True Stories.
M E R C A N T I L E B A N K C O R P O R AT I O N 2 0 0 6 A N N U A L R E P O R T
Name Recognition
L e t t e r t o S h a r e h o l d e r s
“As soon as any customer walks
through that door, they’re greeted
by name,” declares Jackie Jones,
pointing to the entrance of
Mercantile Bank - Kentwood.
Jackie Jones
Customer Specialist
Kentwood
We all have a story to tell.
At Mercantile Bank, our stories revolve around
our customers and the communities we serve:
The new mother whose day we brightened with
a simple courtesy. The business owner whose
future we changed with a word of advice.
The children whose lives we enriched with
an investment of time and attention.
These are the tales we tell each other over
coffee breaks and lunches, while sharing a ride
to work or pitching in on a charity project.
Individually, these stories reflect the character of
the people who work at Mercantile. Collectively,
they illustrate the service commitment that has
It’s a welcome touch at a time
always set Mercantile apart.
when service elsewhere has
become increasingly impersonal and
We thought we’d share just a few of the
indifferent. “People really appreciate
past year’s stories with you in this report to
it when we immediately set aside
our paperwork and say hello. It
makes them feel special. And the
our shareholders.
We know you’ll be gratified that each story
personal connection we make with
concludes with the same happy ending:
customers makes us want to work
even harder for them.”
2006 was another excellent year for the
Corporation and its shareholders.
2
Reaching $2 Billion In Assets
In September, 2006, Mercantile Bank reached another notable
milestone, as we surpassed $2 billion in assets. This was
accomplished in little more than three years after passing the
$1 billion mark – another extraordinary achievement.
Less than a decade ago, the founders of Mercantile Bank were
sitting around a kitchen table, strategizing ways to position our
soon-to-debut enterprise against the larger banks that dominated the
West Michigan landscape. Today, we are one of those “larger” banks.
In fact, as of June 30, 2006, we ranked 292nd in assets out
of more than 7,700 banks nationwide. That puts us in the top
4% of all banks across the country.
Closer to home, we ranked as the 9th largest Michigan-based
bank in the state. This was also as of June 30, 2006, in a universe of
173 state-based financial institutions.
Our market status is even more impressive locally. We are now
number two in market share in the Grand Rapids Metropolitan
Statistical Area. We’ve attained this significant market position in
less than 10 years, with just 8 locations – 6 in West Michigan.
Back to School
Mercantile Bank - Lansing has
partnered with an inner-city school,
Moores Park Elementary, to help
teach kids the importance of saving
and budgeting. The entire Mercantile
staff worked to set up the bank and
Cassy Puskala
Assistant Branch Manager
Lansing
This significant growth is a direct result of the decisions made
around that kitchen table in 1997. We determined that we would
train student “employees.” Students
open accounts and save money to
focus on business banking, limit brick-and-mortar expenses, and
make purchases at an end-of-the-
deliver an unprecedented level of customer service and community
year book fair. Mercantile matches
support. All of these, we felt, would maximize our growth potential
the first $5.00 each student saves.
and deliver superior returns to our shareholders.
Obviously, we’ve been proven right. Now, as we enter our
10th year of operation, we are renewing the commitments we
made at the beginning of our journey – most especially, our pledge
to provide the very best service possible.
“The teachers love it,” says
Cassy Puskala. “They’re using it
to help teach counting and math
to the kids, who range from
kindergartners to third graders.”
3
I Can Do That
“Customers don’t expect me to
have much authority in my position,”
says Cesar Gonzales. “But at
Mercantile, we’re all empowered
to make decisions on the spot.”
Cesar Gonzales
Mortgage Operations Assistant
Grand Rapids
Growing Big, Acting Small
We’ve all seen it: the business with an uncanny ability to satisfy
customers grows larger and larger – and, in the process, seems to
lose touch with its customers and their needs.
This unfortunate scenario has become so prevalent in
American business that our own customers and shareholders have
joined financial analysts and journalists in raising it as a concern.
How, they ask, will Mercantile retain its service culture as it grows
larger and more geographically diverse?
The answer lies in the stories of the Mercantile associates
featured in these pages, and in many other stories we could print if
we had the space. Yes, Mercantile is quickly becoming a “big” bank.
But we still think and act as if we were an entrepreneurial upstart,
striving to win the attention and loyalty of every single customer.
We empower our front-line associates to make the kinds of
decisions other banks reserve only for supervisors. We support our
lenders in exploring every possible avenue to make a deal work.
We encourage each other to volunteer time and talents to improve
So when a customer called to
the quality of life in the communities we serve. All of us work
say she missed a deposit because
long and hard to continually surprise and delight customers and
she was in the hospital giving birth,
potential customers alike.
Cesar immediately waived the
overdraft fee on a check. “Then she
wanted to wait while I got approval
from a manager,” Cesar grins.
“It took me awhile to convince
her I could do it myself!”
We’re able to maintain this entrepreneurial zeal because of
the measured and deliberate nature of our expansion. While other
banks seek to accelerate growth by building an extensive branch
network, we’ve chosen to minimize our physical infrastructure
and build greater efficiencies into our rather non-traditional
banking model.
4
Business Before Pleasure
That means we’re not constantly hiring the first people
Sandy Ross and several of her
that come along to fill position after position at one branch office
Mercantile Bank - Washtenaw colleagues
after another. Instead, we have the luxury of taking our time to
didn’t attend the bank’s holiday party last
find the best of the best – talents who have already proven
themselves elsewhere or who shine with uncommon intelligence,
insight and ambition.
This is just one more vindication of our original vision
for Mercantile … and one more reason Mercantile will be able to
continue “acting small” no matter how large we grow.
New Challenges Emerge
The kind of growth we’ve achieved does not go unnoticed.
One very positive consequence is the attention of a broadening
range of shareholders. One not-so-positive (but entirely expected)
consequence is greater attention from our competitors.
Competitive pressures were one of our main challenges in
2006. Local and regional banks continued to bid aggressively on
existing and potential new Mercantile credit relationships – both
with regard to pricing and deal structure.
year. Instead, they volunteered
at the 2006 Saline Holiday Parade,
held the very same night.
Sandy Ross
Branch Manager
Washtenaw
Despite this, we remained committed to our traditional
“Customers and community always
high standards of loan underwriting. We believe the impact of
come first for us,” says Sandy, who
compromising our own proven pricing and underwriting standards
recently served as chair of the parade
could be detrimental to our ability to sustain our historically high
organizer, the Saline Area Chamber
levels of performance over the long term.
We will always do everything we can to close a deal, but we
will also walk away from any transactions we feel do not provide an
adequate return for the risk involved or are structured in such a way
that, in our opinion, the exposure to potential loss is unacceptable.
of Commerce. “We missed celebrating
with our friends at the bank, but we
really feel we helped improve the
quality of life for people here.”
5
Burning the Midnight Oil
Mercantile offers the technology of
The other key challenge we faced in 2006 was not unique
a much larger bank – including a
sophisticated payroll processing
system. But all the technology in
the world can’t force customers
Mike Kroft
eBanking Services Manager
Grand Rapids
to get their payroll file to us on time
every week.
“We don’t say, well, you’re out
of luck because you missed our
deadline,” Mike Kroft relates.
“We work to make it happen, even
if it means staying late or getting
in early. We’ll manually create files
to Mercantile. The entire banking industry has been, and is,
contending with interest rate uncertainty and a somewhat unusual
“inversion” of the normal relationship between short- and
long-term interest rates. Under this interest rate scenario, short-term
rates have been higher than long-term rates. This makes it much
more difficult for most banks to maintain their margins – that is,
the difference in interest earned on loans and investments and
interest paid on deposits and other indebtedness.
Even with increasing competitive pressures and interest
rate challenges, even though we are operating in an economy that
generally lags behind the rest of the nation, we are pleased to
report that our strategy remains a winning one:
Mercantile Bank once again grew earnings and assets
at double-digit rates in 2006.
Financials at a Glance
Mercantile Bank achieved net income of $19.8 million in fiscal year
2006. This is an increase of 10.9% from the $17.9 million reported
EARNINGS PER SHARE GROWTH SINCE 2002
6,371
6,853
8,108
8,137
8,112
$2.45
$2.20
$1.69
$1.46
if need be. Our customers aren’t
$1.22
going to miss their payroll – not if
we can help it!”
6
2002
2003
2004
2005
2006
Fully Diluted EPS Presented in Accordance with GAAP
Average Shares Outstanding (000)
Out of the Office
for 2005. Diluted earnings per share were $2.45, an increase of
Keane Blaszczynski and his fellow
11.4% from the $2.20 reported for the prior year.
Earnings benefited from solid loan growth, most notably in
our “new” markets of Ann Arbor, Holland and Lansing. These
markets were responsible for 50% of our net new loan growth for
the year and 41% of our net new local deposit growth. They have
proven to be strong complements to our Kent County franchise.
ANNUAL ASSET ENDING BALANCES SINCE 2002 (000)
Mercantile lenders spend a lot of
time out of the office. No, they’re
not on the golf course: “We’re
constantly doing customer tours,”
he says, “checking in to see how
$2,200,000
$2,000,000
$1,800,000
$1,600,000
$1,400,000
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
2
0
/
1
3
/
2
1
3
0
/
1
3
/
2
1
4
0
/
1
3
/
2
1
5
0
/
1
3
/
2
1
6
0
/
1
3
/
2
1
Total revenue, comprised of net interest income and
non-interest income, was $66.8 million for 2006, an increase of
9.7% over the $61.0 million reported in the previous year. Net
Keane Blaszczynski
Vice President, Commercial Lender
Grand Rapids
interest income increased 11.4% year over year to $61.6 million,
they’re doing and how else we
reflecting average earning asset growth of 15.3%. This was partially
can help.”
offset by a 13 basis point decline in net interest margin to 3.37%.
Non-interest income for the year was $5.3 million,
compared with $5.7 million for 2005. However, approximately
$0.7 million of the 2005 fee income represented a one-time gain on
the fourth-quarter 2005 sale of state tax credits derived from the
construction of our new headquarters building. Subtracting this
gain from the equation results in a year-to-year gain in fee income.
Customers are surprised and
gratified by the continued interest.
“They’ve worked with other banks
that just sit back and collect loan
payments.They appreciate that we
really care about their success.”
7
Now We’re Cookin’
Kitty Arbanas is a member of
We continue to leverage our investment in infrastructure,
“Team Gordon,” the seven-person
support staff for Commercial Lender
Gordon Oosting. “We’re all
cross-trained so we can pinch-hit
Kitty Arbanas
Loan Administration Team Leader/Officer
Grand Rapids
supporting additional loan growth while maintaining operating
expense at a relatively stable level throughout the year.
For 2006, our efficiency ratio (the cost of generating $1.00
of net revenue – so lower is better) averaged 48.3%, compared to
51.1% in 2005. This ratio was below 50% for each of the four
quarters of 2006. Non-interest expense was $32.3 million for 2006,
a modest increase of 3.7% over fiscal year 2005; this compares with
a year-over-year asset growth of 12.5%. Salaries and benefits, the
largest component of non-interest expense, was $19.0 million, an
increase of 1.9% over the prior year.
While asset quality remained relatively stable throughout the
year, net loan charge-offs for 2006 were $4.9 million, equivalent to
0.29% of average loans. This compares to $1.1 million or 0.08% of
average loans for the prior year. Non-performing assets were $9.6
million, or 0.46% of total assets at December 31, 2006, compared
with $4.0 million, or 0.22% of total assets, at December 31, 2005.
These figures are historically high for Mercantile, but they
still compare favorably with what is happening both nationally and
for each other – we never have
within our Michigan peer group. FDIC statistics for all insured
to tell a customer to call back
banks reflect non-performing assets of 0.49% of total assets
tomorrow because so-and-so’s
(as of September 30, 2006). A peer group of 40 publicly traded
out of the office.”
The team’s well-oiled interaction
came in handy when they worked
together to prepare a meal for
50 people at Gilda’s Club, a support
community for people with cancer.
“We made 104 meatballs – and they
were gone in 10 minutes!”
8
Michigan banks had non-performing assets of 0.66% of total
assets (again, as of September 30, 2006).
We’ve made a return to our customary high levels of asset
quality a top corporate priority for the coming year.
Total assets grew $229.1 million, or 12.5%, over the past
12 months, reaching $2.07 billion at December 31, 2006. Earning
Stress Relief
asset growth was $204.2 million, or 11.7%, during this period.
“I see 25-35 customers a day,”
Loans increased by $183.7 million, or 11.8%. Again, these results
says Gene Naylor, “and I get to
compare extremely well to our peer group.
As a result of our excellent financial performance, Mercantile
Bank Corporation paid an annual cash dividend of $0.51 per share
on the company’s common stock during 2006, compared to the
$0.43 per share paid in 2005. This represents a year-over-year
dividend increase of $0.08 per share, or 18.6%.
A New Chapter Begins
Although 2006 was an extremely challenging year, we
affirmed our ability to provide superior results in a difficult
operating environment.
We dealt very efficiently and effectively with the numerous
challenges we faced, and we positioned the bank for another
competitive year in 2007.
Highlights of the coming year will include the completion
of construction on our new Lansing office. Our associates and
customers are looking forward to the move from our current
space to this larger, more user-friendly building. The office is
slated for a spring grand opening.
We are also currently in the process of introducing our
next-generation Internet banking platform. Cutting-edge
technology is an essential part of our business plan, as it makes
banking convenient to all, and lessens the need for new
branch offices. Our new Internet product adds features and
functionalities that will enable us to grow this avenue of
know them in their natural settings.
So I can tell when something’s
bothering them. I try to give them
a lift – thanking them for their
Gene Naylor
Courier, Special Services Department
Grand Rapids
business, asking if there’s anything
else we can do for them … I’ve
even helped solve some debit/credit
issues on the spot.”
Easing the stress of customers
has done wonders for Gene, too:
“My stress test is better now than
when I was ‘retired’ – before I
banking for Mercantile customers.
started this job!”
9
Attitude is Everything
Kyle Erickson thought he’d seen
it all after 15 years in the banking
industry. “But until I joined
Mercantile, I’d never seen
Kyle Erickson
Vice President, Commercial Lender
Holland
an entire organization, from front
line to back room, so totally focused
on taking care of customers.”
It’s not just a can-do kind of
place – it’s will do and gladly so.
“I tell my customers, if you’re
L-R: Chuck Christmas, Jerry Johnson,
Mike Price, Bob Kaminski
We want to thank all of our Mercantile associates, as well as
the members of our Board of Directors, for their efforts in 2006.
Each of them has made a singular contribution to our success.
Of course, we couldn’t have done it without the support of
having a bad day, just stop into one
our shareholders. We thank you, and invite you to join us as we write
of our branches. The positive
attitude is so infectious, you’ll
leave smiling – I guarantee it.”
the next chapter in the story of Mercantile Bank.
Gerald R. Johnson, Jr.
Chairman
Chief Executive Officer
Michael H. Price
President
Chief Operating Officer
Robert B. Kaminski, Jr.
Executive Vice President
Secretary
Charles E. Christmas
Senior Vice President
Chief Financial Officer
and Treasurer
10
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________ to ____________________________
For the fiscal year ended December 31, 2006
or
Commission file number 000-26719
MERCANTILE BANK CORPORATION
(Exact name of registrant as specified in its charter)
Michigan
(State or other jurisdiction of incorporation or organization)
38-3360865
(I.R.S. Employer Identification No.)
310 Leonard Street NW, Grand Rapids, Michigan
(Address of principal executive offices)
49504
(Zip Code)
(616) 406-3000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock
Name of each exchange on which registered
The Nasdaq Stock Market LLC
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 No X
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 No X
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
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 Act). Yes
No X
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 average of the closing bid and asked prices of the common
stock as of the last business day of the registrant’s most recently completed second fiscal quarter, was approximately
$290.6 million.
As of February 12, 2007, there were issued and outstanding 8,027,853 shares of the registrant’s common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the 2007 annual meeting of shareholders (Portions of Part III).
ITEM 1.
BUSINESS
The Company
PART I
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 of Michigan
(“our bank”), and of such other subsidiaries as we may acquire or establish. Our bank commenced business on
December 15, 1997.
Mercantile Bank Mortgage Company initiated business in October 2000 as a subsidiary of our bank,
and was reorganized as Mercantile Bank Mortgage Company, LLC (“our mortgage company”), on January 1,
2004. Mercantile Insurance Center, Inc. (“our insurance company”), a subsidiary of our bank, commenced
operations during 2002 to offer insurance products. Mercantile Bank Real Estate Co., L.L.C., (“our real estate
company”), a subsidiary of our bank, was organized on July 21, 2003, principally to develop, construct and
own our new facility in downtown Grand Rapids which serves as our bank’s new main office and Mercantile
Bank Corporation’s headquarters. Mercantile Bank Capital Trust I (the “Mercantile trust”), a business trust
subsidiary, was formed in September 2004 to issue trust preferred securities.
To date we have raised capital from our initial public offering of common stock in October 1997, a
public offering of common stock in July 1998, three private placements of common stock during 2001, a public
offering of common stock in August 2001 and a public offering of common stock in September 2003. In
addition, we raised capital through a public offering of $16.0 million of trust preferred securities in 1999, which
was refinanced as part of a $32.0 million private placement of trust preferred securities in 2004. Our expenses
have generally been paid using the proceeds of the capital sales and dividends from our bank. Our principal
source of future operating funds is expected to be dividends from our bank.
We filed an election to become a financial holding company, pursuant to the Bank Holding Company
Act, as amended by Title I of the Gramm-Leach-Bliley Act and implementing Federal Reserve Board
regulations, which election became effective March 23, 2000.
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 Office of Financial and Insurance Services. Our bank’s deposits are insured to
the maximum extent permitted by law by the Federal Deposit Insurance Corporation (“FDIC”). Our bank’s
primary service area is the Kent and Ottawa County areas of West Michigan, which includes the City of Grand
Rapids, the second largest city in the State of Michigan. In addition, our bank opened new offices in the cities
of East Lansing and Ann Arbor, Michigan, during 2005.
Our bank, through its eight offices, provides commercial and retail banking services primarily to
small- to medium-sized businesses based in and around the Grand Rapids, Holland, Lansing and Ann Arbor
metropolitan areas. These offices consist of a main office located at 310 Leonard Street NW, Grand Rapids,
Michigan, a combination branch and retail loan center located at 4613 Alpine Avenue NW, Comstock Park,
Michigan, a combination branch and operations center located at 5610 Byron Center Avenue SW, Wyoming,
Michigan, and branches located at 4860 Broadmoor Avenue SE, Kentwood, Michigan, 3156 Knapp Street NE,
Grand Rapids, Michigan, 880 East 16th Street, Holland, Michigan, 1651 West Lake Lansing Road, East
Lansing, Michigan, and 325 Eisenhower Parkway, Ann Arbor, Michigan.
2.
Our bank makes secured and unsecured commercial, construction, mortgage and consumer loans, and
accepts checking, savings and time deposits. Our bank owns six automated teller machines ("ATM"), located
at our branch locations in Grand Rapids and Holland, that participate in the MAC, NYCE 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 telephone and personal computer. Courier service is provided
to certain commercial customers, and safe deposit facilities are available at our branch locations in Grand
Rapids and Holland. Our bank does not have trust powers. In December 2001, our bank entered into a joint
brokerage services and marketing agreement with Raymond James Financial Services, Inc. to make available to
its customers financial planning, retail brokerage, equity research, insurance and annuities, retirement planning,
trust services and estate planning.
Our Mortgage Company
Our mortgage company’s predecessor, Mercantile Bank Mortgage Company, commenced operations
on October 24, 2000, when our bank contributed most of its residential mortgage loan portfolio and
participation interests in certain commercial mortgage loans to Mercantile Bank Mortgage Company. On the
same date, our bank also transferred its residential mortgage origination function to Mercantile Bank Mortgage
Company. On January 1, 2004, Mercantile Bank Mortgage Company was reorganized as Mercantile Bank
Mortgage Company, LLC, a limited liability company, which is 99% owned by our bank and 1% owned by our
insurance company. The reorganization had no impact on the company’s financial position or results of
operations. Mortgage loans originated and held by our mortgage company are serviced by our bank pursuant to
a servicing agreement.
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.
Our Real Estate Company
Our real estate company was organized on July 21, 2003, principally to develop, construct and own
our facility in downtown Grand Rapids that serves as our bank’s main office and Mercantile Bank
Corporation’s headquarters. This facility was placed into service during the second quarter of 2005. Our real
estate company is 99% owned by our bank and 1% owned by our insurance company.
The Mercantile Trust
In 2004, we formed the Mercantile trust, a Delaware business trust. Mercantile trust’s business and
affairs are conducted by its property trustee, a Delaware trust company, and three individual administrative
trustees who are employees and officers of the company. Mercantile trust was established for the purpose of
issuing and selling its Series A and Series B trust preferred securities and common securities, and used the
proceeds from the sales of those securities to acquire Series A and Series B Floating Rate Notes issued by the
company. Substantially all of the net proceeds received by the company from the Series A transaction were
used to redeem the trust preferred securities that had been issued by MBWM Capital Trust I in September
1999. We established MBWM Capital Trust I in 1999 to issue the trust preferred securities that were
redeemed. Substantially all of the net proceeds received by the company from the Series B transaction were
contributed to our bank as capital. The Series A and Series B Floating Rate Notes are categorized on our
consolidated financial statements as subordinated debentures. Additional information regarding Mercantile
trust is incorporated by reference to “Note 15 – Subordinated Debentures” and “Note 16 – Regulatory Matters”
of the Notes to Consolidated Financial Statements included in this Annual Report on pages F-54 through F-56.
3.
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 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 and the reserve requirements against member bank deposits. 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
As a 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 examination by the Federal Reserve Board.
The Bank Holding Company Act limits the activities of bank holding companies that have not
qualified as financial holding companies to banking and the management of banking organizations, and to
certain non-banking activities. These non-banking activities include those activities that the Federal Reserve
Board found, 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 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. With the exception of the activities of our mortgage
company discussed above, neither we nor any of our subsidiaries engages in any of the non-banking activities
listed above.
In March 2000, 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 by the Federal
Reserve Board. In order to continue 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 than are permitted
to 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 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 or soundness of depository institutions or the financial system generally. Such
expanded activities 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. Other than the insurance agency activities of our
insurance company, neither we nor our subsidiaries presently engage in any of the expanded activities.
Our bank is subject to restrictions imposed by federal law and regulation. Among other things, these
restrictions apply to any extension of credit to us or to our other subsidiaries, to investments in stock or other
securities that we issue, to the taking of such stock or securities as collateral for loans to any borrower, and to
acquisitions of assets or services from, and sales of certain types of assets to, us or our other subsidiaries.
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.
4.
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 certain restrictions imposed by Federal
and state laws and regulations.
Employees
As of December 31, 2006, we and our bank employed 256 full-time and 69 part-time persons.
Management believes that relations with employees are good.
Lending Policy
As a routine part of our business, we make loans and leases 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 and leases 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 and leases 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 and leases, including the ability to pay; the character of the customer;
evidence of financial responsibility; purpose of the loan or lease; 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 or leased 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 and lease to value limits 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 and lease identification, maintenance of an
allowance for loan and lease losses, loan and lease 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, makes us responsive to our customers. The loan policy currently specifies
lending authority for certain officers up to $3.0 million, and $10.0 million for our bank’s Chairman of the
Board and its President and Chief Executive Officer; however, the $10.0 million lending authority is generally
used only in rare circumstances where timing is of the essence. Generally, loan requests exceeding $2.5 million
require approval by the Officers Loan Committee, and loan requests exceeding $4.0 million, up to the legal
lending limit of approximately $33.6 million, require approval by the Board of Directors. In most
circumstances, we 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 and leases primarily
in our market areas. Our commercial lenders have extensive commercial lending experience, with most having
at least ten years’ experience. Loans and leases 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.
5.
Working capital loans are often structured as a line of credit and are reviewed periodically in
connection with the borrower’s year-end financial reporting. These loans are generally secured by substantially
all of the assets of the borrower, and have an interest rate tied to the national prime rate. Loans and leases for
machinery and equipment purposes typically have a maturity of three to five years and are fully amortizing,
while commercial real estate loans are usually written with a five-year maturity and amortize over a 15 year
period. Commercial loans and leases typically have an interest rate that is fixed to maturity or is tied to the
national prime rate.
We evaluate many aspects of a commercial loan or lease 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. This analysis includes a review of the borrower’s historical and projected
financial results. Appraisals are generally required 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
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 of well-known customers or new customers whose businesses have an established profitable history.
In many cases, risk is further reduced by 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 no material loans to energy producing customers. We have
only limited exposure to companies engaged in agricultural-related activities.
Single-Family Residential Real Estate Loans. Our mortgage company originates single-family
residential real estate loans in our market area, usually according to secondary market underwriting standards.
Loans not conforming to those standards are made in limited circumstances. Single-family residential real
estate loans provide borrowers with a fixed or adjustable interest rate with terms up to 30 years.
Our bank has a home equity line of credit program. Home equity credit is 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 national prime rate.
Consumer Loans. We originate consumer loans for a variety of personal financial needs, including
new and used automobiles, boat loans, credit cards and overdraft protection 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.
6.
Loan and Lease Portfolio Quality
We utilize a comprehensive grading system for our commercial loans and leases as well as residential
mortgage and consumer loans. All commercial loans and leases are graded on a ten grade rating system. The
rating system utilizes standardized grade paradigms that analyze several critical factors such as cash flow,
management and collateral coverage. All commercial loans and leases are graded at inception and reviewed at
various intervals thereafter. Residential mortgage and consumer loans are graded on a four grade rating system
using a separate standardized grade paradigm that analyzes several critical factors such as debt-to-income and
credit and employment histories. Residential mortgage and consumer loans are graded on a random sampling
basis after the loan has been made.
Our independent loan and lease review program is primarily responsible for the administration of the
grading system and ensuring adherence to established lending policies and procedures. The loan and lease
review program is an integral part of maintaining our strong asset quality culture. The loan and lease review
function works closely with senior management, although it functionally reports to the Board of Directors. All
commercial loan and lease relationships equal to or exceeding $1.8 million are formally reviewed every twelve
months, with a random sampling performed on credits under $1.8 million. Our watch list credits are reviewed
monthly by our Watch List Committee, which is comprised of personnel from the administration, lending and
loan and lease review functions.
Loans and leases are placed in a nonaccrual status when, in our opinion, uncertainty exists as to the
ultimate collection of principal and interest. As of December 31, 2006, loans and leases placed in nonaccrual
status totaled $7.8 million, or 0.44% of total loans and leases. As of the same date, loans and leases past due
90 days or more and still accruing interest totaled $0.8 million, or 0.05% of total loans and leases. As of
December 31, 2006, there were no other significant loans and leases where known information about credit
problems of borrowers warranted the placing of the loans or leases in a nonaccrual status. We are not aware of
any potential problem credits that could have a material adverse effect on our operating results, liquidity, or
capital resources.
Additional detail and information relative to the loan and lease portfolio is incorporated by reference
to Management’s Discussion and Analysis of Financial Condition and Results of Operation (“Management’s
Discussion and Analysis”) beginning on Page F-4 and Note 3 of the Consolidated Financial Statements on
pages F-43 and F-44 included in this Annual Report.
Allowance for Loan and Lease Losses
In each accounting period, we adjust the allowance for loan and lease losses (“allowance”) to the
amount we believe is necessary to maintain the allowance at adequate levels. Through the loan and lease
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, but not limited to,
consideration of the internally prepared Loan Loss Reserve Analysis (“Reserve Analysis”), composition of the
loan and lease portfolio, third party analysis of the loan and lease administration processes and portfolio and
general economic conditions. In addition, the strong commercial loan and leases growth is taken into account.
7.
The Reserve Analysis, used since our inception 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 total loans and leases, reserve allocation
factors are based upon the loan ratings as determined by our standardized grade paradigms. For retail loans,
reserve allocation factors are based upon the type of credit. Adjustments for specific lending relationships,
including impaired loans and leases, are made on a case-by-case basis. The reserve allocation factors are
primarily based on the recent levels and historical trends of net loan charge-offs and non-performing assets, the
comparison of the recent levels and historical trends of net loan charge-offs and non-performing assets with a
customized peer group consisting of ten similarly-sized publicly traded banking organizations conducting
business in the states of Michigan, Illinois, Indiana and/or Ohio, the review and consideration of our loan
migration analysis and the experience of senior management making similar loans and leases for an extensive
period of time. We regularly review the Reserve Analysis and make adjustments periodically based upon
identifiable trends and experience.
We believe that the present allowance is adequate, based on the broad range of considerations listed
above.
The primary risks associated with commercial loans and leases are the financial condition of the
borrower, the sufficiency of collateral, and lack of timely payment. We have a policy of requesting and
reviewing periodic financial statements from its commercial loan and lease customers, and periodically
reviewing existence of collateral and its value. The primary risk element that we consider for consumer and
residential real estate loan is lack of timely payment. We have a reporting system that monitors past due loans
and have adopted policies to pursue our creditor’s rights in order to preserve our bank’s collateral position.
Additional detail regarding the allowance is incorporated by reference to Management’s Discussion
and Analysis beginning on Page F-4 and Note 3 of the Notes to Consolidated Financial Statements of the
Company on pages F-43 and F-44 included in this Annual Report.
Although we believe the allowance is adequate to absorb probable incurred losses as they arise, there
can be no assurance that we will not sustain losses in any given period which could be substantial in relation to,
or greater than, the size of the allowance.
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 Mercantile trust. Other funds of
our bank holding company may be invested from time to time in various debt instruments.
As a bank holding company, 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. In addition, our bank holding company’s qualification as a financial holding company enables us
to make equity investments in companies engaged in a broader range of financial activities than we could do
without that qualification. Such expanded activities include 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. 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.
8.
In addition, so long as our bank holding company is qualified as a financial holding company, it would
be permitted, as part of the business of underwriting or merchant banking activity and under certain
circumstances and procedures, to invest in shares or other ownership interests in, or assets of, companies
engaged in non-financial activities. In order to make those investments, our bank holding company would be
required (i) to become, or to have an affiliate that is, a registered securities broker or dealer or a registered
municipal securities dealer, or (ii) to control both an insurance company predominantly engaged in
underwriting life, accident and health, or property and casualty insurance (other than credit insurance) or
issuing annuities, and a registered investment adviser that furnishes investment advice to an insurance company.
We do not currently have any securities, insurance, or investment advisory affiliates of the required types, nor
does our bank holding company have any current plans to make any of the equity investments described in this
paragraph.
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, our mortgage company, or our real estate 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 beginning on Page F-4 and Note 2 of the Notes to Consolidated
Financial Statements on pages F-40 through F-42 included in this Annual Report.
Competition
Our primary markets for loans and core deposits are the Grand Rapids, Holland, Lansing and Ann
Arbor metropolitan areas. 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 out-of-state banks, savings banks, thrifts, credit unions and other financial institutions as well as from
other entities that provide financial services. 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
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 the Gramm-Leach-Bliley Act, effective March 11, 2000, securities firms and insurance
companies that elect to become financial holding companies may acquire banks and other financial institutions.
The Gramm-Leach-Bliley Act may significantly change 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.
Selected Statistical Information
Management’s Discussion and Analysis beginning on Page F-4 in this Annual Report includes selected
statistical information.
9.
Return on Equity and Assets
Return on Equity and Asset information is included in Management’s Discussion and Analysis
beginning on Page F-4 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.
ITEM 1A.
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.
Adverse changes in economic conditions or interest rates may negatively affect our earnings, capital and
liquidity.
The results of operations for financial institutions, including our bank, may be materially and
adversely affected by changes in prevailing local and national economic conditions, including declines in real
estate market values and the related declines in value of our real estate collateral, rapid increases or decreases
in interest rates and changes in the monetary and fiscal policies of the federal government. Our profitability is
heavily influenced by the spread between the interest rates we earn on loans and investments and the interest
rates we pay on deposits and other interest-bearing liabilities. Substantially all of our loans are to businesses
and individuals in western, south central, or southeastern Michigan, and any decline in the economy of these
areas could adversely affect us. Like most banking institutions, our net interest spread and margin will be
affected by general economic conditions and other factors that influence market interest rates and our ability to
respond to changes in these rates. At any given time, our assets and liabilities may be such that they will be
affected differently by a given change in interest rates.
Our credit losses could increase and our allowance for loan and lease losses 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 collectibility of our loan portfolio and provide an allowance for losses
based on several factors. If our assumptions are wrong, our allowance for loan and lease losses may not be
sufficient to cover our losses, which would have an adverse effect on our operating results. While we have not
experienced unusual amounts of charge-offs or nonperforming loans, we cannot assure you that we will not
experience an increase in delinquencies and losses as the loans and leases continue to mature. The actual
amounts of future provisions for loan and lease losses cannot be determined at this time and may exceed the
amounts of past provisions. Additions to our allowance for loan and lease losses decrease our net income.
10.
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
Gerald R. Johnson, Jr., our Chairman and Chief Executive Officer, Michael H. Price, our President and Chief
Operating Officer, and our other senior managers. The loss of either Mr. Johnson or Mr. Price, or any of our
other senior managers, could have an adverse effect on our growth and performance. We have entered into
employment contracts with Mr. Johnson and Mr. Price and two other executive officers. The contracts provide
for a three year employment period that is extended for an additional year each year unless a notice is given
indicating that the contract will not be extended.
In addition, we continue to depend on our city presidents and key commercial loan officers. Our city
presidents and several of our commercial loan officers are responsible, or share responsibility, for generating
and managing a significant portion of our commercial loan and lease 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 and lease portfolio and
performance, and our ability to generate new loans and leases. 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.
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.
Decline in the availability of out-of-area deposits could cause liquidity or interest rate margin concerns,
or limit our growth.
We have utilized and expect to continue to utilize out-of-area or wholesale deposits to support our
asset growth. These deposits are generally a lower cost source of funds when compared to the interest rates that
we would have to offer in our local markets to generate a commensurate level of funds. In addition, the
overhead costs associated with wholesale deposits are considerably less than the overhead costs we would incur
to obtain and administer a similar level of local deposits. A decline in the availability of these wholesale
deposits would require us to fund our growth with more costly funding sources, which could reduce our net
interest margin, limit our growth, reduce our asset size, or increase our overhead costs.
Future sales of our common stock or other securities may dilute the value 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 stock, including shares authorized and unissued under our Stock
Incentive Plan of 2006. In the future, we may issue additional securities, through public or private offerings, in
order to raise additional capital. Any such issuance 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.
11.
Our growth and expansion may be limited by many factors.
Our primary growth strategy has been to grow internally by increasing our business in the western
Michigan area, and more recently in the Lansing and Ann Arbor areas of Michigan. We are also considering
other areas in which we may expand our business. This internal growth strategy depends in large part on
generating an increasing level of loans and deposits at acceptable risk and interest rate levels without
commensurate increases in non-interest expenses. There can be no assurance that we will be successful in
continuing our growth strategy due to delays and other impediments resulting from regulatory oversight, limited
availability of qualified personnel and favorable and cost effective branch sites, and management time, capital,
and expenses required to develop new branch sites and markets. In addition, the success of our growth strategy
will depend on maintaining sufficient regulatory capital levels and on adequate economic conditions in our
market areas.
In addition, although we have no current plans to do so, we may acquire banks, related businesses or
branches of other financial institutions that we believe provide a strategic fit with our business. To the extent
that we grow through acquisitions, we cannot assure you that we will be able to adequately or profitably
manage this growth. Acquiring other banks, businesses, or branches involves risks commonly associated with
acquisitions, including exposure to unknown or contingent liabilities and asset quality issues, difficulty and
expense of integrating the operations and personnel, potential disruption to our business including the diversion
of management’s time and attention, and the possible loss of key employees and customers.
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
out-of-state 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. Most
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 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 the Gramm-Leach-Bliley Act of 1999, effective March 11, 2000, securities firms
and insurance companies that elect to become financial holding companies may acquire banks and other
financial institutions. The Gramm-Leach-Bliley Act affects the competitive environment in which we conduct
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.
We are subject to significant government regulation, and any regulatory changes may adversely affect
us.
The banking industry is heavily regulated under both federal and state law. These regulations are
primarily intended to protect customers, not our creditors or shareholders. Existing state and federal banking
laws subject us to substantial limitations with respect to 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, 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.
12.
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. 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.
Our Articles of Incorporation and By-laws and the laws 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 interests.
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 Bylaws, 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 offering price.
We have paid a 5% stock dividend on our common stock each year since 2001, and have paid a
quarterly cash dividend each quarter beginning with the first quarter of 2003. While we expect to continue
paying cash dividends, there is no assurance that we will continue to do so.
13.
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. 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 sufficiently adequate.
We also face the risk that the design of our controls and procedures prove inadequate or are circumvented,
causing delays in detection or errors in information. Although we maintain a system of controls designed to
keep operational risk 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.
ITEM IB.
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 2006 fiscal year
and that remain unresolved.
ITEM 2.
PROPERTIES
During 2005, our bank placed into service a new four-story facility located approximately two miles
north from the center of downtown Grand Rapids. Design and construction of this facility had started during
2003. This new facility serves as the Company’s headquarters and our bank’s main office, and houses the
administration function, our bank’s commercial lending and review function, our bank’s loan operations
function, a full service branch, portions of our bank’s retail lending and business development function and our
bank’s retail brokerage operation. A majority of functions housed at this facility were formerly operated out of
a leased facility located at 216 North Division Avenue, Grand Rapids, Michigan, approximately two miles from
the new facility. The new facility consists of approximately 55,000 square feet of usable space and contains
multiple drive-through lanes with ample parking. The land and building are owned by our real estate company.
The address of this facility is 310 Leonard Street NW, Grand Rapids, Michigan.
Our bank designed and constructed a full service branch and retail loan facility which opened in July
of 1999 in Alpine Township, a northwest suburb of Grand Rapids. The facility is one story and has
approximately 8,000 square feet of usable space. The land and building are owned by our bank. The facility
has multiple drive-through lanes and ample parking space. The address of this facility is 4613 Alpine Avenue
NW, Comstock Park, Michigan.
14.
During 2001, our bank designed and constructed two facilities on a 4-acre parcel of land located in the
City of Wyoming, a southwest suburb of Grand Rapids. The land had been purchased by our bank in 2000.
The larger of the two buildings is a full service branch and deposit operations facility which opened in
September of 2001. The facility is two-stories and has approximately 25,000 square feet of usable space. The
facility is owned by our bank and has multiple drive-through lanes and ample parking space. The address of
this facility is 5610 Byron Center Avenue SW, Wyoming, Michigan. The other building is a single-story
facility with approximately 11,000 square feet of usable space. Our bank’s accounting, audit, loss prevention
and wire transfer functions are housed in this building, which underwent a renovation in 2005 that almost
doubled its size. This facility is also owned by our bank. The address of this facility is 5650 Byron Center
Avenue SW, Wyoming, Michigan.
During 2002, our bank designed and constructed a full service branch which opened in December of
2002 in the City of Kentwood, a southeast suburb of Grand Rapids. The land had been purchased by our bank
in 2001. The facility is one story and has approximately 10,000 square feet of usable space. The facility is
owned by our bank and has multiple drive-through lanes and ample parking space. The address of this facility
is 4860 Broadmoor Avenue SW, Kentwood, Michigan.
During 2003, our bank designed and constructed a full service branch in the northeast quadrant of the
City of Grand Rapids. The land had been purchased by our bank in 2002. The facility is one story and has
approximately 3,500 square feet of usable space. The facility is owned by our bank and has multiple drive-
through lanes and ample parking space. The address of this facility is 3156 Knapp Street NE, Grand Rapids,
Michigan.
During 2003, our bank designed and started construction of a new two-story facility located in
Holland, Michigan. This facility, which was completed during the fourth quarter of 2004, serves as a full
service banking center for the Holland area, including commercial lending, retail lending and a full service
branch. The facility consists of approximately 30,000 square feet of usable space and contains multiple drive-
through lanes with ample parking. The address of this facility is 880 East 16th Street, Holland, Michigan.
During 2005, our bank opened a branch facility in the City of East Lansing, Michigan. The facility is
one story and has approximately 7,500 square feet of usable space. The facility is operated under a lease
agreement between our bank and a third party. There is ample parking space, but no drive-through lanes. The
address of this facility is 1651 West Lake Lansing Road, East Lansing, Michigan.
During 2005, our bank opened a branch facility in the City of Ann Arbor, Michigan. The facility is
one story and has approximately 10,000 square feet of usable space. The facility is operated under a lease
agreement between our bank and a third party. There is ample parking space, but no drive-through lanes. The
address of this facility is 325 Eisenhower Parkway, Ann Arbor, Michigan.
During 2006, our bank purchased approximately 3 acres of vacant land and designed and initiated
construction of a new three-story facility in East Lansing, Michigan. This facility, which is expected to be
completed during the second quarter of 2007, will serve as a full service banking center for the greater Lansing
area, including commercial lending, retail lending, and a full service branch. The facility will consist of
approximately 27,000 square feet of usable space and will contain multiple drive-through lanes with ample
parking. When completed, this facility will replace the leased facility noted above located on West Lake
Lansing Road in East Lansing. The address of this facility is 3737 Coolidge Road, East Lansing, Michigan.
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.
15.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the Nasdaq Global Select Market under the symbol “MBWM”. At
February 12, 2007, there were 305 record holders of our common stock. In addition, we estimate that there
were approximately 4,000 beneficial owners of our common stock who own their shares through brokers or
banks.
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. The prices have been adjusted for the 5% stock dividends paid on May 16, 2006 and August 1, 2005.
High Low Dividend
2006
First Quarter.............................................
Second Quarter ........................................ 40.55 35.30
Third Quarter ........................................... 41.05 36.92
Fourth Quarter ......................................... 40.81 37.06
$ 38.20
$ 35.71
$ 0.12
0.13
0.13
0.13
2005
First Quarter.............................................
Second Quarter ........................................ 41.67 35.56
Third Quarter ........................................... 45.95 39.68
Fourth Quarter ......................................... 40.92 35.67
$ 34.65
$ 41.52
$ 0.10
0.11
0.11
0.11
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 holding company and substantially all of our assets are held by our 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.
On January 9, 2007, we declared a $0.14 per share cash dividend on our common stock, payable on
March 9, 2007 to record holders as of February 9, 2007. We currently expect to continue to pay a quarterly
cash dividend, although there can be no assurance that we will continue to do so.
16.
Issuer Purchases of Equity Securities
(a) Total
Number of
Shares
Purchased
0
421
0
421
(b) Average
Price Paid Per
Share
$ N/A
38.35
N/A
$ 38.35
(c) Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
0
0
0
0
(d) Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs
0
0
0
0
Period
October 1 – 31
November 1 – 30
December 1 – 31
Total
The shares shown in column (a) above as having been purchased were acquired from one of our employees
when she used shares of common stock that she already owned to pay part of the exercise price when exercising
stock options issued under one of our employee stock option plans.
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 Nasdaq Bank Index from December 31,
2001 through December 31, 2006. The following is based on an investment of $100 on December 31, 2001 in
our common stock, the Nasdaq Composite Index and the SNL Nasdaq Bank Index, with dividends reinvested
where applicable.
17.
Index
Mercantile Bank Corporation
NASDAQ Composite
SNL NASDAQ Bank Index
12/31/01
100.00
100.00
100.00
12/31/02
139.90
68.76
102.85
12/31/03
229.27
103.67
132.76
12/31/04
263.15
113.16
152.16
12/30/05
272.06
115.57
147.52
12/31/06
283.42
127.58
165.62
Period Ending
ITEM 6.
SELECTED FINANCIAL DATA
The Selected Financial Data on page F-3 in this Annual Report is incorporated here by reference.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
Management’s Discussion and Analysis on pages F-4 through F-22 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” on pages F-22 through F-25 in this Annual
Report is incorporated here by reference.
18.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, Notes to Consolidated Financial Statements and the Reports
of Independent Registered Public Accounting Firm on pages F-26 through F-59 in this Annual Report are
incorporated here by reference.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On September 14, 2006, our Audit Committee concluded its proposal process for selection of an
independent registered public accounting firm for 2007, and appointed BDO Seidman, LLP as our independent
registered public accounting firm for the calendar year ending December 31, 2007. On the same date, our
Audit Committee determined to dismiss Crowe Chizek and Company LLC as our independent registered public
accounting firm after it completed its work for the calendar year ending December 31, 2006, and advised
Crowe Chizek and Company LLC that it would not be engaged as our independent registered public accounting
firm for the calendar year ending December 31, 2007. We filed a report on Form 8-K with the Securities and
Exchange Commission on September 19, 2006 reporting the change of accountants and making related
disclosures.
ITEM 9A.
CONTROLS AND PROCEDURES
As of December 31, 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 December 31, 2006. There have been no significant
changes in our internal controls over financial reporting during the quarter ended December 31, 2006, 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). 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 based on the
framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission. Based on our evaluation under the framework in Internal Control – Integrated
Framework, our management concluded that our internal control over financial reporting was effective as of
December 31, 2006. Our management’s assessment of the effectiveness of our internal control over financial
reporting as of December 31, 2006 has been audited by Crowe Chizek and Company LLC, an independent
registered public accounting firm, as stated in their report which is included in this Annual Report.
ITEM 9B.
OTHER INFORMATION
None
19.
PART III
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information presented under the captions “Election of Directors,” “Executive Officers,” “Section
16(a) Beneficial Ownership Compliance” and “Corporate Governance – Code of Ethics” in the definitive Proxy
Statement of Mercantile for our April 26, 2007 Annual Meeting of Shareholders (the “Proxy Statement”), a
copy of which will be filed with the Securities and Exchange Commission before the meeting date, is
incorporated here by reference.
We have a separately-designated standing audit committee established in accordance with Section
3(a)(58)(A) of the Securities Exchange Act of 1934. The members of the Audit Committee consist of Betty S.
Burton, David M. Cassard, C. John Gill, David M. Hecht, Calvin D. Murdock and Merle J. Prins. The Board
of Directors has determined that Mr. Cassard, a member of the Audit Committee, is qualified as an audit
committee financial expert, as that term is defined in the rules of the Securities and Exchange Commission.
Mr. Cassard is independent, as independence for audit committee members is defined in the Nasdaq listing
standards and the rules of the Securities and Exchange Commission.
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, 2006, relating to compensation plans
under which equity securities are authorized for issuance.
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
Weighted average
exercise price of
outstanding options,
warrants and rights
(b)
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)
275,369
$ 25.28
550,884 (2)
0
0
0
Plan Category
Equity compensation
plans approved by
security holders (1)
Equity compensation
plans not approved by
security holders
Total
275,369
$ 25.28
550,884
20.
(1) These plans are Mercantile’s 1997 Employee Stock Option Plan, 2000 Employee Stock Option Plan, 2004
Employee Stock Option Plan, Independent Director Stock Option Plan and the Stock Incentive Plan of 2006.
(2) These securities are available under the Stock Incentive Plan of 2006. 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
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 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 dated February 20, 2007
Consolidated Balance Sheets --- December 31, 2006 and 2005
Consolidated Statements of Income for each of the three years in the period ended December 31, 2006
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period
ended December 31, 2006
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
2006
Notes to Consolidated Financial Statements
The financial statements, the notes to 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
21.
(b)
Exhibits:
EXHIBIT NO.
3.1
3.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
EXHIBIT DESCRIPTION
Our Articles of Incorporation are incorporated by reference to exhibit 3.1 of our
Form 10-Q for the quarter ended June 30, 2004
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
Our 1997 Employee Stock Option Plan is incorporated by reference to exhibit
10.1 of our Registration Statement on Form SB-2 (Commission File No. 333-
33081) that became effective on October 23, 1997 *
Our 2000 Employee Stock Option Plan is incorporated by reference to exhibit
10.14 of our Form 10-K for the year ended December 31, 2000 *
Our 2004 Employee Stock Option Plan is incorporated by reference to exhibit
10.1 of our Form 10-Q for the quarter ended September 30, 2004 *
Form of Stock Option Agreement for options under the 2004 Employee Stock
Option Plan is incorporated by reference to exhibit 10.2 of our Form 10-Q for the
quarter ended September 30, 2004 *
Our Independent Director Stock Option Plan is incorporated by reference to
exhibit 10.26 of our Form 10-K for the year ended December 31, 2002 *
Form of Stock Option Agreement for options under the Independent Director
Stock Option Plan is incorporated by reference to exhibit 10.1 of our Form 8-K
dated October 21, 2004 *
Nonlender Bonus Plan is incorporated by reference to exhibit 10.3 of our Form
10-Q for the quarter ended September 30, 2004 *
Mercantile Bank of West Michigan Deferred Compensation Plan for Members of
the Board of Directors (1999) is incorporated by reference to Exhibit 10.6 of the
Registration Statement of the company and our trust on Form SB-2 (Commission
File Nos. 333-84313 and 333-84313-01) that became effective on September 13,
1999 *
Agreement between Fiserv Solutions, Inc. and our bank dated September 10,
1997, is incorporated by reference to exhibit 10.3 of our Registration Statement on
Form SB-2 (Commission File No. 333-33081) that became effective on October
23, 1997
Extension Agreement of Data Processing Contract between Fiserv Solutions, Inc.
and our bank dated May 12, 2000 extending the agreement between Fiserv
Solutions, Inc. and our bank dated September 10, 1997, is incorporated by
reference to exhibit 10.15 of our Form 10-K for the year ended December 31,
2000
Extension Agreement of Data Processing Contract between Fiserv Solutions, Inc.
and our bank dated November 22, 2002 extending the agreement between Fiserv
Solutions, Inc. and our bank dated September 10, 1997, is incorporated by
reference to exhibit 10.5 of our Form 10-K for the year ended December 31, 2002
22.
EXHIBIT NO.
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
EXHIBIT DESCRIPTION
Amended and Restated Employment Agreement dated as of October 18, 2001,
among the company, our bank and Gerald R. Johnson, Jr., is incorporated by
reference to exhibit 10.21 of our Form 10-K for the year ended December 31,
2001 *
Amended and Restated Employment Agreement dated as of October 18, 2001,
among the company, our bank and Michael H. Price, is incorporated by reference
to exhibit 10.22 of our Form 10-K for the year ended December 31, 2001 *
Employment Agreement dated as of October 18, 2001, among the company, our
bank and Robert B. Kaminski, Jr., is incorporated by reference to exhibit 10.23 of
our Form 10-K for the year ended December 31, 2001 *
Employment Agreement dated as of October 18, 2001, among the company, our
bank and Charles E. Christmas, is incorporated by reference to exhibit 10.23 of
our Form 10-K for the year ended December 31, 2001 *
Amendment to Employment Agreement dated as of October 17, 2002, among the
company, our bank and Gerald R. Johnson, Jr., is incorporated by reference to
exhibit 10.21 of our Form 10-K for the year ended December 31, 2002 *
Amendment to Employment Agreement dated as of October 17, 2002, among the
company, our bank and Michael H. Price, is incorporated by reference to exhibit
10.22 of our Form 10-K for the year ended December 31, 2002 *
Amendment to Employment Agreement dated as of October 17, 2002, among the
company, our bank and Robert B. Kaminski, Jr., is incorporated by reference to
exhibit 10.23 of our Form 10-K for the year ended December 31, 2002 *
Amendment to Employment Agreement dated as of October 17, 2002, among the
company, our bank and Charles E. Christmas, is incorporated by reference to
exhibit 10.24 of our Form 10-K for the year ended December 31, 2002 *
Amendment to Employment Agreement dated as of October 28, 2004, among the
company, our bank and Robert B. Kaminski, Jr., is incorporated by reference to
exhibit 10.21 of our Form 10-K for the year ended December 31, 2004 *
Junior Subordinated Indenture between us and Wilmington Trust Company dated
September 16, 2004 providing for the issuance of the Series A and Series B
Floating Rate Junior Subordinated Notes due 2034 is incorporated by reference to
exhibit 10.1 of our Form 8-K dated December 15, 2004
Amended and Restated Trust Agreement dated September 16, 2004 for Mercantile
Bank Capital Trust I is incorporated by reference to exhibit 10.2 of our Form 8-K
dated December 15, 2004
Placement Agreement between us, Mercantile Bank Capital Trust I, and SunTrust
Capital Markets, Inc. dated September 16, 2004 is incorporated by reference to
exhibit 10.3 of our Form 8-K dated December 15, 2004
Guarantee Agreement dated September 16, 2004 between Mercantile as Guarantor
and Wilmington Trust Company as Guarantee Trustee is incorporated by reference
to exhibit 10.4 of our Form 8-K dated December 15, 2004
23.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.25
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
Non-Lender Bonus Plan 2006, is incorporated by reference to exhibit 10.1 of our
Form 8-K dated November 22, 2005 *
Form of Agreement Amending Stock Option Agreement, dated November 17,
2005 issued under our 2004 Employee Stock Option Plan, is incorporated by
reference to exhibit 10.1 of our Form 8-K dated December 12, 2005 *
Second Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Gerald R. Johnson, Jr. is incorporated by
reference to exhibit 10.28 of our Form 10-K for the year ended December 31,
2005 *
Second Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Michael H. Price is incorporated by reference
to exhibit 10.29 of our Form 10-K for the year ended December 31, 2005 *
Third Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Robert B. Kaminski, Jr. is incorporated by
reference to exhibit 10.30 of our Form 10-K for the year ended December 31,
2005 *
Second Amendment to Employment Agreement dated as of November 17, 2005,
among the company, our bank and Charles E. Christmas is incorporated by
reference to exhibit 10.31 of our Form 10-K for the year ended December 31,
2005 *
Form of Mercantile Bank of Michigan Executive Deferred Compensation
Agreement, that has been entered into between our bank and each of Gerald R.
Johnson, Jr., Michael H. Price, Robert B. Kaminski, Jr., Charles E. Christmas, and
certain other officers of our bank is incorporated by reference to exhibit 10.32 of
our Form 10-K for the year ended December 31, 2005 *
Form of Mercantile Bank of Michigan Split Dollar Agreement that has been
entered into between our bank and each of Gerald R. Johnson, Jr., Michael H.
Price, Robert B. Kaminski, Jr., Charles E. Christmas, and certain other officers of
our bank is incorporated by reference to exhibit 10.33 of our Form 10-K for the
year ended December 31, 2005 *
Director Fee Summary *
Lease Agreement between our bank and Joe D. Pentecost Trust dated April 29,
2005 for our East Lansing, Michigan office is incorporated by reference to exhibit
10.35 of our Form 10-K for the year ended December 31, 2005
Lease Agreement between our bank and The Conlin Company dated July 12, 2005
for our Ann Arbor, Michigan office is incorporated by reference to exhibit 10.36
of our Form 10-K for the year ended December 31, 2005
Stock Incentive Plan of 2006 is incorporated by reference to Appendix A of our
proxy statement for our April 27, 2006 annual meeting of shareholders that was
filed with the Securities and Exchange Commission *
24.
EXHIBIT NO.
10.37
10.38
10.39
21
23
31
32.1
32.2
EXHIBIT DESCRIPTION
Form of Notice of Grant of Incentive Stock Option and Stock Option Agreement
for incentive stock options granted under our Stock Incentive Plan of 2006 is
incorporated by reference to exhibit 10.1 of our Form 8-K dated November 22,
2006 *
Form of Restricted Stock Award Agreement Notification of Award and Terms and
Conditions of Award for restricted stock under our Stock Incentive Plan of 2006 is
incorporated by reference to exhibit 10.2 of our Form 8-K dated November 22,
2006 *
Executive Officer Bonus Plan for 2007 is incorporated by reference to exhibit 10.1
of our Form 8-K dated January 29, 2007 *
Subsidiaries of the company
Consent of Independent Registered Public Accounting Firm
Rule 13a-14(a) Certifications
Section 1350 Chief Executive Officer Certification
Section 1350 Chief Financial Officer Certification
* Management contract or compensatory plan
(c)
Financial Statements Not Included In Annual Report
Not applicable
25.
43495MercantileBlank 2/23/07 8:49 AM Page 1
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MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
F-1
MERCANTILE BANK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
CONTENTS
SELECTED FINANCIAL DATA........................................................................................................................ F-3
MANAGEMENT’S DISCUSSION AND ANALYSIS........................................................................................ F-4
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM............................................ F-26
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING ................................................................................................ F-28
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS ..................................................................................................... F-29
CONSOLIDATED STATEMENTS OF INCOME....................................................................................... F-30
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY .............................. F-31
CONSOLIDATED STATEMENTS OF CASH FLOWS ............................................................................. F-33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ................................................................... F-35
F-2
SELECTED FINANCIAL DATA
2006
2005
2004
(Dollars in thousands except per share data)
2003
2002
Consolidated Results of Operations:
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income tax expense
Income tax expense
Net income
Consolidated Balance Sheet Data:
Total assets
Cash and cash equivalents
Securities
Loans and leases, net of deferred fees
Allowance for loan and lease losses
Bank owned life insurance policies
$ 137,260 $ 102,130
46,838
55,292
3,790
5,661
31,117
26,046
8,145
$ 19,847 $ 17,901
75,673
61,587
5,775
5,261
32,262
28,811
8,964
$ 69,022 $ 54,658 $ 47,632
24,026
23,395
26,595
23,606
31,263
42,427
3,002
3,800
4,674
4,302
3,101
4,409
12,781
18,071
23,198
10,924
13,801
18,857
3,167
3,785
5,136
$ 13,721 $ 10,016 $ 7,757
$2,067,268 $1,838,210 $1,536,119 $1,203,337 $ 922,360
28,117
51,380
96,893
202,419
771,554
1,745,478
10,890
21,411
14,876
30,858
20,811
16,564
121,510
152,965
1,317,124 1,035,963
14,379
17,819
16,441
23,750
36,753
181,614
1,561,812
20,527
28,071
Deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated debentures
Shareholders’ equity
1,646,903
85,472
95,000
32,990
171,915
1,419,352
72,201
130,000
32,990
155,125
1,159,181
56,317
120,000
32,990
141,617
902,892
49,545
90,000
16,495
130,201
754,113
50,335
15,000
16,495
79,834
Consolidated Financial Ratios:
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
1.01%
12.19%
8.31%
1.05%
12.05%
8.73%
0.99%
10.16%
9.79%
0.96%
10.61%
9.00%
0.97%
10.30%
9.45%
Nonperforming loans and leases to total loans and leases
Allowance for loan and lease losses to total loans and leases
0.49%
1.23%
0.26%
1.31%
0.22%
1.35%
0.17%
1.39%
0.10%
1.41%
Tier 1 leverage capital
Tier 1 leverage risk-based capital
Total risk-based capital
10.04%
10.37%
11.45%
10.45%
10.82%
12.00%
11.53%
11.82%
13.03%
12.49%
12.60%
13.84%
10.72%
10.85%
12.10%
Per Share Data:
Net Income:
Basic
Diluted
Book value at end of period
Dividends declared
Dividend payout ratio
NA – Not Applicable
$
2.48 $
2.45
$
2.25
2.20
1.73 $
1.69
1.49 $
1.46
1.23
1.22
21.43
0.51
20.34%
19.46
0.41
17.79%
17.78
0.32
18.60%
16.40
0.27
18.41%
12.66
NA
NA
F-3
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 about our company. Words such as “anticipates,” “believes,” “estimates,” “expects,”
“forecasts,” “intends,” “is likely,” “plans,” “projects,” 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 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 other risk factors described in Item 1A of this Annual Report.
These are representative of the Future Factors that could cause a difference between an ultimate actual outcome and
a preceding forward-looking statement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Management’s Discussion and Analysis of Financial Condition and Results of Operations 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.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination
of the allowance for loan and lease losses, and actual results could differ from those estimates.
The allowance for loan and lease losses is maintained at a level we believe is adequate to absorb probable incurred
losses identified and inherent in the loan and lease portfolio. Our evaluation of the adequacy of the allowance for
loan and lease losses is an estimate based on reviews of individual loans, assessments of the impact of current and
anticipated economic conditions on the portfolio, and historical loss experience. The allowance for loan and lease
losses represents management’s best estimate, but significant downturns in circumstances relating to loan and lease
quality or economic conditions could result in a requirement for an increased allowance for loan and lease losses in
the near future. Likewise, an upturn in loan and lease quality or improved economic conditions may result in a
decline in the required allowance for loan and lease losses. In either instance, unanticipated changes could have a
significant impact on operating earnings.
The allowance for loan and lease losses is increased through a provision charged to operating expense.
Uncollectible loans and leases are charged-off through the allowance for loan and lease losses. Recoveries of loans
and leases previously charged-off are added to the allowance for loan and lease losses. A loan is considered
impaired when it is probable that contractual interest and principal payments will not be collected either for the
amounts or by the dates as scheduled in the loan agreement. Our policy for recognizing income on impaired loans is
to accrue interest unless a loan is placed on nonaccrual status.
F-4
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
of Michigan (“our bank”), and of Mercantile Bank Mortgage Company, LLC (“our mortgage company”), Mercantile
Bank Real Estate Co., L.L.C. (“our real estate company”) and Mercantile Insurance Center, Inc. (“our insurance
company”), which are subsidiaries 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.
We were incorporated on July 15, 1997 as a bank holding company to establish and own our bank. Our bank, after
receiving all necessary regulatory approvals, began operations on December 15, 1997. Our bank has a strong
commitment to community banking and offers a wide range of financial products and services, primarily to small- to
medium-sized businesses, as well as individuals. Our bank’s lending strategy focuses on commercial lending, and, to
a lesser extent, residential mortgage and consumer lending. Our bank also offers a broad array of deposit products,
including checking, savings, money market, and certificates of deposit, as well as security repurchase agreements.
Our primary markets are the Grand Rapids, Holland, Lansing and Ann Arbor metropolitan areas. Our bank utilizes
certificates of deposit from customers located outside of the primary market area to assist in funding the rapid asset
growth our bank has experienced since inception.
We formed a business trust, Mercantile Bank Capital Trust I (“the trust”), in 2004 to issue trust preferred securities.
We issued subordinated debentures to the trust in return for the proceeds raised from the issuance of the trust
preferred securities. In accordance with FASB Interpretation No. 46, the trust is not consolidated, but instead we
report the subordinated debentures issued to the trust as a liability.
Our mortgage company’s predecessor, Mercantile Bank Mortgage Company, was formed to increase the profitability
and efficiency of the company’s mortgage loan operations. Mercantile Bank Mortgage Company initiated business
on October 24, 2000 from our bank’s contribution of most of its residential mortgage loan portfolio and participation
interests in certain commercial mortgage loans. On the same date, our bank had also transferred its residential
mortgage origination function to Mercantile Bank Mortgage Company. On January 1, 2004, Mercantile Bank
Mortgage Company was reorganized as Mercantile Bank Mortgage Company, LLC, a limited liability company.
Mortgage loans originated and held by our mortgage company are serviced by our bank pursuant to a servicing
agreement.
Our insurance company acquired, at nominal cost, 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.
Our real estate company was organized on July 21, 2003, principally to develop, construct and own our new facility
in downtown Grand Rapids which serves as our bank’s new main office and Mercantile Bank Corporation’s
headquarters. Construction was completed during the second quarter of 2005.
FINANCIAL CONDITION
We continued to experience strong asset growth during 2006. Assets increased from $1,838.2 million on December
31, 2005 to $2,067.3 million on December 31, 2006. This represents an increase in total assets of $229.1 million, or
12.5%. The increase in total assets was primarily comprised of a $182.8 million increase in net loans and leases, a
$20.8 million increase in securities and a $14.6 million increase in cash and cash equivalents. The increase in assets
was primarily funded by a $227.6 million increase in deposits, a $13.3 million increase in repurchase agreements and
a $16.8 million increase in shareholders’ equity.
F-5
Earning Assets
Average earning assets equaled 94.9% of average total assets during 2006, compared to 94.8% during 2005.
Although we experienced strong asset growth during 2006, the asset composition remained relatively constant. The
loan portfolio continued to comprise a majority of earning assets, followed by securities and federal funds sold.
Our loan and lease portfolio, which equaled 89.2% of average earnings assets during 2006, is primarily comprised of
commercial loans and leases. Constituting over 92% of loans and leases and growing by $177.3 million during
2006, the commercial loan and lease portfolio represents loans to businesses generally located within our market
areas. Approximately 70% of the commercial loan and lease portfolio is primarily secured by real estate properties,
with the remaining generally secured by other business assets such as accounts receivable, inventory, and equipment.
The continued significant concentration of the loan and lease portfolio in commercial loans and leases and the strong
growth of this portion of our lending business are consistent with our strategy of focusing a substantial amount of our
efforts on “wholesale” banking. Corporate and business lending continues to be an area of expertise for our senior
management team, and our commercial lenders have extensive commercial lending experience, with most having at
least ten 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 virtually our
only source of significant demand deposits.
Residential mortgage and consumer loans, while equaling less than 8% of total loans and leases during 2006, also
experienced strong growth; however, while we expect the residential mortgage loan and consumer loan portfolios to
increase in future periods, the commercial sector of the lending efforts and resultant assets are expected to remain the
dominant loan portfolio category given our wholesale banking strategy.
The following tables present the maturity of total loans outstanding as of December 31, 2006, according to scheduled
repayments of principal on fixed rate loans and repricing frequency on variable rate loans. Floating rate loans that
are currently at interest rate ceilings, totaling $281.0 million as of December 31, 2006, are treated as fixed rate loans
and are reflected using maturity date and not repricing frequency.
Construction and land development
Real estate – secured by 1-4 family
properties
Real estate – secured by multi-family
properties
Real estate – secured by
nonresidential properties
Commercial
Leases
Consumer
0-1
Year
1-5
Years
After 5
Years
Total
$
246,656,000 $
33,858,000 $ 13,142,000 $
293,656,000
64,832,000
53,131,000
13,681,000
131,644,000
16,005,000
14,566,000
432,000
31,003,000
310,559,000
380,139,000
33,000
3,303,000
466,547,000
86,222,000
1,355,000
4,208,000
31,153,000
4,911,000
0
745,000
808,259,000
471,272,000
1,388,000
8,256,000
$ 1,021,527,000 $
659,887,000 $ 64,064,000 $ 1,745,478,000
Fixed rate loans
Floating rate loans
$
93,126,000 $
658,425,000 $ 64,064,000 $
928,401,000
1,462,000
0
815,615,000
929,863,000
$ 1,021,527,000 $
659,887,000 $ 64,064,000 $ 1,745,478,000
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
could occur quickly because of changing economic conditions. 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 “Watch List.” Senior management reviews this list regularly.
F-6
Although the level of net loan and lease charge-offs and nonperforming loans and leases increased during 2006, the
quality of our loan portfolio remains good. The levels of net loan and lease charge-offs and nonperforming loans
and leases approximated banking industry averages during 2006, compared to levels that were below banking
industry averages in prior years. As of December 31, 2006, nonperforming loans and leases totaled $8.6 million, or
0.49% of total loans and leases. At December 31, 2005, nonperforming loans and leases totaled $4.0 million, or
0.26% of total loans and leases. Net loan and lease charge-offs during 2006 totaled $4.9 million, or 0.29% of
average total loans and leases. During 2005, net loan and lease charge-offs totaled $1.1 million, or 0.08% of average
total loans and leases. Over 98% of the loan and lease portfolio consists of loans and leases extended directly to
companies or individuals doing business and residing within our market areas. The remaining portion is comprised
of commercial loans participated with certain unaffiliated commercial banks outside of our market areas, which are
underwritten using the same loan criteria as though our bank was the originating bank.
The following table summarizes nonperforming loans and leases and troubled debt restructurings.
Loans and leases on
nonaccrual status
Loans and leases 90 days
or more past due and
accruing interest
Troubled debt
restructurings
December 31,2006
December 31, 2005
December 31, 2004
December 31, 2003
December 31, 2002
$ 7,752,000
$ 3,601,000
$ 2,842,000
$ 233,000
$ 796,000
819,000
394,000
0
1,552,000
0
0
0
0
0
0
Total
$ 8,571,000
$ 3,995,000
$ 2,842,000
$ 1,785,000
$ 796,000
F-7
The following table summarizes changes in the allowance for loan and lease losses for the past five years.
2006
2005
2004
2003
2002
Loan and leases outstanding at year-end
$ 1,745,478,000
$ 1,561,812,000
$1,317,124,000
$1,035,963,000
$ 771,554,000
Daily average balance of loans and
leases outstanding
Balance of allowance at beginning of
year
Loans and leases charged-off:
Commercial, financial and agricultural
Construction and land development
Leases
Residential real estate
Instalment loans to individuals
Total loans and leases charged-off
Recoveries of previously charged-off
loans and leases:
Commercial, financial and agricultural
Construction and land development
Leases
Residential real estate
Instalment loans to individuals
Total recoveries
$ 1,660,284,000
$ 1,432,609,000
$1,177,568,000
$ 887,512,000
$ 669,781,000
$ 20,527,000
$ 17,819,000
$ 14,379,000
$ 10,890,000
$ 8,494,000
(5,208,000)
0
0
(50,000)
(131,000)
(5,389,000)
(718,000)
(521,000)
0
(131,000)
(22,000)
(1,392,000)
(1,328,000)
0
0
(16,000)
(61,000)
(1,405,000)
(696,000)
(471,000)
0
0
0
0
(26,000) 0
(10,000)
(99,000)
(706,000)
(596,000)
487,000
0
0
2,000
9,000
498,000
298,000
2,000
0
6,000
4,000
310,000
150,000
0
0
0
21,000
171,000
257,000
0
0
22,000
6,000
285,000
78,000
0
0
4,000
18,000
100,000
Net charge-offs
(4,891,000)
(1,082,000)
(1,234,000)
(311,000)
(606,000)
Provision for loan and leases losses
5,775,000
3,790,000
4,674,000
3,800,000
3,002,000
Balance of allowance at year-end
$ 21,411,000
$ 20,527,000
$ 17,819,000
$ 14,379,000
$ 10,890,000
Ratio of net charge-offs during the
period
leases
to average
outstanding during the period
loans and
Ratio of allowance to loans and leases
outstanding at end of the period
(0.29%)
(0.08%)
(0.10%)
(0.04%)
(0.09%)
1.23%
1.31%
1.35%
1.39%
1.41%
In each accounting period, we adjust the allowance to the amount we believe is necessary to maintain the allowance
at adequate levels. Through the loan and lease 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, but not limited to, consideration of the internally prepared Reserve Analysis,
composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and
portfolio and general economic conditions. In addition, the strong commercial loan and leases growth is taken into
account.
The Reserve Analysis, used since our inception 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 total loans and leases, reserve allocation factors are based
upon the loan ratings as determined by our standardized grade paradigms. For retail loans, reserve allocation factors
are based upon the type of credit. Adjustments for specific lending relationships, including impaired loans and
leases, are made on a case-by-case basis. The reserve allocation factors are primarily based on the recent levels and
historical trends of net loan charge-offs and non-performing assets, the comparison of the recent levels and historical
trends of net loan charge-offs and non-performing assets with a customized peer group consisting of ten similarly-
sized publicly traded banking organizations conducting business in the states of Michigan, Illinois, Indiana and/or
Ohio, the review and consideration of our loan migration analysis and the experience of senior management making
similar loans and leases for an extensive period of time. We regularly review the Reserve Analysis and make
adjustments periodically based upon identifiable trends and experience.
F-8
The following table illustrates the breakdown of the allowance balance to loan type (dollars in thousands) and of the
total loan and lease portfolio (in percentages).
December 31, 2006
December 31, 2005
December 31, 2004
December 31, 2003
December 31, 2002
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Commercial,
financial and
agricultural
Construction and
land development
$ 15,706
75.1%
$ 16,507
76.9%
$15,457
79.8%
$12,220
79.0%
$ 9,188
77.9%
3,975
16.8
2,868
14.5
1,581
10.3
1,571
11.4
1,143
13.5
Leases
15
0.1
30
0.1
39
0.2
26
0.2
11
0.1
Residential real
estate
Instalment loans to
individuals
1,591
7.5
1,020
8.2
557
9.3
450
8.9
443
7.9
124
0.5
102
0.3
185
0.4
112
0.5
105
0.6
Unallocated
0
NA
0
NA
0
NA
0
NA
0
NA
Total
$ 21,411
100.0%
$ 20,527
100.0%
$17,819
100.0%
$14,379
100.0%
$10,890
100.0%
The primary risk elements with respect to commercial loans and leases are the financial condition of the borrower,
the sufficiency of collateral, and lack of timely payment. We have a policy of requesting and reviewing periodic
financial statements from commercial loan and lease customers, and we periodically review the existence of
collateral and its value. The primary risk element with respect to each instalment and residential real estate loan is
lack of timely payment. We have a reporting system that monitors past due loans and have adopted policies to
pursue creditor’s rights in order to preserve our bank’s position.
Although we believe that the allowance is adequate to sustain losses as they arise, there can be no assurance that our
bank will not sustain losses in any given period that could be substantial in relation to, or greater than, the size of the
allowance.
The securities portfolio also experienced strong growth during 2006, increasing from $181.6 million on December
31, 2005 to $202.4 million at December 31, 2006. During 2006, the securities portfolio equaled 10.2% of average
earning assets. We maintain the portfolio at levels to provide adequate pledging for the repurchase agreement
program and secondary liquidity for our daily operations. In addition, the portfolio serves a primary interest rate risk
management function. At December 31, 2006, the portfolio was comprised of high credit quality U.S. Government
Agency issued bonds (38%), municipal general obligation and revenue bonds (32%), U.S. Government Agency
issued and guaranteed mortgage-backed securities (26%), Federal Home Loan Bank stock (4%) and a mutual fund
(less than 1%).
F-9
The following table reflects the composition of the securities portfolio, excluding Federal Home Loan Bank stock.
December 31, 2006
December 31, 2005
December 31, 2004
Carrying
Value
Percentage
Carrying
Value
Percentage
Carrying
Value
Percentage
$ 76,836,000
39.4%
$ 63,712,000
36.7%
$ 56,025,000
38.3%
53,083,000
27.2
48,237,000
27.7
37,801,000
25.9
56,870,000
29.2
53,685,000
30.9
45,063,000
30.8
7,073,000
3.6
7,081,000
4.1
7,278,000
5.0
U.S. Government
agency debt obligations
Mortgage-backed
securities
Municipal general
obligations
Municipal revenue
bonds
Mutual fund
1,048,000
0.6
1,012,000
0.6
0
NA
Total
$ 194,910,000
100.0%
$ 173,727,000
100.0%
$ 146,167,000
100.0%
All securities, with the exception of tax-exempt municipal bonds, have been designated as “available for sale” as
defined in Financial Accounting Standards Board Standard (SFAS) No. 115, Accounting for Certain Investments in
Debt and Equity Securities. Securities designated as available for sale are stated at fair value, with the unrealized
gains and losses, net of income tax, reported as a separate component of shareholders’ equity in accumulated other
comprehensive income. The fair value of securities designated as available for sale at December 31, 2006 and 2005
was $131.0 million and $113.0 million, respectively. The net unrealized loss recorded at December 31, 2006 was
$1.7 million, compared to the net unrealized loss of $2.2 million as of December 31, 2005. All tax-exempt
municipal bonds have been designated as “held to maturity” as defined in SFAS No. 115, and are stated at amortized
cost. As of December 31, 2006 and 2005, held to maturity securities had an amortized cost of $63.9 million and
$60.8 million and a fair value of $65.0 million and $62.9 million, respectively.
The following table shows by class of maturities as of December 31, 2006, the amounts and weighted average yields
of investment securities (1):
U.S. Treasury securities and obligations of U.S.
Government agencies and corporations
One year or less
Over one through five years
Over five through ten years
Over ten years
Obligations of states and political subdivisions
One year or less
Over one through five years
Over five through ten years
Over ten years
Mortgage-backed securities
Mutual fund
Carrying
Value
Average
Yield
(Dollars in thousands)
$
0
17,647,000
59,189,000
0
76,836,000
2,593,000
8,798,000
11,533,000
41,019,000
63,943,000
53,083,000
1,048,000
NA
4.72%
5.21
NA
5.10
7.11
6.87
6.38
6.39
6.48
5.03
4.36
$ 194,910,000
5.53%
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent basis.
F-10
Federal funds sold, consisting of excess funds sold overnight to correspondent banks, are used to manage daily
liquidity needs and interest rate sensitivity. During 2006, the average balance of these funds equaled 0.5% of
average earning assets, unchanged from the level during 2005. The levels maintained during 2006 and 2005 are well
within our internal policy guidelines, and future levels are not expected to change significantly.
Cash and due from bank balances increased from $36.2 million at December 31, 2005, to $51.4 million on
December 31, 2006, an increase of $15.2 million. The increase was primarily the result of larger amounts of
deposits made by our deposit customers on the last business day of 2006 when compared to the last business day of
2005. Our commercial lending and wholesale funding focus results in relatively large day-to-day fluctuations of our
cash and due from bank balances; however, relative to our asset size the average balances are generally stable. Cash
and due from bank balances averaged $38.3 million, or 2.0% of average assets during 2006, compared to $36.8
million, or 2.2% of average assets, during 2005.
Net premises and equipment increased from $30.2 million at December 31, 2005, to $33.5 million on December 31,
2006, an increase of $3.3 million. The increase primarily reflects the land acquisition and initial construction costs
associated with our new office facility currently under construction in East Lansing, Michigan. Construction on this
new facility is expected to be completed during the second quarter of 2007.
Source of Funds
Our major sources of funds are from deposits, repurchase agreements and Federal Home Loan Bank (“FHLB”)
advances. Total deposits increased from $1,419.4 million at December 31, 2005, to $1,646.9 million on December
31, 2006, an increase of $227.5 million, or 16.0%. Included within these numbers is the success we achieved in
generating deposit growth from customers located within our market areas during 2006. Local deposits increased
from $456.5 million at December 31, 2005, to $633.1 million on December 31, 2006, an increase of $176.6 million,
or 38.7%. Despite this success in obtaining funds from local customers, the substantial asset growth has necessitated
the continued acquisition of funds from depositors outside of our market areas and FHLB advances. Out-of-area
deposits increased from $962.8 million at December 31, 2005, to $1,013.8 million on December 31, 2006, an
increase of $51.0 million, or 5.3%. Repurchase agreements increased from $72.2 million at December 31, 2005, to
$85.5 million on December 31, 2006, an increase of $13.3 million, or 18.4%. FHLB advances decreased from
$130.0 million at December 31, 2005, to $95.0 million on December 31, 2006, a decrease of $35.0 million, or
26.9%. At December 31, 2006, local deposits and repurchase agreements equaled 38.4% of total funding liabilities,
compared to 31.8% on December 31, 2005.
During 2006, we experienced strong growth in our noninterest-bearing checking deposit accounts. Comprised
primarily of business loan customers, noninterest-bearing checking deposit accounts grew $12.4 million, or 10.2%,
and equaled 6.4% of average total liabilities during 2006. Interest-bearing checking accounts increased $0.2 million,
or 0.4%, and equaled 2.0% of average total liabilities during 2006. Money market deposit accounts decreased $0.9
million, or 9.0%, and equaled 0.6% of average total liabilities during 2006. Business loan customers also comprise
the majority of interest-bearing checking and money market deposit accounts, although to a lesser extent than
noninterest-bearing checking accounts. Pursuant to Federal law and regulations, incorporated businesses may not
own interest-bearing checking accounts and transactions from money market accounts are limited. We anticipate
continued overall growth of our check-writing deposit accounts as additional business loans are extended and
through the efforts of our branch network and business development activities.
During 2006, savings account balances recorded a decrease of $13.9 million, or 13.1%, and equaled 5.2% of average
total liabilities. The decline in savings account balances during 2006 is primarily due to customers opening
certificates of deposit with funds from their savings accounts, as rates offered on certificates of deposit have risen at
a faster pace than rates offered on savings accounts. Business loan customers also comprise the majority of savings
account holders, although to a lesser extent than check-writing accounts. While we anticipate an increase in savings
account balances as additional business loans are extended and through the efforts of our branch network and
business development activities, the increase may be negatively impacted by potential continued fund transfers to
certificate of deposit products.
F-11
Certificates of deposit purchased by customers located within our market areas increased significantly during 2006,
growing from $179.3 million at December 31, 2005, to $358.2 million on December 31, 2006, an increase of $178.9
million, or 99.8%. These deposits accounted for 15.9% of average total liabilities during 2006. The growth was
attributable to individuals, businesses and municipalities, and includes new monies to our bank from existing and
new customers as well as transfers from existing savings accounts. The increase in local municipality certificates of
deposit has been facilitated by our qualifying for funds from new municipal customers and additional funds from
existing customers through a combination of our asset growth and increased profitability as measured by the
municipalities’ investment policy guidelines, and is a trend that we expect to continue.
During 2006, certificates of deposit obtained from customers located outside of our market areas increased by $51.0
million, and represented 55.9% of average total liabilities. At December 31, 2006, out-of-area deposits totaled
$1,013.8 million. Out-of-area deposits consist primarily of certificates of deposit placed by deposit brokers for a fee,
but also include certificates of deposit obtained from the deposit owners directly. The owners of the out-of-area
deposits include individuals, businesses and governmental units located throughout the country. Out-of-area deposits
are utilized to support our asset growth, and are generally a lower cost source of funds when compared to the interest
rates that would have to be offered in the local market to generate a sufficient level of funds. During most of 2006,
rates paid on new out-of-area deposits were very similar to rates paid on new certificates of deposit issued to local
customers. In addition, the 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 individual deposit relationships are established and
as existing customers increase the balances in their deposit accounts, the relatively high reliance on out-of-area
deposits will likely remain.
Repurchase agreements increased $13.3 million and equaled 4.0% of average total liabilities during 2006. As part of
our sweep account program, collected funds from certain business noninterest-bearing checking accounts are
invested in overnight interest-bearing repurchase agreements. Although not considered a deposit account and
therefore not afforded federal deposit insurance, the repurchase agreements are a means of providing a return for
business customers that are not permitted to have an interest-bearing checking account.
FHLB advances decreased $35.0 million and equaled 6.8% of average total liabilities during 2006. FHLB 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 at December 31, 2006 totaled $322.6 million. We first
started to use FHLB advances in late 2002, and expect to continue to use this funding source, along with out-of-area
certificates of deposit, as part of our wholesale funding program.
Shareholders’ equity increased $16.8 million and equaled 8.3% of average assets during 2006. The increase was
primarily attributable to net income from operations. Net income from operations totaled $19.8 million during 2006.
Also positively impacting shareholders’ equity was a $0.3 million mark-to-market adjustment for available for sale
securities as defined in SFAS No. 115, plus proceeds totaling $0.4 million relating to stock option exercises and our
dividend reinvestment and employee stock purchase plans. Negatively impacting shareholders’ equity during 2006
was the payment of cash dividends, which totaled $4.0 million.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2006 and 2005
Summary
We recorded strong earnings performance during 2006. Net income was $19.8 million, or $2.48 per basic share and
$2.45 per diluted share. This earnings performance compares favorably to net income of $17.9 million, or $2.25 per
basic share and $2.20 per diluted share, recorded in 2005. The $1.9 million improvement in net income represents
an increase of 10.9%, while diluted earnings per share were up 11.4%. The earnings improvement during 2006 over
that of 2005 is primarily attributable to higher net interest income, which more than offset increases in provision
expense and overhead costs.
F-12
The following table shows some of the key performance and equity ratios for the years ended December 31, 2006
and 2005.
Return on average total assets
Return on average equity
Dividend payout ratio
Average equity to average assets
2006
2005
1.01%
12.19
20.34
8.31
1.05%
12.05
17.79
8.73
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 $138.5 million and $75.7 million during 2006, respectively, providing for net interest income of
$62.8 million. This performance compares favorably to that of 2005 when interest income and interest expense were
$103.2 million and $46.8 million, respectively, providing for net interest income of $56.4 million. In comparing
2006 with 2005, interest income increased 34.1%, interest expense was up 61.6% and net interest income increased
11.3%. 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 of assets and liabilities, interest rate environment, interest rate risk, common stock sales, liquidity, and
customer behavior also impact net interest income as well as the net interest margin.
The net interest margin declined from 3.50% in 2005 to 3.37% in 2006, a decrease of 3.7%. Our net interest margin
during 2004 was 3.30%. Throughout 2005 and during the first half of 2006, our net interest margin was generally on
an increasing trend. From June 2004 through June 2006, the Federal Open Market Committee (“FOMC”) increased
the federal funds rate by 25 basis points at 17 consecutive meetings, causing the prime rate to increase from 4.00% in
June 2004 to 8.25% in June 2006. Our yield on assets increased significantly during this time period, as the interest
rates on over 70% of our total loans and leases were tied to the prime rate. Our cost of funds also increased during
this time period, as interest rates paid on our deposits and borrowings increased as well. However, our cost of funds
increased at a slower rate than the increase in our yield on assets, with a significant portion of our interest-bearing
liabilities comprised of fixed rate certificates of deposit and borrowings, resulting in a lagged increased cost of funds.
The FOMC has left the federal funds rate unchanged since June 2006, resulting in a relatively steady yield on assets.
However, our cost of funds has continued to increase as maturing fixed rate certificates of deposit and borrowings,
which were obtained during lower interest rate environments, are replaced or renewed at higher interest rates.
Assuming no major changes in the federal funds rate in the near future, we expect our cost of funds, and therefore
our net interest margin, to level-out during the second quarter of 2007.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets,
liabilities and shareholders’ equity during 2006, 2005 and 2004. The table also depicts the dollar amount of change
in interest income and interest expense of interest-earning assets and interest-bearing liabilities, segregated between
change due to volume and change due to rate. For tax-exempt investment 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 $1.2 million, $1.1 million and $1.0 million in 2006, 2005 and 2004, respectively.
F-13
(Dollars in thousands)
Years ended December 31,
----------------------2 0 0 6-----------------
Average
Rate
Average
Balance
Interest
-----------------------2 0 0 5 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 0 4 -----------------
Average
Rate
Average
Balance
Interest
Taxable securities $ 128,382 $
Tax-exempt
securities
Total securities
61,949
190,331
6,557
5.11% $ 114,097 $
5,588
4.90%
$
82,107 $
3,935
4.79%
3,930
10,487
6.34
5.51
58,005
172,102
3,703
9,291
6.38
5.40
48,322
130,429
3,174
7,109
6.57
5.45
Loans and leases
Short-term
investments
Federal funds sold
Total earning
assets
Allowance for loan
and lease losses
Cash and due
from banks
Other non-earning
assets
1,660,284
127,470
7.68
1,432,609
93,666
6.54
1,177,568
62,791
5.33
320
9,745
12
482
3.75
4.95
582
8,156
14
266
2.41
3.26
593
5,942
4
75
0.67
1.26
1,860,680
138,451
7.44
1,613,449
103,237
6.40
1,314,532
69,979
5.32
(21,464)
38,298
82,419
(19,048)
36,827
70,769
(16,203)
31,587
49,262
Total assets
$ 1,959,933
$ 1,701,997
$ 1,379,178
Interest-bearing
demand deposits $
Savings deposits
Money market
accounts
Time deposits
Total interest-
bearing deposits
10,326
1,289,777
1,429,679
75,885
Short-term
borrowings
Federal Home Loan
Bank advances
Long-term
borrowings
Total interest-
bearing liabilities 1,663,391
121,932
35,895
36,530 $
93,046
1,069
3,328
2.93%
3.58
$
36,319 $
113,945
707
2,934
1.95%
2.57
$
32,994 $
136,214
427
2,497
1.29%
1.83
325
60,033
3.15
4.65
9,478
1,036,457
211
35,032
2.23
3.38
8,788
780,867
129
18,733
1.47
2.40
64,755
4.53
1,196,199
38,884
3.25
958,863
21,786
2.27
2,867
3.78
66,814
1,795
2.69
55,816
877
1.57
5,393
4.42
131,137
4,200
3.20
112,869
2,471
2.19
2,658
7.40
35,014
1,959
5.59
18,938
1,461
7.71
75,673
4.55
1,429,164
46,838
3.28
1,146,486
26,595
2.32
Demand deposits
Other liabilities
Total liabilities
Average equity
Total liabilities
and equity
115,390
18,371
1,797,152
162,781
$ 1,959,933
111,892
12,352
1,553,408
148,589
$ 1,701,997
90,534
7,156
1,244,176
135,002
$ 1,379,178
Net interest
income
Rate spread
Net interest
margin
$
62,778
$
56,399
$
43,384
2.89%
3.37%
3.12%
3.50%
3.00%
3.30%
F-14
--------------------2006 over 2005 --------------------
Volume
Total
Rate
-------------------- 2005 over 2004--------------------
Volume
Total
Rate
Years ended December 31,
Increase (decrease) in interest income
Taxable securities
Tax exempt securities
Loans
Short term investments
Federal funds sold
Net change in tax-equivalent
$
969,000
227,000
33,804,000
(2,000)
216,000
$
722,000
250,000
16,123,000
(8,000)
59,000
$
247,000
(23,000)
17,681,000
6,000
157,000
$ 1,653,000
529,000
30,875,000
10,000
191,000
$ 1,565,000
620,000
15,104,000
0
36,000
$
88,000
(91,000)
15,771,000
10,000
155,000
income
35,214,000
17,146,000
18,068,000
33,258,000
17,325,000
15,933,000
Increase (decrease) in interest expense
Interest-bearing demand deposits
Savings deposits
Money market accounts
Time deposits
Short term borrowings
Federal Home Loan Bank
advances
Long term borrowings
Net change in interest
362,000
394,000
114,000
25,001,000
1,072,000
4,000
(605,000)
20,000
9,832,000
268,000
358,000
999,000
94,000
15,169,000
804,000
280,000
437,000
82,000
16,299,000
918,000
47,000
(456,000)
11,000
7,246,000
199,000
233,000
893,000
71,000
9,053,000
719,000
1,193,000
699,000
(312,000)
50,000
1,505,000
649,000
1,729,000
498,000
448,000
983,000
1,281,000
(485,000)
expense
28,835,000
9,257,000
19,578,000
20,243,000
8,478,000
11,765,000
Net change in tax-equivalent
net interest income
$ 6,379,000
$ 7,889,000
$ (1,510,000)
$ 13,015,000
$ 8,847,000
$ 4,168,000
Interest income is primarily generated from the loan and lease portfolio, and to a lesser degree from securities,
federal funds sold and short term investments. Interest income increased $35.3 million during 2006 from that earned
in 2005, totaling $138.5 million in 2006 compared to $103.2 million in the previous year. The increase is primarily
due to the growth in earning assets and a higher interest rate environment during 2006 when compared to 2005.
Reflecting the higher interest rate environment, the yield on average earning assets increased from 6.40% recorded in
2005 to 7.44% in 2006.
The growth in interest income is primarily attributable to an increase in earning assets and an increase in earning
asset yields. During 2006, average earning assets increased $247.3 million, increasing from $1,613.4 million in
2005 to $1,860.7 million during 2006. Growth in average total loans and leases, totaling $227.7 million, comprised
92.1% of the increase in average earning assets during 2006. Interest income generated from the loan and lease
portfolio increased $33.8 million during 2006 over the level earned in 2005, comprised of an increase of $16.1
million from the growth in the loan and lease portfolio and an increase of $17.7 million due to the increase in the
yield earned on the loan portfolio to 7.68% from 6.54%. The increase in the loan and lease portfolio yield is
primarily due to a higher interest rate environment during 2006 than in 2005.
Growth in the securities portfolio and an improved overall yield also added to the increase in interest income during
2006 over that of 2005. Average securities increased by $18.2 million in 2006, increasing from $172.1 million in
2005 to $190.3 million in 2006. The growth equated to an increase in interest income of $1.0 million, while an
improved yield earned on the securities portfolio from 5.40% to 5.51% increased interest income by $0.2 million.
Interest income earned on federal funds sold increased by $0.2 million due to a small increase in the average balance
and a higher yield during 2006.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree from repurchase
agreements, FHLB advances and subordinated debentures. Interest expense increased $28.8 million during 2006
from that expensed in 2005, totaling $75.6 million in 2006 compared to $46.8 million in the previous year. The
increase in interest expense is primarily attributable to the impact of an increase in interest-bearing liabilities and a
higher interest rate environment during 2006 when compared to 2005. Interest-bearing liabilities averaged $1,663.4
million during 2006, or $234.2 million higher than the average interest-bearing liabilities of $1,429.2 million during
2005. This growth resulted in increased interest expense of $9.3 million. An increase in interest expense of $19.6
million was recorded during 2006 primarily due to a higher interest rate environment during 2006 than in 2005. The
cost of average interest-bearing liabilities increased from the 3.28% recorded in 2005 to 4.55% in 2006.
F-15
Average certificate of deposit growth during 2006 of $253.3 million equated to an increase in interest expense of
$9.8 million, with an additional $15.2 million expensed due to the increase in the average rate paid as lower-rate
certificates of deposit matured and were either renewed or replaced with higher-costing certificates of deposit
throughout 2006. A decline in average savings deposits, totaling $20.9 million, equated to a decrease in interest
expense of $0.6 million; however, interest expense of $1.0 million was recorded due to an increase in the average
rate paid during 2006. Growth in average interest-bearing checking accounts of $0.2 million equated to a less than
$0.1 million increase in interest expense, with an additional $0.4 million of interest expense recorded due to a higher
average rate paid during 2006.
Average short term borrowings, comprised of repurchase agreements and federal funds purchased, increased $9.1
million during 2006, resulting in increased interest expense of $0.3 million, with an additional interest expense of
$0.8 million recorded due to an increase in the average rate paid during 2006. Average FHLB advances decreased
$9.2 million, equating to a decrease in interest expense of $0.3 million, with an increased average rate adding $1.5
million to interest expense. Growth in average long-term borrowings, comprised of subordinated debentures and
deferred director and officer compensation programs, equated to an increase in interest expense of less than $0.1
million during 2006, with an increased average rate adding $0.6 million to interest expense.
Provision for Loan and Lease Losses
The provision for loan and lease losses totaled $5.8 million during 2006, compared to the $3.8 million expensed
during 2005. The increase primarily reflects an increase in the volume of loan and lease net charge-offs during 2006
when compared to 2005, partially offset by lower loan and lease growth in 2006. Net loan and lease charge-offs
during 2006 totaled $4.9 million, or 0.29% of average total loans and leases. Net loan and lease charge-offs during
2005 totaled $1.1 million, or 0.08% of average total loans and leases. Loan and lease growth during 2006 equaled
$183.7 million, compared to loan and lease growth of $244.7 million during 2005. The allowance as a percentage of
total loans outstanding as of December 31, 2006 was 1.23%, compared to 1.31% at year-end 2005.
In each accounting period, we adjust the allowance by the amount we believe is necessary to maintain the allowance
at adequate levels. Through the loan and lease 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, but not limited to, consideration of the internally prepared Reserve Analysis,
composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and
portfolio and general economic conditions. In addition, the strong commercial loan and leases growth is taken into
account.
The Reserve Analysis, used since our inception 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 total loans and leases, reserve allocation factors are based
upon the loan ratings as determined by our standardized grade paradigms. For retail loans, reserve allocation factors
are based upon the type of credit. Adjustments for specific lending relationships, including impaired loans and
leases, are made on a case-by-case basis. The reserve allocation factors are primarily based on the recent levels and
historical trends of net loan charge-offs and non-performing assets, the comparison of the recent levels and historical
trends of net loan charge-offs and non-performing assets with a customized peer group consisting of ten similarly-
sized publicly traded banking organizations conducting business in the states of Michigan, Illinois, Indiana and/or
Ohio, the review and consideration of our loan migration analysis and the experience of senior management making
similar loans and leases for an extensive period of time. We regularly review the Reserve Analysis and make
adjustments periodically based upon identifiable trends and experience.
F-16
Noninterest Income
Noninterest income totaled $5.3 million in 2006, a decrease of $0.4 million from the $5.7 million earned in 2005.
Other noninterest income during 2005 included a one-time gain of $0.7 million which was recorded from the sale of
state tax credits derived from the construction of the new main office in downtown Grand Rapids. Deposit and
repurchase agreement service charges were unchanged in 2006 when compared to 2005; although the number of
deposit accounts increased during 2006, the earnings credit rate also increased, reducing the level of fees paid by our
depositors. Earnings from increased cash surrender value of bank owned life insurance policies increased $0.2
million in 2006, primarily reflecting a higher balance from the purchase of additional policies during the year. We
recorded increases in virtually all other fee income-producing activities in 2006 when compared to 2005, with the
exception of residential mortgage banking fees, which decreased $0.1 million due to lower volume of activity.
Noninterest Expense
Noninterest expense during 2006 totaled $32.3 million, an increase of $1.2 million over the $31.1 million expensed
in 2005. Salary expense and benefit costs increased $0.3 million in 2006 when compared to 2005. Base
compensation increased approximately $2.9 million, primarily reflecting the increase in full-time equivalent
employees from 273 at year-end 2005 to 291 at year-end 2006 and annual pay increases. However, bonus expense
declined $2.6 million during 2006 when compared to 2005. Occupancy, furniture and equipment costs increased
$0.9 million in 2006, primarily reflecting a full year’s expense associated with the opening of our new main office in
downtown Grand Rapids 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. All other non-interest expenses, in aggregate, were relatively
unchanged in 2006 when compared to 2005.
While the dollar amount of noninterest costs has increased, the growth of net interest income and fee income has
increased more. Noninterest costs during 2006 were $1.2 million higher than the level of overhead costs expensed
during 2005; however, net interest income and fee income increased a combined $5.9 million during the same time
period. Monitoring and controlling our noninterest costs, while at the same time providing high quality service to
our customers, is one of our priorities. The efficiency ratio, a banking industry standardized calculation that attempts
to reflect the utilization of overhead costs, improved during 2006 and remained well below banking industry
averages. Computed by dividing noninterest expenses by net interest income plus noninterest income, the efficiency
ratio was 48.3% during 2006, compared to 51.1% during 2005.
Federal Income Tax Expense
Federal income tax expense was $9.0 million in 2006, an increase of $0.9 million over the $8.1 million expensed
during 2005. The increase during 2006 is primarily due to the growth in our pre-federal income tax profitability.
The effective tax rate for 2006 was 31.1%, compared to 31.3% in 2005.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Summary
We recorded strong earnings performance during 2005. Net income was $17.9 million, or $2.25 per basic share and
$2.20 per diluted share. This earnings performance compares favorably to net income of $13.7 million, or $1.73 per
basic share and $1.69 per diluted share, recorded in 2004. The $4.2 million improvement in net income represents
an increase of 30.5%, while diluted earnings per share were up 30.2%. The earnings improvement during 2005 over
that of 2004 is primarily attributable to higher net interest income and a lower provision expense, which more than
offset an increase in overhead costs.
Net income for 2004 includes an $845,000 ($548,000 after-tax) write-off associated with the unamortized balance of
issuance costs related to the redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued in
1999 by MBWM Capital Trust I. Excluding this one-time expense, net income for 2004 was $14.3 million ($1.80
per basic share and $1.76 per diluted share). We believe excluding the impact of the one-time charge from 2004
operating results and performance measures allows a more meaningful comparison of 2005 results to 2004 results;
therefore, the following discussion of our results of operations for the years ended December 31, 2005 and
December 31, 2004 includes both GAAP and non-GAAP facts and figures where appropriate.
F-17
The following table shows some of the key performance and equity ratios for the years ended December 31, 2005
and 2004.
Return on average total assets
Return on average equity
Dividend payout ratio
Average equity to average assets
2005
2004
1.05%
12.05
17.79
8.73
0.99%
10.16
18.60
9.79
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 $103.2 million and $46.8 million during 2005, respectively, providing for net interest income of
$56.4 million. This performance compares favorably to that of 2004 when interest income and interest expense were
$70.0 million and $26.6 million, respectively, providing for net interest income of $43.4 million. In comparing 2005
with 2004, interest income increased 47.4%, interest expense was up 76.0% and net interest income increased
30.0%. 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 of assets and liabilities, interest rate risk, common stock sales, liquidity, and customer behavior also
impact net interest income as well as the net interest margin. The net interest margin improved from 3.30% in 2004
to 3.50% in 2005, an increase of 6.1%, primarily due to earning assets repricing faster than interest-bearing liabilities
during the increasing interest rate environment that existed during virtually all of 2005.
Interest income is primarily generated from the loan portfolio, and to a lesser degree from securities, federal funds
sold and short term investments. Interest income increased $33.3 million during 2005 from that earned in 2004,
totaling $103.2 million in 2005 compared to $70.0 million in the previous year. The increase is primarily due to the
growth in earning assets and a higher interest rate environment during 2005 when compared to 2004. Reflecting the
higher interest rates, the yield on average earning assets increased from 5.32% recorded in 2004 to 6.40% in 2005.
The growth in interest income is primarily attributable to an increase in earning assets and an increase in earning
asset yields. During 2005, average earning assets increased $298.9 million, increasing from $1,314.5 million in
2004 to $1,613.4 million during 2005. Growth in average total loans and leases, totaling $255.0 million, comprised
85.3% of the increase in average earning assets during 2005. Interest income generated from the loan and lease
portfolio increased $30.9 million during 2005 over the level earned in 2004, comprised of an increase of $15.1
million from the growth in the loan and lease portfolio and an increase of $15.8 million due to the increase in the
yield earned on the loan and lease portfolio to 6.54% from 5.33%. The increase in the loan and lease portfolio yield
is primarily due to a higher interest rate environment during 2005 than in 2004.
Growth in the securities portfolio, partially offset by a slightly lower yield, also added to the increase in interest
income during 2005 over that of 2004. Average securities increased by $41.7 million in 2005, increasing from
$130.4 million in 2004 to $172.1 million in 2005. The growth equated to an increase in interest income of $2.2
million, while a decrease in the yield earned on the securities portfolio from 5.45% to 5.40% reduced interest income
by $0.1 million. Interest income earned on federal funds sold increased by $0.2 million due to a small increase in the
average balance and a higher yield during 2005.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree from repurchase
agreements, FHLB advances and subordinated debentures. Interest expense increased $20.2 million during 2005
from that expensed in 2004, totaling $46.8 million in 2005 compared to $26.6 million in the previous year. The
increase in interest expense is primarily attributable to the impact of an increase in interest-bearing liabilities and a
higher interest rate environment during 2005 when compared to 2004. Interest-bearing liabilities averaged $1,429.2
million during 2005, or $282.7 million higher than the average interest-bearing liabilities of $1,146.5 million during
2004. This growth resulted in increased interest expense of $8.5 million. An increase in interest expense of $11.7
million was recorded during 2005 primarily due to a higher interest rate environment during 2005 than in 2004. The
cost of average interest-bearing liabilities increased from the 2.32% recorded in 2004 to 3.28% in 2005.
F-18
Growth in average certificates of deposits, totaling $255.6 million, comprised 90.4% of the increase in average
interest-bearing liabilities between 2005 and 2004. Average FHLB advances increased $18.2 million, or 6.4% of the
increase in average interest-bearing liabilities in 2005. The certificate of deposit growth during 2005 equated to an
increase in interest expense of $7.2 million, with an additional $9.1 million expensed due to the increase in the
average rate paid as lower-rate certificates of deposit matured and were either renewed or replaced with higher-
costing certificates of deposit during most of 2005. FHLB advance growth during 2005 equated to an increase in
interest expense of $0.4 million, with an increased average rate adding an additional $1.3 million to interest expense.
A decline in average savings deposits, totaling $22.3 million, equated to a decrease in interest expense of $0.5
million; however, interest expense of $0.9 million was recorded due to an increase in the average rate paid during
2005. Growth in average interest-bearing checking accounts of $3.3 million equated to a less than $0.1 million
increase in interest expense, with an additional $0.2 million of interest expense recorded due to a higher average rate
paid during 2005. Average short term borrowings, comprised of repurchase agreements and federal funds
purchased, increased $11.0 million during 2005, resulting in increased interest expense of $0.2 million, with an
additional interest expense of $0.7 million recorded due to an increase in the average rate paid during 2005.
Growth of $16.1 million in average long-term borrowings, comprised primarily of subordinated debentures but also
including deferred director and officer compensation programs, equated to an increase in interest expense of $1.0
million during 2005; however, a decline in the average rate paid on subordinated debentures resulting from the
September 2004 refinance, equated to a $0.5 million reduction of interest expense during 2005.
Provision for Loan and Lease Losses
The provision for loan and lease losses totaled $3.8 million during 2005, compared to the $4.7 million expensed
during 2004. The decline primarily reflects lower loan and lease loan growth and a decline in the volume of loan
and lease net charge-offs during 2005 when compared to 2004. The allowance as a percentage of total loans
outstanding as of December 31, 2005 was 1.31%, compared to 1.35% at year-end 2004. Loan and lease growth
during 2005 equaled $244.7 million, compared to loan and lease growth of $281.2 million during 2004. Net loan
and lease charge-offs during 2005 totaled $1.1 million, or 0.08% of average total loans and leases. Net loan and
lease charge-offs during 2004 totaled $1.2 million, or 0.10% of average total loans and leases.
In each accounting period, we adjust the allowance by the amount we believe is necessary to maintain the allowance
at adequate levels. Through the loan and lease 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, but not limited to, consideration of the internally prepared Reserve Analysis,
composition of the loan and lease portfolio, third party analysis of the loan and lease administration processes and
portfolio and general economic conditions. In addition, the strong commercial loan and leases growth is taken into
account.
The Reserve Analysis, used since our inception 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 total loans and leases, reserve allocation factors are based
upon the loan ratings as determined by our standardized grade paradigms. For retail loans, reserve allocation factors
are based upon the type of credit. Adjustments for specific lending relationships, including impaired loans and
leases, are made on a case-by-case basis. The reserve allocation factors are primarily based on the recent levels and
historical trends of net loan charge-offs and non-performing assets, the comparison of the recent levels and historical
trends of net loan charge-offs and non-performing assets with a customized peer group consisting of ten similarly-
sized publicly traded banking organizations conducting business in the states of Michigan, Illinois, Indiana and/or
Ohio, the review and consideration of our loan migration analysis and the experience of senior management making
similar loans and leases for an extensive period of time. We regularly review the Reserve Analysis and make
adjustments periodically based upon identifiable trends and experience.
F-19
Noninterest Income
Noninterest income totaled $5.7 million in 2005, an increase of $1.4 million from the $4.3 million earned in 2004.
Deposit and repurchase agreement service charges increased $0.1 million in 2005, primarily reflecting the growth in
the number of deposit accounts and modest increases in the deposit fee structure. The cash surrender value of bank
owned life insurance policies increased $0.3 million in 2005, primarily reflecting a higher balance from the purchase
of additional policies during the year. Primarily reflecting an increase in volume of activity, residential mortgage
banking fees increased $0.2 million during 2005. Other noninterest income includes a gain of $0.7 million which
was recognized during 2005 from the sale of state tax credits derived from the construction of the new main office in
downtown Grand Rapids.
Noninterest Expense
Noninterest expense during 2005 totaled $31.1million, an increase of $7.9 million over the $23.2 million expensed
in 2004. Noninterest expense during 2004 includes an $845,000 write-off associated with the unamortized balance
of issuance costs related to the redemption of the $16.0 million of 9.60% Cumulative Preferred Securities issued in
1999 by the MBWM Capital Trust I. Excluding this one-time write-off, noninterest expense during 2004 totaled
$22.4 million, with the growth in overhead costs during 2005 equating to $8.7 million.
Of the $8.7 million growth in overhead costs, $4.7 million (54.0% of total) was in salaries and benefits, which
primarily reflects the increase in full-time equivalent employees from 194 at year-end 2004 to 273 at year-end 2005
and annual pay increases. Occupancy, furniture and equipment costs increased $1.6 million (18.4% of total) in 2005,
primarily reflecting the opening of our Holland banking office in October of 2004, the opening of our new main
office in downtown Grand Rapids during the second quarter of 2005, the opening of our new leased facilities in
Lansing and Ann Arbor during the third quarter of 2005 and our increased staffing level.
While the dollar amount of noninterest costs has increased, the growth of net interest income and fee income has
increased more. Noninterest costs during 2005 were $8.7 million higher than the level of overhead costs expensed
during 2004; however, net interest income and fee income increased a combined $14.2 million during the same time
period. Monitoring and controlling our noninterest costs, while at the same time providing high quality service to
our customers, is one of our priorities. The efficiency ratio, a banking industry standardized calculation that attempts
to reflect the utilization of overhead costs, declined during 2004 but remained well below banking industry averages.
Computed by dividing noninterest expenses by net interest income plus noninterest income, the efficiency ratio was
51.1% during 2005, compared to 49.6% during 2004. If the one-time write-off addressed above is excluded from the
calculation, our 2004 efficiency ratio improves to 47.8%. The decline in the efficiency ratio is primarily related to
the initial overhead costs associated with our expansion into Lansing and Ann Arbor, especially salary and benefit
and occupancy expenses.
Federal Income Tax Expense
Federal income tax expense was $8.1 million in 2005, an increase of $3.0 million over the $5.1 million expensed
during 2004. The increase during 2005 is primarily due to the growth in our pre-federal income tax profitability and
an increase in the effective tax rate, the latter of which reflects a lower level of tax-exempt income as a percent of
total income.
CAPITAL RESOURCES
Shareholders’ equity is a noninterest-bearing source of funds that provides support for our asset growth.
Shareholders’ equity was $171.9 million and $155.1 million at December 31, 2006 and 2005, respectively. The
$16.8 million increase during 2006 is primarily attributable to net income from operations. Net income from
operations totaled $19.8 million during 2006. Also positively impacting shareholders’ equity was a $0.3 million
mark-to-market adjustment for available for sale securities as defined in SFAS No. 115, plus proceeds totaling $0.4
million relating to stock option exercises and our dividend reinvestment and employee stock purchase plans.
Negatively impacting shareholders’ equity during 2006 was the payment of cash dividends, which totaled $4.0
million.
F-20
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. Our and our bank’s capital ratios as of December 31, 2006 and 2005 are disclosed under
Note 16 on pages F-55 and F-56 of the Notes to Consolidated Financial Statements.
Our ability to pay cash and stock dividends is subject to limitations under various laws and regulations and to
prudent and sound banking practices. On April 11, 2006, we declared a 5% common stock dividend, payable on
May 16, 2006 to record holders as of April 24, 2006. This represented the sixth consecutive year we have paid a 5%
stock dividend. Also during 2006, we paid a cash dividend on our common stock each calendar quarter. These cash
dividends totaled $0.51 per share for 2006, and $4.0 million in aggregate amount. On January 9, 2007, we declared
a $0.14 per common share cash dividend that will be paid on March 9, 2007 to shareholders of record on February 9,
2007.
LIQUIDITY
Liquidity is measured by our ability to raise funds through deposits, borrowed funds, capital or cash flow from the
repayment of loans and investment securities. These funds are used to meet deposit withdrawals, maintain reserve
requirements, fund loans and operate our company. Liquidity is primarily achieved through the growth of deposits
(both local and out-of-area) and liquid assets such as securities available for sale, matured securities, and federal
funds sold. 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.
Our liquidity strategy is to fund loan growth with deposits, repurchase agreements and other borrowed funds and to
maintain an adequate level of short- and medium-term investments to meet typical daily loan and deposit activity.
Net deposit and repurchase agreement growth from customers located in our market areas increased by $189.8
million, or 35.9%, during 2006. This strong growth was not fully sufficient to meet the earning asset growth of
$204.2 million. To assist in providing the additional needed funds, we regularly obtained certificates of deposit from
customers outside of our market areas. As of December 31, 2006, out-of-area deposits totaled $1,013.8 million, an
increase in dollar volume of $51.0 million from the $962.8 million outstanding at December 31, 2005. However, as
a percent of combined total deposits and repurchase agreements, out-of-area deposits declined from 64.6% as of
December 31, 2005 to 58.5% at December 31, 2006.
As a member of the Federal Home Loan Bank of Indianapolis, our bank has access to the FHLB advance borrowing
programs. As of December 31, 2006, advances totaled $95.0 million, compared to $130.0 million outstanding as of
December 31, 2005. Our borrowing line of credit at December 31, 2006 totaled $322.6 million, with availability of
$216.5 million.
We have the ability to borrow money on a daily basis through correspondent banks using established federal funds
purchased lines. During 2006, our federal funds purchased position averaged $3.7 million, compared to an average
federal funds sold position of $9.7 million. At December 31, 2006, our established unsecured federal funds
purchased lines totaled $72.0 million.
F-21
The following table reflects, as of December 31, 2006, significant fixed and determinable contractual obligations to
third parties by payment date.
One Year or Less
One to Three Years
Three to Five Years
Over Five Years
Total
Deposits without a stated maturity
$ 274,919,000
$ 0
$ 0
$ 0
$ 274,919,000
Certificates of deposits
1,027,309,000
313,680,000
30,995,000
0
1,371,984,000
Short term borrowings
95,272,000
0
0
0
95,272,000
Federal Home Loan Bank advances
80,000,000
15,000,000
0
0
95,000,000
Subordinated debentures
0
0
0
32,990,000
32,990,000
Other borrowed money
0
0
0
3,316,000
3,316,000
Operating leases
207,000
324,000
83,000 0
614,000
In addition to normal loan funding and deposit flow, we also need to maintain liquidity to meet the demands of
certain unfunded loan commitments and standby letters of credit. At December 31, 2006, we had a total of $451.1
million in unfunded loan commitments and $73.2 million in unfunded standby letters of credit. Of the total unfunded
loan commitments, $390.2 million were commitments available as lines of credit to be drawn at any time as
customers’ cash needs vary, and $60.9 million were for loan commitments scheduled to close and become funded
within the next twelve months. We monitor fluctuations in loan balances and commitment levels, and include such
data in our overall liquidity management.
The following table depicts our loan commitments at the end of the past three years.
December 31, 2006
December 31, 2005
December 31, 2004
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
$ 345,195,000
$ 303,115,000
$ 226,935,000
29,314,000
8,510,000
7,197,000
60,850,000
73,241,000
$ 524,307,000
27,830,000
7,971,000
10,791,000
83,280,000
59,058,000
$ 492,045,000
24,988,000
8,307,000
5,155,000
55,440,000
56,464,000
$ 377,289,000
MARKET RISK ANALYSIS
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 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.
F-22
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, 2006 (dollars in thousands).
Assets:
Commercial loans (1)
Leases
Residential real estate loans
Consumer loans
Securities (2)
Short term investments
Allowance for loan and lease losses
Other assets
Total assets
Liabilities:
Interest-bearing checking
Savings
Money market accounts
Time deposits under $100,000
Time deposits $100,000 and over
Short term borrowings
Federal Home Loan Bank advances
Long term borrowings
Noninterest-bearing checking
Other liabilities
Total liabilities
Shareholders’ equity
Total sources of funds
Within
Three
Months
Three to
Twelve
Months
One to
Five
Years
$
$ 893,234
11
60,235
3,169
8,711
282
0
0
965,642
39,943
92,370
9,409
34,550
351,745
95,272
30,000
36,306
0
0
689,595
0
689,595
60,125
22
4,597
134
2,478
0
0
0
67,356
0
0
0
53,196
587,818
0
50,000
0
0
0
691,014
0
691,014
$ 601,193
1,355
53,131
4,208
34,159
0
0
0
694,046
0
0
0
42,424
302,251
0
15,000
0
0
0
359,675
0
359,675
$
After
Five
Years
49,638
0
13,681
745
157,071
0
0
0
221,135
0
0
0
0
0
0
0
0
0
0
0
0
0
Total
$ 1,604,190
1,388
131,644
8,256
202,419
282
(21,411)
140,500
2,067,268
39,943
92,370
9,409
130,170
1,241,814
95,272
95,000
36,306
133,197
21,872
1,895,353
171,915
2,067,268
Net asset (liability) GAP
$ 276,047
$ (623,658)
$ 334,371
$ 221,135
Cumulative GAP
$ 276,047
$ (347,611)
$
(13,240)
$ 207,895
Percent of cumulative GAP to
total assets
13.4%
(16.8)%
(0.6)%
10.1%
(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 repricing frequency.
(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2006.
F-23
The following table depicts our GAP position as of December 31, 2005 (dollars in thousands).
Assets:
Commercial loans (1)
Leases
Residential real estate loans
Consumer loans
Securities (2)
Short term investments
Allowance for loan and lease losses
Other assets
Total assets
Liabilities:
Interest-bearing checking
Savings
Money market accounts
Time deposits under $100,000
Time deposits $100,000 and over
Short term borrowings
Federal Home Loan Bank advances
Long term borrowings
Noninterest-bearing checking
Other liabilities
Total liabilities
Shareholders’ equity
Total sources of funds
Within
Three
Months
Three to
Twelve
Months
One to
Five
Years
$
$ 947,769
6
61,448
1,699
8,899
545
0
0
1,020,366
39,792
106,247
10,344
30,475
255,351
81,801
25,000
35,337
0
0
584,347
0
584,347
37,000
485
3,861
134
1,007
0
0
0
42,487
0
0
0
37,109
465,018
0
75,000
0
0
0
577,127
0
577,127
$ 408,931
1,295
49,302
3,011
32,095
0
0
0
494,634
0
0
0
36,370
317,818
0
30,000
0
0
0
384,188
0
384,188
$
After
Five
Years
32,832
0
13,500
539
139,613
0
0
0
186,484
0
0
0
0
0
0
0
0
0
0
0
0
0
Total
$ 1,426,532
1,786
128,111
5,383
181,614
545
(20,527)
114,766
1,838,210
39,792
106,247
10,344
103,954
1,038,187
81,801
130,000
35,337
120,828
16,595
1,683,085
155,125
1,838,210
Net asset (liability) GAP
$ 436,019
$ (534,640)
$ 110,446
$ 186,484
Cumulative GAP
$ 436,019
$
(98,621)
$
11,825
$ 198,309
Percent of cumulative GAP to
total assets
23.7%
(5.4)%
0.6%
10.8%
(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 repricing frequency.
(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2005.
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, 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.
F-24
We conducted multiple simulations as of December 31, 2006, in which 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 net interest income over the next
twelve months, which is well within our policy parameters established to manage and monitor interest rate risk.
Interest Rate Scenario
Dollar Change In
Net Interest Income
Percent Change In
Net Interest Income
Interest rates down 200 basis points
$ (2,776,000)
(4.4)%
Interest rates down 100 basis points
No change in interest rates
Interest rates up 100 basis points
Interest rates up 200 basis points
(2,064,000)
(1,438,000)
569,000
2,552,000
(3.3)
(2.3)
0.9
4.0
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.
F-25
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Grand Rapids, Michigan
We have audited the accompanying consolidated balance sheets of Mercantile Bank Corporation as of December 31,
2006 and 2005, and the related consolidated statements of income, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of
Mercantile’s management. Our responsibility is to express an opinion on these financial statements based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Mercantile Bank Corporation as of December 31, 2006 and 2005, and the results of its
operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with
U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the effectiveness of Mercantile Bank Corporation’s internal control over financial reporting as of December
31, 2006, based on criteria established in Internal Control – Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 20, 2007 expressed
an unqualified opinion thereon.
Grand Rapids, Michigan
February 20, 2007
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
F-26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Grand Rapids, Michigan
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control
Over Financial Reporting, that Mercantile Bank Corporation maintained effective internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal Control – Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Mercantile Bank
Corporation’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. Our responsibility is to express an
opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board
(United States). 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, evaluating management’s
assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
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.
In our opinion, management’s assessment that Mercantile Bank Corporation maintained effective internal control
over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria
established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Also in our opinion, Mercantile Bank Corporation maintained, in all material
respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated financial statements of Mercantile Bank Corporation and our report dated February 20,
2007 expressed an unqualified opinion on those consolidated financial statements.
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Grand Rapids, Michigan
February 20, 2007
F-27
February 20, 2007
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 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 systems of internal control over financial reporting presented in conformity
with generally accepted principles as of December 31, 2006. This assessment was based on criteria for effective
internal control over financial reporting described in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management
believes that, as of December 31, 2006, Mercantile Bank Corporation maintained effective control over financial
reporting presented in conformity with generally accepted accounting principles based on those criteria.
The Company’s independent auditors have issued an audit report on our assessment of the Company’s internal
control over financial reporting.
Mercantile Bank Corporation
/s/ Gerald R. Johnson, Jr.
Gerald R. Johnson, Jr.
Chairman and Chief Executive Officer
/s/ Charles E. Christmas
Charles E. Christmas
Senior Vice President – Chief Financial Officer
F-28
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005
ASSETS
Cash and due from banks
Short term investments
Total cash and cash equivalents
Securities available for sale
Securities held to maturity (fair value of $65,025,000 at
December 31, 2006 and $62,850,000 at December 31, 2005)
Federal Home Loan Bank stock
Total loans and leases
Allowance for loan and lease losses
Total loans and leases, net
Premises and equipment, net
Bank owned life insurance policies
Accrued interest receivable
Other assets
2006
2005
$
51,098,000
282,000
51,380,000
$
36,208,000
545,000
36,753,000
130,967,000
112,961,000
63,943,000
7,509,000
60,766,000
7,887,000
1,745,478,000
(21,411,000)
1,724,067,000
1,561,812,000
(20,527,000)
1,541,285,000
33,539,000
30,858,000
10,287,000
14,718,000
30,206,000
28,071,000
8,274,000
12,007,000
Total assets
$2,067,268,000
$1,838,210,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing
Interest-bearing
Total
Securities sold under agreements to repurchase
Federal funds purchased
Federal Home Loan Bank advances
Subordinated debentures
Other borrowed money
Accrued expenses and other liabilities
Total liabilities
Shareholders' equity
Preferred stock, no par value; 1,000,000 shares
authorized, none issued
Common stock, no par value; 20,000,000 shares
authorized; 8,022,221 and 7,590,526 shares issued
and outstanding at December 31, 2006 and 2005
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
$ 133,197,000
1,513,706,000
1,646,903,000
$ 120,828,000
1,298,524,000
1,419,352,000
85,472,000
9,800,000
95,000,000
32,990,000
3,316,000
21,872,000
1,895,353,000
72,201,000
9,600,000
130,000,000
32,990,000
2,347,000
16,595,000
1,683,085,000
0
0
161,223,000
11,794,000
(1,102,000)
171,915,000
148,533,000
8,000,000
(1,408,000)
155,125,000
Total liabilities and shareholders’ equity
$2,067,268,000
$1,838,210,000
See accompanying notes to consolidated financial statements.
F-29
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2006, 2005 and 2004
Interest income
Loans and leases, including fees
Securities, taxable
Securities, tax-exempt
Federal funds sold
Short-term investments
Total interest income
Interest expense
Deposits
Short-term borrowings
Federal Home Loan Bank advances
Long-term borrowings
Total interest expense
2006
2005
2004
$ 127,470,000
6,557,000
2,739,000
482,000
12,000
137,260,000
$ 93,666,000
5,588,000
2,596,000
266,000
14,000
102,130,000
$ 62,791,000
3,935,000
2,217,000
75,000
4,000
69,022,000
64,755,000
2,867,000
5,393,000
2,658,000
75,673,000
38,884,000
1,795,000
4,200,000
1,959,000
46,838,000
21,786,000
877,000
2,471,000
1,461,000
26,595,000
Net interest income
61,587,000
55,292,000
42,427,000
Provision for loan and lease losses
5,775,000
3,790,000
4,674,000
Net interest income after provision for loan and lease losses
55,812,000
51,502,000
37,753,000
Noninterest income
Service charges on accounts
Increase in cash surrender value of bank owned life
insurance policies
Letter of credit fees
Residential mortgage banking fees
Gain on sale of commercial loans
Gain on sale of securities
Other income
Total noninterest income
Noninterest expense
Salaries and benefits
Occupancy
Furniture and equipment
Data processing
Advertising
Other expense
Total noninterest expenses
1,386,000
1,391,000
1,255,000
1,165,000
443,000
553,000
29,000
0
1,685,000
5,261,000
18,983,000
3,136,000
2,050,000
1,657,000
600,000
5,836,000
32,262,000
997,000
422,000
634,000
84,000
0
2,133,000
5,661,000
18,635,000
2,641,000
1,667,000
1,186,000
554,000
6,434,000
31,117,000
735,000
450,000
440,000
225,000
78,000
1,119,000
4,302,000
13,956,000
1,588,000
1,093,000
880,000
465,000
5,216,000
23,198,000
Income before federal income tax expense
28,811,000
26,046,000
18,857,000
Federal income tax expense
8,964,000
8,145,000
5,136,000
Net income
Earnings per share:
Basic
Diluted
$ 19,847,000
$ 17,901,000
$ 13,721,000
$ 2.48
$ 2.45
$ 2.25
$ 2.20
$ 1.73
$ 1.69
See accompanying notes to consolidated financial statements.
F-30
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2006, 2005 and 2004
Balances, January 1, 2004
$
118,560,000
$ 11,421,000
$
220,000
$
130,201,000
Common
Stock
Retained
Earnings
Accumulated Other
Comprehensive
Income/(Loss)
Total
Shareholders'
Equity
Payment of 5% stock dividend
12,111,000
(12,115,000)
Employee stock purchase plan, 2,388 shares
Dividend reinvestment plan, 3,754 shares
Stock option exercises, 57,011 shares
Stock tendered for stock option
exercises, 12,058 shares
79,000
123,000
524,000
(387,000)
Cash dividends ($0.34 per share)
(2,552,000)
(4,000)
79,000
123,000
524,000
(387,000)
(2,552,000)
Comprehensive income:
Net income
Change in net unrealized gain on securities
available for sale, net of reclassifications
and tax effect
Total comprehensive income
13,721,000
13,721,000
(88,000)
(88,000)
13,633,000
Balances, December 31, 2004
131,010,000
10,475,000
132,000
141,617,000
Payment of 5% stock dividend
17,187,000
(17,191,000)
Employee stock purchase plan, 2,491 shares
Dividend reinvestment plan, 4,099 shares
Stock option exercises, 41,885 shares
Stock tendered for stock option
exercises, 8,043 shares
97,000
159,000
396,000
(316,000)
Cash dividends ($0.41 per share)
(3,185,000)
(4,000)
97,000
159,000
396,000
(316,000)
(3,185,000)
Comprehensive income:
Net income
Change in net unrealized gain (loss) on
securities available for sale, net of
reclassifications and tax effect
Total comprehensive income
17,901,000
17,901,000
(1,540,000)
(1,540,000)
16,361,000
Balances, December 31, 2005
148,533,000
8,000,000
(1,408,000)
155,125,000
See accompanying notes to consolidated financial statements.
F-31
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2006, 2005 and 2004
Balances, December 31, 2005
$
148,533,000
$
8,000,000
$
(1,408,000) $
155,125,000
Common
Stock
Retained
Earnings
Accumulated Other
Comprehensive
Income/(Loss)
Total
Shareholders'
Equity
Payment of 5% stock dividend
12,014,000
(12,018,000)
Employee stock purchase plan, 2,774 shares
Dividend reinvestment plan, 2,531 shares
Stock option exercises, 61,897 shares
Stock tendered for stock option
exercises, 14,939 shares
107,000
98,000
814,000
(585,000)
Cash dividends ($0.51 per share)
(4,035,000)
Equity compensation expense
242,000
(4,000)
107,000
98,000
814,000
(585,000)
(4,035,000)
242,000
Comprehensive income:
Net income
Change in net unrealized loss on
securities available for sale, net of
reclassifications and tax effect
Total comprehensive income
19,847,000
19,847,000
306,000
306,000
20,153,000
Balances, December 31, 2006
$
161,223,000
$ 11,794,000
$
(1,102,000) $
171,915,000
See accompanying notes to consolidated financial statements.
F-32
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2006, 2005 and 2004
Cash flows from operating activities
Net income
Adjustments to reconcile net income
to net cash from operating activities
Depreciation and amortization
Provision for loan and lease losses
Equity compensation expense
Federal Home Loan Bank stock dividends
Gain on sale of commercial loans
Gain on sale of securities
Earnings on bank owned life insurance policies
Net change in
Accrued interest receivable
Other assets
Accrued expenses and other liabilities
Net cash from operating activities
Cash flows from investing activities
Purchases of:
Securities available for sale
Securities held to maturity
Federal Home Loan Bank stock
Proceeds from:
Sales of securities available for sale
Maturities, calls and repayments of
securities available for sale
Maturities, calls and repayments of
securities held to maturity
Redemption of Federal Home Loan Bank stock
Loan originations and payments, net
Purchases of premises and equipment, net
Purchases of bank owned life insurance policies
Net cash from investing activities
Cash flows from financing activities
Net increase in deposits
Net increase in securities sold under agreements
to repurchase
Proceeds from Federal Home Loan Bank advances
Pay-off of Federal Home Loan Bank advances
Proceeds from issuance of subordinated debentures
Pay-off of subordinated debentures
Net increase (decrease) in other borrowed money
Cash paid in lieu of fractional shares on stock dividend
Employee stock purchase plan
Dividend reinvestment plan
Stock option exercises, net
Cash dividends
Net cash from financing activities
2006
2005
2004
$
19,847,000
$
17,901,000
$
13,721,000
2,887,000
5,775,000
242,000
0
(29,000)
0
(1,166,000)
(2,013,000)
(1,068,000)
5,277,000
29,752,000
2,555,000
3,790,000
0
(146,000)
(84,000)
0
(997,000)
(2,630,000)
(981,000)
7,190,000
26,598,000
1,699,000
4,674,000
0
(72,000)
(225,000)
(78,000)
(735,000)
(1,546,000)
(1,478,000)
2,315,000
18,275,000
(24,886,000)
(4,567,000)
0
(38,217,000)
(10,065,000)
(943,000)
(54,718,000)
(8,521,000)
(1,749,000)
0
0
1,748,000
7,423,000
16,686,000
30,382,000
1,330,000
378,000
(190,657,000)
(5,911,000)
(1,621,000)
(218,511,000)
1,586,000
0
(247,242,000)
(7,677,000)
(3,324,000)
(289,196,000)
1,256,000
0
(282,170,000)
(10,516,000)
(6,574,000)
(330,862,000)
227,551,000
260,171,000
256,289,000
13,271,000
80,000,000
(115,000,000)
0
0
1,169,000
(4,000)
107,000
98,000
229,000
(4,035,000)
203,386,000
15,884,000
75,000,000
(65,000,000)
0
0
(4,662,000)
(4,000)
97,000
159,000
80,000
(3,185,000)
278,540,000
6,772,000
75,000,000
(45,000,000)
32,990,000
(16,495,000)
9,495,000
(4,000)
79,000
123,000
137,000
(2,552,000)
316,834,000
See accompanying notes to consolidated financial statements.
F-33
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 2006, 2005 and 2004
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 flow information
Cash paid during the year for
Interest
Federal income tax
Transfers from loans and leases to foreclosed assets
2006
2005
2004
$
$
14,627,000
36,753,000
51,380,000
67,925,000
10,875,000
2,129,000
$
$
15,942,000
20,811,000
36,753,000
40,671,000
8,657,000
1,556,000
$
$
4,247,000
16,564,000
20,811,000
25,107,000
6,125,000
0
See accompanying notes to consolidated financial statements.
F-34
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
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 of Michigan (“Bank”), and of Mercantile Bank
Mortgage Company, LLC (“Mortgage Company”), Mercantile Bank Real Estate Co., L.L.C. (“Mercantile Real
Estate”) and Mercantile Insurance Center, Inc. (“Mercantile Insurance”), subsidiaries of our bank, after elimination
of significant intercompany transactions and accounts.
We formed a business trust, Mercantile Bank Capital Trust I (“the trust”), in 2004 to issue trust preferred securities.
We issued subordinated debentures to the trust in return for the proceeds raised from the issuance of the trust
preferred securities. In accordance with FASB Interpretation No. 46, the trust is not consolidated, but instead we
report the subordinated debentures issued to the trust as a liability.
Nature of Operations: Mercantile was incorporated on July 15, 1997 to establish and own the Bank based in Grand
Rapids, Michigan. The Bank is a community-based financial institution. The Bank began operations on
December 15, 1997. The Bank’s primary deposit products are checking, savings, and term certificate accounts, and
its primary lending products are commercial loans, commercial leases, residential mortgage loans, and instalment
loans. Substantially all loans and leases are secured by specific items of collateral including business assets, real
estate or consumer assets. Commercial loans and leases are expected to be repaid from cash flow from operations of
businesses. Real estate loans are secured by commercial or residential real estate. The Bank’s loan accounts are
primarily with customers located in the Grand Rapids, Holland, Lansing and Ann Arbor metropolitan areas. The
Bank’s retail deposits are also from customers located within those areas. As an alternative source of funds, the
Bank has also issued certificates to depositors outside of the Bank’s primary market areas. Substantially all revenues
are derived from banking products and services and investment securities.
Mercantile Bank Mortgage Company was formed during 2000. A subsidiary of the Bank, Mercantile Bank
Mortgage Company was established to increase the profitability and efficiency of the mortgage loan operations.
Mercantile Bank Mortgage Company initiated business on October 24, 2000 via the Bank’s contribution of most of
its residential mortgage loan portfolio and participation interests in certain commercial mortgage loans. On the same
date, the Bank also transferred its residential mortgage origination function to Mercantile Bank Mortgage Company.
On January 1, 2004, Mercantile Bank Mortgage Company was reorganized as Mercantile Bank Mortgage Company,
LLC, a limited liability company, which is 99% owned by the Bank and 1% owned by Mercantile Insurance.
Mortgage loans originated and held by the Mercantile Bank Mortgage Company are serviced by the Bank pursuant
to a servicing agreement.
Mercantile Insurance was formed during 2002 through the acquisition of an existing shelf insurance agency.
Insurance products are offered through an Agency and Institutions Agreement among Mercantile Insurance, the Bank
and Hub International. The insurance products are marketed through a central facility operated by the Michigan
Bankers Insurance Association, members of which include the insurance subsidiaries of various Michigan-based
financial institutions and Hub International. Mercantile Insurance receives commissions based upon written
premiums produced under the Agency and Institutions Agreement.
Mercantile Real Estate was organized on July 21, 2003, principally to develop, construct, and own a new facility in
downtown Grand Rapids that serves as our bank’s main office and Mercantile’s headquarters. This facility was
placed into service during the second quarter of 2005.
Mercantile filed an election to become a financial holding company pursuant to Title I of the Gramm-Leach-Bliley
Act and implementing Federal Reserve Board regulations effective March 23, 2000.
(Continued)
F-35
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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
future results could differ. The allowance for loan and lease losses and the fair values of financial instruments are
particularly subject to change.
Cash Flow Reporting: Cash and cash equivalents include cash on hand, demand deposits with other financial
institutions, short-term investments (including securities with daily put provisions) and federal funds sold. Cash
flows are reported net for customer loan and deposit transactions, interest-bearing time deposits with other financial
institutions and short-term borrowings with maturities of 90 days or less.
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 are classified as available for sale when they
might be sold prior to maturity. Equity securities with readily determinable fair values are classified as available for
sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other
comprehensive income, net of tax. Other securities such as Federal Home Loan Bank stock are carried at cost.
Interest income includes amortization of purchase premiums and discounts. Premiums and discounts on securities
are amortized 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 trade date and determined using the
specific identification method.
Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses.
In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value
has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) our ability and intent
to hold the security for a period sufficient to allow for any anticipated recovery in fair value.
Loans and Leases: Loans and leases that management has the intent and ability to hold for the foreseeable future or
until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees
and costs and an allowance for loan and lease losses. 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.
Interest income on commercial loans and leases and mortgage loans is discontinued at the time the loan is 90 days
delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically
charged-off no later than 120 days past due. Past due status is based on the contractual terms of the loan or lease. In
all cases, loans and leases are placed on nonaccrual or charged-off at an earlier date if collection of principal and
interest is considered doubtful.
All interest accrued but not received for loans and leases placed on nonaccrual is reversed against interest income.
Interest received on such loans and leases is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans and leases are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably assured.
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. Net unrealized losses,
if any, are recorded as a valuation allowance and charged to earnings. Such loans are sold service released.
Residential mortgage banking fees include fees on direct brokered mortgage loans and the net gain on sale of
mortgage loans originated for sale.
(Continued)
F-36
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Allowance for Loan and Lease Losses: The allowance for loan and lease losses is a valuation allowance for probable
incurred credit losses. Loan and lease losses are charged against the allowance when management believes the
uncollectibility of a loan or lease balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Management estimates the allowance balance required using past loan and lease loss experience, the nature and
volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic
conditions and other factors. 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.
A loan or lease is considered impaired when, based on current information and events, it is probable we will be
unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the
loan agreement. Factors considered by management in determining impairment include payment status, collateral
value and the probability of collecting scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan or lease and the borrower, including the length of delay,
the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans and leases and
construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest
rate, the loan’s obtainable market price or the fair value of collateral if the loan is collateral dependent. Large groups
of smaller balance homogeneous loans are collectively evaluated for impairment. We do not separately identify
individual residential and consumer loans for impairment disclosures.
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 the corporation, (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) the corporation does not maintain
effective control over the transferred assets through an agreement to repurchase them before their maturity.
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.
Long-term Assets: Premises and equipment and other long-term assets are reviewed for impairment when events
indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets
are recorded at fair value.
Foreclosed Assets: Assets acquired through or instead of foreclosure are initially recorded at fair value when
acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense.
Costs after acquisition are expensed.
Bank Owned Life Insurance: The 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.
Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various
customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
(Continued)
F-37
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
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 in accordance with FASB Interpretation No. 45, are recorded at fair value.
Stock Compensation: Statement of Financial Accounting Standards (“SFAS”) no. 123(R), Share-based Payment,
using the modified prospective transition method, was adopted effective January 1, 2006. Accordingly, stock-based
employee compensation cost was recorded starting in 2006 using the fair value method. For 2006, adopting this
standard resulted in a reduction in net income before taxes and net income of $242,000 and a decrease in basic and
diluted earnings per share of $0.03.
Prior to January 1, 2006, employee compensation expense under stock options was reported using the intrinsic value
method; therefore, no stock-based compensation cost is reflected in net income for the years ending December 31,
2005 and 2004, as all options granted had an exercise price equal to or greater than the market price of the
underlying common stock at date of grant.
The following table illustrates the effect on net income and earnings per share if expense was measured using the fair
value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, for the years
ending December 31.
Net income as reported
Deduct: Stock-based compensation expense
determined under fair value based method
Pro forma net income
Basic earnings per share as reported
Pro forma basic earnings per share
Diluted earnings per share as reported
Pro forma diluted earnings per share
2005
2004
$ 17,901,000
$ 13,721,000
861,000
17,040,000
323,000
13,398,000
$
$
2.25
2.14
2.20
2.09
$
$
1.73
1.69
1.69
1.65
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in
deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the
temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted
tax rates. A valuation allowance, if needed, reduces deferred 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, as more fully disclosed separately. 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.
(Continued)
F-38
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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. Earnings per share are restated for all stock dividends, including the 5% stock dividends paid on May
16, 2006, August 1, 2005 and May 3, 2004. The fair value of shares issued in stock dividends is transferred from
retained earnings to common stock to the extent of available retained earnings.
Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other
comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized
as separate components of equity.
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 now are such matters that would have a material effect on the financial
statements.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current
presentation.
Operating Segments: While we monitor the revenue streams of the various products and services offered, the
identifiable segments are not material and operations are managed and financial performance is evaluated on a
company-wide basis. Accordingly, all of our financial service operations are aggregated in one reportable operating
segment.
Adoption of New Accounting Standards: In September 2006, the Securities and Exchange Commission (“SEC”)
released Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements (“SAB 108”), which is effective for fiscal years ending on or
after November 15, 2006. SAB 108 provides guidance on how the effects of prior-year uncorrected financial
statement misstatements should be considered in quantifying a current year misstatement. SAB 108 requires public
companies to quantify misstatements using both an income statement (rollover) and balance sheet (iron curtain)
approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and
qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial
now are considered material based on either approach, no restatement is required so long as management properly
applied its previous approach and all relevant facts and circumstances were considered. Adjustments considered
immaterial in prior years under the method previously used, but now considered material under the dual approach
required by SAB 108, are to be recorded upon initial adoption of SAB 108. The amount so recorded, if any, is
shown as a cumulative effect adjustment recorded in opening retained earnings as of January 1, 2006. The adoption
of SAB 108 had no effect on the financial statements for the year ending December 31, 2006.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an
interpretation of FASB Statement No. 109 (“FIN 48”), which prescribes a recognition threshold and measurement
attribute 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. We have determined that the adoption of FIN 48
will not have a material effect on the financial statements.
(Continued)
F-39
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Effect of Newly Issued But Not Yet Effective Accounting Standards: New accounting standards have been issued
that we do not expect will have a material effect on the financial statements when adopted in future years or for
which we have not yet completed its evaluation of the potential effect upon adoption. In general, these standards
revise accounting for derivatives embedded in other financial instruments for 2007, revise the recognition and
accounting for servicing of financial assets for 2007, establish a hierarchy about the assumptions used to measure fair
value for 2008, revise the accrual of post-retirement benefits associated with providing life insurance for 2008 and
revise the accounting for cash surrender value for 2007.
NOTE 2 – SECURITIES
The fair value of available for sale securities and the related gross unrealized gains and losses recognized in
accumulated other comprehensive income (loss) were as follows:
2006
U.S. Government agency
debt obligations
Mortgage-backed securities
Mutual fund
2005
U.S. Government agency
debt obligations
Mortgage-backed securities
Mutual fund
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
$
77,544,000
54,039,000
1,080,000
$ 197,000
80,000
0
$
(905,000)
(1,036,000)
(32,000)
$
76,836,000
53,083,000
1,048,000
$ 132,663,000
$ 277,000
$ (1,973,000)
$ 130,967,000
$
64,665,000
49,426,000
1,035,000
$
15,000
39,000
0
$
(968,000)
(1,228,000)
(23,000)
$
63,712,000
48,237,000
1,012,000
$ 115,126,000
$
54,000
$ (2,219,000)
$ 112,961,000
The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows:
2006
Municipal general obligation bonds
Municipal revenue bonds
2005
Municipal general obligation bonds
Municipal revenue bonds
Carrying
Amount
Gross
Gross
Unrecognized Unrecognized
Gains
Losses
Fair
Value
$
56,870,000
7,073,000
$ 1,098,000
198,000
$ (197,000)
(17,000)
$
57,771,000
7,254,000
$
63,943,000
$ 1,296,000
$ (214,000)
$
65,025,000
$
53,685,000
7,081,000
$ 1,859,000
339,000
$ (101,000)
(13,000)
$
55,443,000
7,407,000
$
60,766,000
$ 2,198,000
$ (114,000)
$
62,850,000
(Continued)
F-40
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 2 – SECURITIES (Continued)
Securities with unrealized losses at year-end 2006 and 2005, aggregated by investment category and length of time
that individual securities have been in a continuous loss position are as follows:
Description of Securities
2006
U.S. Government agency
debt obligations
Mortgage-backed securities
Mutual fund
Municipal general
obligation bonds
Municipal revenue bonds
2005
U.S. Government agency
debt obligations
Mortgage-backed securities
Mutual fund
Municipal general
obligation bonds
Municipal revenue bonds
Less than 12 Months
Fair
Value
Unrealized
Loss
12 Months or More
Fair
Value
Unrealized
Loss
Total
Fair
Value
Unrealized
Loss
$ 1,971,000 $
1,831,000
0
(9,000) $53,939,000 $ (896,000)
(1,024,000)
(32,000)
40,784,000
1,048,000
(12,000)
0
$55,910,000 $ (905,000)
42,615,000 (1,036,000)
(32,000)
1,048,000
9,097,000
620,000
(90,000)
(3,000)
7,771,000
718,000
(107,000)
(14,000)
16,868,000 (197,000)
(17,000)
1,338,000
$13,519,000 $ (114,000) $104,260,000 $ (2,073,000) $117,779,000 $(2,187,000)
$51,082,000 $ (705,000) $ 5,735,000 $ (263,000)
(479,000)
32,794,000
0
1,012,000
13,284,000
0
(749,000)
(23,000)
$56,817,000 $ (968,000)
46,078,000 (1,228,000)
(23,000)
1,012,000
7,156,000
0
(65,000)
0
1,565,000
723,000
(36,000)
(13,000)
8,721,000 (101,000)
(13,000)
723,000
$92,044,000 $ (1,542,000) $21,307,000 $ (791,000) $113,351,000 $(2,333,000)
We evaluate securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when
economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to
which the fair value has been less than cost, the financial condition and near-term prospects 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. 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, 2006, $117.7 million in debt securities and a mutual fund have unrealized losses with aggregate
depreciation of 1.1% from the amortized cost basis of total securities. 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 unrealized losses were due to an increasing interest rate environment. As we have the
ability to hold debt securities until maturity, or for the foreseeable future if classified as available for sale, no
declines are deemed to be other than temporary.
(Continued)
F-41
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 2 – SECURITIES (Continued)
The amortized cost and fair values of debt securities at year-end 2006, by contractual maturity, are shown below.
The contractual maturity is utilized below 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.
The maturities of securities and their weighted average yields at December 31, 2006 are shown in the following
table. The yields for municipal securities are shown at their tax equivalent yield.
---------------- Held-to-Maturity ---------------- -------------Available-for-Sale --------------
Weighted
Average
Yield
Weighted
Average Amortized
Carrying
Amount
Fair
Value
Fair
Value
Yield
Cost
Due in one year or less
Due from one to five years
Due from five to ten years
Due after ten years
Mortgage-backed
Mutual fund
7.11% $ 2,593,000
8,798,000
6.87
11,533,000
6.38
41,019,000
6.39
0
NA
0
NA
$ 2,606,000
9,060,000
11,789,000
41,570,000
0
0
$
NA
0
4.72% 17,864,000
59,680,000
5.21
NA
0
54,039,000
5.03
1,080,000
4.36
$
0
17,647,000
59,189,000
0
53,083,000
1,048,000
6.48% $ 63,943,000
$ 65,025,000
5.06% $132,663,000 $130,967,000
During 2006 and 2005, there were no securities sold. During 2004, securities with an aggregate amortized cost basis
of $1.7 million were sold, resulting in a gross realized gain of $78,000.
At year-end 2006 and 2005, the amortized cost of securities issued by the state of Michigan and all its political
subdivisions totaled $63.9 million and $60.8 million, with an estimated market value of $65.0 million and $62.9
million, respectively. Total securities of any other specific issuer, other than the U.S. Government and its agencies,
did not exceed 10% of shareholders’ equity.
The carrying value of securities that are pledged to repurchase agreements and other deposits was $92.2 million and
$81.7 million at December 31, 2006 and 2005, respectively.
(Continued)
F-42
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Year-end loans and leases are as follows:
December 31, 2006
Balance
%
December 31, 2005
Balance
%
Percent
Increase/
(Decrease)
Real Estate:
Construction and land
development
Secured by 1 – 4
family properties
Secured by multi-
family properties
Secured by
nonresidential properties
Commercial
Leases
Consumer
$ 293,656,000
16.8% $ 226,544,000
14.5%
29.6%
131,644,000
31,003,000
7.5
1.8
128,111,000
30,114,000
8.2
2.0
808,259,000
471,272,000
1,388,000
8,256,000
46.3
27.0
0.1
0.5
714,963,000
454,911,000
1,786,000
5,383,000
45.8
29.1
0.1
0.3
2.8
3.0
13.0
3.6
(22.3)
53.4
$1,745,478,000
100.0% $1,561,812,000
100.0%
11.8%
Activity in the allowance for loan and lease losses is as follows:
Beginning balance
Provision for loan and lease losses
Charge-offs
Recoveries
2006
2005
2004
$
20,527,000
5,775,000
(5,389,000)
498,000
$
17,819,000
3,790,000
(1,392,000)
310,000
$
14,379,000
4,674,000
(1,405,000)
171,000
Ending balance
$
21,411,000
$
20,527,000
$
17,819,000
Impaired loans and leases were as follows:
Year-end loans with no allocated allowance for loan and lease losses
Year-end loans with allocated allowance for loan and lease losses
Amount of the allowance for loan and lease losses allocated
Average of impaired loans during the year
2006
2005
$
$
$
558,000
3,999,000
4,557,000
1,149,000
6,142,000
$
$
$
1,390,000
965,000
2,355,000
399,000
2,460,000
The Bank recognized no interest income on impaired loans during 2006, 2005 or 2004. Nonperforming loans
includes both smaller balance homogenous loans that are collectively evaluated for impairment and individually
classified impaired loans.
(Continued)
F-43
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Nonperforming loans and leases were as follows:
2006
2005
Loans and leases past due over 90 days still accruing interest
Nonaccrual loans and leases
$
819,000
7,752,000
$
394,000
3,601,000
$
8,571,000
$
3,995,000
Concentrations within the loan portfolio were as follows at year-end:
2 0 0 6
2 0 0 5
Balance
Percentage of
Loan Portfolio
Balance
Percentage of
Loan Portfolio
Commercial real estate loans to
lessors of non-residential
buildings
$ 471,222,000
27.0%
$ 417,470,000
26.7%
NOTE 4 - PREMISES AND EQUIPMENT, NET
Year-end premises and equipment are as follows:
Land and improvements
Buildings and leasehold improvements
Furniture and equipment
Less: accumulated depreciation
2006
2005
$
8,021,000
23,036,000
10,773,000
41,830,000
8,291,000
$
7,135,000
18,450,000
10,351,000
35,936,000
5,730,000
$
33,539,000
$
30,206,000
Depreciation expense in 2006, 2005 and 2004 totaled $2,578,000, $2,043,000 and $1,248,000, respectively.
We entered into lease arrangements for our banking facilities in East Lansing and Ann Arbor, Michigan during 2005.
Rent expense for these two facilities totaled $276,000 and $144,000 during 2006 and 2005, respectively. Minimum
rent commitments under the operating leases were as follows, before considering renewal options that generally are
present:
2007
2008
2009
2010
Total
$ 207,000
160,000
164,000
83,000
$ 614,000
(Continued)
F-44
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 5 – DEPOSITS
Deposits at year-end are summarized as follows:
Noninterest-bearing
demand
Interest-bearing
checking
Money market
Savings
Time, under $100,000
Time, $100,000 and
over
Out-of-area time,
under $100,000
Out-of-area time,
$100,000 and over
December 31, 2006
Balance
%
December 31, 2005
Balance
%
Percent
Increase/
(Decrease)
$ 133,197,000
8.1% $ 120,828,000
8.5%
10.2%
39,943,000
9,409,000
92,370,000
47,840,000
310,326,000
633,085,000
82,330,000
931,488,000
1,013,818,000
2.4
0.6
5.6
2.9
18.8
38.4
5.0
56.6
61.6
39,792,000
10,344,000
106,247,000
23,906,000
2.8
0.7
7.5
1.7
155,401,000
456,518,000
11.0
32.2
80,048,000
5.6
882,786,000
962,834,000
62.2
67.8
0.4
(9.0)
(13.1)
100.1
99.7
38.7
2.9
5.5
5.3
$1,646,903,000
100.0% $1,419,352,000
100.0%
16.0%
Out-of-area certificates of deposit consist of certificates obtained from depositors outside of the primary market area.
As of December 31, 2006, out-of-area certificates of deposit totaling $987.0 million were obtained through deposit
brokers, with the remaining $26.8 million obtained directly from the depositors.
The following table depicts the maturity distribution for certificates of deposit at year-end.
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
2006
2005
$1,027,309,000
258,692,000
54,988,000
11,111,000
19,884,000
$ 787,954,000
243,652,000
68,467,000
33,649,000
8,419,000
$1,371,984,000
$1,142,141,000
The following table depicts the maturity distribution for certificates of deposit with balances of $100,000 or more at
year-end.
Up to three months
Three months to six months
Six months to twelve months
Over twelve months
2006
2005
$ 351,745,000
246,357,000
341,461,000
302,251,000
$ 255,351,000
186,830,000
278,189,000
317,817,000
$1,241,814,000
$1,038,187,000
(Continued)
F-45
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 6 – SHORT-TERM BORROWINGS
Information regarding securities sold under agreements to repurchase, at year-end is summarized below:
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 month end balance during the year
2006
2005
$ 85,472,000
3.88%
72,228,000
3.71%
85,472,000
$ 72,201,000
3.31%
60,743,000
2.63%
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 repurchase agreements are recorded as assets of the Bank and are
primarily held in safekeeping by correspondent banks. Repurchase agreements are offered principally to certain
large deposit customers as uninsured deposit equivalent investments. Repurchase agreements were secured by
securities with a market value of $91.2 million and $80.7 million at year-end 2006 and 2005, respectively.
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows.
2006
2005
Maturities January 2007 through May 2008, fixed rates from
3.70% to 5.69%, averaging 4.90%
$ 95,000,000
Maturities January 2006 through May 2008, fixed rates from
2.13% to 4.92%, averaging 3.68%
Maturities in May 2006, floating rates tied to Libor indices,
averaging 4.42%
$ 120,000,000
10,000,000
$ 95,000,000
$ 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, and substantially all other assets of the
Bank, under a blanket lien arrangement. Our borrowing line of credit as of December 31, 2006 totaled $322.6
million.
Maturities over the next five years are:
2007
2008
2009
2010
2011
$ 80,000,000
15,000,000
0
0
0
(Continued)
F-46
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 8 - FEDERAL INCOME TAXES
The consolidated provision for income taxes is as follows:
Current
Deferred benefit
Tax expense
2006
2005
2004
$
9,438,000
(474,000)
$
9,124,000
(979,000)
$
5,981,000
(845,000)
$
8,964,000
$
8,145,000
$
5,136,000
Income tax expense was less than the amount computed by applying the statutory federal income tax rate to income
before income taxes. The reasons for the difference are as follows:
Statutory rates
Increase (decrease) from
Tax-exempt interest
Life insurance
Rehabilitation tax credits
Other
2006
2005
2004
$ 10,084,000
$
9,116,000
$
6,600,000
(795,000)
(408,000)
0
83,000
(792,000)
(349,000)
0
170,000
(708,000)
(257,000)
(429,000)
(70,000)
Tax expense
$
8,964,000
$
8,145,000
$
5,136,000
The net deferred tax asset recorded includes the following amounts of deferred tax assets and liabilities:
Deferred tax assets
Allowance for loan and lease losses
Unrealized loss on securities available for sale
Deferred loan fees
Deferred compensation
Other
Deferred tax liabilities
Depreciation
Other
$
2006
2005
7,494,000
594,000
231,000
1,181,000
234,000
9,734,000
1,052,000
525,000
1,577,000
$
7,184,000
758,000
307,000
821,000
239,000
9,309,000
947,000
515,000
1,462,000
Net deferred tax asset
$
8,157,000
$
7,847,000
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. Management has determined that no valuation
allowance was required at year-end 2006 or 2005.
(Continued)
F-47
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 9 – STOCK-BASED COMPENSATION
Stock-based compensation plans are used to provide directors and employees with an increased incentive to
contribute to the long-term performance and growth of Mercantile, to join the interests of directors and employees
with the interests of Mercantile’s shareholders through the opportunity for increased stock ownership and to attract
and retain directors and employees. From 1997 through 2005, stock option grants were provided to directors and
certain employees through several stock option plans, including the 1997 Employee Stock Option Plan, 2000
Employee Stock Option Plan, 2004 Employee Stock Option Plan and Independent Director Stock Option Plan.
During 2006, stock option and restricted stock grants were provided to certain employees through the Stock
Incentive Plan of 2006.
Under our 1997 Employee Stock Option Plan, 2000 Employee Stock Option Plan and 2004 Employee Stock Option
Plan, stock options granted to employees were 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 officers during
2005 vested about three weeks after being granted. Under our Independent Director Stock Option Plan, 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. The Stock Incentive Plan of 2006, approved by our shareholders at
the annual meeting on April 27, 2006, replaced all of our outstanding stock option plans for stock options not
previously granted. Under the Stock Incentive Plan of 2006, 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 Mercantile stock on the
day before the date of grant, with price, vesting and expiration date parameters determined by Mercantile’s
Compensation Committee on a grant-by-grant basis. Generally, the stock options granted to employees during 2006
fully vest after two years and expire after seven years. The restricted stock awards granted to certain employees
during 2006, totaling 20,190 shares and having a fair value per share of $39.84, fully vest after four years. No
payments were required from employees for the restricted stock awards. At year-end 2006, there were 550,884
shares authorized for future incentive awards.
As of December 31, 2006, there was $300,000 of total unrecognized compensation cost related to unvested stock
options granted under our various stock-based compensation plans. The compensation cost is expected to be
recognized over a weighted-average period of 1.5 years. As of December 31, 2006, there was $690,000 of total
unrecognized compensation cost related to unvested restricted stock granted under our Stock Incentive Plan of 2006.
The compensation cost is expected to be recognized over a period of 3.9 years.
A summary of stock option activity is as follows.
2006
2005
2004
Weighted
Average
Price
Shares
Weighted
Average
Price
Shares
Weighted
Average
Price
Shares
314,830
24,640
(61,897)
(2,204)
$ 21.81
39.84
13.14
33.55
310,495
47,540
(41,885)
(1,320)
$ 17.77
37.68
9.45
35.36
321,203
46,303
(57,011)
0
$ 13.56
36.43
9.19
0.00
275,369
$ 25.28
314,830
$ 21.81
310,495
$ 17.77
Outstanding at
beginning
of year
Granted
Exercised
Forfeited or expired
Outstanding at
end of year
Options exercisable
at year-end
223,505
$ 22.63
269,700
$ 20.17
241,658
$ 13.62
(Continued)
F-48
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
The fair value of each stock option award is estimated on the date of grant using a closed option valuation (Black-
Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical
volatilities on our common stock. Historical data is used to estimate stock option expense and post-vesting
termination behavior. The expected term of stock options granted is based on historical data and represents the
period of time that stock options granted are expected to be outstanding, which takes into account that the stock
options are not transferable. The risk-free interest rate for the expected term of the stock option is based on the U.S.
Treasury yield curve in effect at the time of the stock option grant.
The fair value of stock options granted was determined using the following weighted-average assumptions as of grant
date.
Risk-free interest rate
Expected option life
Expected stock price volatility
Dividend yield
2006
2005
2004
4.60%
5 Years
26%
1%
4.12%
7 Years
26%
1%
3.45%
7 Years
22%
1%
Options outstanding at year-end 2006 were as follows:
Outstanding
Exercisable
Range of
Exercise
Prices
$ 4.00 - $ 8.00
$ 8.01 - $12.00
$12.01 - $16.00
$16.01 - $20.00
$20.01 - $24.00
$24.01 - $28.00
$32.01 - $36.00
$36.01 - $40.00
$40.01 - $44.00
Weighted Average Weighted
Average
Exercise
Price
Remaining
Contractual
Life
Number
8,952
42,208
29,306
37,907
7,272
30,592
41,783
70,186
7,163
0.6 Years
3.0 Years
4.8 Years
5.6 Years
5.8 Years
6.8 Years
7.7 Years
8.2 Years
7.8 Years
$ 7.46
9.20
13.07
16.84
21.19
27.94
35.29
38.44
42.29
Weighted
Average
Exercise
Price
$ 7.46
9.20
13.07
16.84
NA
27.94
35.36
37.68
NA
Number
8,952
42,208
29,306
37,907
0
30,592
34,847
39,693
0
Outstanding at year end
275,369
6.1 Years
$ 25.28
223,505
$ 22.63
The weighted-average remaining contractual life of the 223,505 stock options exercisable as of December 31, 2006
was 5.8 years.
Options outstanding at year-end 2006, 2005 and 2004 were as follows:
Minimum exercise price
Maximum exercise price
Average remaining option term
2006
2005
2004
$
7.46
42.29
6.1 Years
$
7.46
42.29
6.5 Years
$
7.46
42.29
6.5 Years
(Continued)
F-49
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
Information related to stock option grants and exercises during 2006, 2005 and 2004 follows:
2006
2005
2004
Intrinsic value of stock options exercised
Cash received from stock option exercises
Tax benefit realized from stock option exercises
Weighted average fair value of stock options granted
$1,616,000
229,000
0
11.44
$1,243,000
80,000
0
13.51
$1,310,000
137,000
0
9.82
The aggregate intrinsic value of all stock options outstanding at December 31, 2006 was $3,507,000.
The aggregate intrinsic value of all stock options exercisable at December 31, 2006 was $3,367,000.
Shares issued as a result of the exercise of stock option grants are new shares as provided for under our stock-based
compensation plans.
NOTE 10 – RELATED PARTIES
Certain directors and executive officers of the Bank, including their immediate families and companies in which they
are principal owners, were loan customers of the Bank. At year-end 2006 and 2005, the Bank had $18.3 million and
$14.0 million in loan commitments to directors and executive officers, of which $8.8 million and $8.9 million were
outstanding at year-end 2006 and 2005, respectively, as reflected in the following table.
Beginning balance
New loans
Repayments
Ending balance
2006
2005
$
8,865,000
2,356,000
(2,424,000)
$ 10,210,000
761,000
(2,106,000)
$
8,797,000
$
8,865,000
Related party deposits and repurchase agreements totaled $15.7 million and $13.3 million at year-end 2006 and
2005, respectively.
NOTE 11 – 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 the 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.
(Continued)
F-50
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 11 – COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
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,
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 related to loan commitments was $0.5 million at year-end 2006 and 2005.
At year-end 2006 and 2005, 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:
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
2006
2005
$ 345,195,000
$ 303,115,000
29,314,000
8,510,000
7,197,000
60,850,000
73,241,000
27,830,000
7,971,000
10,791,000
83,280,000
59,058,000
$ 524,307,000
$ 492,045,000
Commitments to make 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, line of credit facilities are for a one year term and are at a
floating rate tied to the prime rate. For term debt secured by real estate, customers are generally offered a floating
rate tied to the prime rate and a fixed rate currently ranging from 7.25% to 8.25%. These credit facilities generally
balloon within five years, with payments based on amortizations ranging from 10 to 25 years. For term debt secured
by non-real estate collateral, customers are generally offered a floating rate tied to the prime rate and a fixed rate
currently ranging from 7.25% to 8.25%. These credit facilities generally mature and fully amortize within five years.
The following instruments are considered financial guarantees under FASB Interpretation 45. These instruments are
carried at fair value.
2 0 0 6
2 0 0 5
Contract
Amount
Carrying
Value
Contract
Amount
Carrying
Value
Standby letters of credit
$
73,241,000
$ 279,000
$ 59,058,000
$ 205,000
We were required to have $8.9 million and $8.6 million of cash on hand or on deposit with the Federal Reserve Bank
of Chicago to meet regulatory reserve and clearing requirements at year-end 2006 and 2005, respectively. These
balances do not earn interest.
(Continued)
F-51
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 12 – BENEFIT PLANS
We have a 401(k) benefit plan that covers substantially all of our employees. Our 2006, 2005 and 2004 matching
401(k) contribution charged to expense was $674,000, $554,000 and $413,000, respectively. The percent of our
matching contributions to the 401(k) is determined annually by the Board of Directors. The 401(k) benefit plan
allows employee contributions up to 15% of their compensation, which are matched at 100% of the first 5% of the
compensation contributed. Matching contributions are immediately vested.
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 only upon termination of service as a
director. The deferred amounts are categorized on our financial statements as other borrowed money. The deferred
balances are paid interest at a rate equal to the prime rate, adjusted at the beginning of each calendar quarter.
Interest expense for the plan during 2006, 2005 and 2004 was $81,000, $43,000 and $21,000, respectively.
We have a non-qualified deferred compensation program in which selected officers may defer all or portions of
salary and bonus payments. The deferred amounts are categorized on our financial statements as other borrowed
money. The deferred balances are paid interest at a rate equal to the prime rate, adjusted at the beginning of each
calendar quarter. Interest expense for the plan during 2006, 2005 and 2004 was $148,000, $79,000 and $38,000,
respectively.
The Mercantile Bank Corporation Employee Stock Purchase Plan of 2002 (“Stock Purchase Plan”) 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 average, rounded to the nearest whole cent, of the highest and
lowest sales prices of our common stock reported on The Nasdaq Stock Market. Originally, 25,000 shares of
common stock may be issued under the Stock Purchase Plan; however, the number of shares has been and may
continue to be adjusted in the future to reflect stock dividends and other changes in our capitalization. The numbers
of shares issued under the Stock Purchase Plan totaled 2,774 and 2,491 in 2006 and 2005, respectively. As of
December 31, 2006, there were 20,820 shares available under the Stock Purchase Plan.
(Continued)
F-52
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as follows at year-end.
2 0 0 6
2 0 0 5
Carrying
Values
Fair
Values
Carrying
Values
Fair
Values
Financial assets
Cash and cash equivalents
Securities available for sale
Securities held to maturity
Federal Home Loan Bank stock
Loans, net
Bank owned life insurance policies
Accrued interest receivable
$ 51,380,000
130,967,000
63,943,000
7,509,000
1,724,067,000
30,858,000
10,287,000
$ 51,380,000
130,967,000
65,025,000
7,509,000
1,707,039,000
30,858,000
10,287,000
$ 36,753,000
112,961,000
60,766,000
7,887,000
1,541,285,000
28,071,000
8,274,000
$ 36,753,000
112,961,000
62,850,000
7,887,000
1,540,183,000
28,071,000
8,274,000
Financial liabilities
Deposits
Securities sold under agreements
to repurchase
Federal funds purchased
Federal Home Loan Bank advances
Accrued interest payable
Subordinated debentures
1,646,903,000
1,654,798,000
1,419,352,000
1,425,606,000
85,472,000
9,800,000
95,000,000
20,213,000
32,990,000
85,472,000
9,800,000
94,801,000
20,213,000
32,984,000
72,201,000
9,600,000
130,000,000
12,465,000
32,990,000
72,201,000
9,600,000
129,942,000
12,465,000
32,990,000
Carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, accrued
interest receivable and payable, bank owned life insurance policies, demand deposits, securities sold under
agreements to repurchase, and variable rate loans or deposits that reprice frequently and fully. 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. For fixed rate loans or deposits and for variable rate loans or deposits with
infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates
applied to the estimated life and credit risk. Fair value of subordinated debentures and Federal Home Loan Bank
advances is based on current rates for similar financing. Fair value of off balance sheet items is estimated to be
nominal.
(Continued)
F-53
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 14 – EARNINGS PER SHARE
The factors used in the earnings per share computation follow.
Basic
Net income
2006
2005
2004
$ 19,847,000
$ 17,901,000
$ 13,721,000
Weighted average common shares outstanding
8,003,013
7,959,338
7,909,687
Basic earnings per common share
$
2.48
$
2.25
$
1.73
Diluted
Net income
$ 19,847,000
$ 17,901,000
$ 13,721,000
Weighted average common shares outstanding for
basic earnings per common share
8,003,013
7,959,338
7,909,687
Add: Dilutive effects of assumed exercises of
stock options
Average shares and dilutive potential
common shares
109,342
177,826
198,110
8,112,355
8,137,163
8,107,797
Diluted earnings per common share
$
2.45
$
2.20
$
1.69
Stock options for 10,268, 7,166 and 50,767 shares of common stock were not considered in computing diluted
earnings per common share for 2006, 2005 and 2004, respectively, because they were antidilutive.
NOTE 15 – SUBORDINATED DEBENTURES
Mercantile Trust, a business trust formed by the company, was incorporated in 2004 for the purpose of issuing Series
A and Series B Preferred Securities. On September 16, 2004, Mercantile Trust sold the Series A Preferred
Securities in a private sale for $16.0 million, and also sold $495,000 of Series A Common Securities to Mercantile.
The proceeds of the Series A Preferred Securities and the Series A Common Securities were used by Mercantile
Trust to purchase $16,495,000 of Series A Floating Rate Notes that were issued by Mercantile on September 16,
2004. Mercantile used the proceeds of the Series A Floating Rate Notes to finance the redemption on September 17,
2004 of the $16.0 million of 9.60% Cumulative Preferred Securities issued in 1999 by MBWM Capital Trust I. On
December 10, 2004, Mercantile Trust sold the Series B Preferred Securities in a private sale for $16.0 million, and
also sold $495,000 of Series B Common Securities to Mercantile. The proceeds of the Series B Preferred Securities
and the Series B Common Securities were used by Mercantile Trust to purchase $16,495,000 of Series B Floating
Rate Notes that were issued by Mercantile on December 10, 2004. Substantially all of the net proceeds of the Series
B Floating Rate Notes were contributed to our bank as capital to provide support for asset growth, fund investments
in loans and securities and for general corporate purposes.
The only significant assets of Mercantile Trust are the Series A and Series B Floating Rate Notes, and the only
significant liabilities of Mercantile Trust are the Series A and Series B Preferred Securities. The Series A and Series
B Floating Rate Notes are categorized on our consolidated balance sheet as subordinated debentures and the interest
expense is recorded on our consolidated statement of income under interest expense on long-term borrowings.
(Continued)
F-54
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 16 - REGULATORY MATTERS
Mercantile and the Bank 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 adequately 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 being
closely monitored 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 in
the discretion of the federal regulator. At year-end 2006 and 2005, the most recent regulatory notifications
categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no
conditions or events since that notification that we believe has changed the Bank’s category.
At year end, actual capital levels (in thousands) and minimum required levels for Mercantile and the Bank were:
Actual
Amount
Ratio
Minimum Required
for Capital
Adequacy Purposes
Ratio
Amount
Minimum Required
to be Well
Capitalized Under
Prompt Corrective
Action Regulations
Ratio
Amount
$ 226,428
222,812
11.5%
11.3
$ 158,196
158,019
8.0%
8.0
$
NA
197,524
NA
10.0%
205,017
201,401
10.4
10.2
205,017
201,401
10.0
9.9
79,098
79,010
81,682
81,623
4.0
4.0
4.0
4.0
NA
118,514
NA
6.0
NA
102,029
NA
5.0
2006
Total capital (to risk
weighted assets)
Consolidated
Bank
Tier 1 capital (to risk
weighted assets)
Consolidated
Bank
Tier 1 capital (to average
assets)
Consolidated
Bank
(Continued)
F-55
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 16 - REGULATORY MATTERS (Continued)
Actual
Amount
Ratio
Minimum Required
for Capital
Adequacy Purposes
Ratio
Amount
Minimum Required
to be Well
Capitalized Under
Prompt Corrective
Action Regulations
Ratio
Amount
2005
Total capital (to risk
weighted assets)
Consolidated
Bank
Tier 1 capital (to risk
weighted assets)
Consolidated
Bank
Tier 1 capital (to average
assets)
Consolidated
Bank
$ 209,060
205,642
12.0%
11.8
$ 139,337
139,158
8.0%
8.0
$
NA
173,947
NA
10.0%
188,533
185,115
10.8
10.6
188,533
185,115
10.5
10.3
69,669
69,579
72,163
72,100
4.0
4.0
4.0
4.0
NA
104,368
NA
6.0
NA
90,124
NA
5.0
Federal and state banking laws and regulations place certain restrictions on the amount of dividends the Bank can
transfer to Mercantile and on the capital levels that must be maintained. At year-end 2006, under the most restrictive
of these regulations (to remain well capitalized), the Bank could distribute approximately $22.5 million to Mercantile
as dividends without prior regulatory approval.
The capital levels as of year-end 2006 and 2005 include $32.0 million of trust preferred securities issued by
Mercantile Trust in September 2004 and December 2004 subject to certain limitations. Federal Reserve guidelines
limit the amount of trust preferred securities which can be included in Tier 1 capital of Mercantile to 25% of total
Tier 1 capital. At year-end 2006 and 2005, all $32.0 million of the trust preferred securities were included as Tier 1
capital of Mercantile.
NOTE 17 - OTHER COMPREHENSIVE INCOME/(LOSS)
Other comprehensive income/(loss) components and related taxes were as follows.
Unrealized holding gains and losses on
available-for-sale securities
Reclassification adjustments for gains
and losses later recognized in income
Net unrealized gains and losses
Tax effect of unrealized holding gains and
losses on available-for-sale securities
Tax effect of reclassification adjustments for
gains and losses later recognized in income
2006
2005
2004
$
470,000
$
(2,368,000)
$
(208,000)
0
470,000
0
(2,368,000)
(78,000)
(130,000)
(164,000)
828,000
70,000
0
0
(28,000)
Other comprehensive income/(loss)
$
306,000
$
(1,540,000)
$
(88,000)
(Continued)
F-56
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 18 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest
Income
Net Interest
Income
Net
Income
Earnings per Share
Basic
Fully Diluted
2006
First quarter
Second quarter
Third quarter
Fourth quarter
2005
First quarter
Second quarter
Third quarter
Fourth quarter
2004
First quarter
Second quarter
Third quarter
Fourth quarter
$ 31,099,000
33,746,000
35,675,000
36,740,000
$15,099,000
15,646,000
15,547,000
15,295,000
$ 4,929,000
5,111,000
5,202,000
4,605,000
$ 0.62
0.64
0.65
0.57
$ 21,705,000
24,346,000
26,764,000
29,315,000
$12,655,000
13,608,000
14,072,000
14,957,000
$ 4,362,000
4,690,000
4,300,000
4,549,000
$ 0.58
0.62
0.57
0.60
$ 15,354,000
16,130,000
17,819,000
19,719,000
$ 9,489,000
10,000,000
10,856,000
12,082,000
$ 2,973,000
3,146,000
3,114,000
4,488,000
$ 0.40
0.42
0.41
0.59
$ 0.61
0.63
0.64
0.57
$ 0.56
0.61
0.56
0.59
$ 0.39
0.41
0.40
0.58
NOTE 19 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company only financial statements.
CONDENSED BALANCE SHEETS
ASSETS
Cash and cash equivalents
Investment in bank subsidiary
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Subordinated debentures
Shareholders’ equity
2006
2005
$
2,323,000
200,300,000
2,890,000
$
2,045,000
183,707,000
2,898,000
$ 205,513,000
$ 188,650,000
$
608,000
32,990,000
171,915,000
$
535,000
32,990,000
155,125,000
Total liabilities and shareholders’ equity
$ 205,513,000
$ 188,650,000
(Continued)
F-57
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 19 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF INCOME
Income
Dividends from subsidiaries
Other
Total income
Expenses
Interest expense
Other operating expenses
Total expenses
2006
2005
2004
$ 6,440,000
73,000
6,513,000
$ 4,832,000
46,000
4,878,000
$ 4,032,000
25,000
4,057,000
2,429,000
1,917,000
4,346,000
1,837,000
942,000
2,779,000
1,402,000
1,666,000
3,068,000
Income before income tax benefit and equity in
undistributed net income of subsidiary
2,167,000
2,099,000
989,000
Federal income tax benefit
(1,392,000)
(936,000)
(1,051,000)
Equity in undistributed net income of subsidiary
16,288,000
14,866,000
11,681,000
Net income
$ 19,847,000
$ 17,901,000
$ 13,721,000
(Continued)
F-58
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 and 2005
NOTE 19 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net
cash from operating activities
Equity in undistributed income of subsidiary
Equity compensation expense
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 from investing activities
Cash flows from financing activities
Proceeds from the issuance of subordinated debentures
Pay-off of subordinated debentures
Stock option exercises, net
Employee stock purchase plan
Dividend reinvestment plan
Cash dividends
Fractional shares paid
Net cash from financing activities
2006
2005
2004
$ 19,847,000
$ 17,901,000
$ 13,721,000
(16,288,000)
242,000
9,000
73,000
3,883,000
(14,866,000)
0
(98,000)
317,000
3,254,000
(11,681,000)
0
553,000
(140,000)
2,453,000
0
0
0
0
(16,495,000)
(16,495,000)
0
0
229,000
107,000
98,000
(4,035,000)
(4,000)
(3,605,000)
0
0
80,000
97,000
159,000
(3,185,000)
(4,000)
(2,853,000)
32,990,000
(16,495,000)
137,000
79,000
123,000
(2,552,000)
(4,000)
14,278,000
Net change in cash and cash equivalents
278,000
401,000
236,000
Cash and cash equivalents at beginning of period
2,045,000
1,644,000
1,408,000
Cash and cash equivalents at end of period
$ 2,323,000
$ 2,045,000
$ 1,644,000
F-59
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 February 22, 2007.
MERCANTILE BANK CORPORATION
/s/ Gerald R. Johnson, Jr.
Gerald R. Johnson, Jr.
Chairman of the Board 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 February 22, 2007.
/s/ Betty S. Burton
Betty S. Burton, Director
/s/ David M. Cassard
David M. Cassard, Director
/s/ Edward J. Clark
Edward J. Clark, Director
/s/ Peter A. Cordes
Peter A. Cordes, Director
/s/ C. John Gill
C. John Gill, Director
/s/ Doyle A. Hayes
Doyle A. Hayes, Director
/s/ David M. Hecht
David M. Hecht, Director
/s/ Susan K. Jones
Susan K. Jones, Director
/s/ Lawrence W. Larsen
Lawrence W. Larsen, Director
/s/ Calvin D. Murdock
Calvin D. Murdock, Director
/s/ Michael H. Price
Michael H. Price, Director, President and Chief
Operating Officer
/s/ Merle J. Prins
Merle J. Prins, Director
/s/ Dale J. Visser
Dale J. Visser, Director
/s/ Donald Williams, Sr.
Donald Williams, Sr., Director
/s/ Gerald R. Johnson, Jr.
Gerald R. Johnson, Jr., Chairman of the Board and
Chief Executive Officer (principal executive officer)
/s/ Charles E. Christmas
Charles E. Christmas, Senior Vice President, Chief
Financial Officer and Treasurer (principal financial and
accounting officer)
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43495MercantileInfo 2/27/07 9:14 AM Page 1
Corporate Information
DIRECTORS AND
EXECUTIVE OFFICERS
OFFICERS
Mercantile Bank of Michigan
Amy M. Derry
Assistant Branch Manager (Knapps), Officer
Betty S. Burton
Retired Educator and Business Owner
Sonali D. Allen
Vice President, Community Development Officer
Kevin R. DeVries
Vice President, IT Director
David M. Cassard
President, Waters Corporation
Kathleen M. Arbanas
Loan Administration Team Leader, Officer
Charles E. Christmas
Senior Vice President, CFO & Treasurer,
Mercantile Bank Corporation
Mark S. Augustyn
Senior Vice President, Commercial Lender
Edward J. Clark
Chairman & CEO,
American Seating Company
Peter A. Cordes
President & CEO, GWI Engineering, Inc.
C. John Gill
Retired Executive, Gill Industries
Doyle A. Hayes
President & CEO,
Pyper Products Corporation
David M. Hecht
Attorney
Gerald R. Johnson, Jr.
Chairman & CEO,
Mercantile Bank Corporation
Susan K. Jones
Owner, Susan K. Jones & Associates;
Professor, Ferris State University;
Partner, The Callahan Group LLC
Robert B. Kaminski, Jr.
Executive Vice President and Secretary,
Mercantile Bank Corporation
Lawrence W. Larsen
President & CEO, Central Industrial
Supply Company; President & CEO,
Jet Products, Inc.
Calvin D. Murdock
President, SF Supply, Inc.
Michael H. Price
President & COO,
Mercantile Bank Corporation
Merle J. Prins
Retired Bank Executive
Andrew M. Baker
Mortgage Lender, Officer
Stacie L. Bakke
Assistant Special Services Manager, Officer
Andrew D. Bellingar
Vice President, Commercial Lender (Lansing)
Beatrice M. Berghorst
Assistant Branch Manager (Holland), Officer
Ramon Berlanga
Assistant Vice President, Commercial Lender
Keane A. Blaszczynski
Vice President, Commercial Lender
Jenny J. Bloem
Assistant Vice President, Assistant Controller
Curtis J. Bobeldyk
Vice President, Business Development Officer
(Holland)
Jeffery P. Brown
Item Processing Manager, Officer
Walter G. Byers
Senior Vice President,
Washtenaw City President
John E. Byl
Vice President, Treasury Sales Manager
Sherri A. Calcut
Senior Vice President, Retail Loan
Department Head
Joseph S. Calvaruso
Senior Vice President,
Director of Risk Management
Cathleen A. Calveneau
Vice President, Branch Manager (Knapps)
Dale J.Visser
Chairman, Visser Brothers, Inc.
Charles E. Christmas
Senior Vice President & CFO
Donald Williams, Sr.
Dean Emeritus,
Grand Valley State University
Kimberly A. Christmas
Vice President, Branch Manager (Alpine)
Rose M. Constantine
Assistant Vice President, Mortgage Lender
Carolyn J. DeNeut
Executive Assistant, Officer
Harold L. Drenten
Senior Vice President,
Business Development Officer
Raymond A. Duimstra
Vice President, Commercial Lender
Kyle B. Erickson
Vice President, Commercial Lender (Holland)
Marianne Essing
Assistant Vice President,
Deposit/Proof Operations Supervisor
Melissa L. Fairchild
Loan Production Specialist (Holland), Officer
Douglas R. Fisher
Broker, Officer
Thomas L. Fitzgerald
Senior Vice President, Credit Administrator
Ralph E. Gady
Assistant Vice President, Payroll Manager
Kent G. Gagnon
Vice President, Business Development Officer
Daren L. Gantz
Vice President, Accounting Manager
Lawrence A. Gass
Vice President,
Business Development Officer (Washtenaw)
Thomas M. Gotelaere
Assistant Vice President,
Mortgage Lender (Washtenaw)
Bryan J. Gras
Vice President, Commercial Lender (Holland)
Terri L. Gray
Vice President, Retail Lender
Maurice H. Groce
Assistant Vice President,
Business Development Officer
Elizabeth J. Gromko
Assistant Vice President, Treasury Sales Specialist
Dennis K. Grounds
Vice President, Commercial Lender (Lansing)
C. Howard Haas
Senior Vice President, Lansing City President
Bart J. Hamlin
Vice President, Commercial Lender
Jennifer S. Harris
Assistant Payroll Manager, Officer
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Beth A. Harrison
Executive Assistant (Holland), Officer
Justin M. Karl
Commercial Loan Portfolio Manager, Officer
Michael H. Price
President & CEO
Eric S. Haynes
Commercial Loan Portfolio Manager, Officer
Jennifer A. Kastelic
Loan Review Specialist, Officer
Cassanda A. Puskala
Assistant Branch Manager (Lansing), Officer
Adrienne S. Heidema
Internal Audit Team Leader, Officer
Thomas J. Kelly
Senior Vice President, Commercial Lender
Thomas Q. Hoban
Senior Vice President,
Commercial Lender (Lansing)
Sarah M. Hodgkins
Vice President,
Systems Support Manager
Mark R. Hoffhines
Senior Vice President, Commercial Lender
Susan L. Hoffman
Assistant Vice President,
Mortgage Operations Supervisor
Gregory G. Holt
Real Estate Valuation Risk Manager, Officer
Douglas J. Holtrop
Assistant Vice President,
Commercial Loan Portfolio Manager
Brett E. Hoover
Vice President, Human Resource Administrator
Christine L. Hugmeyer
Vice President, Branch Manager (Wyoming)
Joy A. Hulst
Vice President, Mortgage Lender
Brenda K. Ingersoll
Assistant Vice President,
Commercial Operations Supervisor
Sandy K. Jager
Vice President, Internal Auditor
Christine G. Johnson
Vice President,
Commercial Lender (Washtenaw)
Gerald R. Johnson, Jr.
Chairman
Mildred L. Johnson
Assistant Vice President, Funds Manager
Jeffrey R. Kaiser
Vice President, Loan Review Manager
Amy W. Kam
Executive Assistant, Officer
Robert B. Kaminski, Jr.
Executive Vice President, COO & Secretary
Matthew L. Kind
Loan Review Specialist, Officer
Derrick J. Kooistra
Assistant Vice President,
Operations Project Manager
Jason M. Kooistra
Assistant Vice President, Broker
Jason H. Kovick
Assistant Vice President,
Branch Manager (Lansing)
Michael R. Kroft
Vice President,
Electronic Banking Services Manager
Kyle P. Kunnen
Vice President, Operations Manager
Mary B. Libby
Vice President, Mortgage Manager (Holland)
Wanda Martinez
Assistant Vice President,
Assistant Branch Manager (Wyoming)
Raymond E. Reitsma
Senior Vice President,
Commercial Loan Manager
Deborah A. Rogers
Senior Vice President,
Business Development Officer
Jason R. Ross
Retail Lender, Officer
Sandra M. Ross
Vice President, Branch Manager (Washtenaw)
Claire L. Rotman
Assistant Vice President,
Branch Manager (Holland)
Melanie S. Salamone
Vice President, Branch Manager (Kentwood)
Michael J. Sankey
Vice President, Controller
Kevin M. Schafer
Assistant Vice President,
Commercial Credit Manager
Lori A. Schafer
Mortgage Loan Processing Supervisor, Officer
Danna A. Mathiesen
Assistant Vice President, Retail Lender
Donald K. Schneider
Vice President, Retail Lender
Kathleen M. Mauric
Assistant Vice President, Wire Transfer Manager
Katherine B. McHenry
Assistant Vice President, Commercial Lender
Gretchen A. Murphy
Vice President, Training Director
Robert M. Nicey
Vice President, Commercial Lender
Theodore A. Schork
Senior Vice President,
Commercial Lender (Washtenaw)
John R. Schulte
Senior Vice President,
Chief Information Officer
Suzanne C. Schultz
Senior Loan Administrative Assistant,
Officer (Washtenaw)
Jodi L. Nowicki-Domanski
Assistant Vice President, Risk Management
Scott P. Setlock
Assistant Commercial Credit Manager, Officer
Gordon L. Oosting
Senior Vice President, Commercial Lender
John R. Shaw
Mortgage Lender, Officer (Lansing)
John E. Ormstad
Electronic Banking Assistant Manager, Officer
Michael F. Siminski II
Vice President, Commercial Lender
Gary L. Palmitier
Vice President, Commercial Lender (Holland)
Lindsay A. Spitler
Assistant Vice President, Commercial Lender
Daniel A. Poskey
Assistant Branch Manager (Leonard), Officer
Kevin M. Stacey
Senior Vice President,
Loan Review Department Head
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Cheri L. Stanton
Vice President, Branch Manager (Leonard)
OFFICERS
Mercantile Bank Mortgage Company, LLC
Jonathan P. Steiner
Senior Vice President, Holland City President
Mark S. Augustyn
Senior Vice President, Commercial Lender
Tara M. Strickler
Branch Operations Manager, Officer
Andrew M. Baker
Mortgage Lender, Officer
David A. Struck
Loan Review Specialist, Officer
Andrew M. Bellingar
Vice President, Commercial Lender (Lansing)
Sherri A. Calcut
President, Mortgage Company
Rose M. Constantine
Assistant Vice President, Mortgage Lender
Kyle B. Erickson
Vice President, Commercial Lender (Holland)
Melissa L. Fairchild
Loan Production Specialist (Holland), Officer
Thomas M. Gotelaere
Assistant Vice President,
Mortgage Lender (Washtenaw)
Dennis K. Grounds
Vice President, Commercial Lender (Lansing)
Susan L. Hoffman
Assistant Vice President,
Mortgage Operations Supervisor
Joy A. Hulst
Vice President, Mortgage Lender
Mary B. Libby
Vice President, Mortgage Manager (Holland)
Danna A. Mathiesen
Assistant Vice President, Retail Lender
Jason R. Ross
Retail Lender, Officer
Lori A. Schafer
Mortgage Loan Processing Supervisor, Officer
Donald K. Schneider
Vice President, Retail Lender
John R. Shaw
Mortgage Lender, Officer (Lansing)
Jessica L.Webster
Assistant Vice President, Commercial Lender
H. Joann Yates
Assistant Vice President, Mortgage Lender
Katie L. Stygstra
Broker Assistant, Officer
Jason A.Taber
Assistant Vice President,
Loan Operations Manager
Julie R.VanDyke
Loan Administrative Assistant Team Leader
(Holland), Officer
Tina L. Van Valkenburg
Assistant Vice President,
Human Resource Specialist
Matthew J.Venema
Commercial Loan Portfolio Manager, Officer
Audrey J.Versluis
Assistant Vice President, Special Services Manager
Jessica L.Webster
Assistant Vice President, Commercial Lender
Michael F. Webster
Vice President, Commercial Lender
Paul R.Wegener
Assistant Vice President,
Loss Prevention & Security Manager
Lonna L.Wiersma
Senior Vice President, Human Resource Director
Catherine A.Williams
Branch Operations Assistant Manager, Officer
Kyle E.Wilson
Assistant Vice President, Commercial Lender
H. Joann Yates
Assistant Vice President, Mortgage Lender
William H.Young
Senior Vice President, Commercial Lender
John R. Zimmerman
Vice President,
Marketing/Corporate Communications Manager
Matthew J. Zimmerman
Vice President, Commercial Lender
Laurie A. Zurek
Vice President, Retail Lender
SHAREHOLDER INFORMATION
Annual Meeting
The Corporation’s Annual Meeting of
Shareholders will be held on Thursday,
April 26, 2007, at Cascade Hills Country
Club, 3725 Cascade Road SE, Grand
Rapids MI 49546 at 9:00 a.m. EST.
Administrative Headquarters
310 Leonard Street NW, 4th Floor
Grand Rapids MI 49504
616.406.3000
Legal Counsel
Dickinson Wright PLLC
500 Woodward Avenue Suite 4000
Detroit MI 48226-3425
Independent Certified
Public Accountants
Crowe Chizek and Company LLP
55 Campau Avenue NW
Grand Rapids MI 49503
Investor Relations
Margolin & Associates, Inc.
2575 Bolton Road
Cleveland Heights OH 44118
Common Stock Listing
Nasdaq Global Select Market
Symbol: MBWM
Stock Registrar and Transfer Agent
Computershare
PO Box 43023
Providence RI 02940-3023
1.877.282.1168
www.computershare.com
SEC Form 10-K
Copies of the Corporation’s Annual
Report on Form 10-K, as filed with the
Securities and Exchange Commission,
are available to shareholders without
charge upon written request. Please mail
your request to: Charles E. Christmas,
Mercantile Bank Corporation,
310 Leonard Street NW,
4th Floor, Grand Rapids, MI 49504.
Mercantile Bank Corporation does not
discriminate on the basis of race, color,
national origin, sex, religion, age or disability
in employment or the provision of services.
43495MercantileInfo 2/27/07 9:14 AM Page 4
Mission Statement
The mission of Mercantile Bank of Michigan is to provide financial products and
services in a highly professional and personalized manner. We recognize that our
most important partners are our customers. We will satisfy our customers by
delivering top quality service that distinguishes us from our competitors.
Our employees are our most valuable asset. We strive to hire exceptional
team members and are committed to maintaining an environment of growth
and development.
We recognize the importance of being strong supporters of the diverse
communities we serve, and pledge our commitment to making them stronger.
We believe that fulfilling our mission to our customers, employees and
community will allow us to reward our shareholders with an excellent return
on their investment in Mercantile Bank.
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Mercantile Bank Corporation Board of Directors
Back row (L-R): Ed Clark, Susan Jones, Larry Larsen, Jerry Johnson,
Mike Price, Cal Murdock, Betty Burton, Dale Visser, Doyle Hayes,
Merle Prins, Pete Cordes. Front row (L-R): John Gill, Dave Cassard,
David Hecht, Don Williams.
Quality, Not Quantity
“To a lot of banks, service is simply
having a branch on every corner,”
says Mike Sankey. “It has nothing to
Mike Sankey
Controller
Grand Rapids
do with the customer experience
inside those branches.”
Mercantile has a limited
number of branches, so the
emphasis is on the quality of the
customer interaction. “We don’t
have to hire anybody that comes
along just to fill our buildings.
We take our time to get the very
best people. Then we empower
them to do whatever it takes to
®
please customers.”
®
310 Leonard Street NW
Grand Rapids MI 49504
888.345.6296
www.mercbank.com
002CS-13283