease charge-offs during the first six months of 2006 totaled $1.7
million, or 0.22% of average total loans and leases on an annualized basis.
During the first six months of 2005, net loan and lease charge-offs totaled $0.6
million, or 0.09% of average total loans and leases on an annualized basis.
Nonperforming assets at June 30, 2006 totaled $8.7 million, or 0.44% of
period-ending total assets. Nonperforming assets at June 30, 2005 totaled $3.7
million, or 0.22% of period-ending total assets, while at December 31, 2005,
nonperforming assets totaled $4.0 million, or 0.22% of period-ending total
assets.
We believe we have instilled a strong credit culture within our lending
departments as it pertains to the underwriting and administration processes,
which in part is reflected in our loan and lease net charge-off and delinquency
ratios. Over 98% of the loan portfolio consists of loans extended directly to
companies and individuals doing business and residing within our market area.
The remaining portion is comprised of commercial loans participated with certain
commercial banks outside the immediate area, which we underwrite using the same
loan underwriting criteria as though our bank was the originating bank.
Securities increased $7.1 million during the first six months of 2006. Purchases
during the first six months of 2006 totaled $14.8 million, while proceeds from
maturities, calls and repayments of securities totaled $4.8 million. Our
securities portfolio primarily consists of U.S. Government Agency bonds,
mortgage-backed securities issued or guaranteed by U.S. Government Agencies,
investment-grade tax-exempt municipal securities and Federal Home Loan Bank of
Indianapolis ("FHLBI") stock.
Cash and cash equivalents increased $10.6 million during the first six months of
2006, totaling $47.4 million on June 30, 2006. Cash and due from bank balances
were up $10.9 million, while short-term investments decreased $0.3 million. Our
commercial lending and wholesale funding focus results in relatively large
day-to-day fluctuations of our cash and cash equivalent balances. The average
cash and cash equivalents during the first six months of 2006 equaled $49.4
million.
Premises and equipment at June 30, 2006 equaled $30.8 million, an increase of
$0.6 million over the past six months. Purchases of premises and equipment
during the first six months of 2006 totaled $1.9 million, while depreciation
expense equaled $1.3 million.
Deposits increased $128.6 million during the first six months of 2006, totaling
$1,547.9 million at June 30, 2006. Local deposits increased $88.6 million, while
out-of-area deposits increased $40.0 million. As a percent of total deposits,
local deposits increased from 32.2% on December 31, 2005, to 35.2% on June 30,
2006. Noninterest-bearing demand deposits, comprising 8.4% of total deposits,
increased $8.7 million during the first six months of 2006. Savings deposits
(5.6% of total deposits) decreased $19.2 million, interest-bearing checking
deposits (2.2% of total deposits) decreased $6.1 million and money market
deposit accounts (0.7% of total deposits) increased $0.4 million during the
first six months of 2006. Local certificates of deposit, comprising 18.3% of
total deposits, increased by $104.8 million during the first six months of 2006.
The increase in local certificates of deposit is primarily attributable to
increases in balances from municipalities and transfers of monies by consumer
and commercial customers from savings accounts to certificate of deposit
products, the latter of which reflecting that rates offered on certificates of
deposit have risen at a faster pace than the rates offered on savings accounts.
24
MERCANTILE BANK CORPORATION
Out-of-area deposits increased $40.0 million during the first six months of
2006, totaling $1,002.8 million as of June 30, 2006. Out-of-area deposits
consist primarily of certificates of deposit obtained from depositors located
outside our market area and placed by deposit brokers for a fee, but also
include certificates of deposit obtained from the deposit owners directly.
Out-of-area deposits are utilized to support our asset growth, and are generally
a lower cost source of funds when compared to the deposit interest rates that
would have to be offered in the local market to generate a sufficient level of
funds. During the first six months of 2006, rates paid on new out-of-area
certificates of deposit were similar to the rates paid on new certificates of
deposit issued to local customers. Overhead costs associated with the
out-of-area deposits are considerably less than the overhead costs that would be
incurred to administer a similar level of local deposits. Although local
deposits have and are expected to increase as new business, governmental and
consumer deposit relationships are established, our relatively high reliance on
out-of-area deposits is expected to continue.
Repurchase agreements decreased by $7.8 million during the first six months of
2006, totaling $64.4 million as of June 30, 2006. As part of our sweep account
program, collected funds from certain business noninterest-bearing checking
accounts are invested into over-night interest-bearing repurchase agreements.
Although not considered a deposit account and therefore not afforded federal
deposit insurance, the repurchase agreements have characteristics very similar
to that of our business checking deposit accounts.
Federal funds purchased increased by $1.8 million during the first six months of
2006, totaling $11.4 million as of June 30, 2006. Advances obtained from the
FHLBI totaled $130.0 million as of June 30, 2006, unchanged from December 31,
2005, as $50.0 million in new advances replaced the $50.0 million from maturing
advances during the first six months of 2006. The FHLBI advances are
collateralized by residential mortgage loans, first mortgage liens on
multi-family residential property loans and 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 June 30,
2006 totaled $295.9 million, with availability approximating $154.0 million.
FHLBI advances, along with out-of-area deposits, are the primary components of
our wholesale funding program.
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 meet deposit withdrawals, maintain reserve requirements, fund
loans and support our operations. Liquidity is primarily achieved through the
growth of deposits (both local and out-of-area), advances from the FHLBI and
federal funds purchased, as well as liquid assets such as securities available
for sale, matured securities, and federal funds sold. Asset and liability
management is the process of managing our balance sheet to achieve a mix of
earning assets and liabilities that maximizes profitability, while providing
adequate liquidity.
Our liquidity strategy is to fund asset growth with deposits, repurchase
agreements and FHLBI advances and to maintain an adequate level of short- and
medium-term investments to meet typical daily loan and deposit activity.
Although deposit and repurchase agreement growth from depositors located in our
market area has generally consistently increased, this growth has not been
sufficient to meet our substantial loan growth and provide monies for additional
investing activities. To assist in providing the additional needed funds, we
have regularly obtained monies from wholesale funding sources. Wholesale funds,
comprised of certificates of deposit from customers outside of our market area
and advances from the FHLBI, totaled $1,132.8 million, or 64.6% of combined
deposits and borrowed funds as
25
MERCANTILE BANK CORPORATION
of June 30, 2006. As of December 31, 2005, wholesale funds totaled $1,092.8
million, or 67.0% of combined deposits and borrowed funds. Reliance on wholesale
funds is expected to continue due to our anticipated future asset growth.
As a member of the FHLBI, our bank has access to the FHLBI's borrowing programs.
At June 30, 2006, advances from the FHLBI totaled $130.0 million, unchanged from
the amount outstanding at December 31, 2005. Based on available collateral at
June 30, 2006, our bank could borrow an additional $154.0 million.
Our bank has the ability to borrow money on a daily basis through correspondent
banks via established unsecured federal funds purchased lines, totaling $62.0
million as of June 30, 2006. The average balance of federal funds purchased
during the first six months of 2006 equaled $4.5 million, compared to an $11.6
million average federal funds sold position during the same time period.
In addition to typical loan funding and deposit flow, we must maintain liquidity
to meet the demands of certain unfunded loan commitments and standby letters of
credit. As of June 30, 2006, our bank had a total of $436.2 million in unfunded
loan commitments and $66.6 million in unfunded standby letters of credit. Of the
total unfunded loan commitments, $372.8 million were commitments available as
lines of credit to be drawn at any time as customers' cash needs vary, and $63.4
million were for loan commitments expected to close and become funded within the
next three to six months. We monitor fluctuations in loan balances and
commitment levels, and include such data in managing our overall liquidity.
CAPITAL RESOURCES
Shareholders' equity is a noninterest-bearing source of funds that provides
support for asset growth. Shareholders' equity increased by $6.6 million during
the first six months of 2006, from $155.1 million on December 31, 2005, to
$161.7 million at June 30, 2006. The increase is primarily attributable to net
income of $10.0 million recorded during the first six months of 2006.
Shareholders' equity was negatively impacted during the first six months of 2006
by the payment of cash dividends totaling $2.0 million and a $1.9 million
mark-to-market adjustment for available for sale securities as defined in SFAS
No. 115. Shareholders' equity also increased $0.2 million from the issuance of
new shares of common stock resulting from our dividend reinvestment plan,
employee stock purchase plan and stock option exercises.
We are subject to regulatory capital requirements primarily administered by
federal bank regulatory agencies. Failure to meet the various capital
requirements can initiate regulatory action that could have a direct material
effect on the financial statements. The capital ratios of the company and our
bank as of June 30, 2006 and December 31, 2005 are disclosed under Note 9 of the
Notes to Consolidated Financial Statements.
Our and our bank's ability to pay cash and stock dividends is subject to
limitations under various laws and regulations and to prudent and sound banking
practices. We declared a 5% stock dividend on April 11, 2006, that was
distributed on May 16, 2006 to record holders as of April 24, 2006. All earnings
per share and dividend per share information have been adjusted for the 5% stock
dividend. We paid a $0.12 per share cash dividend on March 10, 2006 and a $0.13
per share cash dividend on June 9, 2006. On July 11, 2006, we declared a $0.13
per share cash dividend payable on September 8, 2006 to record holders as of
August 10, 2006.
26
MERCANTILE BANK CORPORATION
RESULTS OF OPERATIONS
Net income for the second quarter of 2006 was $5.1 million ($0.64 per basic
share and $0.63 per diluted share), which represents a 9.0% increase over net
income of $4.7 million ($0.59 per basic share and $0.58 per diluted share)
recorded during the second quarter of 2005. Net income for the first six months
of 2006 was $10.0 million ($1.26 per basic share and $1.24 per diluted share),
which represents a 10.9% increase over net income of $9.1 million ($1.14 per
basic share and $1.12 per diluted share) recorded during the first six months of
2005. The improvement in net income during both time periods is primarily the
result of higher net interest income and improved operating efficiency, which
more than offset a higher provision expense.
Interest income during the second quarter of 2006 was $33.7 million, an increase
of 38.6% over the $24.3 million earned during the second quarter of 2005.
Interest income during the first six months of 2006 was $64.8 million, an
increase of 40.8% over the $46.1 million earned during the first six months of
2005. The growth in interest income during both time periods is primarily
attributable to growth in earning assets and an increasing interest rate
environment. During the second quarter of 2006, earning assets averaged $1,841.7
million, $259.2 million higher than average earning assets of $1,582.5 million
during the second quarter of 2005. Average loans were up $240.6 million and
securities increased $15.5 million. During the first six months of 2006, earning
assets averaged $1,810.4 million, $263.0 million higher than average earning
assets of $1,547.4 million during the same time period in 2005. Average loans
were up $238.4 million and securities increased $20.7 million. Also positively
impacting the growth in interest income was the increased yield on earning
assets. During the second quarter of 2006 and 2005, earning assets had a
weighted average yield (tax equivalent-adjusted basis) of 7.42% and 6.24%,
respectively. During the first six months of 2006 and 2005, earning assets had a
weighted average yield of 7.29% and 6.07%, respectively. With approximately 65%
of our total loans and leases tied to the prime rate, our asset yield has
benefited from recent increases in the prime rate. Between June 30, 2004 and
June 30, 2006, the Federal Open Market Committee has raised the target federal
funds rate by a total of 425 basis points, with the prime rate increasing by the
same magnitude.
Interest expense during the second quarter of 2006 was $18.1 million, an
increase of 68.6% over the $10.7 million expensed during the second quarter of
2005. Interest expense during the first six months of 2006 was $34.1 million, an
increase of 72.3% over the $19.8 million expensed during the first six months of
2005. The increase in interest expense is primarily attributable to an increase
in interest-bearing liabilities necessitated by asset growth and a higher
interest rate environment. During the second quarter of 2006, interest-bearing
liabilities averaged $1,644.8 million, $246.4 million higher than average
interest-bearing liabilities of $1,398.4 million during the second quarter of
2005. Interest-bearing deposits were up $234.5 million and short-term borrowings
increased $13.1 million. During the first six months of 2006, interest-bearing
liabilities averaged $1,616.7 million, $249.4 million higher than average
interest-bearing liabilities of $1,367.3 million during the same time period in
2005. Interest-bearing deposits were up $236.0 million and short-term borrowings
increased $9.7 million. During the second quarter of 2006 and 2005,
interest-bearing liabilities had a weighted average rate of 4.41% and 3.08%,
respectively. During the first six months of 2006 and 2005, interest-bearing
liabilities had a weighted average rate of 4.25% and 2.92%, respectively. The
higher weighted average cost of interest-bearing liabilities is primarily due to
the increase in market interest rates.
27
MERCANTILE BANK CORPORATION
Net interest income during the second quarter of 2006 was $15.6 million, an
increase of 15.0% over the $13.6 million earned during the second quarter of
2005. Net interest income during the first six months of 2006 was $30.7 million,
an increase of 17.1% over the $26.3 million earned during the same time period
in 2005. The increase in net interest income is primarily due to the growth in
earning assets, supported by a relatively stable net interest margin. The net
interest margin during the second quarter of 2006 was 3.47%, compared to 3.52%
during the second quarter of 2005. During the first six months of 2006, the net
interest margin was 3.49%, unchanged from the level during the same time period
in 2005.
The following table sets forth certain information relating to our consolidated
average interest-earning assets and interest-bearing liabilities and reflects
the average yield on assets and average cost of liabilities for the second
quarter of 2006 and 2005. Such yields and costs are derived by dividing income
or expense by the average daily balance of assets or liabilities, respectively,
for the period presented. Tax-exempt securities interest income and yield have
been computed on a tax equivalent basis using a marginal tax rate of 35%.
Securities interest income was increased by $301,000 and $273,000 in the second
quarter of 2006 and 2005, respectively, for this adjustment.
Quarters ended June 30,
-----------------------------------------------------------------
2006 2005
------------------------------- -------------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- -------
(dollars in thousands)
ASSETS
Loans and leases $1,643,022 $31,304 7.64% $1,402,469 $22,250 6.36%
Securities 187,102 2,600 5.56 171,620 2,309 5.38
Federal funds sold 11,230 139 4.96 7,853 56 2.82
Short term investments 312 4 4.80 511 4 2.81
---------- ------- ---------- -------
Total interest-earning assets 1,841,666 34,047 7.42 1,582,453 24,619 6.24
Allowance for loan losses (21,457) (18,620)
Other assets 119,204 105,370
---------- ----------
Total assets $1,939,413 $1,669,203
========== ==========
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing deposits $1,403,912 $15,358 4.39% $1,169,350 $ 8,892 3.05%
Short-term borrowings 75,894 720 3.81 62,802 375 2.40
FHLB advances 129,121 1,369 4.25 131,264 1,006 3.03
Long-term borrowings 35,830 653 7.31 34,965 465 5.26
---------- ------- ---------- -------
Total interest-bearing
liabilities 1,644,757 18,100 4.41 1,398,381 10,738 3.08
Noninterest-bearing
deposits 117,125 112,302
Other liabilities 17,492 11,523
Shareholders' equity 160,039 146,997
---------- ----------
Total liabilities and
shareholders' equity $1,939,413 $1,669,203
========== ------- ========== -------
Net interest income $15,947 $13,881
======= =======
Net interest rate spread 3.01% 3.16%
==== ====
28
MERCANTILE BANK CORPORATION
Net interest rate spread
on average assets 3.30% 3.34%
==== ====
Net interest margin on
earning assets 3.47% 3.52%
==== ====
Provisions to the allowance during the second quarter of 2006 were $1.5 million,
an increase of 66.7% over the $0.9 million that was expensed during the second
quarter of 2005. Provisions to the allowance during the first six months of 2006
were $2.7 million, an increase of 67.7% over the $1.6 million that was expensed
during the same time period in 2005. The increase during both time periods
primarily reflects the higher volume of net loan and lease charge-offs. Net loan
and lease charge-offs of $1.0 million were recorded during the second quarter of
2006, compared to net loan and lease charge-offs of $0.1 million during the
second quarter of 2005. During the first six months of 2006, net loan and lease
charge-offs totaled $1.7 million, compared to net loan and lease charge-offs of
$0.6 million during the same time period in 2005. The allowance, as a percentage
of total loans and leases outstanding, was 1.29% as of June 30, 2006, compared
to 1.32% at June 30, 2005.
In each accounting period, the allowance is adjusted to the amount believed
necessary to maintain the allowance at adequate levels. Through the loan review
and credit departments, we attempt to allocate specific portions of the
allowance based on specifically identifiable problem loans and leases. The
evaluation of the allowance is further based on, although not limited to,
consideration of the internally prepared Allowance Analysis, composition of the
loan and lease portfolio, third party analysis of the loan administration
processes and loan portfolio and general economic conditions. In addition, the
rapid growth of the loan and lease portfolio is taken into account.
The Allowance Analysis, used since the inception of our bank and completed
monthly, applies reserve allocation factors to outstanding loan and lease
balances to calculate an overall allowance dollar amount. For commercial loans
and leases, which continue to comprise a vast majority of our loan and lease
portfolio, reserve allocation factors are based upon the loan ratings as
determined by our loan rating paradigm that is administered by our loan review
function. For retail loans, reserve allocation factors are based upon the type
of credit. Adjustments for specific loan relationships, including impaired
loans, are made on a case-by-case basis. The reserve allocation factors are
based on the experience of senior management making similar loans in the same
community over almost 20 years. The Allowance Analysis is reviewed regularly by
senior management and the Board of Directors and is adjusted periodically based
upon identifiable trends and experience.
Noninterest income during the second quarter of 2006 was $1.28 million, an
increase of 4.7% over the $1.22 million earned during the second quarter of
2005. Noninterest income during the first six months of 2006 was $2.52 million,
an increase of 3.7% over the $2.43 million earned during the same time period in
2005. Service charge income on deposits and repurchase agreements decreased
$12,000 (3.5%) during the second quarter of 2006 when compared to the second
quarter of 2005, and declined $34,000 (5.0%) during the first six months of 2006
when compared to the same time period during 2005, primarily reflecting an
increase in the earnings credit rate on noninterest-bearing checking accounts
which was only partially offset by an increase in new accounts opened during the
last twelve months. During both time periods, we recorded increased fee income
in virtually all other major fee income categories.
29
MERCANTILE BANK CORPORATION
Noninterest expense during the second quarter of 2006 was $8.0 million, an
increase of 12.4% over the $7.1 million expensed during the second quarter of
2005. Noninterest expense during the first six months of 2006 was $16.0 million,
an increase of 14.6% over the $14.0 million expensed during the same time period
in 2005. Employee salary and benefit expenses were $0.3 million higher during
the second quarter of 2006 than the level expensed during the second quarter of
2005, and were $0.9 million higher during the first six months of 2006 than the
level expensed during the first six months of 2005. The increases during both
time periods primarily resulted from the hiring of additional staff and merit
annual pay increases, partially offset by lower non-lender bonus program
expenses. The level of full-time equivalent employees increased from 237 at June
30, 2005 to 277 as of June 30, 2006. During the second quarter of 2005 and the
first six months of 2005, we expensed $0.6 million and $1.2 million,
respectively, for the non-lender bonus program. During the second quarter of
2006 and the first six months of 2006, no expense was recorded for the
non-lender bonus program, primarily reflecting management's assessment of the
likelihood of achieving a 15% growth in net income for all of 2006. Occupancy
and furniture and equipment costs increased $0.4 million during the second
quarter of 2006 over the level expensed during the second quarter of 2005, and
increased $0.9 million during the first six months of 2006 over the level
expensed during the first six months of 2005, primarily reflecting the opening
of our new main office during the second quarter of 2005 and the opening of our
new leased facilities in Lansing and Ann Arbor during the third quarter of 2005.
Other overhead costs increased $0.2 million during the second quarter of 2006
over the level expensed during the second quarter of 2005, and increased $0.3
million during the first six months of 2006 over the level expensed during the
first six months of 2005, primarily reflecting additional expenditures required
to administer the increased asset base.
Monitoring and controlling noninterest costs, while at the same time providing
high quality service to customers, is a key component to our business strategy.
While the dollar volume of noninterest costs has increased, the rate of growth
has been lower than the rate of increase in net interest income and noninterest
income. Noninterest expenses increased by $0.9 million during the second quarter
of 2006 over the amount expensed during the second quarter of 2005, and
increased by $2.0 million during the first six months of 2006 over the amount
expensed during the first six months of 2005. However, net revenues (net
interest income plus noninterest income) increased at a substantially higher
level of $2.1 million and $4.6 million during the same time periods,
respectively.
Federal income tax expense was $2.3 million during the second quarter of 2006,
an increase of 9.0% over the $2.1 million expensed during the second quarter of
2005. Federal income tax expense was $4.5 million during the first six months of
2006, an increase of 11.0% over the $4.0 million expensed during the first six
months of 2005. The increases during both time periods primarily results from
the increase in net income before federal income tax. Our effective tax rate was
approximately 30.8% during the second quarter of 2006 and 2005, as well as
during the first six months of 2006 and 2005.
30
MERCANTILE BANK CORPORATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risk exposure is interest rate risk and, to a lesser extent,
liquidity 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. We derive our income primarily from the excess of interest collected on
our interest-earning assets over the interest paid on our 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 our net interest margin during periods of changing market
interest rates. The following table depicts our GAP position as of June 30, 2006
(dollars in thousands):
31
MERCANTILE BANK CORPORATION
Within Three to One to After
Three Twelve Five Five
Months Months Years Years Total
-------- --------- -------- --------- ----------
Assets:
Commercial loans and leases (1) $838,371 $ 57,265 $594,775 $ 49,757 $1,540,168
Residential real estate loans 54,687 2,672 52,139 13,446 122,944
Consumer loans 1,291 562 4,935 571 7,359
Investment securities (2) 8,888 2,143 33,306 144,332 188,669
Short-term investments 271 0 0 0 271
Allowance for loan and leases losses 0 0 0 (21,507) (21,507)
Other assets 0 0 0 131,525 131,525
-------- --------- -------- --------- ----------
Total assets 903,508 62,642 685,155 318,124 1,969,429
Liabilities:
Interest-bearing checking 33,643 0 0 0 33,643
Savings 87,048 0 0 0 87,048
Money market accounts 10,762 0 0 0 10,762
Time deposits < $100,000 27,288 43,655 34,501 0 105,444
Time deposits $100,000 and over 315,038 522,257 344,237 0 1,181,532
Short-term borrowings 75,831 0 0 0 75,831
FHLB advances 30,000 75,000 25,000 0 130,000
Long-term borrowings 35,947 0 0 0 35,947
Noninterest-bearing checking 0 0 0 129,483 129,483
Other liabilities 0 0 0 18,079 18,079
-------- --------- -------- --------- ----------
Total liabilities 615,557 640,912 403,738 147,562 1,807,769
Shareholders' equity 0 0 0 161,660 161,660
-------- --------- -------- --------- ----------
Total sources of funds 615,557 640,912 403,738 309,222 1,969,429
-------- --------- -------- --------- ----------
Net asset (liability) GAP $287,951 $(578,270) $281,417 $ 8,902
======== ========= ======== =========
Cumulative GAP $287,951 $(290,319) $ (8,902)
======== ========= ========
Percent of cumulative GAP to
total assets 14.6% (14.8)% (0.5)%
======== ========= ========
(1) Floating rate loans that are currently at interest rate ceilings are
treated as fixed rate loans and are reflected using maturity date and not
next repricing date.
(2) Mortgage-backed securities are categorized by expected final maturities
based upon prepayment trends as of June 30, 2006
The second interest rate risk measurement we use 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, 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
32
MERCANTILE BANK CORPORATION
assets and liabilities; and changes in market conditions impacting loan and
deposit volume and pricing. These assumptions are inherently uncertain, 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 the timing, magnitude, and frequency of
interest rate changes and changes in market conditions and the company's
strategies, among other factors.
We conducted multiple simulations as of June 30, 2006, whereby it was assumed
that changes in market interest rates occurred ranging from up 200 basis points
to down 200 basis points in equal quarterly instalments over the next twelve
months. The following table reflects the suggested impact on our net interest
income over the next twelve months, which are well within our policy parameters
established to manage and monitor interest rate risk.
Dollar Change In Percent Change In
Interest Rate Scenario Net Interest Income Net Interest Income
---------------------- ------------------- -------------------
Interest rates down 200 basis points $(5,969,000) (9.4)%
Interest rates down 100 basis points (4,837,000) (7.6)
No change in interest rates (3,675,000) (5.8)
Interest rates up 100 basis points (1,725,000) (2.7)
Interest rates up 200 basis points 215,000 0.3
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; economic and competitive conditions; potential
changes in lending, investing and deposit gathering strategies; client
preferences; and other factors.
ITEM 4. CONTROLS AND PROCEDURES
As of June 30, 2006, 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 June
30, 2006. There have been no significant changes in our internal controls over
financial reporting during the quarter ended June 30, 2006 that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
33
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in various legal proceedings that are
incidental to our business. In our opinion, we are not a party to any current
legal proceedings that are material to our financial condition, either
individually or in the aggregate.
ITEM 1A. RISK FACTORS
There have been no material changes in our risk factors from those previously
disclosed in our annual report on Form 10-K for the year ended December 31,
2005.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On April 18, 2006, we issued 19,227 shares of our common stock to one of our
employees upon his exercise of employee stock options issued under our 1997
Employee Stock Option Plan. We received a weighted average exercise price of
$9.184 per share aggregating $176,580 for these shares. The exercise price for
these shares was substantially paid by the employee delivering to us common
stock of the company that he already owned having an aggregate value of
$176,558, with the difference paid in cash. Also on April 18, 2006, we issued
2,888 shares of our common stock to one of our employees upon his exercise of
employee stock options issued under our 1997 Employee Stock Option Plan. We
received a weighted average exercise price of $8.769 per share aggregating
$25,325 for these shares. The exercise price for these shares was substantially
paid by the employee delivering to us common stock of the company that he
already owned having an aggregate value of $25,318, with the difference paid in
cash. On May 24, 2006, we issued 8,963 shares of our common stock to one of our
employees upon his exercise of employee stock options issued under our 1997
Employee Stock Option Plan. We received a weighted average exercise price of
$9.724 per share aggregating $87,153 for these shares. The exercise price for
these shares was substantially paid by the employee delivering to us common
stock of the company that he already owned having an aggregate value of $87,093,
with the difference paid in cash. The shares issued under the 1997 Employee
Stock Option Plan were issued in reliance on an exemption from registration
under the Securities Act of 1933 based on Section 4(2) of that Act, and
Regulation D issued under that Act.
Issuer Purchases of Equity Securities
(d) Maximum
(c) Total Number of Number of Shares
(b) Average Shares Purchased as Part that May Yet Be
(a) Total Number of Price Paid Per of Publicly Announced Purchased Under the
Period Shares Purchased Share Plans or Programs Plans or Programs
------ ------------------- -------------- ------------------------ -------------------
April 1 - 30 8,500 $39.61 0 0
May 1 - 31 3,244 39.59 0 0
June 1 - 30 0 N/A 0 0
------ ------ --- ---
Total 11,744 39.60 0 0
====== ====== === ===
The shares shown in column (a) above as having been purchased were acquired from
five of our employees when they used shares of common stock that they already
owned to pay part of the exercise price when exercising stock options issued
under our employee stock option plans.
34
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At our Annual Meeting held on April 27, 2006, our shareholders voted to elect
five directors, Doyle A. Hayes, Susan K. Jones, Lawrence W. Larsen, Michael H.
Price and Dale J. Visser, each for a three year term expiring at the Annual
Meeting of the shareholders of the company in 2009. The results of the election
were as follows:
Votes Votes Votes Broker
Nominee For Against Withheld Non-Votes
------- --------- ------- -------- ---------
Doyle A. Hayes 6,754,553 0 260,758 0
Susan K. Jones 6,742,089 0 273,278 0
Lawrence W. Larsen 6,733,285 0 282,083 0
Michael H. Price 6,716,922 0 298,400 0
Dale J. Visser 6,521,371 0 493,997 0
The terms of office of the following directors (who were not up for election)
continued after the Annual Meeting: Betty S. Burton, David M. Cassard, Edward J.
Clark, Peter A. Cordes, C. John Gill, David M. Hecht, Gerald R. Johnson, Jr.,
Calvin D. Murdock, Merle J. Prins and Donald Williams, Sr.
Also at our Annual Meeting held on April 27, 2006, our shareholders voted to
approve the Stock Incentive Plan of 2006. The results of the voting were as
follows:
Votes Votes Votes Broker
For Against Abstained Non-Votes
--------- ------- --------- ---------
4,053,059 583,640 26,658 2,353,501
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
3.1 Our Articles of Incorporation are incorporated by reference to
Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2004
3.2 Our Amended and Restated Bylaws dated as of January 16, 2003 are
incorporated by reference to Exhibit 3.2 of our Registration
Statement on Form S-3 (Commission File No. 333-103376) that became
effective on February 21, 2003
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 8, 2006.
MERCANTILE BANK CORPORATION
By: /s/ Gerald R. Johnson, Jr.
------------------------------------
Gerald R. Johnson, Jr.
Chairman of the Board and Chief
Executive Officer
(Principal Executive Officer)
By: /s/ Charles E. Christmas
------------------------------------
Charles E. Christmas
Senior Vice President, Chief
Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
36
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------
3.1 Our Articles of Incorporation are incorporated by reference to
Exhibit 3.1 of our Form 10-Q for the quarter ended June 30, 2004
3.2 Our Amended and Restated Bylaws dated as of January 16, 2003 are
incorporated by reference to Exhibit 3.2 of our Registration
Statement on Form S-3 (Commission File No. 333-103376) that became
effective on February 21, 2003
31 Rule 13a-14(a) Certifications
32.1 Section 1350 Chief Executive Officer Certification
32.2 Section 1350 Chief Financial Officer Certification