48696MercantileCvr:Annual Report 2004 2/23/09 8:05 AM Page 1
®
310 Leonard Street NW
Grand Rapids MI 49504
888.345.6296
www.mercbank.com
MERC ANTILE B ANK CORPORATION 2008 ANNUAL REPORT
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We believe in our customers.
We believe in our communities.
We believe in Michigan.
We believe in the future.
We Believe
in Holiday
Spirit.
When we were told
that ACCESS of West
Michigan was facing a
huge increase in need
this past holiday, we
donated the funds to
feed 105 families a
delicious, nutritious,
much-appreciated
Christmas dinner.
We Believe
in Green.
We provided the
construction loan for
Celadon New Town
Development, an
innovative residential,
commercial and
retail project in
Grand Rapids. All the
buildings are built to
the Michigan Green
Built Standard or will
be LEED certified.
The project includes
insulation made
with recycled
newspapers, Energy
Star appliances,
reclaimed brick, solar
heating, rain gardens
and more. The project
has been warmly
received by the
community, and units
are selling before
the project is even
complete!
We Believe
in Inner
Cities.
Bear Manor Properties
has been renovating
and developing
residential and
commercial projects
in inner city Grand
Rapids since 2004.
The projects include
homes, offices, retail
spaces and more, all
financed by Mercantile
Bank. In 2008, Bear
Manor won a Historic
Preservation Award
for its work.
We Believe
in Kids.
Since the opening of
our Leonard Street
headquarters,
employees have
volunteered their time
to mentor students at
the nearby Harrison
Park Elementary
School. In 2008,
34 employees
volunteered at least
once a week to tutor
a child – a 50%
increase over 2007.
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It’s no secret that America is in the midst of its worst economy
in decades. You can’t turn on the TV, open a newspaper or
log on to the Internet without experiencing a barrage of
financial doom and gloom. You probably know someone who
has lost a job or taken a cut in salary. You may be feeling the
financial pinch yourself.
Mercantile Bank has not been immune to the effects of this
downturn. As a bank heavily invested in the business
community, we feel the pain when our customers’ sales
decrease and their growth is curtailed. In the extreme,
businesses can find their ability to repay loans compromised,
which directly affects our bottom line.
While we want to acknowledge these challenges in this
Report, we also want to express something that seems to
be in short supply these days: Optimism.
The economy will recover. The stock market will bounce back.
Our home state of Michigan will regain its financial footing.
With the support of Mercantile Bank, our customers will
help lead the way.
We Believe in
Technology.
In 2009, Mercantile
will utilize new
technologies to
make banking even
more convenient.
We are introducing
MercMobile™, which
lets customers use
their cell phones
to access balance
information, pay bills,
transfer funds and
more. We are also
extending our
Electronic Check
Deposit service to
retail customers:
Merc@Home™
Deposit allows
account holders to
scan checks and
deposit them online.
On the Cover: A new day dawns over a West Michigan lake.
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2008 in Review
Like many financial institutions, Mercantile Bank has been greatly
impacted by the collapse of the sub-prime lending market.
Mercantile Bank never participated in that business. However, we
have certainly felt the fallout – the flood of foreclosures leading from
this collapse has eroded both real estate values and family wealth.
Couple this with a state economy that is severely challenged by America’s
highest unemployment rate and the continuing troubles of Detroit’s
We Believe
in Growth.
In 2008, we provided
financing to Design 1
Salon and Day Spa,
enabling the company
automakers, and you can see why 2008 was such a challenging year
to construct a new
salon with adjacent
retail space. This
was Design 1’s fourth
location in the Grand
Rapids market.
This project created
quality jobs in both
the construction and
retail sectors.
We Believe
in Home-
ownership.
We donated funds to
Home Repair Services in
2008. This agency works
with lower income
homeowners and their
families to strengthen and
sustain homeownership,
and prevent foreclosures.
4
for a Michigan bank. The confluence of financial stresses created a
maelstrom of economic woes and the most challenging business
conditions in many years.
Still, the second half of 2008 produced some positive signs for us.
While each of the first two quarters of 2008 showed net losses – due to
significant additions to our reserve for loan losses – Mercantile Bank
returned to profitability in quarters three and four. Our net interest
margin expanded during the most recent two quarters from its
second-quarter low point. Since the end of the second quarter, we
increased quarterly net interest income by $1.9 million through a
combination of margin expansion and earning asset growth.
The provision for loan and lease losses declined from that recorded during
the first six months, as the rate of loan downgrades improved slightly
during the second half of the year. Loans outstanding rose modestly year
over year, another positive development. Also, our loan yields began to
stabilize in the fourth quarter, despite falling interest rates, as the result
of several pricing initiatives we implemented throughout the year.
Still, there’s no denying that 2008 proved to be a deviation from our
historical levels of profitability. Our 2008 performance was impacted
primarily by declining interest rates that lowered our average net interest
margin relative to 2007, and deteriorating asset quality that gave rise
to a higher provision for loan and lease losses.
Asset quality remains our major concern and we continue to be relentlessly
vigilant in the identification and management of problem assets. We began
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We Believe
in Outreach.
We were the title
sponsor for the 2008
Bowling Party held by
the United Church
Outreach Ministry
(UCOM). Many
employees also
participated in the
event, which raised
$6,000. UCOM
provided basic
material and
educational assistance
to more than 40,000
Grand Rapids
residents last year,
16,000 of them
children.
Winding through the fall colors of a Michigan forest.
5
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We Believe
in Financial
Literacy.
We teach financial
basics to people
around the state in
many different venues.
For instance, our
Lansing team has
conducted a banking
program with Lansing
Public Schools for
the past three years.
We were awarded the
2008 Michigan Bankers
Association Financial
Literacy Award for
our efforts.
6
The Lake Michigan shoreline, just minutes from our Holland office.
48696Mercantile8pg:Annual Report 2004 2/19/09 2:23 PM Page 5
actively working with our borrowers as soon as our local economy began
to show weakness – more than six quarters ago, earlier than many of our
banking peers – and we’ve made significant upgrades to an already strong
risk management process. We have worked hard to identify our distressed
borrowers and we are now working with them to achieve the best possible
result for all stakeholders. Our performance in the second half of 2008
reflects these efforts.
It should be noted that, contrary to media reports that credit has dried up,
Mercantile Bank continues to actively seek new loan customers who are
positioned to succeed in this challenging environment.
Enhancing the Customer Experience
We also continue to develop new ways to serve customers, boost
customer satisfaction and improve our competitive position. We made
a number of moves in the past year that have significantly enhanced the
customer experience:
Free ATM. All Mercantile deposit customers can now withdraw cash
from any ATM, anywhere, absolutely free. Not only do we waive our fee,
we reimburse our customers for any fee assessed by another bank. This is a
distinct advantage over our competitors, and we intend to fully highlight
it in our marketing efforts.
Executive Banking. In 2008, we relaunched our popular Executive
Banking package with expanded VIP-quality services and tools for managing
personal banking needs. Response has been very favorable.
Merc@Work. We created a Merc@Work checking account expressly
for the employees of our business customers. Employees who direct deposit
their payroll checks to this account receive a host of exclusive perks.
Direct deposit also benefits employers, so businesses welcome this outreach
to their employees.
Saturday Hours. Three of our Grand Rapids locations added Saturday
hours (9:00 a.m. – noon) in September to better serve our customers and
build retail sales opportunities. While many of our business customers bank
with us via Internet or courier service, the Saturday hours have been very well
received by our ever-growing base of personal customers.
We Believe
in Fun.
Our financial
contributions ensured
that a number of
middle school students
could attend Mystic
Lake YMCA Camp
in Lansing for four
fun-filled days in June.
We Believe
in Family.
In May, our Washtenaw
team bought food and
cooked a meal at the
Ann Arbor Ronald
McDonald House,
which allows families
of hospitalized kids
to stay close by.
There was nearly
100% employee
participation, and
the team is on the
schedule to repeat
in 2009.
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Serving the Community
Make no mistake, most of our customers are doing well for themselves
even in the midst of this recession. But many in the communities
we serve are not. More people are hurting and in need of assistance.
More charitable organizations face funding challenges. In response,
we intensified our efforts to lend a helping hand in 2008.
On a corporate level, we continued to focus our philanthropy on children
and underserved segments of our local communities. They are among
the first to feel the effects of economic stress, and they are often ill
equipped to deal with it. We consider it both a responsibility and a
privilege to make their lives better.
On an individual level, our employees devoted nearly 23,000 hours to
community service in 2008 – and almost 66,000 volunteer hours over the
past three years. Whether it’s organizing fundraising events or mentoring
school kids, serving on non-profit Boards or collecting and distributing
food for those in need, our employees are always ready to roll up their
sleeves and get involved.
You’ll read about a few of our 2008 community activities throughout
this Report. Keep in mind that this is just a small fraction of the total,
and that we’ll deliver more of the same in 2009.
2009 and Beyond
Unfortunately, there’s likely to be more of the same economic distress in
2009, as well. Many difficult months lie ahead, especially for the citizens
and businesses of Michigan.
However, while the national media and many economists seem to
have given up on Michigan, Mercantile Bank has not. Most of us were
born and raised here, and we’ve been through difficult times before.
We see every day the great strength and strong work ethic of Michigan
residents. We work every day with some of the country’s most innovative
entrepreneurs, visionaries who will help transition Michigan to a new,
more robust economy.
We Believe
in Healthy
Bodies.
The second
Wednesday of every
month, Grand Rapids
employees volunteer
to make sandwiches
and pack evening
meal bags for Kids
Food Basket, a hunger
relief organization
that provides needy
children with an
evening meal each
weekday. In 2008,
employees also
donated over 1,700
juice boxes and
decorated more than
3,000 supper bags.
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We Believe
in Healthy
Minds.
In 2007, we made a
five-year financial
commitment to
network180, Kent
County’s public mental
health system. Our
$30,000 donation
in 2008 helped
network180 provide
care to children,
teens, adults, families
and seniors who
experience mental
health or substance
abuse problems,
or who are living
with a developmental
disability.
A portion of the ever-expanding skyline of Grand Rapids, Michigan.
9
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We Believe
in Beauty.
We donated funds
to help the West
Grand Neighborhood
Association repair
a series of murals
underneath a
Grand Rapids highway
overpass. The murals
accent rain gardens
that were planted as
part of a neighborhood
beautification project.
We Believe
in Hope.
For the fifth straight year,
our Holland office
sponsored the annual
Steak and Burger
fundraising dinner held
by the Boys and Girls
Club of Greater Holland.
The Holland team contin-
ued to volunteer many
hours at the Club, which
provides young people
with support, guidance
and hope for the future.
10
L-R: Mike Price, Bob Kaminski, Chuck Christmas
Yes, we believe in Michigan. And we believe Mercantile Bank is ideally
positioned to help our customers lead the way to an economic recovery.
After all, we’ve always been more than bankers. We serve as trusted business
advisors. Our advice and expertise is valued now more than ever, and we look
forward to playing an important role in Michigan’s recovery.
As a sign of our faith, and a validation of our shareholders’ faith in us, a
quarterly cash dividend of $0.04 per share was declared by our Board of
Directors on January 8, 2009, and paid on March 10, 2009. This is the
company’s 25th consecutive quarterly cash dividend payment to shareholders.
We want to thank all of our dedicated and talented employees, and the hard-
working members of our Board of Directors, for their efforts in 2008. We also thank
the shareholders who continue to stand by us through these challenging times.
We believe in all of you.
Michael H. Price
Chairman
President
Chief Executive Officer
Robert B. Kaminski, Jr.
Executive Vice President
Chief Operating Officer
Charles E. Christmas
Senior Vice President
Chief Financial Officer
Treasurer
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, 2008
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, a non-accelerated
filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer ___
Non-accelerated filer ___
Accelerated filer X
Smaller reporting company ___
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 closing price of the common stock as of the last business day
of the registrant’s most recently completed second fiscal quarter, was approximately $56.2 million.
As of February 2, 2009, there were issued and outstanding 8,592,730 shares of the registrant’s common stock.
Portions of the proxy statement for the 2009 annual meeting of shareholders (Portions of Part III).
DOCUMENTS INCORPORATED BY REFERENCE
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 facility in downtown Grand Rapids which serves as our bank’s 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 Regulation. 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, and in Novi, Michigan, during 2007.
Our bank, through its nine offices, provides commercial and retail banking services primarily to small-
to medium-sized businesses based in and around the Grand Rapids, Holland, Lansing, Ann Arbor and Oakland
County 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, 3737 Coolidge Road, East Lansing,
Michigan, 325 Eisenhower Parkway, Ann Arbor, Michigan, and 28350 Cabot Drive, Novi, Michigan.
2.
Our bank makes secured and unsecured commercial, construction, mortgage and consumer loans, and
accepts checking, savings and time deposits. Our bank owns seven automated teller machines ("ATM"),
located at our branch locations in Grand Rapids, Holland and East Lansing, 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, Holland and East Lansing. 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. The joint brokerage
services and marketing agreement was terminated during the first quarter 2009.
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 17 – Subordinated Debentures” and “Note 18 – Regulatory Matters”
of the Notes to Consolidated Financial Statements included in this Annual Report.
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 restrictions imposed by Federal and state
laws and regulations.
Employees
As of December 31, 2008, we and our bank employed 269 full-time and 71 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 $5.0 million, and $10.0 million for our bank’s Chairman of the
Board 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 Mercantile 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 to 20
year period. Commercial loans and leases typically have an interest rate that is fixed to maturity or is tied to the
Mercantile 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 Wall Street Journal 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 random sampling basis
after the loan has been made using a separate standardized grade paradigm that analyzes several critical factors
such as debt-to-income and credit and employment histories.
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, 2008, loans and leases placed in nonaccrual
status totaled $47.9 million, or 2.58% of total loans and leases. As of the same date, loans and leases past due
90 days or more and still accruing interest totaled $1.4 million, or 0.07% of total loans and leases.
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”) and Note 3 of the Consolidated Financial Statements 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 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 historical strong commercial loan and lease growth and expansions into new markets are 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 the 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 or Ohio, the review and consideration of our loan and lease
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.
7.
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 our 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 loans 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 and Note 3 of the Notes to Consolidated Financial Statements of the Company 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.
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.
8.
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 and Note 2 of the Notes to Consolidated Financial Statements included
in this Annual Report.
Competition
Our primary markets for loans and core deposits are the Grand Rapids, Holland, Lansing, Ann Arbor
and Oakland County 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 affects the competitive environment in which we conduct our
business. The financial services industry is also likely to become more competitive as further technological
advances enable more companies to provide financial services.
Selected Statistical Information
Management’s Discussion and Analysis beginning on Page F-4 in this Annual Report includes selected
statistical information.
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.
9.
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.
Difficult market conditions have adversely affected our industry.
Dramatic declines in the housing market over the past two years, with falling home prices and
increasing foreclosures, unemployment and under-employment, have negatively impacted the credit
performance of real estate related loans and resulted in significant write-downs of asset values by financial
institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans,
have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge
with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the
financial markets generally and the strength of counterparties, many lenders and institutional investors have
reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil
and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of
consumer confidence, increased market volatility and widespread reduction of business activity generally. The
resulting economic pressure on consumers and lack of confidence in the financial markets has adversely
affected our business, financial condition and results of operations. Market developments may affect consumer
confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and
default rates, which may impact our charge-offs and provision for credit losses. A worsening of these
conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in
the financial institutions industry.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more than 12
months. In more recent months, the volatility and disruption have reached unprecedented levels. In some cases,
the markets have produced downward pressure on stock prices and credit availability for certain issuers without
apparent regard to those issuers’ underlying financial strength. The current levels of market disruption and
volatility have an adverse effect, which may be material, on our ability to access capital and on our business,
financial condition and results of operations.
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 the decline in the economy of these
areas has adversely affected us. Additional stresses on our financial condition are likely given the deteriorated
economic conditions within our markets. 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.
10.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and
commercial soundness of other financial institutions. Financial services institutions are interrelated as a result
of trading, clearing, counterparty or other relationships. We have exposure to many different industries and
counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result,
defaults by, or even rumors or questions about, one or more financial services institutions, or the financial
services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by
us or by other institutions. Even routine funding transactions expose us to credit risk in the event of default of
our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot
be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument
exposure due us. There is no assurance that any such losses would not materially and adversely affect our
results of operations.
There can be no assurance that recently enacted legislation will stabilize the U.S. financial system.
On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of
2008 (the “EESA”). The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the
U.S. Congress in response to the financial crisis affecting the banking system, financial markets, and other
financial institutions. Among other things, the EESA established the Troubled Asset Relief Program, or TARP.
Under TARP, the U.S. Treasury was given the authority, among other things, to purchase up to $700 billion of
mortgages, mortgage-backed securities and certain other financial instruments from financial institutions and
others for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14,
2008, the U.S. Treasury announced a program under the EESA pursuant to which it would make senior
preferred stock investments in qualifying financial institutions (the “TARP Capital Purchase Program”). Also
on October 14, 2008, the Federal Deposit Insurance Corporation announced the development of a guarantee
program under the systemic risk exception to the Federal Deposit Insurance Act pursuant to which the FDIC
would, among other things, offer a guarantee of certain financial institution indebtedness in exchange for an
insurance premium to be paid to the FDIC by issuing financial institutions (the “FDIC Temporary Liquidity
Guarantee Program”). On February 17, 2009, President Obama signed into law the American Recovery and
Reinvestment Act of 2009 (the “ARRA”), a further package of economic stimulus measures. In addition,
Treasury Secretary Geithner has announced further measures to address the crisis in the financial services
sector. There can be no assurance, however, as to the actual impact that the EESA, the ARRA, their respective
implementing regulations, the programs of the FDIC or any other governmental agency, or any further
legislation, will have on the financial markets. The failure to stabilize the financial markets, and a continuation
or worsening of current financial market conditions, could materially and adversely affect our business,
financial condition, results of operations, access to credit or the trading price of our common stock.
The impact on us of recently enacted legislation, in particular the Emergency Economic Stabilization Act
of 2008 and its implementing regulations, and actions by the FDIC, cannot be predicted at this time.
The programs established or to be established under the EESA and TARP or other legislation may
have adverse effects upon us. We may face increased regulation of our industry. Compliance with such
regulation may increase our costs and limit our ability to pursue business opportunities. Also, participation in
specific programs may subject us to additional restrictions. For example, participation in the TARP Capital
Purchase Program would limit (without the consent of the U.S. Treasury) our ability to increase our dividend or
to repurchase our common stock for so long as any securities issued by us under such program remained
outstanding. It would also subject us to additional executive compensation restrictions. The effects of
participating or not participating in any such programs, and the extent of our participation in such programs,
cannot reliably be determined at this time.
11.
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. 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.
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
Michael H. Price, Chairman of the Board, President and Chief Executive Officer, and our other senior
managers. The loss of 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. 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 and regional presidents and key commercial loan
officers. Our city and regional 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. Wholesale deposits
include deposits obtained through brokers. If a bank is not well capitalized, regulatory approval is required to
accept brokered deposits.
12.
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 preferred or common 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.
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, Ann Arbor and Oakland County 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.
13.
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.
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.
14.
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 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.
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 1B. Unresolved Staff Comments
We have received no written comments regarding our periodic or current reports from the staff of the
Securities and Exchange Commission that were issued 180 days or more before the end of our 2008 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. This facility serves as our 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, and portions of our bank’s retail lending and business
development function. The 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.
15.
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 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. 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 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 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, which is owned by our bank, 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 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, and serves as a full service banking center for the Ann Arbor
area, including commercial lending, retail lending and a full service branch. 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 was completed during the
second quarter of 2007, and serves as a full service banking center for the greater Lansing area, including
commercial lending, retail lending, and a full service branch. The facility consists of approximately 27,000
square feet of usable space and contains multiple drive-through lanes with ample parking. The address of this
facility is 3737 Coolidge Road, East Lansing, Michigan.
During 2007, our bank opened a branch facility in the City of Novi, Michigan. The facility is one
story and has approximately 8,600 square feet of usable space. The facility is operated under a lease agreement
between our bank and a third party, and serves as a full service banking center for the Oakland County area,
including commercial lending, retail lending and a full service branch. There is ample parking space, but no
drive-through lanes. The address of this facility is 28350 Cabot Road, Novi, 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.
16.
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 traded on the Nasdaq Global Select Market under the symbol “MBWM”. At
February 10, 2009, there were 393 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. Applicable prices have been adjusted for the 5% stock dividend paid on May 4, 2007.
High Low Dividend
2008
First Quarter.............................................
$ 16.19
Second Quarter ........................................ 11.40
Third Quarter ........................................... 10.09
9.69
Fourth Quarter .........................................
$ 10.19
$ 0.15
0.08
0.04
0.04
7.10
4.82
4.00
2007
First Quarter.............................................
Second Quarter ........................................ 31.43 26.59
Third Quarter ........................................... 27.40 19.86
Fourth Quarter ......................................... 22.70 14.49
$ 29.30
$ 36.62
$ 0.13
0.14
0.14
0.14
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 8, 2009, we declared a $0.04 per share cash dividend on our common stock, payable on
March 10, 2009 to record holders as of February 10, 2009. We currently expect to continue to pay a quarterly
cash dividend, although there can be no assurance that we will continue to do so.
Issuer Purchases of Equity Securities
We did not purchase any shares of our common stock during the fourth quarter of 2008.
17.
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,
2003 through December 31, 2008. The following is based on an investment of $100 on December 31, 2003 in
our common stock, the Nasdaq Composite Index and the SNL Nasdaq Bank Index, with dividends reinvested
where applicable.
Index
Mercantile Bank Corporation
NASDAQ Composite
SNL Bank NASDAQ
Period Ending
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
100.00
100.00
100.00
114.78
108.59
114.61
118.66
110.08
111.12
123.62
120.56
124.75
54.67
132.39
97.94
15.60
78.72
71.13
Item 6.
Selected Financial Data.
The Selected Financial Data on page F-3 in this Annual Report is incorporated here by reference.
18.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.
Management’s Discussion and Analysis included in this Annual Report is incorporated here by
reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information under the heading “Market Risk Analysis” included in this Annual Report is
incorporated here by reference.
Item 8.
Financial Statements and Supplementary Data.
The Consolidated Financial Statements, Notes to Consolidated Financial Statements and the Reports
of Independent Registered Public Accounting Firm included in this Annual Report are incorporated here by
reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None
Item 9A. Controls and Procedures.
As of December 31, 2008, 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, 2008.
There have been no significant changes in our internal controls over financial reporting during the
quarter ended December 31, 2008, that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). There are inherent limitations in
the effectiveness of any system of internal control. Accordingly, even an effective system of internal control
can provide only reasonable assurance with respect to financial statement preparation.
Under the supervision and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting as of December 31, 2008. This evaluation 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 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, 2008. Refer to page F-32 for management’s report.
Our independent registered public accounting firm has issued an audit report on our internal control
over financial reporting which is included in this Annual Report.
Item 9B. Other Information.
None
19.
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information presented under the captions “Election of Directors,” “Executive Officers,” “Section
16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance – Code of Ethics” in the
definitive Proxy Statement of Mercantile for our April 23, 2009 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, David M. Hecht, Calvin D. Murdock, Merle J. Prins and Timothy O. Schad. The
Board of Directors has determined that Messrs. Cassard, Murdock and Schad, members of the Audit
Committee, are qualified as audit committee financial experts, as that term is defined in the rules of the
Securities and Exchange Commission. Messrs. Cassard, Murdock and Schad are 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.
20.
Equity Compensation Plan Information
The following table summarizes information, as of December 31, 2008, 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)
325,434
$ 20.49
396,000 (2)
0
0
0
Plan Category
Equity compensation
plans approved by
security holders (1)
Equity compensation
plans not approved by
security holders
Total
325,434
$ 20.49
396,000
(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, and Director Independence.
The information presented under the captions “Transactions with Related Persons” and “Corporate
Governance – Director Independence” in the Proxy Statement is incorporated here by reference.
Item 14. Principal Accountant Fees and Services.
The information presented under the caption “Principal Accountant Fees and Services” in the Proxy
Statement is incorporated here by reference.
21.
Item 15. Exhibits and Financial Statement Schedules
PART IV
(a) (1) Financial Statements. The following financial statements and reports of independent registered public
accounting firms of Mercantile Bank Corporation and its subsidiaries are filed as part of this report:
Report of Independent Registered Public Accounting Firm dated March 11, 2009 – BDO Seidman,
LLP
Report of Independent Registered Public Accounting Firm dated February 20, 2007 – Crowe Horwath
LLP
Consolidated Balance Sheets --- December 31, 2008 and 2007
Consolidated Statements of Income for each of the three years in the period ended December 31, 2008
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period
ended December 31, 2008
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
2008
Notes to Consolidated Financial Statements
The consolidated financial statements, the notes to the consolidated financial statements, and the
reports of independent registered public accounting firm listed above are incorporated by reference in
Item 8 of this report.
(2) Financial Statement Schedules
Not applicable
(b)
Exhibits:
EXHIBIT NO.
EXHIBIT DESCRIPTION
3.1
3.2
10.1
10.2
10.3
Our Articles of Incorporation are incorporated by reference to exhibit 3.1 of our
Form 10-Q for the quarter ended June 30, 2008
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 *
22.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
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
filed October 22, 2004 *
Mercantile Bank of Michigan Amended and Restated Deferred Compensation Plan
for Members of the Board of Directors dated June 29, 2006 is incorporated by
reference to exhibit 10.9 of our Form 10-K for the year ended December 31, 2007
First Amendment dated October 25, 2007 to the Mercantile Bank of Michigan
Amended and Restated Deferred Compensation Plan for Members of the Board of
Directors dated June 29, 2006 is incorporated by reference to exhibit 10.10 of our
Form 10-K for the year ended December 31, 2007
Second Amendment dated October 23, 2008 to the Mercantile Bank of Michigan
Amended and Restated Deferred Compensation Plan for Members of the Board of
Directors dated June 29, 2007
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 21, 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
Extension Agreement of Data Processing Contract between Fiserv Solutions, Inc.
and our bank dated December 20, 2006 extending the agreements between Fiserv
Solutions, Inc. and our bank dated September 10, 1997 and November 21, 2002 is
incorporated by reference to exhibit 10.14 of our Form 10-K for the year ended
December 31, 2007
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 *
23.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
10.27
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 filed 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
filed 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 filed 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 filed December 15, 2004
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 filed December 14, 2005 *
24.
EXHIBIT NO.
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37
10.38
EXHIBIT DESCRIPTION
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 Amended and Restated Executive Deferred
Compensation Agreement dated November 18, 2006, 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 10.34 of our Form 10-K for the year ended
December 31, 2007 *
Form of First Amendment to the Mercantile Bank of Michigan Executive Deferred
Compensation Agreement dated November 18, 2006, 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, dated
October 25, 2007 is incorporated by reference to exhibit 10.35 of our Form 10-K
for the year ended December 31, 2007 *
Form of Second Amendment to the Mercantile Bank of Michigan Executive
Deferred Compensation Agreement date November 18, 2006, that has been
entered into between our bank and each of Michael H. Price, Robert B. Kaminski,
Charles E. Christmas, and certain other officers of our bank, dated October 23,
2008 *
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 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 *
25.
EXHIBIT NO.
EXHIBIT DESCRIPTION
10.39
10.40
10.41
10.42
10.43
10.44
10.45
10.46
10.47
10.48
21
23.1
23.2
31
32.1
32.2
Amendment and Restatement of Stock Incentive Plan of 2006 dated November 18,
2008 *
Form of Notice of Grant of Incentive Stock Option and Stock Option Agreement
for incentive stock options granted in 2006 under our Stock Incentive Plan of 2006
is incorporated by reference to exhibit 10.1 of our Form 8-K filed November 22,
2006 *
Form of Notice of Grant of Incentive Stock Option and Stock Option Agreement
for incentive stock options granted after 2006 under our Stock Incentive Plan of
2006 is incorporated by reference to exhibit 10.41 of our Form 10-K for the year
ended December 31, 2007 *
Form of Restricted Stock Award Agreement Notification of Award and Terms and
Conditions of Award for restricted stock granted in 2006 under our Stock
Incentive Plan of 2006 is incorporated by reference to exhibit 10.2 of our Form 8-
K filed November 22, 2006 *
Form of Restricted Stock Award Agreement Notification of Award and Terms and
Conditions of Award for restricted stock granted after 2006 under our Stock
Incentive Plan of 2006 is incorporated by reference to exhibit 10.43 of our Form
10-K for the year ended December 31, 2007 *
Executive Officer Bonus Plan for 2007 is incorporated by reference to exhibit 10.1
of our Form 8-K filed January 29, 2007 *
Retirement Agreement by and among Mercantile Bank Corporation, Mercantile
Bank of Michigan and Gerald R. Johnson, Jr. is incorporated by reference to
exhibit 10.1 of our Form 8-K filed May 25, 2007 *
Additional Release of Claims Pursuant to Retirement Agreement Dated May 24,
2007 by and among Mercantile Bank Corporation, Mercantile Bank of Michigan
and Gerald R. Johnson, Jr. is incorporated by reference to exhibit 10.1 of our
Form 10-Q for the quarter ended September 30, 2007 *
Mercantile Bank Corporation Employee Stock Purchase Plan of 2002
Lease Agreement between our bank and CD Partners LLC dated October 2, 2007
for our Oakland County, Michigan office is incorporated by reference to exhibit
10.47 of our Form 10-K for the year ended December 31, 2007
Subsidiaries of the company
Consent of BDO Seidman, LLP
Consent of Crowe Horwath LLP
Rule 13a-14(a) Certifications
Section 1350 Chief Executive Officer Certification
Section 1350 Chief Financial Officer Certification
26.
* Management contract or compensatory plan
(c)
Financial Statements Not Included In Annual Report
Not applicable
27.
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2008 and 2007
F-1
MERCANTILE BANK CORPORATION
FINANCIAL INFORMATION
December 31, 2008 and 2007
CONTENTS
SELECTED FINANCIAL DATA ........................................................................................................................ F-3
MANAGEMENT’S DISCUSSION AND ANALYSIS........................................................................................ F-4
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS.......................................... F-29
REPORT BY MERCANTILE BANK CORPORATION’S MANAGEMENT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING ................................................................................................ F-32
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS ..................................................................................................... F-33
CONSOLIDATED STATEMENTS OF INCOME....................................................................................... F-34
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY .............................. F-35
CONSOLIDATED STATEMENTS OF CASH FLOWS.............................................................................. F-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ................................................................... F-39
F-2
SELECTED FINANCIAL DATA
2008
2007
2006
(Dollars in thousands except per share data)
2005
2004
Consolidated Results of Operations:
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Noninterest income
Noninterest expense
Income (loss) before income tax expense (benefit)
Income tax expense (benefit)
Net income (loss)
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
Deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated debentures
Shareholders’ equity
Consolidated Financial Ratios:
Return on average assets
Return on average shareholders’ equity
Average shareholders’ equity to average assets
Nonperforming loans and leases to total loans and leases
Allowance for loan and lease losses to total loans and leases
Tier 1 leverage capital
Tier 1 leverage risk-based capital
Total risk-based capital
Per Share Data:
Net income (loss):
Basic
Diluted
Book value at end of period
Dividends declared
Dividend payout ratio
$ 121,072 $ 144,181
88,624
55,557
11,070
5,870
38,356
12,001
3,035
8,966
74,863
46,209
21,200
7,282
42,126
(9,835)
(4,876)
(4,959) $
$
$ 137,260 $ 102,130 $ 69,022
26,595
46,838
75,673
42,427
55,292
61,587
4,674
3,790
5,775
4,302
5,661
5,261
23,198
31,117
32,262
18,857
26,046
28,811
5,136
8,145
8,964
$ 19,847 $ 17,901 $ 13,721
$2,208,010 $2,121,403 $2,067,268 $1,838,210 $1,536,119
20,811
25,804
36,753
51,380
202,419
242,787
152,965
181,614
1,745,478 1,561,812 1,317,124
1,856,915
17,819
20,527
21,411
27,108
23,750
28,071
30,858
42,462
29,430
211,736
1,799,880
25,814
39,118
1,599,575
94,413
270,000
32,990
174,372
1,591,181
97,465
180,000
32,990
178,155
1,646,903 1,419,352 1,159,181
56,317
72,201
85,472
120,000
130,000
95,000
32,990
32,990
32,990
141,617
155,125
171,915
(0.23)%
(2.87)%
8.01%
2.66%
1.46%
0.43%
5.10%
8.44%
1.66%
1.43%
1.01%
12.19%
8.31%
1.05%
12.05%
8.73%
0.99%
10.16%
9.79%
0.49%
1.23%
0.26%
1.31%
0.22%
1.35%
9.17%
9.68%
10.93%
9.97%
10.14%
11.39%
10.04%
10.37%
11.45%
10.45%
10.82%
12.00%
11.53%
11.82%
13.03%
$
(0.59) $
(0.59)
$
1.06
1.06
2.36 $
2.33
2.14 $
2.10
1.65
1.61
20.29
0.31
NA
20.89
0.55
52.16%
21.43
0.48
20.34%
19.46
0.39
17.79%
17.78
0.30
18.60%
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 local real estate values; 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
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 income tax accounting, and actual results could differ from those
estimates. Management has reviewed the analyses with the Audit Committee of our Board of Directors.
Allowance For Loan and Lease Losses: The allowance for loan and lease losses (“allowance”) 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 is an estimate based on past loan loss experience, the nature and
volume of the loan and lease portfolio, information about specific borrower situations and estimated collateral values
and assessments of the impact of current and anticipated economic conditions on the loan and lease portfolio.
Allocations of the allowance may be made for specific loans or leases, but the entire allowance is available for any
loan or lease that, in management’s judgment, should be charged-off. Loan and lease losses are charged against the
allowance when management believes the uncollectibility of a loan or lease is likely. The balance of the allowance
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 in the future. Likewise, an upturn in
loan and lease quality or improved economic conditions may result in a decline in the required allowance in the
future. In either instance, unanticipated changes could have a significant impact on operating earnings.
F-4
The allowance is increased through a provision charged to operating expense. Uncollectible loans and leases are
charged-off through the allowance. Recoveries of loans and leases previously charged-off are added to the
allowance. A loan or lease 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 or lease agreement.
Impairment is evaluated in aggregate for smaller-balance loans of similar nature such as residential mortgage,
consumer and credit card loans, and on an individual loan or lease basis for other loans. If a loan or lease is
impaired, a portion of the allowance is allocated so that the loan or lease is reported, net, at the present fair value of
estimated future cash flows using the loan’s or lease’s existing interest rate or at the fair value of collateral if
repayment is expected solely from the collateral. Loans and leases are evaluated for impairment when payments are
delayed, typically 30 days or more, or when serious deficiencies are identified within the credit relationship. Our
policy for recognizing income on impaired loans is to accrue interest unless a loan is placed on nonaccrual status.
We put loans into nonaccrual status when the full collection of principal and interest is not expected.
Income Tax Accounting: Income tax liabilities or assets are established for the amount of taxes payable or
refundable for the current year. Deferred income tax liabilities and assets are also established for the future tax
consequences of events that have been recognized in our financial statements or tax returns. A deferred income tax
liability or asset is recognized for the estimated future tax effects attributable to temporary differences that can be
carried forward (used) in future years. The valuation of current and deferred income tax liabilities and assets is
considered critical as it requires us to make estimates based on provisions of the enacted tax laws. The assessment of
tax liabilities and assets involves the use of estimates, assumptions, interpretations and judgments concerning
accounting pronouncements, federal and state tax codes and the extent of future taxable income. There can be no
assurance that future events, such as court decisions, positions of federal and state taxing authorities, and the extent
of future taxable income, will not differ from our current assessment, the impact of which could be significant to the
consolidated results of operations and reported earnings. We believe our tax liabilities and assets are adequate and
are properly recorded in the consolidated financial statements.
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, Ann Arbor and Oakland County areas. Our bank
utilizes certificates of deposit from customers located outside of the primary market area to assist in funding the
historically strong 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.
F-5
Our mortgage company’s predecessor, Mercantile Bank Mortgage Company, was formed to increase the profitability
and efficiency of our 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 facility in
downtown Grand Rapids which serves as our bank’s main office and Mercantile Bank Corporation’s headquarters.
Construction was completed during the second quarter of 2005.
FINANCIAL CONDITION
Primarily reflecting weakening and relatively poor economic conditions within our markets during 2008, our asset
growth during 2008 was lower than historical levels. Assets increased from $2,121.4 million on December 31, 2007
to $2,208.0 million on December 31, 2008. This represents an increase in total assets of $86.6 million, or 4.1%.
Our asset growth during 2007 was also lower than historical levels due to competitive commercial loan pricing and
underwriting environments, combined with weakening economic conditions. Asset growth averaged $288.0 million
per year during the period of 2004 through 2006. The increase in total assets during 2008 was primarily comprised
of a $55.7 million increase in net loans and leases and a $31.1 million increase in securities. The increase in assets
was primarily funded by a $90.0 million increase in Federal Home Loan Bank (“FHLB”) advances.
Earning Assets
Average earning assets equaled 95.4% of average total assets during 2008, compared to 95.0% during 2007, with our
asset composition remaining relatively unchanged. The loan and lease portfolio continued to comprise a majority of
earning assets, followed by securities and federal funds sold.
Our loan and lease portfolio, which equaled 88.9% of average earnings assets during 2008, is primarily comprised of
commercial loans and leases. Commercial loans and leases increased by $51.1 million during 2008, and at
December 31, 2008, totaled $1,710.3 million, or 92.1% of the total loan and lease portfolio. As was the case during
2007, the growth in our commercial loan and lease portfolio slowed during 2008. The lower level of growth during
2008 primarily reflected the weakening and relatively poor economic conditions within our markets, compared to
2007 when our loan growth was slowed by competitive pricing and underwriting environments and weakening
economic conditions within our markets. The competitive pressures, from financial institutions and other entities
such as private equity funds, negatively impacted the volume of loans we booked and accelerated the level of loan
payoffs. We believe that adhering to prudent underwriting practices, rather than focusing on loan growth, outweighs
the resulting lower level of interest income and net income due to the smaller balance of our commercial loan and
lease portfolio.
F-6
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 historical
strong growth of this portion of our lending business are consistent with our stated 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 employees. Our commercial lending business generates the largest portion of local deposits, and is our
primary source of demand deposits.
During the latter part of 2007, our loan review function completed a real estate loan project that expanded our
traditional loan coding paradigm to provide increased specificity in the categorization of loans secured by real estate.
The following table summarizes our loans secured by real estate, excluding residential mortgage loans representing
permanent financing to owner occupied dwellings and home equity lines of credit, as of December 31, 2008:
Residential – Vacant Land
Residential – Land Development
Residential – Construction
Commercial – Vacant Land
Commercial – Land Development
Commercial – Construction NonOwner Occupied
Commercial – Construction Owner Occupied
Commercial – NonOwner Occupied
Commercial – Owner Occupied
Total
$
21,374,000
54,055,000
16,839,000
29,269,000
24,629,000
102,464,000
9,344,000
558,360,000
370,099,000
$ 1,186,433,000
Residential mortgage and consumer loans increased in aggregate $5.9 million during 2008, and at December 31,
2008, totaled $146.6 million, or 7.9% of the total loan and lease portfolio. Although residential mortgage loan and
consumer loan portfolios may increase in future periods, we expect the commercial sector of the lending efforts and
resultant assets to remain the dominant loan portfolio category given our wholesale banking strategy.
The following table presents total loans outstanding as of December 31, 2008, 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 or interest rate floors 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
Fixed rate loans
Floating rate loans
0-1
Year
1-5
Years
After 5
Years
Total
$
183,749,000 $
79,285,000 $
358,000 $
263,392,000
69,079,000
57,214,000
14,483,000
140,776,000
31,107,000
13,784,000
2,474,000
47,365,000
360,096,000
368,926,000
143,000
2,447,000
$ 1,015,547,000 $
477,023,000
132,709,000
1,842,000
2,808,000
881,350,000
44,231,000
516,201,000
14,566,000
1,985,000
0
5,846,000
591,000
764,665,000 $ 76,703,000 $ 1,856,915,000
$
318,977,000 $
696,570,000
$ 1,015,547,000 $
764,422,000 $ 63,223,000 $ 1,146,622,000
710,293,000
13,480,000
764,665,000 $ 76,703,000 $ 1,856,915,000
243,000
F-7
Our credit policies establish guidelines to manage credit risk and asset quality. These guidelines include loan review
and early identification of problem loans and leases to provide effective loan and lease 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 leases and the
possibility that changes in these could occur quickly because of changing economic conditions. Identified problem
loans and leases, which exhibit characteristics (financial or otherwise) that could cause the loans and leases to
become nonperforming or require restructuring in the future, are included on the internal “watch list.” Senior
management and the Board of Directors review this list regularly.
The level of net loan and lease charge-offs and nonperforming assets has increased during the past two years.
Although we were never directly involved in the underwriting of or the investing in subprime residential real estate
loans, the apparent substantial and rapid collapse of this line of business during 2007 and 2008 throughout the
United States had a significant negative impact on the residential real estate development lending portion of our
business. The resulting decline in real estate prices and slowdown in sales stretched the cash flow of our local
developers and eroded the value of our underlying collateral, causing elevated levels of nonperforming assets and net
loan and lease charge-offs.
As of December 31, 2007, nonperforming assets totaled $35.7 million, or 1.68% of total assets, an increase from the
$9.6 million, or 0.46% of total assets, as of December 31, 2006. Nonperforming loans and leases totaled $29.8
million and foreclosed properties/repossessed assets equaled $5.9 million at year-end 2007, compared to $8.6
million and $1.0 million, respectively, at year-end 2006. As of December 31, 2007, nonperforming loans secured by
real estate, combined with all foreclosed properties, totaled $28.6 million, or 80% of total nonperforming assets.
Nonperforming loans and foreclosed properties associated with the development of residential real estate totaled
$11.1 million, with another $3.2 million in nonperforming loans secured by, and foreclosed properties consisting of,
residential properties. Net loan and lease charge-offs during 2007 totaled $6.7 million, or 0.38% of average total
loans and leases. During 2006, net loan and lease charge-offs totaled $4.9 million, or 0.29% of average total loans
and leases.
During the first quarter of 2008, we experienced a sudden and rapid deterioration in a number of commercial loan
relationships which previously had been performing fairly well. An analysis of certain commercial borrowers
revealed a reduced capability on the part of these borrowers to make required payments as indicated by factors such
as delinquent loan payments, diminished cash flow, deteriorating financial performance, or past due property taxes,
and in the case of commercial and residential development projects slow absorption or sales trends. In addition,
commercial real estate is the primary source of collateral for many of these borrowing relationships and updated
evaluations and appraisals in many cases reflected significant declines from the original estimated values.
During the second quarter of 2008, we found that the financial performance of some of our borrowers and guarantors
had become increasingly strained, as real estate remained unsold or insufficiently leased and liquid sources of
repayment were exhausted or significantly depleted. Completed evaluations and appraisals during this period
reflected substantial declines from the originally estimated values, and in some cases even in comparison to property
value estimates made within the past several quarters.
While we continued to face a distressed operating environment during the third quarter of 2008, we experienced a
marked slowdown in borrowing relationships that deteriorated to nonperforming status. In addition, we saw notable
improvement in a number of larger commercial loan relationships. Although we experienced a small net increase in
the level of nonperforming assets during the third quarter, the rate of increase was considerably lower than over the
past few quarters.
During the fourth quarter of 2008, we saw a continuation of the stresses caused by the weakening and poor economic
conditions, especially in the commercial real estate markets. High vacancy rates or slow absorption has resulted in
inadequate cash flow generated from some real estate projects we have financed, and has required guarantors to
provide personal funds to make full contractual loan payments and pay other operating costs. In some cases, the
guarantors’ cash reserves have become seriously diminished, not only from recent cash outlays but from depressed
stock portfolios as well. In addition, auto industry uncertainties are placing stress on the commercial and industrial
segment of our loan portfolio.
F-8
As of December 31, 2008, nonperforming assets totaled $57.4 million, or 2.60% of total assets, an increase from the
$35.7 million, or 1.68% of total assets, as of December 31, 2007. Nonperforming loans and leases totaled $49.3
million and foreclosed properties/repossessed assets equaled $8.1 million at year-end 2008, compared to $29.8
million and $5.9 million, respectively, at year-end 2007. As of December 31, 2008, nonperforming loans secured by
real estate, combined with all foreclosed properties, totaled $52.3 million, or about 91% of total nonperforming
assets. Nonperforming loans and foreclosed properties associated with the development of residential real estate
totaled $25.3 million, with another $4.2 million in nonperforming loans secured by, and foreclosed properties
consisting of, residential properties. Net loan and lease charge-offs during 2008 totaled $19.9 million, or 1.09% of
average total loans and leases. During 2007, net loan and lease charge-offs totaled $6.7 million, or 0.38% of average
total loans and leases. The increase in net loan and lease charge-offs during 2008 primarily reflects a combination of
a higher level of nonperforming assets and the significant decline in property values.
The following table provides a breakdown of nonperforming assets as of December 31, 2008 and net loan charge-
offs during 2008 by property type:
Residential – Land Development
Residential – Construction
Residential – Owner Occupied / Rental
Commercial – Land Development
Commercial – Owner Occupied
Commercial – NonOwner Occupied
Commercial – NonReal Estate
Consumer – NonReal Estate
Total
Nonperforming
Assets
$ 14,273,000
11,040,000
4,160,000
2,234,000
6,495,000
14,055,000
5,134,000
30,000
$ 57,421,000
Net Loan
Charge-Offs
$ 2,624,000
604,000
2,850,000
1,599,000
789,000
5,710,000
5,688,000
42,000
$19,906,000
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, 2008
December 31, 2007
December 31, 2006
December 31, 2005
December 31, 2004
$ 47,945,000
$ 28,832,000
$ 7,752,000
$ 3,601,000
$ 2,842,000
1,358,000
977,000
819,000
394,000
0
0
0
0
0
0
Total
$49,303,000
$ 29,809,000
$ 8,571,000
$ 3,995,000
$ 2,842,000
F-9
The following table summarizes changes in the allowance for loan and lease losses for the past five years:
2008
2007
2006
2005
2004
Loan and leases outstanding at year-end
$ 1,856,915,000
$ 1,799,880,000
$1,745,478,000
$1,561,812,000
$1,317,124,000
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
$ 1,829,686,000
$ 1,765,465,000
$1,660,284,000
$1,432,609,000
$1,177,568,000
$ 25,814,000
$ 21,411,000
$ 20,527,000
$ 17,819,000
$ 14,379,000
(12,566,000)
(4,835,000)
(174,000)
(2,900,000)
(119,000)
(4,232,000)
(1,353,000)
(18,000)
(1,618,000)
(53,000)
(20,594,000) (7,274,000)
(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)
597,000 586,000
11,000
8,000
0
6,000
3,000
51,000
26,000
7,000
688,000 607,000
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
Net charge-offs
(19,906,000)
(6,667,000)
(4,891,000)
(1,082,000)
(1,234,000)
Provision for loan and leases losses
21,200,000
11,070,000
5,775,000
3,790,000
4,674,000
Balance of allowance at year-end
$ 27,108,000
$ 25,814,000
$ 21,411,000
$ 20,527,000
$ 17,819,000
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
(1.09%)
(0.38%)
(0.29%)
(0.08%)
(0.10%)
1.46%
1.43%
1.23%
1.31%
1.35%
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 establish 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 historically strong commercial loan and lease growth and
expansions into new markets are 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 or Ohio,
the review and consideration of our loan and lease 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-10
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, 2008
December 31, 2007
December 31, 2006
December 31, 2005
December 31, 2004
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Amount
Loan
Portfolio
Commercial,
financial and
agricultural
Construction and
land development
$ 20,170
77.9%
$ 18,947
77.4%
$15,706
74.7%
$16,507
76.9%
$15,457
79.8%
5,137
14.1
4,907
14.7
3,975
17.1
2,868
14.5
1,581
10.3
Leases
41
0.1
29
0.1
15
0.1
30
0.1
39
0.2
Residential real
estate
Instalment loans to
individuals
1,656
7.6
1,829
7.5
1,591
7.6
1,020
8.2
557
9.3
104
0.3
102
0.3
124
0.5
102
0.3
185
0.4
Unallocated
0
0.0
0
0.0
0
0.0
0
0.0
0
0.0
Total
$ 27,108
100.0%
$ 25,814
100.0%
$21,411
100.0%
$20,527
100.0%
$17,819
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.
Securities increased $31.1 million during 2008, from $211.7 million on December 31, 2007 to $242.8 million at
December 31, 2008. During 2008, the securities portfolio equaled 10.6% of average earning assets. Proceeds from
called U.S. Government Agency bonds totaled $60.0 million during 2008, with another $8.1 million received from
principal paydowns on mortgage-backed securities and $1.8 million from matured and called tax-exempt municipal
securities. The proceeds were invested back into the securities portfolio, with $40.9 million invested in U.S.
Government Agency bonds and $27.7 million invested in mortgage-backed securities. We also purchased $27.6
million in bonds issued through the Michigan Strategic Fund during 2008, although we sold $5.5 million shortly after
purchase. These bonds are purchased and sold at par value, and are sellable back to the re-marketing brokerage firm
weekly. In addition, FHLB of Indianapolis stock increased $5.9 million to support the increased level of FHLB
advances. We maintain the securities 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, 2008, the portfolio was comprised of high credit quality U.S. Government
Agency issued bonds (26%), U.S. Government Agency issued and guaranteed mortgage-backed securities (32%),
tax-exempt municipal general obligation and revenue bonds (27%), Michigan Strategic Fund bonds (9%), Federal
Home Loan Bank stock (6%) and a mutual fund (less than 1%).
F-11
The following table reflects the composition of the securities portfolio, excluding Federal Home Loan Bank stock:
December 31, 2008
December 31, 2007
December 31, 2006
Carrying
Value
Percentage
Carrying
Value
Percentage
Carrying
Value
Percentage
$ 62,382,000
27.5%
$ 80,945,000
40.1%
$ 76,836,000
39.4%
77,026,000
33.9
54,619,000
27.0
53,083,000
27.2
56,893,000
25.1
57,668,000
28.5
56,870,000
29.2
7,544,000
3.3
7,662,000
3.8
7,073,000
3.6
22,105,000
9.7
0
0.0
0
0.0
U.S. Government
agency debt obligations
Mortgage-backed
securities
Municipal general
obligations
Municipal revenue
bonds
Michigan Strategic Fund
bonds
Mutual fund
1,156,000
0.5
1,109,000
0.6
1,048,000
0.6
Total
$ 227,106,000
100.0%
$ 202,003,000
100.0%
$ 194,910,000
100.0%
All securities, with the exception of tax-exempt municipal bonds, have been designated as “available for sale” as
defined in Statement of Financial Accounting Standards (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, 2008 and 2007
was $162.7 million and $136.7 million, respectively. The net unrealized gain recorded at year-end 2008 was $3.2
million, compared to a net unrealized gain of $0.4 million at year-end 2007. 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, 2008 and 2007, held to maturity securities had an amortized cost of $64.4 million and $65.3 million and a fair
value of $65.4 million and $66.4 million, respectively.
Market values on our U.S. Government Agency bonds, mortgage-backed securities issued or guaranteed by U.S.
Government Agencies and tax-exempt municipal securities are determined on a monthly basis with the assistance of
a third party vendor. Evaluated pricing models that vary by type of security and incorporate available market data
are utilized. Standard inputs include issuer and type of security, benchmark yields, reported trades, broker/dealer
quotes and issuer spreads. The market value of other securities is estimated at carrying value as those financial
instruments are generally bought and sold at par value. We believe our valuation methodology provides for a
reasonable estimation of market value, and that it is consistent with the requirements of SFAS No. 157. Reference is
made to Note 15 for additional information.
F-12
The following table shows by class of maturities as of December 31, 2008, 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
Michigan Strategic Fund bonds
Mutual fund
Carrying
Value
Average
Yield
$
0
12,235,000
17,065,000
33,082,000
62,382,000
NA
4.70%
5.29
5.33
5.20
1,884,000
10,457,000
13,496,000
38,600,000
64,437,000
77,026,000
22,105,000
1,156,000
6.64
6.73
6.57
6.35
6.47
5.16
2.99
4.00
$ 227,106,000
5.32%
(1) Yields on tax-exempt securities are computed on a fully taxable-equivalent basis.
Federal funds sold, consisting of excess funds sold overnight to correspondent banks, are used to manage daily
liquidity needs and interest rate sensitivity. During 2008, the average balance of these funds equaled 0.6% of
average earning assets, up slightly from 0.4% during 2007. The levels maintained during 2008 and 2007 are well
within our internal policy guidelines. Given the volatile market conditions, during the fourth quarter of 2008 we
made the decision to operate with a higher than normal balance of federal funds sold. It is expected that we will
maintain the higher balance of federal funds sold, likely to average 1.0% to 1.5% of average earning assets, until
market conditions return to more normalized levels.
Non-Earning Assets
Cash and due from bank balances decreased from $29.1 million at December 31, 2007, to $16.8 million on
December 31, 2008, a decrease of $12.3 million. While we experienced only nominal change in our cash balances,
our due from bank balances declined significantly primarily due to two programs that were instituted in mid 2007: 1)
an image exchange program with our primary correspondent bank for our outgoing cash letter that resulted in faster
collection of items in the outgoing cash letter, and 2) the virtual elimination of required reserves on deposit with the
Federal Reserve Bank of Chicago due to the institution of a deposit reclassification program. Cash and due from
bank balances averaged $21.0 million, or 1.0% of average assets during 2008, compared to $33.1 million, or 1.6% of
average assets, during 2007.
Net premises and equipment decreased from $34.3 million at December 31, 2007, to $32.3 million on December 31,
2008, a decrease of $2.0 million. Net purchases of premises and equipment during 2008 totaled $0.7, while
depreciation and amortization expense equaled $2.7 million.
F-13
Source of Funds
Our major sources of funds are from deposits, repurchase agreements and FHLB advances. Total deposits increased
from $1,591.2 million at December 31, 2007, to $1,599.6 million on December 31, 2008, an increase of $8.4
million. Local deposits decreased from $666.1 million at year-end 2007, to $470.4 million at year-end 2008, a
decrease of $195.7 million. Out-of-area deposits increased from $925.0 million at December 31, 2007, to $1,129.2
million on December 31, 2008, an increase of $204.2 million. FHLB advances increased from $180.0 million at
year-end 2007 to $270.0 million at year-end 2008, while repurchase agreements decreased from $97.5 million to
$94.4 million, or $3.1 million, during the same time period. At December 31, 2008, local deposits and repurchase
agreements equaled 28.0% of total funding liabilities, compared to 39.8% on December 31, 2007.
We experienced declines in our local deposits throughout 2008, but especially during the latter half of 2008, for a
variety of reasons. First, we witnessed local depositors purposely reducing their deposit balances with us, in large
part reflecting their concerns over our financial health and that of the entire banking industry, with some larger
depositors transferring portions of their deposit balances to one or more other financial institutions. This practice
was very pronounced with our municipality and larger business and individual deposit customers. Next, we lost
deposit balances due to relatively high certificate of deposit rates offered by some financial institutions located in our
markets. While we believe our certificate of deposit rates, which in most cases exceed the rates offered in the
brokered deposit markets, are competitive, some financial institutions in our markets were offering certificate of
deposit rates that far exceeded our rates, sometimes by as much as 100 basis points. Finally, it appears that the
distressed economy is resulting in some of our business customers having lower checking and savings account
balances and municipal customers having lower savings and certificate of deposit balances than typical.
Noninterest-bearing checking deposit accounts declined $22.4 million during 2008, primarily resulting from lower
deposit balances from our title company depositors due in large part to lower volumes of real estate transactions.
Interest-bearing checking accounts increased $5.8 million and money market deposit accounts increased $13.0
million during 2008, the latter primarily reflecting a $10.0 million deposit from a local municipality. Savings
account balances recorded a decrease of $30.8 million during 2008, while certificates of deposit purchased by
customers located within our market areas decreased $161.4 million. These declines are due to a combination of risk
diversification practices on the part of the depositors, higher deposit rates offered by competitors and lower funds
available stemming from the distressed economy. One municipal depositor withdrew about $32.0 million in
December of 2008 upon the maturity of a single certificate of deposit, but soon thereafter opened a $10.0 million
money market deposit account and then in January 2009 opened a new $20.0 million certificate of deposit.
The local deposit environment was very challenging during 2008, and it appears that it will remain that way for at
least the next few quarters. Until our operating results and overall financial health improve, as well as that of the
entire banking industry, it is very likely that some customers will continue to engage in risk diversification practices.
Combined with a distressed economy and a competitive banking environment, our ability to raise local deposits
efficiently and economically will be difficult. However, we continue to enjoy deposit relationships with virtually all
of our customers who have withdrawn some of their deposits, and we have developed various strategic plans and
initiatives to hopefully regain a majority of the lost deposits in future periods. Maintaining and growing our local
deposit base is one of our key initiatives.
Certificates of deposit obtained from customers located outside of our market areas increased by $204.2 million
during 2008, and as of December 31, 2008 totaled $1,129.2 million. The increase primarily reflects the decline in
our local deposit base, net of the growth in FHLB advances. 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 United States.
Repurchase agreements decreased $3.1 million during 2008, and as of December 31, 2008 totaled $94.4 million. As
part of our sweep account program, collected funds from certain business noninterest-bearing checking accounts are
invested in overnight interest-bearing repurchase agreements. Such repurchase agreements are not deposit accounts
and are not afforded federal deposit insurance.
F-14
FHLB advances increased $90.0 million during 2008, and as of December 31, 2008 totaled $270.0 million. 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, 2008 totaled $316.5 million, with
availability approximating $37.0 million.
Shareholders’ equity decreased $3.8 million during 2008. The decrease was primarily attributable to net loss from
operations, which totaled $5.0 million during 2008. Also negatively impacting shareholders’ equity during 2008 was
the payment of cash dividends, which totaled $2.6 million. Positively impacting shareholders’ equity was unrealized
gains for a $1.8 million, net of tax, adjustment for available for sale securities as defined in SFAS No. 115, and a
$1.2 million, net of tax, change in the fair value of interest rate swaps.
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2008 and 2007
Summary
A net loss of $5.0 million, or $0.59 per basic and diluted share, was recorded in 2008, compared to net income of
$9.0 million, or $1.06 per basic and diluted share, generated in 2007. The decline in earnings performance during
2008 from that of 2007 is primarily the result of lower net interest income and a higher provision for loan and lease
losses. Net income during 2007 includes a one-time $1.2 million ($0.8 million after-tax) expense associated with the
financial retirement package for former Chairman and Chief Executive Officer, Gerald R. Johnson Jr., which was
recorded in conjunction with Mr. Johnson’s retirement effective June 30, 2007. Excluding this one-time expense, net
income for 2007 was $9.8 million, or $1.16 per basic share and $1.15 per diluted share.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2008
and 2007:
Return on average assets
Return on average shareholders’ equity
Dividend payout ratio
Average shareholders’ equity to average assets
2008
2007
(0.23)%
(2.87)
NA
8.01
0.43%
5.10
52.16
8.44
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 $122.3 million and $74.9 million during 2008, respectively, providing for net interest income of
$47.4 million. During 2007, interest income and interest expense were $145.4 million and $88.6 million,
respectively, providing for net interest income of $56.8 million. In comparing 2008 with 2007, interest income
decreased 15.9%, interest expense was down 15.5%, and net interest income decreased 16.4%. The level of net
interest income is primarily a function of asset size, as the weighted average interest rate received on earning assets is
greater than the weighted average interest cost of funding sources; however, factors such as types and levels of assets
and liabilities, interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact
net interest income as well as the net interest margin.
F-15
The net interest margin declined from 2.87% in 2007 to 2.30% in 2008, a decrease of 19.9%. With approximately
60% of our total loans and leases tied to Prime or LIBOR rates, our earning asset yield in 2008 has been
substantially impacted by the steep reduction in market interest rates that began late in the third quarter of 2007.
Between mid-September 2007 and late April 2008, the Federal Open Market Committee (“FOMC’) lowered the
targeted federal funds rate by a total of 325 basis points. The resulting similar decline in the Prime and LIBOR rates,
combined with an increased level of nonperforming assets, a very competitive loan and deposit environment, and a
flat to inverted yield curve over an extended period of time, have significantly negatively impacted our yield on
earning assets and level of interest income. Our cost of funds also decreased in 2008 compared to 2007 as we paid
lower interest rates on our deposits and borrowings; however, due to a significant portion of our interest-bearing
liabilities being comprised of fixed rate certificates of deposit and borrowings, our cost of funds declined at a much
slower rate than our earning asset yield, resulting in the compressed net interest margin.
The decision by the FOMC to lower the targeted federal funds rate by 50 basis points in early October 2008 placed
additional pressure on our yield on earning assets and level of interest income in light of our Prime-based loans
repricing downward. Although the FOMC lowered the targeted federal funds rate by another 50 basis points in late
October 2008 and an additional 75 basis points in mid-December 2008, we decided to keep the Mercantile Bank
Prime Rate unchanged at 4.50%. Virtually all of our prime-based commercial floating rate loans are tied to the
Mercantile Bank Prime Rate. Despite the 100 basis point reduction in the targeted federal funds rate in October
2008, deposit rates remained substantially unchanged. The steady deposit rates, combined with an already very low
Prime Rate, placed significant pressure on our net interest income and net interest margin, and we believed it was
prudent to not lower the Mercantile Bank Prime Rate in association with the FOMC’s 50 basis point reduction in the
targeted federal funds rate in late October and the 75 basis point reduction in mid-December.
Our net interest margin, which equaled 2.15% in the second quarter of 2008, has improved over the last six months
of 2008, equaling 2.30% and 2.40% in the third and fourth quarters of 2008, respectively. Our implementation of
several loan pricing initiatives, including the decision to not lower the Mercantile Prime Rate in association with the
two most recent FOMC rate reductions, stabilized our yield on loans and leases in the latter part of 2008. The
stabilization of our earning asset yield, which is most influenced by our yield on loans and leases, combined with a
reduction in our cost of funds resulting from maturing fixed rate certificates of deposit and borrowings repricing
downward in light of decreased market interest rates, resulted in the improved net interest margin. If the interest rate
environment stabilizes in 2009, we anticipate that the quarterly net interest margin improvement experienced during
the last two quarters of 2008 will continue as we continue to reprice maturing fixed rate liabilities downward.
During the first six months of 2008, we entered into interest rate swaps to convert the variable rate cash flows on
certain of our Prime-based commercial loans to a fixed rate of interest. On October 30, 2008, we terminated all of
our interest rate swaps. The termination coincides with our decision to not lower the Mercantile Bank Prime Rate in
association with the FOMC’s reduction of the targeted federal funds rate by 50 basis points announced on October
29, 2008. During 2008, the net cash flow received from the interest rate swap arrangements contributed $1.0 million
to interest income.
The following table depicts the average balance, interest earned and paid, and weighted average rate of our assets,
liabilities and shareholders’ equity during 2008, 2007 and 2006. The subsequent 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%. As a result, securities interest
income was increased by $1.2 million in each of 2008, 2007 and 2006.
F-16
(Dollars in thousands)
Years ended December 31,
---------------------- 2 0 0 8 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 0 7 -----------------
Average
Rate
Average
Balance
Interest
---------------------- 2 0 0 6 ----------------
Average
Rate
Average
Balance
Interest
Taxable securities $ 147,668 $
Tax-exempt
securities
Total securities
69,857
217,525
7,888
5.34%
$ 141,289 $
7,243
5.13%
$ 128,382 $
6,557
5.11%
4,180
12,068
5.98
5.55
64,122
205,411
4,013
11,256
6.26
5.48
61,949
190,331
3,930
10,487
6.34
5.51
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
1,829,686
110,013
6.01
1,765,465
133,685
7.57
1,660,284
127,470
7.68
392
11,353
7
204
1.79
1.80
510
8,239
20
420
3.92
5.10
320
9,745
12
482
3.75
4.95
2,058,956
122,292
5.94
1,979,625
145,381
7.34
1,860,680
138,451
7.44
(30,184)
21,004
107,546
(23,157)
33,099
94,279
(21,464)
38,298
82,419
Total assets
$ 2,157,322
$ 2,083,846
$ 1,959,933
Interest-bearing
demand deposits $
Savings deposits
Money market
accounts
Time deposits
Total interest-
bearing deposits
13,948
1,332,071
1,453,844
97,313
Short-term
borrowings
Federal Home Loan
Bank advances
Long-term
borrowings
Total interest-
bearing liabilities 1,856,675
258,939
46,579
42,734 $
65,091
492
922
1.15%
1.42
$
37,143 $
86,009
1,047
2,977
2.82%
3.46
$
36,530 $
93,046
1,069
3,328
2.93%
3.58
192
58,206
1.38
4.37
11,706
1,385,260
359
71,838
3.07
5.19
10,326
1,289,777
325
60,033
3.15
4.65
59,812
4.11
1,520,118
76,221
5.01
1,429,679
64,755
4.53
2,021
2.08
93,307
3,493
3.74
75,885
2,867
3.78
10,554
4.08
118,904
6,100
5.13
121,932
5,393
4.42
2,476
5.32
36,610
2,810
7.68
35,895
2,658
7.40
74,863
4.03
1,768,939
88,624
5.01
1,663,391
75,673
4.55
Demand deposits
Other liabilities
Total liabilities
Average equity
Total liabilities
and equity
108,584
19,286
1,984,545
172,777
$ 2,157,322
115,172
23,838
1,907,949
175,897
$ 2,083,846
115,390
18,371
1,797,152
162,781
$ 1,959,933
Net interest
income
Rate spread
Net interest
margin
$
47,429
$
56,757
$
62,778
1.91%
2.30%
2.33%
2.87%
2.89%
3.37%
F-17
-------------------- 2008 over 2007 --------------------
Volume
Total
Rate
--------------------2007 over 2006 --------------------
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
$
645,000
167,000
(23,672,000)
(13,000)
(216,000)
$
334,000
348,000
4,713,000
(4,000)
121,000
$
311,000
(181,000)
(28,385,000)
(9,000)
(337,000)
$
686,000
83,000
6,215,000
8,000
(62,000)
$
662,000
136,000
7,984,000
7,000
(76,000)
$
24,000
(53,000)
(1,769,000)
1,000
14,000
income
(23,089,000)
5,512,000
(28,601,000)
6,930,000
8,713,000
(1,783,000)
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
(555,000)
(2,055,000)
(167,000)
(13,632,000)
(1,472,000)
139,000
(599,000)
59,000
(2,673,000)
144,000
(694,000)
(1,456,000)
(226,000)
(10,959,000)
(1,616,000)
(22,000)
(351,000)
34,000
11,805,000
626,000
18,000
(246,000)
43,000
4,644,000
652,000
(40,000)
(105,000)
(9,000)
7,161,000
(26,000)
4,454,000
(334,000)
5,927,000
655,000
(1,473,000)
(989,000)
707,000
152,000
(137,000)
53,000
844,000
99,000
expense
(13,761,000)
3,651,000
(17,412,000)
12,951,000
5,027,000
7,924,000
Net change in tax-equivalent
net interest income
$ 9,328,000
$ 1,861,000
$ (11,189,000)
$ (6,021,000)
$ 3,686,000
$ (9,707,000)
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 decreased $23.1 million during 2008 from that
earned in 2007, totaling $122.3 million in 2008 compared to $145.4 million in the previous year. The decrease is
primarily due to the lower interest rate environment and increased level of nonperforming assets during 2008 when
compared to 2007, which more than offset the growth in average earning assets year over year. The yield on average
earning assets declined from 7.34% in 2007 to 5.94% in 2008.
During 2008, average earning assets increased $79.4 million, from $1,979.6 million in 2007 to $2,059.0 million
during 2008. Growth in average total loans and leases, totaling $64.2 million, comprised 80.9% of the increase in
average earning assets during 2008. Interest income generated from the loan and lease portfolio decreased $23.7
million in 2008 compared to the level earned in 2007; a decline in loan yield from 7.57% in 2007 to 6.01% in 2008
resulted in a $28.4 million reduction in interest income while growth in the loan and lease portfolio during 2008
resulted in a $4.7 million increase in interest income. The decrease in the loan and lease portfolio yield is primarily
due to a lower interest rate environment during 2008 than in 2007 and an increase in nonperforming loans.
Interest income generated from the securities portfolio increased in 2008 compared to the level earned in 2007 as a
result of growth in the portfolio and an increased yield. Average securities increased by $12.1 million in 2008,
increasing from $205.4 million in 2007 to $217.5 million in 2008. The growth equated to an increase in interest
income of $0.7 million. The improved yield, which equaled 5.55% in 2008 compared to 5.48% in 2007, resulted in
a $0.1 million increase in interest income. Interest income earned on federal funds sold decreased by $0.2 million
due to a decline in the average rate, which more than offset an increase in the average balance.
Interest expense is primarily generated from interest-bearing deposits, and to a lesser degree, from repurchase
agreements, FHLB advances, and subordinated debentures. Interest expense decreased $13.7 million during 2008
from that expensed in 2007, totaling $74.9 million in 2008 compared to $88.6 million in the previous year. The
decline in interest expense is primarily attributable to a decreased cost of funds, which mainly resulted from maturing
fixed rate certificates of deposit and borrowings being renewed or replaced at lower interest rates, reflecting the
decreased interest rate environment in 2008. Interest-bearing liabilities averaged $1,856.7 million during 2008, or
$87.8 million higher than the average interest-bearing liabilities of $1,768.9 million during 2007. This growth
resulted in increased interest expense of $3.7 million. A decline in interest expense of $17.4 million was recorded
during 2008 due to a decreased cost of funds primarily attributable to lower average rates paid on fixed rate
certificates of deposit and borrowings. The cost of average interest-bearing liabilities decreased from the 5.01%
recorded in 2007 to 4.03% in 2008.
F-18
Average certificates of deposit declined $53.2 million during 2008, which equated to a decrease in interest expense
of $2.7 million. An additional $10.9 million reduction in interest expense resulted from a decrease in the average
rate paid as higher-rate certificates of deposit matured and were either renewed or replaced with lower-costing
certificates of deposit throughout 2008. A decline in other average interest-bearing deposit accounts, totaling $13.1
million, equated to a decrease in interest expense of $0.4 million, with an additional interest expense reduction of
$2.4 million recorded due to a decrease in the average rate paid during 2008.
Average short-term borrowings, primarily comprised of repurchase agreements and federal funds purchased,
increased $4.0 million during 2008, resulting in increased interest expense of $0.1 million, while a decrease in the
average rate paid during 2008 resulted in a reduction in interest expense of $1.6 million. Average FHLB advances
increased $140.0 million, equating to an increase in interest expense of $5.9 million, while a decreased average rate
paid on the advances resulted in a $1.5 million reduction in interest expense. Growth in average long-term
borrowings, which is comprised of subordinated debentures, structured repurchase agreements, and deferred director
and officer compensation programs, equated to an increase in interest expense of $0.7 million during 2008, with a
decreased average rate reducing interest expense by $1.0 million.
Provision for Loan and Lease Losses
The provision for loan and lease losses totaled $21.2 million in 2008, compared to the $11.1 million expensed in
2007. The increase primarily reflects a higher volume of nonperforming loans and leases, increased net loan charge-
offs, and other downgrades within our commercial loan and lease portfolio, necessitating a higher allowance balance.
Nonperforming loans and leases totaled $49.3 million, or 2.66% of total loans and leases, as of December 31, 2008,
compared to $29.8 million, or 1.66% of total loans and leases, as of December 31, 2007. Net loan and lease charge-
offs during 2008 totaled $19.9 million, or 1.09% of average total loans and leases. Net loan and lease charge-offs
during 2007 totaled $6.7 million, or 0.38% of average total loans and leases. Loan and lease growth during 2008
equaled $57.0 million, compared to loan and lease growth of $54.4 million during 2007. The allowance as a
percentage of total loans outstanding as of December 31, 2008 was 1.46%, compared to 1.43% at year-end 2007.
Although we believe the allowance is adequate to cover losses as they arise, there can be no assurance that we will
not sustain losses in any given period that could be substantial in relation to, or greater than, the size of the
allowance.
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 historically strong commercial loan and lease growth and
expansions into new markets are 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 or Ohio,
the review and consideration of our loan and lease 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 $7.3 million in 2008, an increase of $1.4 million from the $5.9 million earned in 2007.
Service charge income on deposits and repurchase agreements increased $0.4 million during 2008 when compared to
2007, primarily reflecting a decrease in the earnings credit rate and improved collection of overdraft service charges.
Earnings from the increased cash surrender value of bank owned life insurance policies, primarily reflecting
additional investments during the year and improved yields, increased $0.5 million in 2008. Residential mortgage
banking fees increased $0.2 million in 2008 due to a higher volume of activity. We recorded increases in virtually
all other fee income-producing activities in 2008 when compared to 2007 primarily due to increased volumes.
Noninterest Expense
Noninterest expense during 2008 totaled $42.1 million, an increase of $3.7 million over the $38.4 million expensed
in 2007. Salary expense and benefit costs decreased $0.4 million in 2008 when compared to 2007. Included in 2007
salary and benefit costs is a one-time $1.2 million expense associated with the financial retirement package for
former Chairman and Chief Executive Officer, Gerald R. Johnson, Jr., in conjunction with Mr. Johnson’s retirement
effective June 30, 2007. Salary expense and benefit costs increased $0.8 million in 2008 if this one-time expense is
excluded from 2007 salary and benefit costs; the resulting increase primarily reflects annual pay increases and the
hiring of additional staff related to our expansion into Oakland County in late 2007. Occupancy, furniture and
equipment costs increased $0.4 million in 2008. Costs associated with the administration and resolution of problem
assets, including legal costs, property tax payments, appraisal fees and write-downs on foreclosed properties, totaled
$3.3 million in 2008 compared to $1.1 million in 2007. FDIC deposit insurance assessments totaled $1.9 million in
2008 compared to $0.7 million in 2007. The FDIC issued a final rule in December 2008 that uniformly raised
deposit insurance assessment rates for the first quarter of 2009 and indicated that another final rule will be issued in
early 2009 that will modify the current deposit insurance assessment methodology. Our 2009 FDIC deposit
insurance assessments may increase as a result of these changes in methodology. Other non-interest expenses, in
aggregate, increased $0.3 million in 2008 when compared to 2007, reflecting additional expenditures required to
administer an increased asset base.
Federal Income Tax Expense
During 2008, we recorded a loss before federal income tax of $9.8 million and a federal income tax benefit of $5.0
million, compared to net income before federal income tax of $12.0 million and federal income tax expense of $3.0
million during 2007. Our effective tax rate for 2008 was (49.6%), compared to 25.3% for 2007. The difference in
the effective tax rate primarily reflects the significant difference in income before federal income tax expense
(benefit), and the relationship of tax-exempt income to income (loss) before federal income tax expense (benefit).
SFAS No. 109, Accounting for Income Taxes, requires that companies assess whether a valuation allowance should
be established against their deferred tax assets based on the consideration of all available evidence using a “more
likely than not” standard. In accordance with SFAS No. 109, we reviewed our deferred tax assets and determined
that no valuation allowance was necessary at year end 2008 or 2007. Despite the loss in 2008 and the challenging
economic environment, we are in a cumulative income position, have a history of strong earnings, are well-
capitalized, and have cautiously optimistic expectations regarding future taxable income. In making such judgments,
significant weight is given to evidence that can be objectively verified. In making decisions regarding any valuation
allowance, we consider both positive and negative evidence and analyze changes in near-term market conditions as
well as other factors which may impact future operating results. The deferred tax assets will be analyzed quarterly
for changes affecting realizability, and there can be no guarantee that a valuation allowance will not be necessary in
future periods.
F-20
RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006
Summary
Net income during 2007 was $9.0 million, or $1.06 per basic and diluted share, compared to net income of $19.8
million, or $2.36 per basic share and $2.33 per diluted share, recorded in 2006. The $10.8 million decline in net
income represents a decrease of 54.8%, while diluted earnings per share were down 54.5%. The decline in net
income during 2007 from that of 2006 is primarily the result of lower net interest income and a higher provision for
loan and lease losses. In addition, net income during 2007 includes a one-time $1.2 million ($0.8 million after-tax)
expense associated with the financial retirement package for former Chairman and Chief Executive Officer, Gerald
R. Johnson Jr., which was recorded in conjunction with Mr. Johnson’s retirement effective June 30, 2007. Excluding
this one-time expense, net income for 2007 was $9.8 million, or $1.16 per basic share and $1.15 per diluted share.
The following table shows some of the key performance and equity ratios for the years ended December 31, 2007
and 2006:
Return on average assets
Return on average shareholders’ equity
Dividend payout ratio
Average shareholders’ equity to average assets
2007
2006
0.43%
5.10
52.16
8.44
1.01%
12.19
20.34
8.31
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 $145.4 million and $88.6 million during 2007, respectively, providing for net interest income of
$56.8 million. During 2006, interest income and interest expense were $138.5 million and $75.7 million,
respectively, providing for net interest income of $62.8 million. In comparing 2007 with 2006, interest income
increased 5.0%, interest expense was up 17.1% and net interest income decreased 9.6%. The level of net interest
income is primarily a function of asset size, as the weighted average interest rate received on earning assets is greater
than the weighted average interest cost of funding sources; however, factors such as types and levels of assets and
liabilities, interest rate environment, interest rate risk, asset quality, liquidity, and customer behavior also impact net
interest income as well as the net interest margin.
The net interest margin declined from 3.37% in 2006 to 2.87% in 2007, a decrease of 14.8%. Our net interest
margin during 2005 was 3.50%. 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 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.
From the period of June 2006 through September 2007, the FOMC left the federal funds rate unchanged, resulting in
a relatively steady yield on assets. However, our cost of funds continued to increase as maturing fixed rate
certificates of deposit and borrowings, which were obtained during lower interest rate environments, were replaced
or renewed at higher interest rates, resulting in a declining net interest margin. In September 2007, the FOMC
started to aggressively lower the federal funds rate with three interest rate reductions totaling 100 basis points
through the end of 2007, causing the prime rate to decline from 8.25% to 7.25%. With about 60% of our total loans
and leases tied to the prime rate and a significant portion of our interest-bearing liabilities comprised of fixed rate
certificates of deposit and borrowings, our asset yield declined at a much faster rate than our cost of funds, resulting
in further compression of our net interest margin.
F-21
Also negatively impacting our net interest margin during 2007 was an increase in nonperforming assets, with a
higher level of loans on nonaccrual status and a higher balance of foreclosed properties than in previous periods. A
very competitive loan and deposit pricing environment, combined with a continuation of a flat to inverted yield
curve, also negatively impacted our net interest margin.
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 $6.9 million during 2007 from that earned
in 2006, totaling $145.4 million in 2007 compared to $138.5 million in the previous year. The increase is primarily
due to the growth in earning assets, which more than offset the lower interest rate environment and increased level of
nonperforming assets during 2007 when compared to 2006. The yield on average earning assets declined from
7.44% recorded in 2006 to 7.34% in 2007.
During 2007, average earning assets increased $118.9 million, from $1,860.7 million in 2006 to $1,979.6 million
during 2007. Growth in average total loans and leases, totaling $105.2 million, comprised 88.5% of the increase in
average earning assets during 2007. Interest income generated from the loan and lease portfolio increased $6.2
million during 2007 over the level earned in 2006, comprised of an increase of $8.0 million from the growth in the
loan and lease portfolio and a decrease of $1.8 million due to a decline in the yield earned on the loan portfolio to
7.57% from 7.68%. The decrease in the loan and lease portfolio yield is primarily due to a lower interest rate
environment during 2007 than in 2006 and an increase in nonperforming loans.
Growth in the securities portfolio also added to the increase in interest income during 2007 over that of 2006.
Average securities increased by $15.1 million in 2007, increasing from $190.3 million in 2006 to $205.4 million in
2007. The growth equated to an increase in interest income of $0.8 million. The yield earned on the securities
portfolio decreased slightly during 2007, from 5.51% to 5.48%. Interest income earned on federal funds sold
decreased by $0.1 million due to a small decline in the average balance during 2007.
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 $12.9 million during 2007
from that expensed in 2006, totaling $88.6 million in 2007 compared to $75.7 million in the previous year. The
increase in interest expense is primarily attributable to the impact of an increase in interest-bearing liabilities and an
increased cost of funds associated with the renewal and replacement of maturing fixed rate certificates of deposit and
borrowings in 2007 that were obtained during periods of lower interest rates when compared to the interest rate
environment during 2007. Interest-bearing liabilities averaged $1,768.9 million during 2007, or $105.5 million
higher than the average interest-bearing liabilities of $1,663.4 million during 2006. This growth resulted in
increased interest expense of $5.0 million. An increase in interest expense of $7.9 million was recorded during 2007
primarily due to an increased cost of funds primarily attributable to fixed rate certificates of deposit and borrowings.
The cost of average interest-bearing liabilities increased from the 4.55% recorded in 2006 to 5.01% in 2007.
Average certificate of deposit growth during 2007 of $95.5 million equated to an increase in interest expense of $4.6
million, with an additional $7.2 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 2007. A decline in other average interest-bearing deposit accounts, totaling $5.0 million, equated to a
decrease in interest expense of $0.2 million, with an additional interest expense reduction of $0.2 million recorded
due to a decrease in the average rate paid during 2007.
Average short term borrowings, comprised of repurchase agreements and federal funds purchased, increased $17.4
million during 2007, resulting in increased interest expense of $0.7 million, with a slight reduction in interest
expense due to a decrease in the average rate paid during 2007. Average FHLB advances decreased $3.0 million,
equating to a decrease in interest expense of $0.1 million; however, an increased average rate added $0.8 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 2007, with an increased average rate adding $0.1 million to interest expense.
F-22
Provision for Loan and Lease Losses
The provision for loan and lease losses totaled $11.1 million during 2007, compared to the $5.8 million expensed
during 2006. The increase primarily reflects a higher volume of nonperforming loans and leases and other
downgrades within our commercial loan and lease portfolio, necessitating a higher allowance balance.
Nonperforming loans and leases totaled $29.8 million, or 1.66% of total loans and leases, as of December 31, 2007,
compared to $8.6 million, or 0.49% of total loans and leases, as of December 31, 2006. Net loan and lease charge-
offs during 2007 totaled $6.7 million, or 0.38% of average 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. Loan and lease growth during 2007
equaled $54.4 million, compared to loan and lease growth of $183.7 million during 2006. The allowance as a
percentage of total loans outstanding as of December 31, 2007 was 1.43%, compared to 1.23% at year-end 2006.
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 historically strong commercial loan and lease growth and
expansions into new markets are taken into account.
Noninterest Income
Noninterest income totaled $5.9 million in 2007, an increase of $0.6 million from the $5.3 million earned in 2006.
Service charge income on deposits and repurchase agreements increased $0.2 million during 2007 when compared to
2006, reflecting an increase in the number of deposit accounts and modest increases in our fee structure. Earnings
from increased cash surrender value of bank owned life insurance policies increased $0.1 million in 2007, 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 2007 when compared to 2006, with the exception of residential
mortgage banking fees, which decreased $0.1 million due to a lower volume of activity.
Noninterest Expense
Noninterest expense during 2007 totaled $38.4 million, an increase of $6.1 million over the $32.3 million expensed
in 2006. Salary expense and benefit costs increased $3.9 million in 2007 when compared to 2006. Included in 2007
salary and benefit costs is a one-time $1.2 million expense associated with the financial retirement package for
former Chairman and Chief Executive Officer, Gerald R. Johnson, Jr., in conjunction with Mr. Johnson’s retirement
effective June 30, 2007. The remainder of the increase in salary and benefit costs during 2007 primarily reflects the
increase in full-time equivalent employees from 291 at year-end 2006 to 306 at year-end 2007 and annual pay
increases. Occupancy, furniture and equipment costs increased $0.2 million in 2007. Other non-interest expenses, in
aggregate, increased $2.0 million in 2007 when compared to 2006, reflecting increased costs associated with a
higher level of nonperforming assets, higher FDIC insurance premiums and additional expenditures required to
administer an increased asset base.
Federal Income Tax Expense
Federal income tax expense was $3.0 million in 2007, a decrease of $6.0 million from the $9.0 million expensed
during 2006. The decrease during 2007 is primarily due to the decline in our pre-federal income tax profitability.
Our effective tax rate for 2007 was 25.3%, compared to 31.1% in 2006, reflecting a decrease in taxable income and
the related increase in tax-exempt income as a percent of taxable income.
CAPITAL RESOURCES
Shareholders’ equity is a noninterest-bearing source of funds that generally provides support for our asset growth.
Shareholders’ equity was $174.4 million and $178.2 million at December 31, 2008 and 2007, respectively. The $3.8
million decline during 2008 is primarily attributable to net loss from operations, which totaled $5.0 million. Also
negatively impacting shareholders’ equity during 2008 was the payment of cash dividends, which totaled $2.6
million. Positively impacting shareholders’ equity was unrealized gains for a $1.8 million, net of tax, adjustment for
available for sale securities as defined in SFAS No. 115, and a $1.2 million, net of tax, change in the fair value of
interest rate swaps.
F-23
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, 2008 and 2007 are disclosed in
Note 18 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. During 2008, we paid a cash dividend on our common stock each calendar
quarter. However, reflecting our financial results and the poor and weakening economy, we lowered the dollar
amount of the cash dividends paid during 2008. During the first quarter of 2008, our cash dividend was $0.15 per
share, but that was lowered to $0.08 per share during the second quarter and $0.04 per share during the third and
fourth quarters. The reduction of the cash dividends during 2008 had a positive impact on our capital ratios. On
January 8, 2009, we declared a $0.04 per common share cash dividend that will be paid on March 10, 2009 to
shareholders of record on February 10, 2009.
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 fund loans, meet deposit withdrawals,
maintain reserve requirements and operate our company. Liquidity is primarily achieved through the growth of local
and out-of-area deposits 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 FHLB advances, and to
maintain an adequate level of short- and medium-term investments to meet typical daily loan and deposit activity.
Although deposit and repurchase agreement growth from customers located in our market areas has historically
generally increased, this growth has not been sufficient to meet our historical substantial loan growth and provide
monies for additional investing activities. To assist in providing the additional needed funds, we have regularly
obtained monies from wholesale funding sources. Wholesale funds, comprised of certificates of deposit from
customers outside of our market areas and advances from the FHLB, totaled $1,414.2 million, or 71.5% of combined
deposits and borrowed funds as of December 31, 2008, compared to $1,105.0 million, or 58.7% of combined
deposits and borrowed funds as of December 31, 2007.
Although local deposits have historically generally increased as new business, municipal governmental unit and
individual deposit relationships are established and as existing customers increase the balances in their accounts, the
relatively high reliance on wholesale funds will likely remain. As part of our interest rate risk management strategy,
a majority of our wholesale funds have a fixed rate and mature within one year, reflecting the fact that a majority of
our loans and leases have a floating interest rate tied to either the Prime or LIBOR rates. While this strategy
increases inherent liquidity risk, we believe the increased liquidity risk is sufficiently mitigated by the benefits
derived from an interest rate risk management standpoint. In addition, we have developed a comprehensive
contingency funding plan which we believe further mitigates the increased liquidity risk.
Wholesale funds are generally a lower all-in cost source of funds when compared to the interest rates that would
have to be offered in the local markets to generate a commensurate level of funds. Interest rates paid on new out-of-
area deposits and FHLB advances have historically been similar to interest rates paid on new certificates of deposit
issued to local customers. In addition, the overhead costs associated with wholesale funds are considerably less than
the overhead costs that would be incurred to attract and administer a similar level of local deposits, especially if the
estimated costs of a needed expanded branching network were taken into account. We believe the relatively low
overhead costs reflecting our limited branch network mitigate our high reliance on wholesale funds and resulting
relatively low net interest margin.
F-24
As a member of the Federal Home Loan Bank of Indianapolis, our bank has access to the FHLB advance borrowing
programs. Advances totaled $270.0 million as of December 31, 2008, compared to $180.0 million outstanding as of
December 31, 2007. Based on available collateral as of December 31, 2008, we could borrow an additional $37.0
million. Our bank also has the ability to borrow up to $30.0 million on a daily basis through a correspondent bank
using an established unsecured federal funds purchased line. During 2008, our federal funds purchased position
averaged $4.2 million, compared to an average federal funds sold position of $11.4 million. Given the volatile
market conditions, during the fourth quarter of 2008 we made the decision to operate with a higher than normal
balance of federal funds sold. It is expected that we will maintain the higher balance of federal funds sold, likely to
average 1.0% to 1.5% of average earning assets, until market conditions return to more normalized levels. As a
result, we expect the use of our federal funds purchased line of credit, in at least the near future, will be rare, if at all.
During 2008 our bank established a line of credit through the Discount Window of the Federal Reserve Bank of
Chicago. Using a substantial majority of our tax-exempt municipal securities as collateral, at year-end 2008 we
could have borrowed up to about $60.0 million for terms of 1 to 28 days, or up to about $45.0 million for terms of 29
to 90 days. We do not plan to regularly access this line of credit.
The following table reflects, as of December 31, 2008, significant fixed and determinable contractual obligations to
third parties by payment date, excluding accrued interest:
One Year or Less
One to Three Years
Three to Five Years
Over Five Years
Total
Deposits without a stated maturity
$ 235,789,000
$ 0
$ 0
$ 0
$ 235,789,000
Certificates of deposits
1,179,405,000
167,415,000
16,966,000
0
1,363,786,000
Short term borrowings
94,413,000
0
0
0
94,413,000
Federal Home Loan Bank advances
70,000,000
150,000,000
50,000,000
0
270,000,000
Subordinated debentures
0
0
0
32,990,000
32,990,000
Other borrowed money
0
15,000,000
0
4,528,000
19,528,000
Operating leases
329,000 432,000
168,000
0
929,000
In addition to normal loan funding and deposit flow, we must maintain liquidity to meet the demands of certain
unfunded loan commitments and standby letters of credit. At December 31, 2008, we had a total of $379.7 million
in unfunded loan commitments and $51.4 million in unfunded standby letters of credit. Of the total unfunded loan
commitments, $368.7 million were commitments available as lines of credit to be drawn at any time as customers’
cash needs vary, and $11.0 million were for loan commitments scheduled to close and become funded within the
next twelve months. The level of commitments to make loans has declined significantly when compared to historical
level, primarily reflecting relatively poor economic conditions. 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, 2008
December 31, 2007
December 31, 2006
$ 323,785,000
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
30,658,000
9,413,000
4,881,000
10,959,000
51,439,000
$ 431,135,000
$ 377,493,000
$ 345,195,000
33,083,000
9,035,000
6,910,000
66,196,000
81,292,000
$ 574,009,000
29,314,000
8,510,000
7,197,000
60,850,000
73,241,000
$ 524,307,000
F-25
We monitor our liquidity position and funding strategies on an ongoing basis, but recognize that unexpected events,
economic or market conditions, reduction in earnings performance, declining capital levels or situations beyond our
control could either cause short term or long term liquidity challenges. While we believe it is unlikely that a funding
crisis of any significant degree is likely to materialize, we have developed a comprehensive contingency funding plan
that provides a framework for meeting both temporary and longer-term liquidity disruptions. Depending on the
particular circumstances of a liquidity situation, possible strategies may include obtaining funds via one or a
combination of the following sources of funds: established lines of credit at correspondent banks, the FHLB and the
Federal Reserve Bank of Chicago, brokered certificate of deposit market, wholesale securities repurchase markets,
issuance of term debt, common or preferred stock, or sale of securities or other assets.
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.
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.
F-26
The following table depicts our GAP position as of December 31, 2008 (dollars in thousands):
Assets:
Commercial loans (1)
Leases
Residential real estate loans
Consumer loans
Securities (2)
Federal funds sold
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
$ 731,445
23
52,208
2,350
38,942
8,950
100
0
0
834,018
$ 212,433
120
16,871
97
1,884
0
0
0
0
231,405
$ 702,801
1,842
57,214
2,808
43,153
0
0
0
0
807,818
$
After
Five
Years
61,629
0
14,483
591
158,808
0
0
0
0
235,511
50,248
49,943
24,886
59,325
377,341
94,413
15,000
37,518
0
0
708,674
0
708,674
0
0
0
82,272
660,467
0
55,000
0
0
0
797,739
0
797,739
0
0
0
37,342
147,039
0
200,000
15,000
0
0
399,381
0
399,381
0
0
0
0
0
0
0
0
0
0
0
0
0
Total
$ 1,708,308
1,985
140,776
5,846
242,787
8,950
100
(27,108)
126,366
2,208,010
50,248
49,943
24,886
178,939
1,184,847
94,413
270,000
52,518
110,712
17,132
2,033,638
174,372
2,208,010
Net asset (liability) GAP
$ 125,344
$ (566,334)
$ 408,437
$ 235,511
Cumulative GAP
$ 125,344
$ (440,990)
$
(32,553)
$ 202,958
Percent of cumulative GAP to
total assets
5.7%
(20.0)%
(1.5)%
9.2%
(1) Floating rate loans that are currently at interest rate ceilings or interest rate floors are treated as fixed rate loans and are
reflected using maturity date and not repricing frequency.
(2) Mortgage-backed securities are categorized by expected maturities based upon prepayment trends as of December 31, 2008.
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-27
We conducted multiple simulations as of December 31, 2008, 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 in comparison to estimated net interest income based on our balance sheet structure, including the
balances and interest rates associated with our specific loans, securities, deposits and borrowed funds, as of
December 31, 2008. The resulting estimates are 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
$ 8,298,000
Interest rates down 100 basis points
No change in interest rates
Interest rates up 100 basis points
Interest rates up 200 basis points
7,935,000
7,352,000
6,260,000
6,963,000
17.2%
16.5
15.3
13.0
14.4
The resulting estimates have been significantly impacted by the current interest rate and economic environment, as
adjustments have been made to critical model inputs with regards to traditional interest rate relationships. This is
especially important as it relates to floating rate commercial loans and brokered certificates of deposit, which
comprise a substantial portion of our balance sheet. As of December 31, 2008, the Mercantile Prime Rate is 4.50%
as compared to the Wall Street Journal Prime Rate of 3.25%. Historically, the two indices have been equal;
however, we elected not to reduce the Mercantile Prime Rate in late October and mid-December of 2008 when the
Wall Street Journal Prime Rate declined by 50 and 75 basis points, respectively. In conducting our simulations at
year-end 2008, we have made the assumption that the Mercantile Prime Rate will remain unchanged until the Wall
Street Journal Prime Rate exceeds the Mercantile Prime Rate, at which time the two indices will remain equal in the
increasing interest rate scenarios. We have also made similar assumptions in regards to our local deposit rates,
which in general have not been reduced since the separation of the Mercantile and Wall Street Journal Prime Rate
indices. Also, brokered certificate of deposit rates have substantially decreased since December of 2008, with part
of the decline attributable to a significant imbalance whereby the supply of available funds far outweighs the demand
from banks looking to raise funds. As a result, we have substantially limited further reductions in brokered
certificate of deposit rates in the declining interest rate scenarios.
In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other
variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and
interest-bearing liabilities; level of nonperforming assets; economic and competitive conditions; potential changes in
lending, investing, and deposit gathering strategies; client preferences; and other factors.
F-28
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,
2008 and 2007, and the related consolidated statements of income, changes in shareholders' equity and cash flows for
the years ended December 31, 2008 and 2007. These financial statements are the responsibility of the Company’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, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall presentation of the financial
statements. 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, 2008 and 2007, and the results of its
operations and its cash flows for the years ended December 31, 2008 and 2007 in conformity with accounting
principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), Mercantile Bank Corporation’s internal control over financial reporting as of December 31, 2008, 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 March 11, 2009 expressed an unqualified
opinion thereon.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Grand Rapids, Michigan
March 11, 2009
F-29
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Grand Rapids, Michigan
We have audited the accompanying consolidated statements of income, changes in shareholders' equity and cash
flows for the year ended December 31, 2006. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial statements 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 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
results of its operations and its cash flows for the year ended December 31, 2006 in conformity with U.S. generally
accepted accounting principles.
/s/ Crowe Horwath LLP
Crowe Horwath LLP
Grand Rapids, Michigan
February 20, 2007
F-30
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Mercantile Bank Corporation
Grand Rapids, Michigan
We have audited Mercantile Bank Corporation’s internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). 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, included in the accompanying Report by Mercantile Bank
Corporation’s Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion
on the Company’s internal control over financial reporting based on our audit.
We 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, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the
assessed risk. Our audit also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinion.
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, Mercantile Bank Corporation maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of Mercantile Bank Corporation as of December 31, 2008 and 2007, and the
related consolidated statements of income, changes in shareholders’ equity and cash flows for the years ended
December 31, 2008 and 2007, and our report dated March 11, 2009 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Grand Rapids, Michigan
March 11, 2009
F-31
March 11, 2009
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 system of internal control over financial reporting that is designed to produce
reliable financial statements in conformity with generally accepted accounting principles as of December 31, 2008.
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, 2008, 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 the effectiveness of the Company’s internal
control over financial reporting.
Mercantile Bank Corporation
/s/ Michael H. Price
Michael H. Price
Chairman of the Board, President and Chief Executive Officer
/s/ Charles E. Christmas
Charles E. Christmas
Senior Vice President – Chief Financial Officer and Treasurer
F-32
MERCANTILE BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and 2007
ASSETS
Cash and due from banks
Short-term investments
Federal funds sold
Total cash and cash equivalents
Securities available for sale
Securities held to maturity (fair value of $65,381,000 at
December 31, 2008 and $66,440,000 at December 31, 2007)
Federal Home Loan Bank stock
Loans and leases
Allowance for loan and lease losses
Loans and leases, net
Premises and equipment, net
Bank owned life insurance policies
Accrued interest receivable
Other assets
2008
2007
$
16,754,000
100,000
8,950,000
25,804,000
$
29,138,000
292,000
0
29,430,000
162,669,000
136,673,000
64,437,000
15,681,000
65,330,000
9,733,000
1,856,915,000
(27,108,000)
1,829,807,000
1,799,880,000
(25,814,000)
1,774,066,000
32,334,000
42,462,000
8,513,000
26,303,000
34,351,000
39,118,000
9,957,000
22,745,000
Total assets
$2,208,010,000
$2,121,403,000
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 interest 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; 8,593,304 and 8,527,197 shares issued
and outstanding at December 31, 2008 and 2007
Retained earnings (deficit)
Accumulated other comprehensive income
Total shareholders’ equity
$ 110,712,000
1,488,863,000
1,599,575,000
$ 133,056,000
1,458,125,000
1,591,181,000
94,413,000
0
270,000,000
32,990,000
19,528,000
17,132,000
2,033,638,000
97,465,000
13,800,000
180,000,000
32,990,000
4,013,000
23,799,000
1,943,248,000
0
0
172,353,000
(1,281,000)
3,300,000
174,372,000
172,938,000
4,948,000
269,000
178,155,000
Total liabilities and shareholders’ equity
$2,208,010,000
$2,121,403,000
See accompanying notes to consolidated financial statements.
F-33
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2008, 2007 and 2006
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
2008
2007
2006
$ 110,013,000
7,888,000
2,960,000
204,000
7,000
121,072,000
$ 133,685,000
7,243,000
2,813,000
420,000
20,000
144,181,000
$ 127,470,000
6,557,000
2,739,000
482,000
12,000
137,260,000
59,812,000
2,021,000
10,554,000
2,476,000
74,863,000
76,221,000
3,493,000
6,100,000
2,810,000
88,624,000
64,755,000
2,867,000
5,393,000
2,658,000
75,673,000
Net interest income
46,209,000
55,557,000
61,587,000
Provision for loan and lease losses
21,200,000
11,070,000
5,775,000
Net interest income after provision for loan and lease losses
25,009,000
44,487,000
55,812,000
Noninterest income
Service charges on accounts
Earnings on bank owned life insurance policies
Credit and debit card fees
Letter of credit fees
Mortgage banking activities
Net gain on sales of commercial loans
Other income
Total noninterest income
Noninterest expense
Salaries and benefits
Occupancy
Furniture and equipment rent, depreciation and maintenance
Nonperforming asset costs
Data processing
FDIC insurance
Advertising
Other expense
Total noninterest expenses
1,994,000
1,727,000
745,000
687,000
662,000
0
1,467,000
7,282,000
22,493,000
3,826,000
1,980,000
3,266,000
2,394,000
1,890,000
559,000
5,718,000
42,126,000
1,610,000
1,252,000
668,000
613,000
464,000
0
1,263,000
5,870,000
22,876,000
3,300,000
2,063,000
1,099,000
2,017,000
654,000
585,000
5,762,000
38,356,000
1,386,000
1,165,000
557,000
443,000
553,000
29,000
1,128,000
5,261,000
18,983,000
3,136,000
2,050,000
430,000
1,657,000
184,000
600,000
5,222,000
32,262,000
Income (loss) before federal income tax expense (benefit)
(9,835,000)
12,001,000
28,811,000
Federal income tax expense (benefit)
(4,876,000)
3,035,000
8,964,000
Net income (loss)
Earnings (loss) per share:
Basic
Diluted
$
(4,959,000)
$
8,966,000
$ 19,847,000
$ (0.59)
$ (0.59)
$ 1.06
$ 1.06
$ 2.36
$ 2.33
See accompanying notes to consolidated financial statements.
F-34
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2008, 2007 and 2006
Balances, January 1, 2006
$
148,533,000
$
8,000,000
$
(1,408,000) $
155,125,000
Common
Stock
Retained
Earnings (Deficit)
Accumulated Other
Comprehensive
Income (Loss)
Total
Shareholders'
Equity
Payment of 5% stock dividend
12,014,000
(12,018,000)
Employee stock purchase plan, 2,912 shares
Dividend reinvestment plan, 2,657 shares
Stock option exercises, 64,971 shares
Stock tendered for stock option
exercises, 15,685 shares
107,000
98,000
814,000
(585,000)
Cash dividends ($0.48 per share)
(4,035,000)
Stock-based 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
Payment of 5% stock dividend
11,131,000
(11,135,000)
Employee stock purchase plan, 3,966 shares
Dividend reinvestment plan, 3,137 shares
Stock option exercises, 52,117 shares
Stock tendered for stock option
exercises, 18,291 shares
91,000
76,000
643,000
(587,000)
Cash dividends ($0.55 per share)
(4,677,000)
Stock-based compensation expense
361,000
(4,000)
91,000
76,000
643,000
(587,000)
(4,677,000)
361,000
Comprehensive income:
Net income
Change in net unrealized gain (loss) on
securities available for sale, net of
reclassifications and tax effect
Total comprehensive income
8,966,000
8,966,000
1,371,000
1,371,000
10,337,000
Balances, December 31, 2007
172,938,000
4,948,000
269,000
178,155,000
See accompanying notes to consolidated financial statements.
F-35
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)
Years ended December 31, 2008, 2007 and 2006
Balances, December 31, 2007
$
172,938,000
$
4,948,000
$
269,000
$
178,155,000
Common
Stock
Retained
Earnings (Deficit)
Accumulated Other
Comprehensive
Income (Loss)
Total
Shareholders'
Equity
Employee stock purchase plan, 10,904 shares
Dividend reinvestment plan, 4,340 shares
Stock option exercises, 2,000 shares
Stock tendered for stock option exercises,
1,123 shares
Stock-based compensation expense
76,000
40,000
16,000
(16,000)
654,000
Cash dividends ($0.31 per share)
(1,355,000)
(1,270,000)
76,000
40,000
16,000
(16,000)
654,000
(2,625,000)
Comprehensive income (loss):
Net loss
Change in net unrealized gain
on securities available for sale,
net of reclassifications and tax effect
Change in net fair value of interest rate
swaps, net of reclassifications and tax effect
Total comprehensive loss
(4,959,000)
(4,959,000)
1,795,000
1,795,000
1,236,000
1,236,000
(1,928,000)
Balances, December 31, 2008
$
172,353,000
$
(1,281,000) $ 3,300,000
$
174,372,000
See accompanying notes to consolidated financial statements.
F-36
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2008, 2007 and 2006
Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income (loss)
to net cash from operating activities:
Depreciation and amortization
Provision for loan and lease losses
Deferred income tax benefit
Stock-based compensation expense
Net gain on sales of commercial loans
Proceeds from sales of mortgage loans held for sale
Origination of mortgage loans held for sale
Net gain on sales of mortgage loans
Loss on sale of foreclosed assets
Earnings on bank owned life insurance
Net change in:
Accrued interest receivable
Other assets
Accrued interest 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:
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 and lease originations and payments, net
Purchases of premises and equipment, net
Proceeds from sale of foreclosed assets
Purchases of bank owned life insurance policies
Net cash for investing activities
Cash flows from financing activities
Net increase (decrease) in time deposits
Net increase (decrease) in all other deposits
Net increase (decrease) in securities sold under
agreements to repurchase
Net increase (decrease) in federal funds purchased
Proceeds from Federal Home Loan Bank advances
Pay-off of Federal Home Loan Bank advances
Increase in structured repurchase agreements
Increase 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
2008
2007
2006
$
(4,959,000) $
8,966,000
$
19,847,000
2,762,000
21,200,000
(1,558,000)
654,000
0
44,095,000
(42,810,000)
(506,000)
1,768,000
(1,727,000)
1,444,000
(61,000)
(6,667,000)
13,635,000
3,080,000
11,070,000
(2,103,000)
361,000
0
32,911,000
(33,408,000)
(432,000)
157,000
(1,252,000)
330,000
(2,243,000)
1,927,000
19,364,000
2,887,000
5,775,000
(474,000)
242,000
(29,000)
18,133,000
(18,766,000)
(231,000)
8,000
(1,165,000)
(2,013,000)
(1,658,000)
5,277,000
27,833,000
(96,292,000)
(978,000)
(5,948,000)
(15,406,000)
(4,658,000)
(2,224,000)
(24,886,000)
(4,567,000)
0
73,571,000
11,969,000
7,423,000
1,840,000
0
(86,489,000)
(673,000)
4,777,000
(1,617,000)
(111,809,000)
3,221,000
0
(66,681,000)
(3,513,000)
1,476,000
(7,008,000)
(82,824,000)
1,330,000
378,000
(189,793,000)
(5,911,000)
1,055,000
(1,621,000)
(216,592,000)
42,774,000
(34,380,000)
(50,972,000)
(4,750,000)
229,843,000
(2,292,000)
(3,052,000)
(13,800,000)
266,500,000
(176,500,000)
15,000,000
515,000
0
76,000
40,000
0
(2,625,000)
94,548,000
11,993,000
4,000,000
175,000,000
(90,000,000)
0
697,000
(4,000)
91,000
76,000
56,000
(4,677,000)
41,510,000
13,271,000
200,000
80,000,000
(115,000,000)
0
969,000
(4,000)
107,000
98,000
229,000
(4,035,000)
203,386,000
See accompanying notes to consolidated financial statements.
F-37
MERCANTILE BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years ended December 31, 2008, 2007 and 2006
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 taxes
Transfers from loans and leases to foreclosed assets
2008
2007
2006
$
$
(3,626,000)
29,430,000
25,804,000
80,748,000
0
9,062,000
$
$
(21,950,000)
51,380,000
29,430,000
87,707,000
5,730,000
6,898,000
$
$
14,627,000
36,753,000
51,380,000
67,925,000
10,875,000
2,129,000
See accompanying notes to consolidated financial statements.
F-38
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
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(R), Consolidation of Variable Interest Entities,
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, Ann Arbor and Oakland County 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 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 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 Federal Reserve Board regulations effective March 23, 2000.
(Continued)
F-39
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
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
actual 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 accretion of discounts. Premiums and discounts on
securities are amortized or accreted on the level-yield method without anticipating prepayments, except for
mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade
date and determined using the specific identification method.
Declines in the fair value of securities below their amortized 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 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. Net unamortized deferred loan fees amounted to $0.8 million and $0.3
million at December 31, 2008 and 2007, respectively.
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 when they are 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.
(Continued)
F-40
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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. The
balance of loans held for sale equaled $1.1 million and $1.9 million as of December 31, 2008 and 2007, respectively.
Mortgage banking activities include fees on direct brokered mortgage loans and the net gain on sale of mortgage
loans originated for sale.
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, 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 Bank does not maintain effective
control over the transferred assets through an agreement to repurchase them before their maturity. Our transfers of
financial assets are limited to commercial loan participations sold, which were insignificant for 2008, 2007 and 2006,
and the sale of residential mortgage loans in the secondary market, the extent of which is disclosed in the
consolidated statements of cash flows.
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-lived Assets: Premises and equipment and other long-lived 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 the lower of carrying value or fair value.
(Continued)
F-41
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Foreclosed Assets: Assets acquired through or in lieu of foreclosure are initially recorded at the estimated fair value
net of estimated selling costs when acquired, establishing a new cost basis. If fair value declines, a valuation
allowance is recorded through expense. Costs after acquisition are expensed. Foreclosed assets are included in other
assets in the accompanying consolidated balance sheets and totaled $8.1 million and $5.9 million at December 31,
2008 and 2007, respectively.
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.
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 Financial Accounting Standards Board (“FASB”)
Interpretation No. 45, are recorded at fair value.
Stock-Based Compensation: Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-
Based Payment, compensation cost for equity-based awards is measured on the grant date based on the fair value of
the award at that date, and is recognized over the requisite service period, net of estimated forfeitures. Fair value of
stock option awards is estimated using a closed option valuation (Black-Scholes) model. Fair value of restricted
stock awards is based upon the quoted market price of the common stock on the date of grant.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable, the change in
deferred income tax assets and liabilities, and any adjustments related to unrecognized tax benefits. Deferred income
tax assets and liabilities are recognized for the tax consequences of temporary differences between the carrying
amounts and tax bases of assets and liabilities, computed using enacted tax rates applicable to future years. A
valuation allowance, if needed, reduces deferred income tax assets to the amount expected to be realized.
Fair Values of Financial Instruments: Fair values of financial instruments are estimated using relevant market
information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for
particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair
value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated
future business or the values of assets and liabilities not considered financial instruments.
Earnings Per Share: Basic earnings per share is based on weighted average common shares outstanding during the
period exclusive of unvested restricted shares outstanding. Diluted earnings per share include the dilutive effect of
additional potential common shares issuable under stock options and restricted stock awards and are determined
using the treasury stock method.
Stock Dividend: Earnings per share are restated for all stock dividends, including the 5% stock dividends paid on
May 4, 2007 and May 16, 2006. The fair value of shares issued in stock dividends is transferred from retained
earnings to common stock to the extent of available retained earnings.
(Continued)
F-42
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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. For 2008, other comprehensive income also includes the change in fair value of
interest rate swaps as discussed in more detail in Note 13.
Derivatives: Derivative financial instruments are recognized as assets or liabilities at fair value. The accounting for
changes in the fair value of derivatives depends on the use of the derivatives and whether the derivatives qualify for
hedge accounting. During 2008, our derivatives consisted of interest rate swap agreements, which were used as part
of our asset liability management to help manage interest rate risk. We do not use derivatives for trading purposes.
Changes in the fair value of derivatives that are designated as a hedge of the variability of cash flows to be received
on the hedged asset or liability and are effective are reported in other comprehensive income. They are later
reclassified into earnings in the same periods during which the hedged transaction affects earnings and are included
in the line item in which the hedged cash flows are recorded. If hedge accounting does not apply, changes in the fair
value of derivatives are recognized immediately in current earnings as noninterest income or expense.
If designated as a hedge, we formally document the relationship between derivatives as hedged items, as well as the
risk-management objective and the strategy for undertaking hedge transactions. This documentation includes linking
cash flow hedges to specific assets on the balance sheet. If designated as a hedge, we also formally assess, both at
the inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in
offsetting changes in cash flows of the hedged items. Ineffective hedge gains and losses are recognized immediately
in current earnings as noninterest income or expense. We discontinue hedge accounting when we determine the
derivative is no longer effective in offsetting changes in the cash flows of the hedged item, the derivative is settled or
terminates, or treatment of the derivatives as a hedge is no longer appropriate or intended.
Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are
recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably
estimated. We do not believe there are any such matters 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 Segment: While we monitor the revenue streams of the various products and services offered, the
Company manages its business on the basis of one operating segment, banking, in accordance with the qualitative
and quantitative criteria established by SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information.
Adoption of New Accounting Standards: In December 2007, the FASB issued SFAS No. 141(R), Business
Combinations, to further enhance the accounting and financial reporting related to business combinations. SFAS
No. 141(R) establishes principles and requirements for how the acquirer in a business combination (1) recognizes
and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree, (2) recognizes and measures the goodwill acquired in the business
combination or a gain from a bargain purchase, and (3) determines what information to disclose to enable users of
the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R)
applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. Therefore, the effects of the adoption of SFAS
No. 141(R) will depend upon the extent and magnitude of acquisitions after December 31, 2008.
(Continued)
F-43
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes
a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157
applies to other accounting pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute.
SFAS No. 157 does not require any new fair value measurements and was originally effective beginning January 1,
2008. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2. FSP FAS 157-2 allows entities
to electively defer the effective date of SFAS No. 157 until January 1, 2009 for nonfinancial assets and nonfinancial
liabilities except those items recognized or disclosed at fair value on an annual or more frequently recurring basis.
We will apply the fair value measurement and disclosure provisions of SFAS No. 157 to nonfinancial assets and
nonfinancial liabilities effective January 1, 2009. The application of such is not expected to be material to our
results of operations or financial position. On October 10, 2008, the FASB issued FSP FAS 157-3 to clarify the
application of fair value measurements of a financial asset when the market for that asset is not active. This
clarifying guidance became effective upon issuance. This new guidance had no effect on our consolidated results of
operations or financial position. See Note 15 for a discussion regarding the January 1, 2008 implementation of
SFAS No. 157 relating to our financial assets and liabilities.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities. This Statement permits entities to choose to measure eligible items at fair value at specified election
dates. For items for which the fair value option has been elected, unrealized gains and losses are to be reported in
earnings at each subsequent reporting date. The fair value option is irrevocable unless a new election date occurs,
may be applied instrument by instrument, with a few exceptions, and applies only to entire instruments and not to
portions of instruments. SFAS No. 159 provides an opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply complex hedge accounting. SFAS No.
159 was effective beginning January 1, 2008. Through December 31, 2008, we have not elected the fair value
option for any of our financial assets or liabilities.
In March 2008, the FASB issued SFAS No. 161, Disclosures About Derivative Instruments and Hedging Activities –
an Amendment of FASB Statement No. 133. SFAS No. 161 expands disclosure requirements regarding an entity’s
derivative instruments and hedging activities. Expanded qualitative disclosures that will be required under SFAS
No. 161 include: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related
hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
and related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial
statements. SFAS No. 161 is effective beginning January 1, 2009. We do not expect SFAS No. 161 to have a
material effect on our derivative disclosures upon adoption.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS
No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in the preparation of financial statements of nongovernmental entities that are
presented in conformity with U.S. generally accepted accounting principles (“GAAP”). SFAS No. 162 directs the
GAAP hierarchy to the entity, not the independent auditors, as the entity is responsible for selecting accounting
principles for financial statements that are presented in conformity with GAAP. SFAS No. 162 became effective 60
days following the Securities and Exchange Commission’s September 2008 approval of the Public Accounting
Oversight Board amendments to remove the GAAP hierarchy from the audit standards. The adoption of SFAS No.
162 did not have an impact on our consolidated results of operations or financial position.
(Continued)
F-44
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 2 – SECURITIES
The amortized cost, fair value of available for sale securities and the related gross unrealized gains and losses
recognized in accumulated other comprehensive income (loss) are as follows:
2008
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Mutual fund
2007
U.S. Government agency
debt obligations
Mortgage-backed securities
Mutual fund
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
$
61,511,000
74,702,000
22,105,000
1,175,000
$ 1,264,000
2,324,000
0
0
$
(393,000)
0
0
(19,000)
$
62,382,000
77,026,000
22,105,000
1,156,000
$ 159,493,000
$ 3,588,000
$
(412,000)
$ 162,669,000
$
80,129,000
55,003,000
1,127,000
$ 860,000
193,000
0
$
(44,000)
(577,000)
(18,000)
$
80,945,000
54,619,000
1,109,000
$ 136,259,000
$ 1,053,000
$
(639,000)
$ 136,673,000
The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows:
2008
Municipal general obligation bonds
Municipal revenue bonds
2007
Municipal general obligation bonds
Municipal revenue bonds
Carrying
Amount
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
$
56,893,000
7,544,000
$ 1,133,000
175,000
$ (351,000)
(13,000)
$
57,675,000
7,706,000
$
64,437,000
$ 1,308,000
$ (364,000)
$
65,381,000
$
57,668,000
7,662,000
$ 1,084,000
198,000
$ (164,000)
(8,000)
$
58,588,000
7,852,000
$
65,330,000
$ 1,282,000
$ (172,000)
$
66,440,000
(Continued)
F-45
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 2 – SECURITIES (Continued)
Securities with unrealized losses at year-end 2008 and 2007, aggregated by investment category and length of time
that individual securities have been in a continuous loss position, are as follows:
Description of Securities
2008
U.S. Government agency
debt obligations
Mortgage-backed securities
Michigan Strategic Fund bonds
Mutual fund
Municipal general
obligation bonds
Municipal revenue bonds
2007
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
$20,588,000 $ (387,000) $ 1,994,000 $
0
0
0
0
0
0
0
0
1,156,000
(6,000)
0
0
(19,000)
$22,582,000 $ (393,000)
0
0
0
0
(19,000)
1,156,000
3,547,000
307,000
(76,000)
(1,000)
10,852,000
794,000
(275,000)
(12,000)
14,399,000 (351,000)
(13,000)
1,101,000
$24,442,000 $ (464,000) $ 14,796,000 $ (312,000) $ 39,238,000 $ (776,000)
0 $
$
1,241,000
0
0
(3,000)
0
$ 7,953,000 $ (44,000)
(574,000)
35,277,000
(18,000)
1,109,000
$ 7,953,000 $ (44,000)
36,518,000 (577,000)
(18,000)
1,109,000
2,899,000
255,000
(29,000)
(1,000)
11,001,000
1,029,000
(135,000)
(7,000)
13,900,000 (164,000)
(8,000)
1,284,000
$ 4,395,000 $
(33,000) $56,369,000 $ (778,000) $ 60,764,000 $ (811,000)
We evaluate securities for other-than-temporary impairment at least on a quarterly basis. 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.
There were one U.S. Government agency debt obligation, 36 municipal general obligation bonds and three municipal
revenue bonds in a continuous loss position for 12 months or more at December 31, 2008. At December 31, 2008,
67 debt securities and a mutual fund with a fair value totaling $39.2 million have unrealized losses with aggregate
depreciation of $0.8 million, or 0.3% from the amortized cost basis of total securities. At December 31, 2008, 289
debt securities with a fair value totaling $161.3 million have unrealized gains with aggregate appreciation of $4.9
million, or 2.2% 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 changing interest rate environments. As we have the intent and 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-46
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 2 – SECURITIES (Continued)
The amortized cost and fair values of debt securities at year-end 2008, 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, 2008 are also 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
6.64% $ 1,884,000
Due in one year or less
10,457,000
6.73
Due from one to five years
13,496,000
6.57
Due from five to ten years
38,600,000
6.35
Due after ten years
0
Mortgage-backed securities
NA
0
Michigan Strategic Fund bonds NA
0
NA
Mutual fund
$
NA
0
$ 1,914,000
4.70% 11,934,000
10,891,000
16,637,000
13,948,000
5.29
32,940,000
38,628,000 5.33
74,702,000
5.16
0
22,105,000
2.99
0
1,175,000
4.00
0
$
0
12,235,000
17,065,000
33,082,000
77,026,000
22,105,000
1,156,000
6.47% $ 64,437,000
$ 65,381,000
4.87% $159,493,000 $162,669,000
During 2008, 2007 and 2006, there were no securities sold.
At year-end 2008 and 2007, the amortized cost of securities issued by the state of Michigan and all its political
subdivisions totaled $64.4 million and $65.3 million, with an estimated market value of $65.4 million and $66.4
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 secure repurchase agreements and other deposits was $124.2
million and $109.2 million at December 31, 2008 and 2007, respectively. In addition, substantially all of our
municipal bonds have been pledged to the Discount Window of the Federal Reserve Bank of Chicago. Investments
in Federal Home Loan Bank stock are restricted and may only be resold, or redeemed by, the issuer.
(Continued)
F-47
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES
Year-end loans and leases are as follows:
Real Estate:
Construction and land
development
Secured by 1 – 4
family properties
Secured by multi-
family properties
Secured by
nonresidential properties
Commercial
Leases
Consumer
December 31, 2008
Balance
%
December 31, 2007
Balance
%
Percent
Increase
(Decrease)
$ 263,392,000
14.1% $ 263,868,000
14.7%
(0.2)%
140,776,000
47,365,000
7.6
2.6
135,517,000
51,951,000
7.5
2.9
881,350,000
516,201,000
1,985,000
5,846,000
47.5
27.8
0.1
0.3
855,872,000
484,645,000
2,865,000
5,162,000
47.6
26.9
0.1
0.3
3.9
(8.8)
3.0
6.5
(30.7)
13.3
$1,856,915,000
100.0% $1,799,880,000
100.0%
3.2%
Activity in the allowance for loan and lease losses is as follows:
Beginning balance
Provision for loan and lease losses
Charge-offs
Recoveries
2008
2007
2006
$
25,814,000
21,200,000
(20,594,000)
688,000
$
21,411,000
11,070,000
(7,274,000)
607,000
$
20,527,000
5,775,000
(5,389,000)
498,000
Ending balance
$
27,108,000
$
25,814,000
$
21,411,000
Impaired loans and leases were as follows:
2008
2007
Year-end loans with no allocated allowance for loan and lease losses
Year-end loans with allocated allowance for loan and lease losses
$
22,557,000
22,222,000
$
10,842,000
14,052,000
$
44,779,000
$
24,894,000
Amount of the allowance for loan and lease losses allocated
$
3,980,000
$
3,237,000
Impaired loans and leases for which no allocation to the allowance for loan and leases losses has been made
generally reflect situations whereby the loans and leases have been charged-down to estimated collateral value. The
Bank recognized no interest income on impaired loans during 2008, 2007 or 2006. Average impaired loans were
$35.9 million, $14.0 million and $6.1 million during 2008, 2007 and 2006, respectively. Lost interest income on
nonaccrual loans totaled $2.1 million, $0.9 million and $0.3 million in 2008, 2007 and 2006, respectively.
Nonperforming loans includes both smaller balance homogenous loans that are collectively evaluated for impairment
and the above individually classified impaired loans.
(Continued)
F-48
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 3 – LOANS AND LEASES AND ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)
Nonperforming loans and leases were as follows:
2008
2007
Loans and leases past due 90 days or more still accruing interest
Nonaccrual loans and leases
$
1,358,000
47,945,000
$
977,000
28,832,000
$
49,303,000
$
29,809,000
Concentrations within the loan portfolio were as follows at year-end:
2008
2007
Balance
Percentage of
Loan Portfolio
Balance
Percentage of
Loan Portfolio
Commercial real estate loans to
lessors of non-residential
buildings
$ 489,580,000
26.4%
$ 483,210,000
26.8%
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
2008
2007
$
8,538,000
24,888,000
12,484,000
45,910,000
13,576,000
$
8,534,000
24,559,000
12,164,000
45,257,000
10,906,000
$
32,334,000
$
34,351,000
Depreciation expense in 2008, 2007 and 2006 totaled $2.7 million, $2.7 million and $2.6 million, respectively.
We entered into a lease arrangement for our banking facility in Ann Arbor, Michigan during 2005, and for our
banking facility in Oakland County during 2007. Rent expense for these facilities totaled $319,000 and $169,000
during 2008 and 2007, respectively. Minimum rent commitments under the operating leases were as follows, before
considering renewal options that generally are present:
2009
2010
2011
2012
2013
Total
$ 329,000
254,000
178,000
168,000
0
$ 929,000
(Continued)
F-49
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
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, 2008
Balance
%
December 31, 2007
Balance
%
Percent
Increase
(Decrease)
$ 110,712,000
6.9% $ 133,056,000
8.4%
(16.8)%
50,248,000
24,886,000
49,943,000
49,991,000
184,573,000
470,353,000
3.1
1.6
3.1
3.1
11.6
29.4
44,491,000
11,872,000
80,750,000
52,675,000
2.8
0.7
5.1
3.3
343,296,000
666,140,000
21.6
41.9
12.9
109.6
(38.2)
(5.1)
(46.2)
(29.4)
128,948,000
8.1
100,703,000
6.3
28.0
1,000,274,000
1,129,222,000
62.5
70.6
824,338,000
925,041,000
51.8
58.1
21.3
22.1
$1,599,575,000
100.0% $1,591,181,000
100.0%
0.5%
Out-of-area certificates of deposit consist of certificates obtained from depositors outside of the primary market
areas. As of December 31, 2008, out-of-area certificates of deposit totaling $1,101.2 million were obtained through
deposit brokers, with the remaining $28.0 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
2008
2007
$1,179,405,000
140,299,000
27,116,000
10,232,000
6,734,000
$1,030,178,000
227,492,000
32,231,000
21,777,000
9,334,000
$1,363,786,000
$1,321,012,000
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
2008
2007
$ 377,341,000
281,568,000
378,899,000
147,039,000
$ 356,661,000
247,322,000
320,297,000
243,354,000
$1,184,847,000
$1,167,634,000
(Continued)
F-50
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
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
2008
2007
$ 94,413,000
1.96%
93,149,000
2.04%
105,986,000
$ 97,465,000
2.94%
88,685,000
3.67%
102,881,000
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
held in safekeeping by a correspondent bank. Repurchase agreements are offered principally to certain large deposit
customers. Repurchase agreements were secured by securities with a market value of $106.5 million and $108.1
million at year-end 2008 and 2007, respectively.
NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows:
2008
2007
Maturities January 2009 through December 2013, fixed rates from
2.95% to 5.30%, averaging 3.79%
$ 270,000,000
$
0
Maturities January 2008 through January 2012, fixed rates from
4.01% to 5.34%, averaging 4.71%
0
180,000,000
$ 270,000,000
$ 180,000,000
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, 2008 totaled $316.5
million.
Maturities over the next five years are:
2009
2010
2011
2012
2013
$ 70,000,000
65,000,000
85,000,000
40,000,000
10,000,000
(Continued)
F-51
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 8 - FEDERAL INCOME TAXES
The consolidated income tax (benefit) provision is as follows:
Current expense (benefit)
Deferred benefit
Tax expense (benefit)
2008
2007
2006
$
$
(3,318,000)
(1,558,000)
(4,876,000)
$
$
5,138,000
(2,103,000)
3,035,000
$
$
9,438,000
(474,000)
8,964,000
Income tax benefit for 2008 was more than, and income tax expense for 2007 and 2006 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
Bank owned life insurance
Other
Tax (benefit) expense
2008
2007
2006
$
(3,442,000)
$
4,200,000
$ 10,084,000
(818,000)
(605,000)
(11,000)
(4,876,000)
$
(794,000)
(438,000)
67,000
3,035,000
(795,000)
(408,000)
83,000
8,964,000
$
$
The net deferred income tax asset recorded includes the following amounts of deferred income tax assets and
liabilities:
Deferred income tax assets
Allowance for loan and lease losses
Deferred loan fees
Deferred compensation
Nonaccrual loan interest income
Fair value write-downs on foreclosed properties
Other
Deferred income tax liabilities
Depreciation
Unrealized gain on securities
Net fair value of interest rate swaps
Other
Net deferred income tax asset
2008
2007
$
9,488,000
263,000
1,584,000
440,000
303,000
727,000
12,805,000
907,000
1,112,000
666,000
674,000
3,359,000
9,446,000
$
$
9,035,000
111,000
1,404,000
175,000
27,000
633,000
11,385,000
1,006,000
145,000
0
713,000
1,864,000
9,521,000
$
SFAS No. 109, Accounting for Income Taxes, requires that companies assess whether a valuation allowance should
be established against their deferred tax assets based on the consideration of all available evidence using a “more
likely than not” standard. In accordance with SFAS No. 109, we reviewed our deferred tax assets and determined
that no valuation allowance was necessary at year end 2008 or 2007. Despite the loss in 2008 and the challenging
economic environment, we are in a cumulative income position, have a history of strong earnings, are well-
capitalized, and have cautiously optimistic expectations regarding future taxable income. In making such judgments,
significant weight is given to evidence that can be objectively verified. In making decisions regarding any valuation
allowance, we consider both positive and negative evidence and analyze changes in near-term market conditions as
well as other factors which may impact future operating results. The deferred tax assets will be analyzed quarterly
for changes affecting realizability, and there can be no guarantee that a valuation allowance will not be necessary in
future periods.
(Continued)
F-52
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 8 – FEDERAL INCOME TAXES (Continued)
We adopted the provisions of FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes,
on January 1, 2007. The adoption of FIN 48 had no affect on the financial statements. We had no recognized tax
benefits at any time during 2008 or 2007 and do not anticipate any significant increase in unrecognized tax benefits
during 2009. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is
our policy to record such accruals in our income tax accounts; no such accruals existed at any time during 2008 or
2007. We file U.S. federal income tax returns which are subject to examination for all years after 2004.
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 align 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 the past three years, 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 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 date of grant, or for stock options granted in 2006 or 2007, the
day before the date of grant, if the closing price was higher on the day before the date of grant. Price, vesting and
expiration date parameters are determined by Mercantile’s Compensation Committee on a grant-by-grant basis.
Generally, the stock options granted to employees during the past three years fully vest after two years and expire
after seven years. The restricted stock awards granted to certain employees during the past three years fully vest
after four years. No payments were required from employees for the restricted stock awards. At year-end 2008,
there were approximately 396,000 shares authorized for future incentive awards.
As of December 31, 2008, there was $0.2 million of total unrecognized compensation cost related to unvested stock
options granted under our various stock-based compensation plans. This unrecognized compensation cost is
expected to be recognized over a weighted-average period of 1.5 years. As of December 31, 2008, there was $1.1
million 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 3.0 years.
(Continued)
F-53
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
A summary of restricted stock activity is as follows:
2008
2007
2006
Weighted
Average
Fair Value
Shares
Weighted
Average
Fair Value
Shares
63,024
56,710
0
(6,724)
$ 23.69
6.21
NA
24.83
21,159
44,450
0
(2,585)
$ 37.94
17.74
NA
37.94
Weighted
Average
Fair Value
$
NA
37.94
NA
NA
Shares
0
21,159
0
0
113,010
$ 14.85
63,024
$ 23.69
21,159
$ 37.94
Nonvested at
beginning of year
Granted
Vested
Forfeited
Nonvested at
end of year
A summary of stock option activity is as follows:
2008
2007
2006
Weighted
Average
Price
Shares
Weighted
Average
Price
Shares
Weighted
Average
Price
Shares
271,755
67,460
(2,000)
(11,781)
$ 24.34
6.21
8.22
29.48
288,962
54,099
(52,117)
(19,189)
$ 24.07
17.74
12.33
34.38
330,378
25,867
(64,971)
(2,312)
$ 20.77
37.94
12.52
31.95
325,434
$ 20.49
271,755
$ 24.34
288,962
$ 24.07
Outstanding at
beginning of year
Granted
Exercised
Forfeited or expired
Outstanding at
end of year
Options exercisable
at year-end
198,694
$ 25.23
181,544
$ 23.68
234,534
$ 21.55
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
2008
2007
2006
2.00%
5 Years
44%
1%
3.40%
5 Years
26%
1%
4.60%
5 Years
26%
1%
(Continued)
F-54
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 9 – STOCK-BASED COMPENSATION (Continued)
Options outstanding at year-end 2008 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
67,460
21,157
27,736
76,242
7,632
25,428
72,987
19,856
6,936
6.9 Years
1.6 Years
2.8 Years
5.2 Years
3.8 Years
4.8 Years
6.3 Years
4.9 Years
5.8 Years
$ 6.21
8.44
12.89
17.21
20.18
26.61
34.77
37.94
40.28
Weighted
Average
Exercise
Price
$ NA
8.44
12.89
16.14
20.18
26.61
34.77
37.94
NA
Number
0
21,157
27,736
25,263
7,632
25,428
72,987
18,491
0
Outstanding at year end
325,434
5.3 Years
$ 20.49
198,694
$ 25.23
The weighted-average remaining contractual life of the 198,694 stock options exercisable as of December 31, 2008
was 4.6 years.
Information related to options outstanding at year-end 2008, 2007 and 2006 were as follows:
Minimum exercise price
Maximum exercise price
Average remaining option term
2008
2007
2006
$
6.21
40.28
5.3 Years
$
8.22
40.28
5.9 Years
$
7.09
40.28
6.1 Years
Information related to stock option grants and exercises during 2008, 2007 and 2006 follows:
Aggregate intrinsic value of stock options exercised
Cash received from stock option exercises
Tax benefit realized from stock option exercises
Weighted average per share fair value of stock
2008
2007
2006
$ 13,000
0
0
$1,019,000
56,000
0
$1,616,000
229,000
0
options granted
2.32
4.60
11.44
The closing price of our stock on December 31, 2008 was below the exercise price of all of our stock option grants.
Therefore, the aggregate intrinsic value of all stock options outstanding and exercisable at December 31, 2008 was
$0.
Shares issued as a result of the exercise of stock option grants have been authorized and unissued shares.
(Continued)
F-55
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
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 2008 and 2007, the Bank had $17.7 million and
$19.1 million in loan commitments to directors and executive officers, of which $14.1 million and $14.7 million
were outstanding at year-end 2008 and 2007, respectively, as reflected in the following table:
Beginning balance
New loans
Repayments
Ending balance
2008
2007
$ 14,719,000
1,777,000
(2,406,000)
$
8,797,000
9,551,000
(3,629,000)
$ 14,090,000
$ 14,719,000
Related party deposits and repurchase agreements totaled $12.7 million and $14.2 million at year-end 2008 and
2007, 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.
These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized, if any, in
the balance sheet. Our maximum exposure to loan loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual
notional amount of those instruments. We use the same credit policies in making commitments and conditional
obligations as we do for on-balance sheet instruments. Collateral, such as accounts receivable, securities, inventory,
and property and equipment is generally obtained based on management’s credit assessment of the borrower. 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 2008 and 2007.
At year-end 2008 and 2007, the rates on existing off-balance sheet instruments were substantially equivalent to
current market rates, considering the underlying credit standing of the counterparties.
(Continued)
F-56
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 11 – COMMITMENTS AND OFF-BALANCE-SHEET RISK (Continued)
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
2008
2007
$ 323,785,000
$ 377,493,000
30,658,000
9,413,000
4,881,000
10,959,000
51,439,000
33,083,000
9,035,000
6,910,000
66,196,000
81,292,000
$ 431,135,000
$ 574,009,000
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 5.00% to 6.50%. 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 5.00% to 7.00%. These credit facilities generally mature and fully amortize within five years.
Certain of our commercial loan customers have entered into interest rate swap agreements directly with our
correspondent banks. To assist our commercial loan customers in these transactions, and to encourage our
correspondent banks to enter into the interest rate swap transactions with minimal credit underwriting analyses on
their part, we have entered into risk participation agreements with the correspondent banks whereby we agree to
make payments to the correspondent banks owed by our commercial loan customers under the interest rate swap
agreement in the event that our commercial loan customers do not make the payments. We are not a party to the
interest rate swap agreements under these arrangements. As of December 31, 2008, the total notional amount of the
underlying interest rate swap agreements was $61.8 million, with a net fair value from our commercial loan
customers’ perspective of negative $8.0 million. Payments made during 2008 in regards to the risk participation
agreements totaled $16,000; however, we believe the affected customer will reimburse us for such payments and
therefore we have accrued no liability for these payments or such potential future payments. These risk participation
agreements are considered financial guarantees in accordance with FASB Interpretation No. 45 and are therefore
recorded as liabilities at fair value, generally equal to the fees collected at the time of their execution. These
liabilities are accreted into income during the term of the interest rate swap agreements, generally ranging from four
to fifteen years. This liability totaled $0.3 million and $0.1 million at December 31, 2008 and 2007, respectively.
The following instruments are considered financial guarantees under FASB Interpretation No. 45. These instruments
are carried at fair value.
2008
2007
Contract
Amount
Carrying
Value
Contract
Amount
Carrying
Value
Standby letters of credit
$
51,439,000
$ 282,000
$ 81,292,000
$ 357,000
We were required to have $0.3 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 2008 and 2007. These balances do not earn interest.
(Continued)
F-57
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 12 – BENEFIT PLANS
We have a 401(k) benefit plan that covers substantially all of our employees. Our 2008, 2007 and 2006 matching
401(k) contributions charged to expense were $781,000, $747,000 and $674,000, 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 up to a maximum matching contribution for the 2008 plan year of $11,500. 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 upon termination of service as a
director or specific dates selected by the 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 Wall Street Journal Prime
Rate, adjusted at the beginning of each calendar quarter. Interest expense for the plan during 2008, 2007 and 2006
was $89,000, $109,000 and $81,000, 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 Wall Street Journal Prime Rate, adjusted at the
beginning of each calendar quarter. Interest expense for the plan during 2008, 2007 and 2006 was $140,000,
$190,000 and 148,000, 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 10,904 and 3,966 in 2008 and 2007, respectively. As of
December 31, 2008, there were 5,989 shares available under the Stock Purchase Plan. Effective February 26, 2009,
the Stock Purchase Plan was amended to increase the number of shares that can be issued under the plan to 55,000
shares, subject to adjustments.
NOTE 13 – HEDGING ACTIVITIES
Our interest rate risk policy includes guidelines for measuring and monitoring interest rate risk. Within these
guidelines, parameters have been established for maximum fluctuations in net interest income. Possible fluctuations
are measured and monitored using net interest income simulation. Our policy provides for the use of certain
derivative instruments and hedging activities to aid in managing interest rate risk to within policy parameters.
A majority of our assets are comprised of commercial loans on which the interest rates are variable, while a majority
of our liabilities are comprised of fixed rate certificates of deposit and FHLB advances. Due to this repricing
mismatch, we may periodically enter into derivative financial instruments to mitigate the exposure in cash flows
resulting from changes in interest rates.
(Continued)
F-58
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 13 – HEDGING ACTIVITIES (Continued)
During 2008, we entered into several interest rate swaps with an aggregate notional amount of $275.0 million. The
interest rate swaps qualified as cash flow hedges that converted the variable rate cash inflows on certain of our
prime-based commercial loans to a fixed rate of interest. The interest rate swaps paid interest to us at stated fixed
rates and required that we make interest payments based on the average of the Wall Street Journal Prime Rate.
On October 30, 2008, we terminated all of our interest rate swaps. The termination coincided with our decision to
not lower our prime rate in association with the Federal Open Market Committee’s reduction of the targeted federal
funds rate by 50 basis points announced on October 29, 2008. Virtually all of our prime-based commercial floating
rate loans are tied to the Mercantile Bank Prime Rate, while our interest rate swaps utilized the Wall Street Journal
Prime Rate. The resulting difference negatively impacted the effectiveness of our interest rate swaps, so we believed
it was prudent to terminate them. The aggregate fair value of the interest rate swaps on October 30, 2008 was $2.4
million, which will be accreted into interst income on loans and leases during the upcoming periods based on the
original term of the interest rate swaps as follows: $765,000 during the first quarter of 2009; $525,000 during the
second quarter 2009; $250,000 during the third and fourth quarters 2009; and $100,000 during the first quarter 2010.
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS
Carrying amount and estimated fair values of financial instruments were as follows at year-end:
2008
2007
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
$ 25,804,000
162,669,000
64,437,000
15,681,000
1,829,807,000
42,462,000
8,513,000
$ 25,804,000
162,669,000
65,381,000
15,681,000
1,872,141,000
42,462,000
8,513,000
$ 29,430,000
136,673,000
65,330,000
9,733,000
1,774,066,000
39,118,000
9,957,000
$ 29,430,000
136,673,000
66,440,000
9,733,000
1,777,883,000
39,118,000
9,957,000
Financial liabilities
Deposits
Securities sold under agreements
to repurchase
Federal funds purchased
Federal Home Loan Bank advances
Subordinated debentures
Accrued interest payable
1,599,575,000
1,610,953,000
1,591,181,000
1,585,921,000
94,413,000
0
270,000,000
32,990,000
15,245,000
94,413,000
0
274,847,000
31,100,000
15,245,000
97,465,000
13,800,000
180,000,000
32,990,000
21,130,000
97,465,000
13,800,000
180,303,000
32,678,000
21,130,000
(Continued)
F-59
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 14 – FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
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 and 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 and deposits and for variable rate loans and 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.
Current accounting pronouncements require disclosure of the estimated fair value of financial instruments. Effective
January 1, 2008, fair value is defined in accordance with SFAS No. 157 as disclosed in Note 15. Given the current
market conditions, a portion of our loan portfolio is not readily marketable and market prices do not exist. We have
not attempted to market our loans to potential buyers, if any exist, to determine the fair value of those instruments in
accordance with the definition of SFAS No. 157. Since negotiated prices in illiquid markets depends upon the then
present motivations of the buyer and seller, it is reasonable to assume that actual sales prices could vary widely from
any estimate of fair value made without the benefit of negotiations. Additionally, changes in market interest rates
can dramatically impact the value of financial instruments in a short period of time. Accordingly, the fair value
measurements for loans included in the table above are unlikely to represent the instruments’ liquidation values.
NOTE 15 – FAIR VALUE MEASUREMENTS
Effective January 1, 2008, we implemented SFAS No. 157 relating to our financial assets and liabilities. SFAS No.
157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or
transfer the liability occurs in the principal market for the asset or liability, or in the absence of a principal market,
the most advantageous market for the asset or liability. The price of the principal (or most advantageous) market
used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly
transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow
for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a
forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii)
knowledgeable, (iii) able to transact and (iv) willing to transact.
SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income
approach and/or the cost approach. The market approach uses prices and other relevant information generated by
market transactions involving identical or comparable assets and liabilities. The income approach uses valuation
techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted
basis. The cost approach is based on the amount that currently would be required to replace the service capacity of
an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques
refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be
observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability
developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the
reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or
liability developed based on the best information available in the circumstances. In that regard, SFAS No. 157
establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets
for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
(Continued)
F-60
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that we have the ability to
access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or
liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or
other inputs that are observable or can be derived from or corroborated by observable market data by correlation or
other means.
Level 3: Significant unobservable inputs that reflect our own assumptions about the assumptions that market
participants would use in pricing an asset or liability.
The following is a description of our valuation methodologies used to measure and disclose the fair values of our
financial assets and liabilities on a recurring or nonrecurring basis:
Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value
measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured
using independent pricing models. Level 2 securities include U.S. Government Agency bonds and mortgage-backed
securities issued or guaranteed by U.S. Government Agencies. We have no Level 1 or 3 securities.
Securities held to maturity. Securities held to maturity are carried at amortized cost when we have the positive intent
and ability to hold them to maturity. The fair value of held to maturity securities, as disclosed in the accompanying
consolidated financial statements, is based on quoted prices, if available. If quoted prices are not available, fair
values are measured using independent pricing models.
Mortgage loans held for sale. Mortgage loans held for sale are carried at the lower of cost or fair value and are
measured on a nonrecurring basis. Fair value is based on independent quoted market prices, where applicable, or the
prices for other mortgage whole loans with similar characteristics. As of December 31, 2008, we determined that the
fair value of our mortgage loans held for sale was similar to the cost; therefore, we carried the $1.1 million of such
loans at cost so they are not included in the nonrecurring table below.
Loans and leases. We do not record loans and leases at fair value on a recurring basis. However, from time to time,
we record nonrecurring fair value adjustments to collateral dependent loans and leases to reflect partial write-downs
or specific reserves that are based on the observable market price or current estimated value of the collateral. These
loans and leases are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing
basis until recovery or charge-off. At time of foreclosure or repossession, foreclosed and repossessed assets are
adjusted to fair value less costs to sell upon transfer of the loans and leases to foreclosed and repossessed assets,
establishing a new cost basis. At that time, they are reported in our fair value disclosures related to nonfinancial
assets.
Derivatives. For interest rate swaps, we measure fair value utilizing models that use primarily market observable
inputs, such as yield curves and option volatilities, and accordingly, are classified as Level 2. We had no interest
rate swap contracts outstanding as of December 31, 2008.
(Continued)
F-61
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 15 – FAIR VALUE MEASUREMENTS (Continued)
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2008 are as
follows:
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
Total
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Securities available for sale
Total
$ 162,669,000
$ 162,669,000
$
$
0
0
$ 162,669,000
$ 162,669,000
$
$
0
0
We had no assets or liabilities measured at Level 3 during 2008; however, in previous Form 10-Q filings we
indicated that our securities available for sale were measured at Level 1. We recently re-reviewed documentation
provided to us by our third party securities pricing vendor and determined that the measurement tools utilized to
determine the fair value of our securities more closely reflects a Level 2 categorization than Level 1 as previously
reported. There have been no significant measurement methodology changes employed by our securities pricing
vendor.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The balances of assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2008 and
related gains (losses) during 2008 are as follows:
Quoted
Price in
Active
Markets for
Identical
Assets
(Level 1)
Total
Significant
Other
Significant
Observable Unobservable
Inputs
(Level 2)
Inputs
(Level 3)
Total
Gains
(Losses)
Impaired loans (1)
Total
$ 37,197,000
$ 37,197,000
$
$
0
0
$ 37,197,000
$ 37,197,000
$
$
0
0
$ (16,710,000)
$ (16,710,000)
(1) Represents carrying value and related write-downs and specific reserves for which adjustments are based on
the estimated value of the property.
Nonfinancial Assets and Liabilities Subject to FSP FAS 157-2 Deferral Provisions
We will apply the fair value measurement and disclosure provisions of SFAS No. 157 effective on January 1, 2009
to nonfinancial assets and liabilities measured on a nonrecurring basis. We measure the fair value of the following
on a nonrecurring basis: (1) long-lived assets and (2) foreclosed and repossessed assets.
(Continued)
F-62
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 16 – EARNINGS (LOSS) PER SHARE
The factors used in the earnings (loss) per share computation follow:
Basic
Net income (loss)
2008
2007
2006
$ (4,959,000)
$ 8,966,000
$ 19,847,000
Weighted average common shares outstanding
8,470,721
8,453,483
8,403,163
Basic earnings (loss) per common share
$
(0.59)
$
1.06
$
2.36
Diluted
Net income (loss)
$ (4,959,000)
$ 8,966,000
$ 19,847,000
Weighted average common shares outstanding for
basic earnings (loss) per common share
8,470,721
8,453,483
8,403,163
Add: Dilutive effects of share-based awards
0
44,255
114,809
Average shares and dilutive potential
common shares
8,470,721
8,497,738
8,517,972
Diluted earnings (loss) per common share
$
(0.59)
$
1.06
$
2.33
Share-based awards for 438,444, 196,256 and 31,940 shares of common stock were not considered in computing
diluted earnings per common share for 2008, 2007 and 2006, respectively, because they were antidilutive.
NOTE 17 – SUBORDINATED DEBENTURES
The 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, the 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 the 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, the 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 the 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 the trust are the Series A and Series B Floating Rate Notes, and the only significant
liabilities of the 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 sheets as subordinated debentures and the interest expense is
recorded on our consolidated statements of income under interest expense on long-term borrowings.
(Continued)
F-63
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 18 - 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 not well capitalized, regulatory approval is
required to accept brokered deposits. Subject to limited exceptions, no institution may make a capital distribution if,
after making the distribution, it would be undercapitalized. If an institution is undercapitalized, it is subject to 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 at
the discretion of the federal regulator. At year-end 2008 and 2007, 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
$ 229,307
226,034
10.9%
10.8
$ 167,836
167,480
8.0%
8.0
NA
$
209,350
NA
10.0%
203,072
199,853
203,072
199,853
9.7
9.6
9.2
9.0
83,918
83,740
88,577
88,413
4.0
4.0
4.0
4.0
NA
125,610
NA
6.0
NA
110,516
NA
5.0
2008
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-64
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 18 - 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
2007
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
$ 235,700
232,435
11.4%
11.3
$ 165,562
165,292
8.0%
8.0
NA
$
206,615
NA
10.0%
209,886
206,621
10.1
10.0
209,886
206,621
10.0
9.8
82,781
82,646
84,169
84,061
4.0
4.0
4.0
4.0
NA
123,969
NA
6.0
NA
105,076
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 2008, under the most restrictive
of these regulations (to remain well capitalized), the Bank could distribute approximately $12.0 million to Mercantile
as dividends without prior regulatory approval.
The capital levels as of year-end 2008 and 2007 include $32.0 million of trust preferred securities issued by the trust
in September 2004 and December 2004 subject to certain limitations. Under applicable Federal Reserve guidelines,
the trust preferred securities constitute a restricted core capital element. The guidelines provide that the aggregate
amount of restricted core elements that may be included in Tier 1 capital must not exceed 25% of the sum of all core
capital elements, including restricted core capital elements, net of goodwill less any associated deferred tax liability.
At year-end 2008 and 2007, all $32.0 million of the trust preferred securities were included as Tier 1 capital of
Mercantile.
(Continued)
F-65
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 19 - OTHER COMPREHENSIVE INCOME
Other comprehensive income components, other than net income (loss), and related taxes were as follows:
Unrealized holding gains on
available-for-sale securities
Change in net fair value of interest rate swaps
Reclassification adjustments for gains
later recognized in income
Net unrealized gains
Tax effect of unrealized holding gains
on available-for-sale securities and
unrealized gain on interest rate swaps
Tax effect of reclassification adjustments for
gains later recognized in income
2008
2007
2006
$
2,761,000
2,876,000
$
2,110,000
0
$
470,000
0
(974,000)
4,663,000
0
2,110,000
0
470,000
(1,973,000)
(739,000)
(164,000)
341,000
0
0
Other comprehensive income
$
3,031,000
$
1,371,000
$
306,000
Accumulated other comprehensive income, net of tax, consists of a net unrealized gain on available-for-sale
securities of $2,064,000 and a fair value of interest rate swaps of $1,236,000 at December 31, 2008. At December
31, 2007, accumulated other comprehensive income, net of tax, consists of a net unrealized gain on available-for-sale
securities totaling $269,000.
NOTE 20 - QUARTERLY FINANCIAL DATA (UNAUDITED)
2008
First quarter
Second quarter
Third quarter
Fourth quarter
2007
First quarter
Second quarter
Third quarter
Fourth quarter
2006
First quarter
Second quarter
Third quarter
Fourth quarter
Interest
Income
Net Interest
Income
Net
Income (Loss)
Earnings (Loss) per Share
Diluted
Basic
$ 31,955,000
29,139,000
29,843,000
30,134,000
$11,383,000
10,592,000
11,728,000
12,505,000
$ (3,738,000)
(2,612,000)
1,079,000
313,000
$ (0.44)
(0.31)
0.13
0.04
$ (0.44)
(0.31)
0.13
0.04
$ 36,025,000
36,084,000
36,779,000
35,293,000
$14,484,000
13,948,000
14,051,000
13,074,000
$ 4,283,000
2,221,000
2,367,000
95,000
$ 0.51
0.26
0.28
0.01
$ 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
$ 0.59
0.61
0.62
0.54
$ 0.51
0.26
0.28
0.01
$ 0.58
0.60
0.61
0.54
(Continued)
F-66
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 21 – 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
2008
2007
$
407,000
203,153,000
4,396,000
$
2,137,000
206,890,000
3,373,000
$ 207,956,000
$ 212,400,000
$
594,000
32,990,000
174,372,000
$
1,255,000
32,990,000
178,155,000
Total liabilities and shareholders’ equity
$ 207,956,000
$ 212,400,000
CONDENSED STATEMENTS OF INCOME
Income
Dividends from subsidiaries
Other
Total income
Expenses
Interest expense
Other operating expenses
Total expenses
2008
2007
2006
$ 4,739,000
0
4,739,000
$ 7,291,000
19,000
7,310,000
$ 6,440,000
73,000
6,513,000
1,914,000
2,431,000
4,345,000
2,512,000
2,835,000
5,347,000
2,429,000
1,917,000
4,346,000
Income before income tax benefit and equity in
undistributed net income (loss) of subsidiary
394,000
1,963,000
2,167,000
Federal income tax benefit
(1,417,000)
(1,783,000)
(1,392,000)
Equity in undistributed net income (loss) of subsidiary
(6,770,000)
5,220,000
16,288,000
Net income (loss)
$ (4,959,000)
$ 8,966,000
$ 19,847,000
(Continued)
F-67
MERCANTILE BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007
NOTE 21 – MERCANTILE BANK CORPORATION (PARENT COMPANY ONLY)
CONDENSED FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income (loss) to net
cash from operating activities:
Equity in undistributed (income) loss of subsidiary
Stock-based 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
Stock option exercises, net
Employee stock purchase plan
Dividend reinvestment plan
Cash dividends
Fractional shares paid
Net cash for financing activities
2008
2007
2006
$ (4,959,000)
$ 8,966,000
$ 19,847,000
6,770,000
654,000
(1,023,000)
(661,000)
779,000
(5,220,000)
361,000
(483,000)
648,000
4,272,000
(16,288,000)
242,000
9,000
73,000
3,883,000
0
0
0
0
0
0
0
76,000
40,000
(2,625,000)
0
(2,509,000)
56,000
91,000
76,000
(4,677,000)
(4,000)
(4,458,000)
229,000
107,000
98,000
(4,035,000)
(4,000)
(3,605,000)
Net change in cash and cash equivalents
(1,730,000)
(186,000)
278,000
Cash and cash equivalents at beginning of period
2,137,000
2,323,000
2,045,000
Cash and cash equivalents at end of period
$
407,000
$ 2,137,000
$ 2,323,000
F-68
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized,
on March 12, 2009.
MERCANTILE BANK CORPORATION
/s/ Michael H. Price
Michael H. Price
Chairman of the Board, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities indicated on March 12, 200 .
9
/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/ 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, Chairman of the Board, President and
Chief Executive Officer (principal executive officer)
/s/ Merle J. Prins
Merle J. Prins, Director
/s/ Timothy O. Schad
Timothy O. Schad, Director
/s/ Dale J. Visser
Dale J. Visser, Director
/s/ Donald Williams, Sr.
Donald Williams, Sr., Director
/s/ Charles E. Christmas
Charles E. Christmas, Senior Vice President, Chief
Financial Officer and Treasurer (principal financial and
accounting officer)
48696MercCorpInfo:2005 Corporate Info Pages 2/26/09 10:17 AM Page 1
Corporate Information
2009 DIRECTORS AND
EXECUTIVE OFFICERS
2009 STRATEGIC PLANNING TEAM
MERCANTILE BANK OF MICHIGAN
Betty S. Burton
Retired Educator and Business Owner
Mark S. Augustyn
Senior Vice President, Commercial Loan Manager
Sherri A. Calcut
Senior Vice President, President
Mercantile Bank Mortgage Company
Charles E. Christmas
Senior Vice President, Chief Financial Officer
Alfred A. DeFlaviis
Senior Vice President, East Region President
Thomas L. Fitzgerald
Senior Vice President, Commercial Loan Manager
C. Howard Haas
Senior Vice President, City President – Lansing
Mark R. Hoffhines
Senior Vice President, Commercial Lender
Sandy K. Jager
Senior Vice President, Internal Auditor
Amy W.M. Kam
Officer, Senior Executive Assistant
Robert B. Kaminski
President, Chief Operating Officer
Gordon L. Oosting
Senior Vice President, Commercial Lender
Michael H. Price
Chairman, President & Chief Executive Officer
Raymond E. Reitsma
Senior Vice President, Senior Lending Officer
John R. Schulte
Senior Vice President, Chief Information Officer
Michelle L. Shangraw
Senior Vice President, Retail Banking Director
Jonathan P. Steiner
Senior Vice President, City President – Holland
Joseph M. Valicevic
Senior Vice President, Commercial Loan Manager
Lonna L. Wiersma
Senior Vice President, Human Resource Director
Robert T. Worthington
Senior Vice President,
Risk Management Director
David M. Cassard
President, Waters Corporation
(real estate investment)
Charles E. Christmas
Senior Vice President
Chief Financial Officer & Treasurer
Mercantile Bank Corporation
Edward J. Clark
Chairman & Chief Executive Officer
American Seating Company
Peter A. Cordes
President & Chief Executive Officer
GWI Engineering, Inc.
(industrial automation systems)
Doyle A. Hayes
President & Chief Executive Officer
Pyper Products Corporation
(plastic injection molding and assembly);
Majority Member, Talent Trax, LLC
(staffing organization)
David M. Hecht
Attorney
Susan K. Jones
Owner
Susan K. Jones & Associates
(marketing consulting firm);
Professor
Ferris State University
Robert B. Kaminski, Jr.
Executive Vice President
Chief Operating Officer & Secretary
Mercantile Bank Corporation
Lawrence W. Larsen
President & Chief Executive Officer
Central Industrial Corporation
(material handling and components supplier)
Calvin D. Murdock
President
SF Supply, Inc.
(electrical and automation supplies)
Michael H. Price
Chairman, President & Chief Executive Officer
Mercantile Bank Corporation
Merle J. Prins
Retired Bank Executive
Timothy O. Schad
Chairman & Chief Executive Officer
Nucraft Furniture Company
Dale J. Visser
Chairman
Visser Brothers, Inc.
(construction general contractor)
Donald Williams, Sr.
Dean Emeritus
Grand Valley State University
SHAREHOLDER INFORMATION
Annual Meeting
The Corporation’s Annual Meeting of
Shareholders will be held on Thursday,
April 23, 2009, at Kent Country Club,
1600 College Ave. NE, Grand Rapids,
MI 49505 at 9:00 a.m. local time.
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
www.dickinsonwright.com
Independent Certified
Public Accountants
BDO Seidman, LLP
99 Monroe Avenue N.W., Suite 800
Grand Rapids, MI 49503-2654
www.bdo.com
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 Trust Company, N.A.
P.O. Box 43102
Providence, RI 02940-3010
Shareholder Inquires 1-800-730-4001
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.
48696MercCorpInfo:2005 Corporate Info Pages 2/26/09 10:17 AM Page 2
Mission Statement
The mission of Mercantile Bank Corporation 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 Corporation.
48696MercantileCvr:Annual Report 2004 2/23/09 8:05 AM Page 2
We believe in our customers.
We believe in our communities.
We believe in Michigan.
We believe in the future.
We Believe
in Holiday
Spirit.
When we were told
that ACCESS of West
Michigan was facing a
huge increase in need
this past holiday, we
donated the funds to
feed 105 families a
delicious, nutritious,
much-appreciated
Christmas dinner.
We Believe
in Green.
We provided the
construction loan for
Celadon New Town
Development, an
innovative residential,
commercial and
retail project in
Grand Rapids. All the
buildings are built to
the Michigan Green
Built Standard or will
be LEED certified.
The project includes
insulation made
with recycled
newspapers, Energy
Star appliances,
reclaimed brick, solar
heating, rain gardens
and more. The project
has been warmly
received by the
community, and units
are selling before
the project is even
complete!
We Believe
in Inner
Cities.
Bear Manor Properties
has been renovating
and developing
residential and
commercial projects
in inner city Grand
Rapids since 2004.
The projects include
homes, offices, retail
spaces and more, all
financed by Mercantile
Bank. In 2008, Bear
Manor won a Historic
Preservation Award
for its work.
We Believe
in Kids.
Since the opening of
our Leonard Street
headquarters,
employees have
volunteered their time
to mentor students at
the nearby Harrison
Park Elementary
School. In 2008,
34 employees
volunteered at least
once a week to tutor
a child – a 50%
increase over 2007.
48696MercantileCvr:Annual Report 2004 2/23/09 8:05 AM Page 1
®
310 Leonard Street NW
Grand Rapids MI 49504
888.345.6296
www.mercbank.com
MERC ANTILE B ANK CORPORATION 2008 ANNUAL REPORT